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WIsrael: Startup exodus Michael Eisenberg travels more than a million miles a year between
Jerusalem and Silicon Valley. He knows the airport security procedures
by heart and the ground crews by name. The purpose of his travel
is to oversee his companies, to maintain and strengthen contacts,
and to attend high-tech conferences.
While flying to New York, he meets VC fund managers and CEOs of Israeli high-tech companies. On the flight from New York to Tel Aviv, a representative from Nasdaq is traveling to Israel, for the second time this month, to investigate a few of the 70 Israeli startups knocking on Nasdaq's door. He travels with other leading investment bankers on their way to do business in Israel.
Each of these travelers adds to the ever-thickening weave of the American-Israeli venture capital industry.
In 1998, Ami Dotan of Neurone Venture Capital Fund traveled once every three months to the United States to assist with HyperBanner's settling, mingling and recruiting. Today, since he spends two weeks of every month in the United States, Dotan maintains a home there as well. What exactly are Israeli VC managers looking for in the States?
The answer is to be found in the unprecedented rise of the Israeli high-tech industry and the subsequent growth of the venture capital market.
Zeev Holzman, CEO of ABS GE Capital Giza Fund, tracks the evolution of this industry. In 1999, Israeli venture capital funds raised $1.2 billion; whereas, during the first five months of 2000 alone, the same amount has already been raised.
Since this industry became active in Israel, at the beginning of 1994, investment firms have raised $4.4 billion; more than half of this amount was raised during the past year and a half.
From only 14 VC and investment companies in 1995, Israel has progressed to more than 100 investment funds operating today. The total annual capital raised will reach $2 billion by the end of the year.
American
intervention
The fast-growing Israeli industry attracts investors from all over the world. Israel is now a gigantic seedbed for startups, but the terrain for full growth is still the United States.
Nasdaq's increasingly competitive entry requirements and intense marketing demands have caught the Israeli high-tech industry off guard. If, in the past, a company was expected to raise between $7 million and $8 million before its IPO, today it must raise at least $50 million before going public.
This predicament triggered the first Israeli approach to American companies for assistance, both with funding and with market connections.
The response was not enthusiastic at first. But, during the past two years, the relations between American and Israeli VCs have improved to the point where there is always an American participant in the second or third round of financing for an Israeli company.
It is even possible to generalize that only American companies participate in these rounds, because of the large amount of money raised.
In the past, private investors were a significant factor in the establishment of venture capital funds. A few years ago, the funds in Israel managed only small capital amounts, making a $2 million to $3 million private investment seem very significant.
Once the market was institutionalized, the contribution of such amounts became inconsequential. In the past, Israeli managers solicited funding through personal or professional relationships.
Such ties can be seen in the activities of Ed Mlavsky, Marshall Butler and Kenneth Rind, who introduced the concept of venture capital and served as the founding fathers of the first Israeli VC funds.
Insofar as money alone is no longer the objective, what happens to the role of private investors? Today, private investors in Israel have a different significance. Money is not as important as the connections and personal acquaintances that these investors can bring to a VC fund. In the end, it all comes down to connections, which can take a product quickly to market. Funding, however, comes from elsewhere.
Most of the Israeli venture capital funds raise capital from foreign -- especially American -- companies. This is mainly because of the inability of the Israeli capital market to fulfill companies' increasing financial needs. Today, major investment is procured overseas.
Formerly, it was almost impossible to penetrate the solid walls of institutional investment in the United States. Israeli VCs practically had to beg for recognition in order to obtain investments. Today, things have changed. The American institutions are no longer asking Israeli VC managers, "Why Israel?" but rather, "Why your VC and not another Israeli VC?"
Israel has achieved a fairly good reputation in only a few years, which has led to investment from multiple sources.
There is a growing phenomenon of large American high-tech companies investing in the Israeli high-tech industry. Some companies, such as Intel (INTC), Motorola (MOT) and Philips, have chosen the strategy of placing an active investment delegation in Israel.
Intel, for example, already has 14 investments in various Israeli companies and is constantly seeking new possibilities. But "salvation" doesn't always come from the United States alone.
European dough
Eurofund 2000 and Magnum Communications Fund are two venture capital funds that are almost entirely funded by European companies.
Vertex Management Israel, part of the Vertex Group, is a unique Israeli fund in that it receives most of its funding from VCs in the Far East. Its president, Yoram Oron, says, "In the past, the approach to business relations was very conservative and based on personal connections.
"Today, we feel a strong awakening in the Far East regarding investments in the Israeli high-tech industry and a motivation to cooperate further with Israeli VCs."
What
about Israeli investment?
However, in the past six months, they have been showing more interest in technology investment. And yet, the amount raised from Israeli companies is still rather insignificant. It seems that even in the future, Israel will never really serve as a major money source for its own high-tech industry.
During the first quarter of 2000, 60 percent of the overall capital invested in Israeli high-tech companies came from the United States. American companies usually enter the more progressive rounds with larger amounts being raised.
Dotan explains that "startups are moving to their second round while already on a flight to the States." Consequently, there is no room left for Israeli VCs in these rounds, since the increasing amounts are out of their reach.
Three to four years ago, high-tech companies would raise $2 million to $7 million in their second or third round. Today, the rounds usually involve $10 million to $25 million, during which the Israeli VC usually initiates the entrance of an American VC.
Most Israeli VCs prefer having American VCs participate due to the added value they provide. However, they are confined to the seed rounds, which are limited in number, and this creates stiff competition among them.
Amir Galor, general partner of Israel Infinity Venture Capital Fund, explains that there is no comparison between the American venture capital market, which has been active for more than 20 years, and the Israeli arena.
The proximity and influence of the American VCs create an unmatched advantage for an Israeli company. The entrance of American venture capital funds helps Israeli startups to overcome their biggest disadvantage: a lack of management capabilities.
Leading American VC funds investing in Israeli high-tech are USVP, Oak Investment Partners, Lucent Ventures, Mayfield Fund, Newbury Ventures, CrossPoint Venture Partners and more. This cooperation creates growing personal relations among executives, which leads to further investments.
Negotiating
Israeli (in)dependence
Gemini's policy is to keep its options open without exclusively merging with American firms. But is a scenario in which American VCs begin planting "colonies" in Israel with Israeli management (such as Sequoia Seed) possible?
Holzman assumes not. The huge deal flow in the United States is more than enough for American VCs. Holzman predicts that it is unlikely for the leading VCs to leave Silicon Valley and travel all the way to Israel because there is no reason. The American managers are too "rich and spoiled" to move to Israel.
Boaz Dinte, a general partner at Evergreen, offers another explanation for why this scenario seems a little far-fetched. American companies are very comfortable receiving new startups already "baked" by the Israeli VCs and ready for launching. They receive a steady deal flow from Tel Aviv, so why should they bother "schlepping" to Israel?
Dotan thinks otherwise. In his opinion, anyone who thinks that American VCs will not flood to Israel within three years is burying his or her head in the sand. "Money talks," he says, and wherever money and success are to be found, so are VCs -- either as affiliates or as direct investment divisions, such as Sequoia Seed. Sequoia Capital Seed Fund is an American VC firm situated in and managed from Menlo Park, Calif., and locally represented in Israel by Haim Sadger. Sequoia has already invested in six Israeli companies.
Even though Sadger represents a pioneering American VC in Israel, he does not assume that this new trend will become a full-grown phenomenon.
"Don't forget," he says, "that the motivation for establishing Sequoia in Israel was not initiated by the fund's managers; rather, Cisco (CSCO) led them here to be the forerunners of investment." Sadger adds that there are cultural differences, which will always be an obstacle to the merging process.
The Israeli entrepreneur has an altogether different mentality from that of the American, meaning that many problems and incompatibilities may ensue as American companies enter seed-stage startups.
Moshe Bar Niv, general partner of Ascend Technology Ventures, doesn't share this notion, but rather believes that the compatibility of Israeli entrepreneurs and American VCs depends solely on the entrepreneur's individual personality.
Bar Niv distinguishes between two types of Israeli entrepreneurs: those who have studied in the United States and have had experience working in American companies, and young Israeli entrepreneurs who haven't been exposed to the American mentality.
The former can easily carry on a dialogue with American VCs and enjoy good cooperation. The latter usually lack the business experience required for the task.
Jon Medved, general partner of Israel Seed Partners, opposes the notion that cultural differences might prevent cooperation. He says, "Israeli and Silicon Valley entrepreneurs are very similar in culture." He attributes this to several factors: compact geographical space, non-hierarchical societies, adventurous people who question authority, informal [environments], and cultures of immigration.
Medved assumes from these similarities that it will be easy for American VCs to adapt to the Israeli business culture and that, therefore, it is only a matter of time until they arrive en masse. Medved also quotes one of Intel's executives in Israel, who says, "I like Israel because it's so much like America."
As Israeli venture capitalists debate over whether American VC funds will actually enter Israel, the question arises: Aren't they already here? The American VC market has been the main, and almost only, source of funding for this entire industry, nurturing the miraculous growth of Israeli VCs and high-tech companies.
The process of merging between America and Israel began quite a while ago and is accelerating each day, bringing these markets closer together.
A slight difference between American and Israeli VCs is the emphasis Israeli funds place on telecom investments, while completely ignoring the dotcoms.
Investing
in telecom comes first
The Internet revolution, specifically the content website arena, has not penetrated the VC funds in Israel. Matty Karp, a managing partner of Concord Ventures, points out that Israel hasn't been able to generate companies such as Amazon.com (AMZN) or eBay (EBAY).
The basic presupposition is that Israel is a small country that hasn't yet gained enough knowledge and experience establishing and running giant companies. The technology is very advanced, but the execution capabilities of global operations and marketing strategies have not been adequately developed.
Since there is no point in establishing a dot-com unless there is the potential to become a giant, the Israeli VC funds refrain from investing in this field. Israeli funds focus on Internet companies that develop enabling technologies, Internet infrastructure and streaming acceleration technologies.
Management
is the key
This requires more nursing and attention on the funds' side, since they must help with management recruiting, planning of business strategies, and trips to the United States to meet future clients and contacts. With so much to do, the funds must enlarge their professional teams and even recruit more partners to handle their portfolios.
Shlomo Kalish, founding partner of Jerusalem Global Ventures, stresses that the main problem in Israel is the lack of high-quality management. The Israeli companies that are acquired by American companies, such as Intel, Cisco and Microsoft (MSFT), are inserting American managing norms and creating an internal reservoir of American executives in Israel.
To combat insufficient managerial experience, both American and Israeli VCs attempt to recruit American executives for their companies.
In contrast, Sequoia Seed, managed by one representative in Israel, is increasing its investments. Sequoia's Sadger is able to avoid researching and testing the capabilities of startups before deciding to invest.
He simply sends them to Sequoia's "daughter" company, Cisco, which tests products and helps him decide whether to invest. When considering affiliations with American venture capital funds, Israeli funds consider the added value that accompanies American affiliates. American VCs help Israeli companies eliminate months of hard work and uncertainty, and speed up time to market. Today, advised by their accountants and lawyers, Israeli startups are setting up in the United States, especially in Delaware. Even though the entrepreneurs are Israeli, they move their businesses to the United States, live there, and manage an "American" company, with their R&D center located in Israel and their sales department in the United States.
The taxes and securities legislation in Israel are relatively outdated and don't keep up with the fast pace of the high-tech industry.
Bar Niv believes that the Israeli government is limiting industry advancement by restricting the VCs. Instead of trying to update old restrictions, as they are doing today, he suggests that U.S. laws be duplicated in Israel. In the meantime, Israeli legislators and state leaders are watching, with worried eyes, as promising startups leave the country. Amendments are being made, but not fast enough.
In some cases, entrepreneurs establish their companies as completely American, leaving themselves as the only evidence of "Israel." It is interesting to point out that probably all Israeli VC funds have invested in two or three of these types of companies.
In the past, Israeli companies had to register in Israel to receive government funding. Today, most companies don't bother to approach the government because of the amount of foreign investment capital flowing into Israel.
They also prefer the benefits of an American backing: closer proximity to the market and faster progression to an IPO. Medved mentions DealTime as the classic integration of Israeli and American management. The company has 100 employees, 50 in the United States and 50 in Israel, and two CEOs, one Israeli and one American.
As a result of this continuous merging, the state of Israel is forced to adapt to American standardization and legislation, and entrepreneurs are becoming American-oriented. The high-tech industry in Israel is becoming Americanized with competitive salaries and shares for employees that are up to Silicon Valley standards.
Other aspects of this Americanization include imported American managers, English-speaking companies in Israel, and, of course, a nonstop flow of American cash.
Not
necessarily a two-way street
Israeli funds are immigrating to the United States for several reasons: to be closer to the market, assist their companies that are already there, provide them with fund services, and be the first ones to reach, meet and greet the "escaping" Israeli startups.
Even though the activity surrounds only Israeli companies in the United States, there have been several successful Israeli investments in purely American companies. Israel Seed, for example, recently invested in PrimeShot.com, an American Internet-based event-photography booking and merchandising company.
These, and a few other "reverse" investments, may imply new motivations and directions for deal flows.
Chemi Peres, a managing director of PolarisVC, the largest fund in Israel, which manages more than $700 million, sees his fund as equally as large and powerful as an American VC, and feels that the global market is opening up to Israeli investments.
Peres expresses the goal of Israeli venture capital firms: to break away from Israel and join the big kids' game. "Polaris," he says, "has proven itself as a strong and successful fund; we don't see ourselves restricted to any geographical place."
According to the latest dialogues between the VCs, and following the large merger and acquisition deals involving Israeli companies, it is expected that American venture capital funds will begin settling in Israel on a permanent basis. In just a few years, Israeli VCs will all be a part of a larger affiliation, fully integrated with the American giants.
Is Israel becoming a microcosm, or a miniature lab of what the high-tech industry will evolve into? From a local industry to a global industry? From national pride to international merging of technology and resources?
This could be a premature prediction, but judging from the way the Israeli and the U.S. industries are merging, full globalization is inevitable. |
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