Israel's Venture Capital World

The future growth of Israeli high-tech exports depends on the success of today's start-ups which, in turn, depends on the influx of investment, especially from venture capital funds.

Also on Israel's Venture Capital World:

Investing in High-tech

Nothing Ventured Nothing Gained

Venture capitalism is alive and well in Israel. The money which poured into the country since the early 1990's has - in the main - served to bring fledgling ideas and companies from their earliest start up stages to prototypes, beta-siting, production, marketing, and finally export.

The capital which was risked in Israel enabled local entrepreneurs to develop, among a myriad of products, internet telephony, internet video, medical electro- optics, and computer aided design software that are in the forefront of their respective fields. The venture funds have also spawned an entire industry - from analysts to lawyers to accountants and to entrepreneurs - who have found their niche in Israel's burgeoning venture capital marketplace.

Israel's venture capital market is now in a "creation and investment" mode. This follows the first wave of venture capital financing, which hit the Israeli coast in 1992: Yozma had brought in approximately $200 million, and by the end of '95, other venture capital entities had brought in a total of about $300 million - totaling no less than $500 million altogether. However, within a short time, due to a number of factors relating to investment variables, this money began drying up.

Therefore, by the middle of 1996 fund managers and foreign investors had sensed a need for new financing, and created what should be termed the "second wave" of venture capitalism to reach the shores of Tel Aviv. Throughout 1996, a total of about $300 million was raised, and a further sum of approximately $500 million is expected to be raised by the end of 1997.

"By the end of the first wave of venture capital raising, there was too much money running after too few opportunities," says Yigal Erlich, President & CEO of the government-sponsored Yozma (initiative in Hebrew) Venture Capital Fund. The fund was created in order to both create a venture capital industry, and to entice foreign multinationals to join venture capital partnerships. It succeeded in both missions and was responsible for the raising of more than $200 million during the first investment wave.

"For the first time," says Erlich, "this type of funding was becoming available to all kinds of entrepreneurs with ideas for the market. Because of the relatively easy availability of funds, the asking price entrepreneurs were requesting for participation from investors was driven up. In any wave of fund-raising, there is a phenomenon of rising project costs because of the availability of money. Later the project costs stabilize and drop to more reasonable levels. In the second wave, I expect to see a more developed sense of pricing on all sides, which is characteristic of a more developed venture capital market," he continues. The constant need for new financing is the result of a number of factors. First, the number of new businesses is only growing.

As technology progresses (the Internet, multimedia, wireless communications, bio-medical), new entrepreneurs with new plans abound - and many of them require seed capital. Second, the first set of businesses that received funding and those that have enough promise will need secondary "later stage financing" from the original funds. Because later stage financing is typically far greater than original funding (close to $5 million rather than under $1 million, respectively, according to Erlich), more of the original capital needs to be budgeted for this later stage, leaving less for new offerings. And third, the administrative costs of running the funds have also reduced the available amount of capital remaining for new firms.

Investment in Israeli companies and ideas continues strong because of the impressive gains and profits which have been registered in Israel over the past few years - and not only by the venture capitalists. Out of the 150 firms which received backing from venture capital, close to 20 have gone public, netting their investors decent returns. Some have taken their shares to the American markets, mostly NASDAQ, such as Vocaltec, Summit Design, ESC Medical Systems, and BOS, while others have gone to London's new AIM markets, such as Dematek. Yet others have been acquired by leading companies in their sectors, such as Scorpio by US Robotics, Nicecom by 3Com, Ubique by America Online, Ornet by Siemens, and Medinol by Boston Scientific.

In other words, the growth of Israel's hi-tech sector has enabled it become a larger and larger component of the country's exports. In effect, venture capital has propelled the economy forward during the technological 1990s. Aside from the quantitative differences between the first and second waves, there are also a number of differences in the companies now involved in attempting to take advantage of Israel's developing venture capital market.

Along with Israeli-led investor consortiums (such as those led by Dovrat-Shrem & Company's Polaris fund which in 1996 began building a new $80 million fund, or by Joseph Ciechanover and Yair Shamir in Challenge (Etgar) fund with $80 million, whose mission, which began in 1995, is to serve as a seven-year self-liquidating fund), coalitions between well-known American-based specialized investment banks and Israeli partners are now taking place. For instance, Jerusalem Global is allied with Montgomery Securities. Their relationship is based on the Israeli partner searching for new investment opportunities, while the American partner extends its financial analysis and acumen.

Tamir Fishman, a new group, is the first Israeli venture capital to actually have a foreign investment bank, Hambrecht & Quist, acquire a stake in its equity (33%). Giza Investments, a leader in privatization consulting and investment banking services, is now working with U.S.-based investment bank Alex Brown. And Evergreen, the joint Canadian-Israeli investment firm traded on the Tel Aviv Stock Exchange, has become affiliated with Robertson Stephens.

The Europeans have not been left out of Israel's venture capital market. Some firms such as the Van Leer Group (Netherlands) and Germany's TVM have taken a keen interest in investing in Israel. The Van Leer Group is part of the Inventech fund, which has raised $20 million and invested in 18 companies.

Germany's TVM is a partner in the Star group of venture capital funds, which invest in Israel, America, and Germany, and have a special interest in investing in firms interested in selling to Germany. Siemens, the German-based multinational, also participates in one of the Star funds. However, due to the relative scarcity of European venture capital firms compared with those from the US, they have been, in general, less active in Israel.

Though some of the groups participating in the second wave are new, such as the consortium between George Soros' Quantum and Comverse Technologies, a number of groups active during the first wave - such as Gemini, which works with Advent and Discount Investments Hambrecht & Quist, the American investment bank / venture capital firm, and Nitzanim, which works with AVX and Japan's Kyocera - are also in the process of raising funds in order to begin new investment funds, as part of this second wave.

Gemini is in the process of building a fund with a capitalization of approximately $50 million. Evergreen, the joint Israel-Canada venture, is in fact now looking at the Far East, specifically in Taiwan and Japan, to find more partners to share the risk.

One totally new aspect of the second wave would have to be filed under taking advantage of the hidden potentials of Israel's academic world. All Israeli universities have their own development companies, which patent and attempt to sell technologies and ideas resulting from the research of the faculties. However, one venture capital fund, Pamot, is getting highly involved at the Weizmann Institute of Science, located in Rehovot.

Pamot is not an arm of the university: it is a private company that holds a "right of First Opportunity" on all of the Weizmann Institute projects. This right allows Pamot" to evaluate and retain for investment, with priority over any other entity, any project being developed at the institute, and which is not under previous undertaking of the institute. The majority of the projects at the institute, and any project as of first closing of the fund - are under the above mentioned "Right of First Opportunity". According to Erlich, "This is an entirely new idea and may be the wave of the future when dealing with university research."

To understand the spawning of the first stages of what (with hindsight) has become a successful venture capital market, Israel's internal economic evolution needs to be examined. The confluence of a number of variables, such as high tech exports, the need for more financial fluidity, and IDF-sponsored research and development projects all contributed to creating the favorable conditions that brought this specialized type of investment to Israel.

During the first half of the decade, Israel went through a metamorphosis - from a country that had relied on agriculture, diamond, and defense exports, to one relying on the civilian high tech sector. Within the hi-tech sector a majority of exports were based on telecommunications and electronics. The increase in exports forced more companies to offer their shares to the public - in Israel through the end of 1993 and then later in New York - in order to raise more funds for expansion.

This drew the attention of emerging market specialists around the world. Concurrently, spinoffs from Israel's hi-tech industrial sector, and new ideas for civilian products originating from engineers who left the service of the Israel Defense Forces, began to attract notice within the world's hi-tech sector, especially from Silicon Valley. In addition, the influx of immigrants from the former Soviet Union, who brought scientific and technical skills with them, created a vast pool of technically adept labor into the market, which both new and old companies could tap.

By 1992, economic conditions had matured; prescient local financiers were taking advantage of their knowledge, and were profiting from their early venture capital investments. Some of the early pioneers included Gideon Tolkowsky and Yadin Kaufmann at Veritas, Anglo-American Ventures, and Athena, and Uzia Galil at Elron. Companies that came out of these investments include Elbit Vision Systems-EVS (Elron), Gilat Satellites (AAV), Logal (Veritas), and Mercury Interactive (Athena).

With their acquisitions and investments, they were creating an emerging venture capital market. "However, a structure for this market was lacking, and a vacuum was being created which needed to be filled, so that steady rather than haphazard growth would take place," says Erlich.

The Israeli government did just this in 1992 when it created the Yozma Venture Capital Fund, its tool for organizing and expanding the first stages of a venture capital market. One of Yozma's major purposes was to coalesce local and foreign multinational investors together in risk-taking.

It attracted the likes Boston-based Advent, the China Venture Management of Taiwan, Oxton International of San Francisco, GAN of France. "Some may look askance at the government's involvement in the venture capital market, but we at Yozma had the backing to entice foreign venture capital professionals and the ability to form partnerships with large multinationals such as Daimler-Benz which joined the Eurofund," says Erlich.

By 1997, Yozma, had sponsored ten venture capital funds with firms from all over the globe and had participated in raising close to $200 million. On March 9 of this year, the government announced that as part of its privatization drive, the company had been sold to a group of investors led by the Ofer Brothers (with investments in real estate, shipping, and industry) for a price of NIS 50 million.

The sale to the private sector, in one sense, meant that Yozma had succeeded in fulfilling its mission, because its investments and management knowhow were worth NIS 50 million to the winners (eight groups competed to buy Yozma). The sale also recognized that Yozma had a large part in creating a viable venture capital market in Israel.