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Venturing Toward Growth
(November 23) -- Israel has become one of the world's most attractive venture-capital locations. --
The announcements now occur so frequently there must be a template for them on the computers of public relations companies:
"(Fill in the blank), an Israeli hi-tech start-up in (Herzliya/Ra'anana/Yokne'am/Haifa/Jerusalem) has received (fill in the blank) million dollars from (fill in the blank) venture capital of (Tel Aviv/Jerusalem) to expand its rapidly growing (Internet/biotech/telecommunications) business.
"The company was started (one/two/three) months ago by (fill in the blank, usually under the age of 35), who previously was a (professor/scientist/IDF officer) and founder of XYZ Co., which today is traded on the (NASDAQ/French/German) stock exchanges."
Here's a recent one, picked at random from a scroll of press releases on the Internet:
"HAIFA, Israel - (BUSINESS WIRE) - Oct. 28, 1999 - IIS Intelligent Information Systems Ltd. announced today the signing of a definite agreement whereby two Israeli venture capital funds will invest $1.6 million in the company's subsidiary, StoreAge Networking Technologies Ltd., representing a valuation for the subsidiary of $6.6 million. StoreAge was established in January 1999."
Here's another one: "SAN JOSE, Calif., Nov. 10 /PRNewswire/ - Israeli-based Natural Speech Communication, provider of competitive Automatic Speech Recognition solutions for far-end and near-end applications, today announced that Hapoalim Electronic Communications (Tel Aviv) one of the most influential investors in Israel, has invested $1.5 million in the company.
"This is the first in NSC's second round of financing, in which it plans to raise $5 million in venture capital."
While these announcements may seem repetitive, these investments of millions of dollars in unproven companies with no product, no track record, and sometimes no offices are actually pretty significant. If you add up all of the announcements that are coming out, you're close to understanding what one-time US senator Everett Dirksen said about the US budget: "A billion here, a billion there, pretty soon you're talking about real money."
We are talking about real money - more than $2 billion in the last few years - that is going to Israeli technology companies from the burgeoning Israeli venture-capital community.
In 1998 alone, both local and international firms invested a record $568 million in new companies, one-third more than in 1997, according to international consulting firm PricewaterhouseCoopers and its Israeli partner, Kesselman & Kesselman of Tel Aviv. That's about $100 for every man, woman, and child in Israel.
Does that sound like a lot? It should. US venture capitalists made $19.1 billion in investments in 1998, according to the US National Venture Capital Association. But that's only $70 per American. And Japan, one of the world's great economic powers, only recently started its first independent venture-capital (VC) fund with a relatively paltry 330 million yen, slightly more than $3.1 million, according to the website of Nippon Venture Technology partners.
So far in 1999, Israel is running far ahead of last year's record totals. The latest measurement by Pricewaterhouse Coopers said Israel's venture capitalists invested $359 million in the first half of the year, 30 percent ahead of last year. Israel is keeping pace with similar growth in the US.
"The amount of money in Israel is obscene," says attorney Gene Kleinhendler of Tel Aviv, whose law practice handles venture capital exclusively.
VC funding differs from traditional bank lending. To get money, these entrepreneurs must give up part ownership of the company in exchange for the investment.
Israel has become such a hot venture-capital spot for one simple reason: Success breeds success. Israel has been the home to a handful of spectacular "takeouts" of hi-tech companies at the initial public offering (IPO) or buyout stage, where original investors reaped significant returns on their investments.
A $10,000 investment in CheckPoint at its IPO date in June 1996 was valued on October 30 at $48,200, a gain of 382%. And that's for people who bought in at the public offering. The venture capitalists that came in at the company's early stages earned even more.
Even better, a $10,000 investment in Comverse Technologies at its IPO in November 1992 was worth $111,800 on October 30, a gain of 1,011.8%.
Now, everyone wants in on the party.
But there is more to it than that, say players in the industry. They point to Israel's risk-taking culture, as well as the energy and commitment of immigrants - themselves risk-takers - who have energized these industries.
"Except for Israel and the United States, you don't have the culture for these kind of investments," says Kleinhendler. "You can't find it in Germany, London, or the Far East. We want to get things done and move forward. Israelis are fearless in the way they deal with the world out there. They are not afraid to make a mistake, to be thrown out one door and go to another.
"I've done deals in Europe and the Far East, and you can't find people like that except in the US and Israel. Even Canada is as slow as molasses."
Kleinhendler says Israel is built on a culture of doing, not talking.
"People want 'facts on the ground.' You have got to prove yourself out here. People call up bankers, competitors, do strategic deals, knock on doors and make presentations. They do not wait for an answer but keep pushing.
"At the same time, the laid-back, less-formal atmosphere suits the VCs. There is no bull here. We're all the same. People are very easygoing about giving advice, giving names and numbers," he says. "It's suited to the venture world."
A recent worldwide academic study led by a professor at Babson College in Boston found that Israel is one of the three most entrepreneurial countries in the world, along with the US and Canada.
The study, in which Tel Aviv University professor Miri Lehman participated, found that Israel ranked first among countries studied in the percentage of the adult population investing directly in new businesses. Along with factors encouraging entrepreneurship common to all active countries - including youth and optimism - the study identified several reasons unique to Israel, including transfer of highly developed defense technology, a highly educated work force, and government support.
"Israel has recently experienced a significant change in culture and social norms with respect to entrepreneurship," the study said. "Today, greater emphasis is placed on individualism and the importance of self-employment."
Jonathan Medved, one of the founders of Israel Seed Partners in Jerusalem, a venture-capital fund with $58 million under its management, draws distinct parallels between Israel and California's Silicon Valley, the world's No. 1 home for venture capital. Silicon Valley attracted a record $2.7 billion in the second quarter of 1999, according to PricewaterhouseCoopers.
Medved, who, along with his partners, is in Silicon Valley monthly, says both areas have geographical density. Someone doing a deal in either place can get to virtually any spot he needs in one hour or less. Both regions are magnets for immigrants. Many of the entrepreneurs setting up shop in California are originally from overseas, including China, India, Korea, and even Israel.
"Immigrants are by definition risk-takers," Medved says. "They pick themselves up and remake their lives."
Both regions are also marked by their informality. But that goes far beyond open-necked shirts. The corporate cultures of new companies in both places are marked by non-hierarchical, casual modes of management.
Both regions also have a cluster of universities that are geared toward entrepreneurs, and that run business incubators for start-ups. In California they include Stanford University and University of California at Berkeley. In Israel it is the Technion, Weizmann Institute, and others.
Medved ends the parallels at that point, and adds one factor to the equation in Israel's favor: the IDF. None of America's hi-tech entrepreneurs are learning their trade in the US Army. In Israel, alumni of elite IDF units who learned technology, teamwork, risk-taking, and project completion skills while in the army are fueling many of the start-ups.
"Here, at 17-18 years of age, people go into a crucible, where the best and the brightest are selected for elite units," Medved says. "They are trained on expensive, unbelievable toys and technology. Then, at 23-25, they come out of the army extremely well equipped."
In the US, the best and the brightest are coming out of the top management schools with MBAs. Graduates of Massachusetts Institute of Technology's Sloan School or the University of Pennsylvania's Wharton School go through their own grueling training programs (albeit ones in which they don't shoot guns). Their skills are different from those of Israelis. They have learned more about the fine arts of marketing and sales.
"The Israelis don't have an MBA or the marketing polish, but they are as good a group of raw entrepreneurial talent as the US can throw at the world," Medved says.
Finally, Israelis come out of the army and into the business world with an informal network that is enhanced by the country's small size. Entrepreneur Eli Plotnik of Comsys in Herzliya said in a recent interview that his first choice for a venture-capital fund was one headed up by a high-school friend of his.
Meir Friedlander, president of Vsoft Inc. of Yokne'am, got funded via an army connection. He is backed by Rafael Development Corp. and Discount Investment Corp. which helped set up the company to commercialize technology developed by Rafael, the government armaments research company.
Of course, recent immigrants to Israel from the US sometimes have immigrant fervor, advanced degrees and local connections - albeit not as longstanding - working for them.
When David Teten earned his MBA from Harvard last year and made aliya, he did so with the intention of starting his own business. On August 4 of this year, as he sat in his apartment in Jerusalem's Old City, an idea came to him.
"It hit me like a brick on the head," says Teten, 29.
He furiously wrote a business plan.
A few weeks later he called on a contact he had made while exploring Jerusalem's young, American, Orthodox circles: Shalom Kalish, the founder of the Jerusalem Global venture-capital fund and more recently Yazam.com, a company devoted to bringing together investors with young entrepreneurs in Israel.
A week before Succot, Teten made his pitch to Kalish and a few others at Jerusalem Global's offices in the Har Hotzvim Technology Park in northern Jerusalem.
"My philosophy is people don't invest in presentations but in people," Teten says. "I brought a simple presentation, not even Power Point slides."
To add credibility, the baby-faced but intense Teten brought along Jeffrey Rosenschein of the Hebrew University, a founder of several companies and a member of Teten's advisory board.
He went back right after Succot for a second one-hour meeting.
"They had read through my business plan and had more questions," Teten says.
They asked about legal ramifications if he was ever sued; about whether he or his prospective employees had the right skills; why the company was to be located in Israel; how it was going to set up its presence abroad, its time line, and the like.
"Fortunately I had answers," Teten says. "They said 'this sounds very exciting.' They laid down an offer and a valuation of the company. They said 'contingent on further due diligence' they wanted to invest."
Teten walked out of the meeting with a tentative commitment for an investment of $1.5 million to $2 million. With that likely deal in hand, he went out and hired employees, accountants, and lawyers, all on the promise that the money would come soon - though no one has actually been paid yet.
He expects to sign the contract for the money within weeks. So far, he actually has spent only about $500, he says.
"My time is now worth multiple millions," he says. "It's exciting. I can't go to the supermarket and spend it, but it is exciting."
Teten won't say what the company plans to do, other than that it is an Internet "pure play," meaning all of its operations, sales, and business will be conducted on the Internet. All he will reveal is that he is looking for multilingual employees. His soon-to-be-launched website doesn't even sport the company's real name but uses a code word: israelgold.com.
A year from now he hopes to be on his third round of funding (the second is already in the works) and have offices in London, San Francisco, and New York, customers and revenues. Right after that: a public offering.
How did this all get started?
The Israeli venture-capital industry was born in 1985. The first fund, worth $25 million, was Athena Venture Partners, headed by Dan Tolkowsky, a past commander of the Israel Air Force.
Soon afterward, the Israeli government boosted its research and development budget. In 1993, the Rabin government created the $50 million Yozma VC fund. Rina Pridor, director of the government's business incubator program, says the purpose of Yozma was to bring foreign investment and form VC funds in Israel.
"It worked very successfully," she says, "so much so the government company is not needed anymore."
One irony is that even though the government kick-started the VC process, the world it helped create is antithetical to government in its willingness to move quickly, often without a great deal of study, to value risk-taking and to be relatively loose and unstructured.
"In 1983, guys who worked for the Jewish Agency, generals, and government officials looking for a cushy job ran most companies. Today, the guys come out of the army, the Weizmann Institute, the Technion, and [they] have done post-doctoral work in the US," Kleinhendler says.
"Government now is shunned. It's not of interest to anybody. Government incentives are not what they're after."
According to the Israel Venture Association, approximately 60 Israeli VC funds are exclusively focused on investments in hi-tech, while an equal number of private equity funds also invest in hi-tech companies. The association says Israel is the largest overseas recipient of investments by US-based venture capital and private equity funds.
The foreign names involved in Israel venture capital include: GE Capital - an investment arm of the giant US conglomerate, Sequoia Capital Seed Fund - a partnership between Sequoia Capital and US telecom giant Cisco Systems, and Apax Partners Group. Each of these has invested billions worldwide.
Homegrown funds such as Israel Seed Partners, Gemini Israel Funds ($146 million), Jerusalem Venture Partners ($95 million), and Jerusalem Global ($134 million) have also built names for themselves, with investments in companies that have gone public or been acquired for huge multiples. They are attracting money from such hi-tech superstars as Marc Andreesen, co-founder of Netscape, and Jerry Yang of Yahoo.
How does it work?
The first round of venture funding - commonly called angel funding - is for the smallest amount. Entrepreneurs generally are seeking "only" $100,000 to $500,000. They have little to sell at this point beyond themselves and the kernel of their ideas. Most of them don't have a product; they may not even have an office beyond a cellular telephone and a seat in a cafe.
Gad Barnea, 31, is founder and CEO of ZebraZone, which he describes as a "new e-commerce initiative." More he won't tell, as he is in the first stage of meeting with angels, and he doesn't want to give potential competitors any information. His enterprise at the moment is a summary business plan of two or three pages, a Microsoft Power Point presentation on a laptop computer, a cellphone, and a registered name on the Internet. His website isn't even up and running yet.
Yet Barnea knows what he must do and is confident he will get it done. How much money does he want?
"As much as I can get," he says at first, but later admits to wanting "$1 million or more." He wants the money to build his prototype website a headquarters in the US, and to build his company "with world-class management." He is approaching investors with whom he has connections, family, and previous businesses.
Like many other entrepreneurs, he is a serial business starter with two previous firms under his belt (he sold one, and just left the other to go on to this project). But this one is his big chance - the one he thinks can go all the way.
So far, he has held a dozen meetings with angels. None has come through yet, but he expects two or three of them to provide funding.
"It is a sexy idea and easy to understand," he says. "I am completely confident."
Without an office, Barnea is making his presentations in hotel lobbies and restaurants to small groups in Tel Aviv and Jerusalem. He clearly wants to run on "Internet time" - that compressed, frenetic pace that turns entrepreneurs into billionaires and chews up companies within weeks or, at most, months.
"This first round will last two weeks to one month, once I get the money," he says. "If they don't know the value of moving quickly, I teach them so they understand."
Barnea is willing to give up as much as 25% of the company - at the moment technically worth nothing - to get his money. If the plans come through, however, that chunk of the company could be worth as much as $30 million upon a successful initial public stock offering in a few years. That wouldn't be a bad return on a $1 million investment.
Barnea may have a rough go of it, even though many say that the good ideas are getting funded.
In its recent report, PricewaterhouseCoopers noted that seed investments in venture-backed companies remained relatively low. In the second quarter of this year, 60% of venture capital investments were secondary investments in existing companies.
But the consulting firm said the establishment of new venture capital funds that specialize in early-stage investments is a sign of a potential turnaround.
A second type of first-round investment exists - for companies with a new product that are aiming to make a big change in their operations.
El-On Software Systems in Jerusalem is seeking to make a big splash in the world television market with software that controls all of a broadcaster's functions, from commercials to program archives to billing.
The company, an indirect subsidiary of local software giant Formula Systems, feels this product can be spun off into a separate company with a worldwide market, and is getting ready to make its first foray into the world of venture capital.
El-On is different from a start-up in that it already has a product and a corporate parent. But, like any child ready to go out into the world, El-On must find its own way. Formula may participate in the expansion, which will cost millions of dollars, but it is unwilling to bankroll the whole project.
El-On president Amotz Yarden, who is also president of Sintec Advanced Technologies of Herzliya, one of El-On's corporate parents, says that getting venture-capital money should not be a problem. He believes he and his company have enough of a track record that they will find doors open to them when the business plan is ready.
If the company can spin a tale of providing software to a new generation of Internet and satellite broadcasters, a world where commercial time might be auctioned on-line, where vendors could access a station's "extranet" (an Internet-based network aimed at customers) - then the sky would be the limit.
"We need to develop a product to face the future world - even though it is blurry now - which will give us huge opportunities," Yarden says, trying out the case he will soon make to the VCs.
Though Yarden says El-On has to go to the market in the same way as a start-up, the company could afford the luxury of having a professional firm develop its business plan and make the first contacts with VCs. In El-On's case, Foresight Consulting of Tel Aviv is developing the plan. That firm has worked with numerous start-ups and existing companies as a consultant.
Israel's venture capitalists are also beginning to roll larger sets of dice. According to the PricewaterhouseCoopers survey, the second quarter was characterized by high-value deals, with 60% of the money flowing to just 19 companies, which each raised $5 million to $10m. The most significant increase was in the communications sector, with $81m. invested in venture-backed companies, a 250% jump over the previous quarter.
Pentacom, headquartered in Herzliya, makes a new kind of communication box. CEO Benny Schnaider won't say how many employees he has or how much money he has raised. The company, which has been around for a year, has raised money from Sequoia Capital.
How did he get to them? "I just called people I knew from previous connections," Schnaider says. "Connections always help, but you don't need a middleman. If you have a slick presentation and you can sell yourself, you don't need a middleman."
Schnaider knows the routine: He dresses down (too fancy and you send the wrong message), rehearses his Power Point presentation the night before and finds his "champion" within the VC fund to win over the others.
"You meet with the champion three times, and with the rest of the group maybe two additional times. After you have done it enough times and feel comfortable, it's more important to concentrate on the body language of the other side and fix things on the fly.
"I rehearse it with my partners, and there is a script. There are backup slides on the presentation." He has no prototype of his product, which will be a device to help improve Internet communications, to bring to meetings.
"Initially you make a lot of presentations," he says, "Ten to 20. Then, later on, you self-screen. Then there is focus.
"At the end of the day you focus on no more than three funds. They need a lot of attention. Too many and you dilute your focal point. I think if you have the luxury of picking your VC fund, you want a VC that will give you the most value for your money. You want somebody with business experience and connections."
How much equity is he willing to give up? "The percentage of the company you give up depends on a lot of factors. You may deal with more than one VC in a round. You have to get a lead investor, someone who is better connected than you are. Sometimes he will bring in another VC. They know each other, but don't always like each other."
In a year, he says, the company will seek another round of funding.
After the first, second, or even third round of funding, what's left? The "takeout" for investors, which comes in the form of an initial public offering or an acquisition.
Comsys in Herzliya is closing in on that final step.
A virtual ancient in the hi-tech world, it has been around for five years and has 22 employees. It also has raised money twice - once from its initial investor and current chairman Giora Yaron, and once from investment fund Polaris.
It already has a successful first-generation product, a software-based modem that runs directly on a Pentium computer chip. It developed the product with Rockwell Semiconductor Systems, now known as Conexant.
On its own, Comsys is developing its second product, a modem for the next generation of enhanced cellular telephones. CEO Plotnik says his company is within two to three years of an IPO, but it may go for an interim round of funding before that.
PictureVision Inc. of Jerusalem and suburban Washington, DC, went the buyout route. It is the inventor of widely used software that allows photo processors to put photographs on the Internet. Individuals can then download them, or buy reprints and products like photo-embossed calendars or coffee mugs from third-party vendors.
The company raised $600,000 from angel investors in 1995, $5.6m. from VCs shortly after, and an additional $3m. as part of a joint venture in Japan. In 1998, global photo giant Kodak took an interest and bought 51% for more than $50m., valuing the company at over $100m.
Company cofounder Ya'acov Ben-Ya'acov remains an executive with the firm, which has been able to greatly expand its business with Kodak's backing. Soon after that, US Internet giant America Online bought a piece of the company as well.
Down the road, an IPO at an even higher valuation is still a possibility. Major US department store and photo developing chains, as well as companies in Germany, Japan, and Israel, use its products.
According to PricewaterhouseCoopers, the firms getting VC money are primarily Internet, software, and telecommunications firms. Biotechnology firms received only 2% of second-quarter VC funding in Israel, compared to 35% for software firms.
"Internet is the magic word. Biotech and pharmaceutical is harder, because the cycle of development is much longer," Plotnik says.
But even in the Internet field, Plotnik says, it is important to be first.
"If you are not unique, then you have a problem," he says. "The core competency in Israel is technology. Otherwise, we are far from markets. You have to be excellent in technology." There is a great deal of competition out there, though. J.J. Sussman, a vice president at Yazam.com, said his firm has received 500 business plans since July. Israel Seed and others fund around three of every 100 plans they get.
Clearly, Israeli firms with a technology bent and a clever Internet or telecom story to tell are hot properties. So if you think you have an idea that a VC would be willing to fund - get going. The money is there.
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