Sarah Lacy published a seminal piece yesterday on TechCrunch about the Israeli VC and entrepreneur scene. In an article entitled, “Now that China Is the New Israel…What’s Israel?”, Lacy explores the evolution of the Israel tech industry. From enrapture in 2000 to finishing 2008 without a single IPO and virtually no exits, Lacy questions whether Israel has just hit a bump in the road or just peaked out.
Lacy explains:
Israeli companies have raised just over $10 billion since the beginning 2001, but acquisitions and IPOs have returned just over $860 million over that almost eight-and-a-half-year period…
Somewhere along the way, the entrepreneur scene here lost its mojo.
So I don’t say this to trash Israel, but facts are facts. In sheer numbers, Israel’s place on the global scale of investing has been dwarfed by China, and matched by the United Kingdom. And after three days of talking to dozens of entrepreneurs and investors in Tel Aviv, this seems like a country wandering in the desert, looking for a new tech movement to own and dominate (emphasis mine).
Besides being the hottest reporter in the tech world ever (really), Sarah Lacy has a point. We’ve spoken about the overabundance of foreign private capital making its way to Israel combined with smaller exits and how hard that makes it to post any real returns for an Israeli VC.
Furthermore, Lacy may be correct when she says poignantly:
What happened to Israel is a bit like what happened to Boston—the story and opportunity moved away from what the city’s entrepreneurs were good at. In the case of Israel, security and encryption was always a strength, but that’s not the growth industry that it was. In the case of Boston, enterprise technologies and telecom were always strengths. Now, as media has become the story of the last boom, it’s not a surprise New York surpassed Boston in the amount of venture capital raised.
But I think Lacy misses the point when comparing investments into China with investments into Israel. Israel is a technology development center; Indochina is an investment destination. VCs pour money into Israeli technologies because they are developed by Israelis. Investors sink money into China/India because they have 1/3 of the world’s population. Israeli entrepreneurs export technologies abroad while Indian and Chinese technologies are developed to be consumed in-country. Israel produces and China/India consumes.
Israeli entrepreneurs have learned to sell and run businesses, not just flip them and start again. Real products with real technologies are being sold. Security is a big one but so is Israeli development for the mobile and the mobile web. Mobile 2.0 applications are really just beginning to explode.
But much of this doesn’t require a big box. I think Israel is suffering because there just aren’t that many exits. To me, this doesn’t mean that the Israeli entrepreneur is washed up but that the VC industry just isn’t that interesting here. Too much money chasing too few, good deals. I’ve got friends looking to put seed money into 3-men startups to either make a cash-cash yield because these companies are quickly getting to profitability or to sell out for a few million dollars. No 10x. No multimillion dollars plunked down in successive B,C,D rounds. Just good business. In fact, this may attest to the maturation of the Israeli startup which is able to quickly get up to profitability.
So, Sarah, maybe what’s happened is not that the story and opportunity moved away from what Israeli entrepreneurs are good at but maybe that exact scenario is what happened to the Israeli VCs. From where I sit, I still don’t think Chinese or Indian startups can hold a candle to what’s developed in Tel Aviv.
With global capital markets in the middle of a meltdown, it would be expected that the Israeli hi-tech startup industry would be in shambles. With most investors hunkered down waiting for the storm to pass, they wouldn’t seem to be in the mood to fund new companies. Well that may be what you would expect, in reality it’s not the case. According to a report in Globes the number of startups that have closed their doors this year is actually much less than in the previous 2 years. “According to IVC Online, 35 start-ups have closed down since January: 24 companies in the first quarter, six in the second quarter, and five in July-August. For the sake of comparison, 228 companies closed down in 2007 as a whole and the number that closed in 2006 was about the same.”
That hardly sounds the panic whistle. It’s hard to understand why this is occurring but one reason may be that companies have cut out the frivolous expenses of years passed, and are doing a much better job of making whatever money they raise, last.
That’s the good thing about lousy capital markets. It sends a dose of reality to the startup world, that they better shape up and watch their spending or their sole option will be bankruptcy. I guess you can find some good in any situation.
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Aaron Katsman is Managing Editor of the Israel Opportunity Investor newsletter. He is lead portfolio manager for the Israel Growth Portfolio and Managing Director of America Israel Investment Associates, LLC. For more information, go to www.israelnewsletter.com or call 1-888-327-6179, or email aaron@profile-financial.com.
Avishai Silvershatz , Infinity: Infinity is an equity fund, not a traditional VC, focused on China. We manage over $600M. Our key focus is on a new $300M-plus fund, named the I-China Fund focused on late-stage equity investments. This fund’s main strategy will be to invest in late stage Israeli tech companies and on the other side, partner with Chinese companies that can employ Israeli technologies locally in China.
Who are Infinity’s Chinese partners?
AS: We have a list of very strong partners from both the government and private sectors in China. We’ve received a large commitment from the Chinese government for the fund. Political support of the fund comes from senior levels in both the Israeli government and Chinese government leading up to the Chinese Premier.
I assume that Israeli companies are traditionally nervous about sharing trade secrets. Is this the case?
AS: A key issue to establishing Chinese-Israeli partnerships requires overcoming this fear of Chinese firms co-opting Israeli tech. We successfully mitigate this problem by building multi-layered partnerships with key incentives beginning at the shareholder level all the way up to management level.
What’s Infinity’s advantage as an investor in Israeli firms?
AS: Infinity Equity had the first foreign fund to be incorportated in a GP/LP format in China. Doing business in China since 2004 has helped build a layer of trust for our network. We have strong support from the Chinese government. China is committed to Infinity because “innovation” is one of key things of the Chinese Government’s 5 year plan. The government has committed to moving from a low cost supply of labor to more value-added services as an economy. Innovation is mandated as part of this plan. The government views Israel and this fund as part of this movement to innovate.
What kind of criteria do you use when sizing up an investment?
AS: Typically, we invest in Israeli companies that have proven themselves in gaining marketshare through leading technologies and product development. Similarly, we invest in Chinese companies with strong market presence. We give Chinese companies, in some cases, equity in the Israeli company to incentivize the partnership and align working terms. There has to be mutual interest for these partnerships to work. We’ve had time to home our model over the past few years.
Can you give us an example of a recent investment?
AS: We invested in an Israeli company, Shellcase, which created a technology for packaging of chips used in cameras in cellular handsets. They had a.fab in Jerusalem with good tech and big losses. Many earlier shareholders gave up. We split the company in 2 parts. R&D stayed in Jerusalem and manufacturing shifted to China. The Israeli part of the company was sold to Tessera (TSRA) and the Chinese company is doing well and is very profitable and will probably float next year. Doing the manufacturing in the Far East has enabled them to do very well. By the way, the strong support from the Chinese government in the form of 0% interest loans made this successful investment and venture successful.
Which sectors are you looking at in Israel to make investments?
AS: In particular, we like the IT sector and see a lot of technology strength in Israel and demand for such technology in China. We also think Israel is quite strong in Medical Devices and related technologies. We’re seeing more activity and potential in Internet related technologies, spanning both consumer and B2B. Lastly, Mobile technologies coming out of Israel are very hot and in absolute numbers, China is the fastest growing market in the world.
Given your model, do you begin by targeting an Israeli firm and then look for a Chinese partner or vice-versa?
AS: More often than not, we start with a Chinese partner with a specific need for technology and we go shopping for the best in Israel. But, it really works in both directions. We get a lot of Israeli companies frequently approaching us looking for Chinese partnerships.
So, Israeli firms see Infinity as a distribution partner who takes equity in return for services?
AS: Infinity provides value in two ways. Most companies know that China should be their next play. These companies also realize that they can’t go to China alone. Many have frequently tried and failed to penetrate into China. They need a partner who can talk to Israelis and knows how to do business in China. We also focus on late stage entities and because this part of the market is not very populated, we can put up a lot of money when public markets are not very receptive to tech companies.
Are you seeing any fallout in portfolio companies that have their cash invested in subprime assets?
AS: Some companies lost money. This is not a huge deal. Other trends like the slowdown of the American market, weakening of the dollar has hit foreign companies twice, at both the operations and expenses level. We also see companies hit by the public market window closing and debt players less willing to put money into late stage technology companies.
Which sectors do you see in the near future as capturing larger share for Infinity?
AS: We are seeing more companies with little technology risk (it’s behind them) and less market risk (they’re selling well). As successful entrepreneurs start their second and third firms, we expect to see more of this as well.
Thanks.
The entire interview with Xenia’s Anat Segal is part of our new subscription newsletter, Israel Opportunity Investor. You can find out more about the product and the opportunities we cover at www.israelnewsletter.com.
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Please tell us about Xenia?
Anat Segal, CEO: Xenia is an investment firm founded in mid-2003 by a group of entrepreneurs with the vision of being an incubation powerhouse, engaged in the initiation and building of successful high-tech companies in the areas of IT and medical devices. I would say that there are two main similarities we share with traditional Venture Capital (VC) firms. We invest in startups in return for equity, and the terms of our deals are similar.
What are the differences?
AS: One of the differences is that our investments are in really, really early stage companies. What are typically referred to as seed and pre-seed stage deals. We establish the company alongside the entrepreneur. Our money is typically the first money in the firm. Sometimes there is friend-and-family round. We are first and foremost an investment firm. We base ourselves on the unique structure of the Israeli incubator model. (Continue »)
