Thanks to huge cash inflows, Israeli Venture Capitalists are going global.
BY TOM STEIN
EREL MARGALIT, a dapper, articulate Israeli with Harrison Ford good looks and a flawless American accent, clearly looks uncomfortable. “There ’s something important I need to tell you,” he whispers under his breath. Intrigued, I follow Mr.Margalit as he slips out of the wood-paneled conference room where he and two partners have been holding forth on the state of venture capital in Israel.Maybe he wants to tell me about an overhyped Israeli startup that’s about to make a crash landing. Or maybe he’s got some juicy gossip about a rival venture firm that ’s on the brink of implosion. After all, Mr.Margalit is in a position to know these things. He’s thefounding artner of Jerusalem Venture Partners, one of the biggest and most reputable VC firms in the Holy Land.
“We don ’t like to be referred to as Jerusalem Venture Partners,” Mr.Margalit confides in private. “That name is not relevant anymore, especially as we start to do new deals in places like Paris, New York, and elsewhere. It's best if you just refer to us as JVP in the article.”
OK, so his big news isn’t exactly blockbuster material. But it does say a lot about the dramatic changes sweeping the Israeli venture scene.For most of the ’90s, Israeli venture firms focused exclusively on identifying and nurturing local technology startups.They would provide that first, critical infusion of cash to get the fledgling company off the ground. Once the startup found its legs, the Israeli VCs would pitch it to their counterparts in Silicon Valley, who had the real money, skills, and contacts needed to transform the company into a true contender.In effect, Israelis were the farm system for their big-league brethren in Silicon Valley.They simply did not contemplate the notion of reaching outside their borders and funding companies that did not have Israeli founders or a tight connection to the homeland.
INSIDE THE FOLD
For the most part, the strategy worked.Since 1993, when the Israeli government created the $50 million Yozma Fund to kick-start the high-tech industry, the country has produced an impressive roster of winners, including gems like Check Point Software Technologies (funded by BRM Capital), Comverse Technologies, and most recently Chromatis Networks (funded by JVP), which was sold in May to Lucent Technologies for $4.5 billion (see “The Biggest Sale Ever,” page 3).These successes helped open the door to a flood of new entrants and VC-wannabes.At the beginning of the last decade, there were less than half a dozen venture firms in the country.At last official count, Israel now boasts more than 120 VC and private equity funds, with new firms continuing to pop up, seemingly daily.In dollar terms the growth is also tremendous:according to PricewaterhouseCoopers, Israeli VCs pumped more than $1 billion into local ventures in 1999, up from $568 million in 1998. Today, as the coffers of Israeli VCs grow, many of these players are not content to limit themselves to Israeli-only deals or to be restricted by geographic boundaries. Not only are these firms opening offices overseas as they help to take their portfolio companies global, they are actively seeking new investments in a variety of far-flung locales, an idea unheard of only a year ago.
GO FORTH AND MULTI P LY
“If we ’re looking at two companies in the same space, we just won’t go for the Israeli one,” explains Nir Barkat, a managing director at BRM Capital in Jerusalem. “We will go for the best one.” BRM specializes in Internet infrastructure investments, having backed companies like Global CommerceZone, PeopleLink, and BackWeb Technologies.“We know this domain very well,”insists Mr.Barkat, who now frequently pronounces on technology on local television and in the newspapers.“We can add value to any company in this space.”He says that the vast majority of his portfolio companies have roots in Israel, but that soon a greater proportion of investments will have no Israeli component whatsoever.“If we can help an Israeli company, we should be able to help anyone,” he says emphatically. Is it a sign of maturity that venture firms like JVP,BRM,and a handful of other top-tier VCs now want to export their expertise to markets around the globe? Or is this just overweening pride and a sure recipe for disaster? “When Israeli firms invest globally, it’s a result of exuberance and arrogance mixed with ignorance,”says Jonathan Medved,a artner at Israel Seed Partners, an early-stage VC firm that promises to keep a laser focus on local deals.“After all, what does a Vietnamese entrepreneur in Silicon Valley need from an Israeli VC firm?” Indeed, say skeptics, it’s only the second-rate companies that can ’t raise money in their own countries that are starting to look to Israel in a desperate effort to raise funds.“If a company is so great,why do the founders want to fly halfway around the world to meet with us?”concurs Matty Karp,a managing partner of Concord Ventures in Herzelia, an affluent suburb of Tel Aviv.
LAND OF MILK AND MONEY
One reason could be that Israel is overflowing with capital to spend. In the last year or so it has developed a reputation as a country rolling in easy money. Outside investors, attracted by the nation’s profuse engineering talent and entrepreneurial drive, have been pouring money into Israeli venture firms.Everyone from America Online and Intel to General Motors and Boeing to large financial institutions and endowments are investing in Israeli funds.Where once VC firms here would be lucky to raise $20 million, today they are churning out $200 million funds with startling regularity.And now that many Israeli funds are as bloated as their North American counterparts, they are all but forced to uncover new avenues for investments.In just the first quarter of this year, Israeli VCs invested $209.9 million in technology startups. That’s an increase of 50 percent from the previous quarter and a dramatic 177 percent from the first quarter of 1999, when they pumped just $75.8 million into startups, according to the research firm IVC-Online.
With all this money on hand,more than one observer has wondered aloud whether Israeli VCs can responsibly manage these larger funds.One American who worked in the Israeli venture industry for several years says that for the most part,VCs in Israel are awestruck little brothers compared with their Silicon Valley counterparts.“They don ’t have the skills,savvy,and contacts to create really great companies,”says the American.He adds that Israeli VCs are more interested in off-loading their portfolio companies on large foreign corporations than in helping to build long-term industry leaders and multibillion-dollar behemoths. Critics love to cite Mirabilis,the inventor of instant messaging,as a prime example. They say the company, which AOL bought for $287 million in 1998,would be much more valuable as a self-contained publicly traded entity.Stephan Ouaknine (pronounced oaknine), a cocksure 20-something Canadian who moved to Israel to “cultivate the silicon, not the land,”has an even harsher view of Israeli VCs.“The majority of these guys have nowhere near the understanding of the industries they rofess to have,” he snorts.Mr.Ouaknine is the CEO of Airslide Systems,a year-old startup that makes equipment for wireless networks. He says that when he first approached Israeli VCs,they did not give him the time of day.But that all changed after Sequoia Capital,a well-known Silicon Valley VC firm with a small office in Haifa,stepped up with several million dollars in seed funding.“They know Sequoia has a track record,so now they want to follow,” he says.Indeed,others echo that sentiment:if one Israeli VC is interested in a deal, they all want a piece.While this type of bandwagon is also typical VC behavior in Silicon Valley,it is all the more extreme in this insular,gossip-ridden country. “I think most VCs here still can ’t believe they missed an opportunity to invest in us,” says the balding, intense Mr.Ouaknine as he sits back in his new Herzelia office that overlooks the squat buildings and bustling eateries that dot this up-and-coming technology district. “I still get daily emails from guys who want to participate in our next round.”But now that he has U.S.funding,Mr.Ouaknine says accepting Israeli VC money would be a step back.“It ’s not that these guys are inherently bad,”he says.“They just can’t open the same kind of doors as the top-tier U.S.firms.”
Despite some inevitable shortcomings,VCs in Israel have made a lot of smart moves.Foremost,they were never really seduced by the Internet fads andquick IPO money that swept up most American VCs.The firms stayed focused on pure technology plays —or at least startups with a strong technology component.They never truly bought into the e-tailing craze or business-to-business marketplaces.So while many U.S.funds watch in horror as their high-priced portfolio companies wither,VCs in Israel are still holding solid companies that have good technology,viable business models, and, importantly, real exit potential. “In Israel,we have a blessing and a curse,”explains Mr.Medved of Israel Seed Partners.“Our blessing is great technical talent that gives us a first to market advantage.But our curse is that,geographically,we are far from that market. So we have to build companies by leveraging our technical advantage and staying away from companies that are too closely tied to consumer branding.”
That’s not to say that Israeli VCs have never taken the easy bait.Israel Seed Partners, for one, has made one or two regrettable investments in the Internet content space,while other top firms like BRM, JVP,and Polaris Venture Capital also have some questionable e-commerce investments. Still, these deals are few and far between. “Sure, we’ve been tempted by Internet portals,content providers,and destination sites,”says Mr.Margalit.“But I think it ’s clear that Israeli companies are much better at bringing new technologies into the world rather than dominating the customer experience.”
CONVERSION RATE
For better or worse, venture capital has penetrated to the very core of the Israeli psyche. As in the IPO-obsessed culture of the United States,it seems like everyone in Israel now wants to be a VC.It ’s the hip new profession,attracting everyone from diamond heirs,politicians,and fighter pilots to the cashier at the local grocery store.“It’s a real sign of trouble when the cashier at the supermarket starts asking for investment tips on private companies,”says Mr.Karp only half-jokingly.The attraction makes sense:the rewards of big hits have reached mythic proportions in a country where money is often a major topic of conversation. Ha ’aretz ,the most respected Israeli daily newspaper,went as far as to publish a guesstimate of what all the JVP partners made shortly after the huge Chromatis deal was reported.Put this together with the fact that all the success stories of local startups are constantly splashed across the front pages of Israeli newspapers,and you’ve got a technology frenzy.A standing joke here is that the country’s former prime minister, Benjamin Netanyahu,now professes to be a VC,even though he reportedly knows next to nothing about technology.“Don’t even mention Netanyahu in your magazine,” pleads Mr.Margalit.“It will cheapen the whole article.”
Other nouveau VCs like Beny Steinmetz come from fabulously wealthy backgrounds.Mr.Steinmetz ran his family’s diamond business in Belgium for 17 years before returning to Israel three years ago at the age of 40.“After six months here, I knew this was the business with the highest quality people and the opportunity for the greatest return on investment,”says Mr.Steinmetz,who founded StiVentures in Herzelia with his own money. He admits that,in the beginning,he viewed venture capital as just a hobby,but says he is now completely devoted.Indeed, his firm now has 25 employees and close to 40 companies in its portfolio,including Alchemedia, Download Accelerator,and naturally, Diamonds.com.
Of course,the venture boom now gripping Israel is not destined to last forever.This year ’s Nasdaq turbulence had the same effect there as elsewhere.As with any shakeout,the best firms will survive and,in the end,be even stronger. “We have seen lots of money flood into the country and lots of new VCs pop up without any relevant experience and no real value,”says Mr.Karp.“Some outfits will go belly-up, but that will free up resources for those who can manage investments better and lead to a healthy rationalization process.” Venture investing has come of age in Israel.For a good part of this century,settlers from all over the globe have trudged to this arid land.Over the course of several decades,they miraculously transformed the country into a thriving agricultural haven.Today,VCs are planting the seeds and nurturing the startups that could remake Israel into a world-class technological powerhouse.
