June 6, 2012 3:17 pm
This article is provided to FT.com readers by mergermarket—a news service focused on providing actionable, origination intelligence to M&A professionals. www.mergermarket.com
The evolution of Israel’s VC sector remains uncertain despite an increase in M&A activity there over the past few years, mergermarket reports. While M&A and exits in other regions have been stagnant due to the economic downturn, in Israel deals have totalled USD 4.15bn in the first five months of 2012, with 29 M&A transactions.
The so-called “Start Up Nation” has seen 73 deals worth USD 7.56bn between 1 June 2011 and 31 May 2012, according to mergermarket data. Short-term investments have gained Israel a second nickname, “Quick-Sell Nation,” said Ronen Shilo, founder and CEO of Conduit, which recently became Israel’s first billion-dollar Internet company.
The local VC market remains relatively small, with less funds available. This has created a surge of trade exits as a growing number of companies in the early and later growth stages are unable to raise sufficient funds from VCs, industry sources told this news service.
Apple and other global corporations with cash in hand continue to appreciate Israeli innovation providing an easy exit route to local targets. In early January, Apple acquired Israeli chip company Anobit for USD 390m while virtualization company VMWare announced on 22 May its intention to acquire Israeli desktop data management and recovery company Wanova.
A “garage” culture
Israeli companies sell because they are comfortable at the stage they are at, explained Tal Keinan, founder and CEO of AdExtent. “Most of us enjoy the garage stage,” he said, adding that the mindset of an Israeli entrepreneur is to take only as much funding as he needs.
In 2011, the average VC financing round in Israel was USD 3.92m, while the average exit was USD 60m, noted a government official at a mergermarket conference on Israeli M&A earlier this year. Some VC-backed entrepreneurs indicated they enjoy managing young companies even if a bit of bootstrapping is required.
Capital needs have changed as the result of a fundamental disruption in both the US and Israeli VC markets, angel investor Jeff Pulver said. In the late 1990s, companies needed a minimum of USD 5m to operate, whereas now they need USD 50,000. More investors can provide seed funding, and most entrepreneurs don’t need to go to VCs for early stage funding.
Lack of VC competition and negative ROI
Israel’s VC industry is smaller than in other regions in terms of the number of funds and amount of capital they manage, explained Eran Flumin, Director of Israel operations at the global consulting and research firm, Frost & Sullivan. “There are not many Israeli funds that can invest USD 10m per company or even USD 5m,” said Flumin. The result has been a lack of competition among VCs, enabling them to gain the upper hand in bargaining with entrepreneurs, he said.
In general, Israeli companies are unable to raise the same amount of money in Israel as they would abroad. A USD 20m round in Silicon Valley would likely be only USD 15m to USD 17m in Israel because of the lack of VC competition, explained Izhar Shay, General Partner at Canaan Partners, a US VC fund with an office in Israel.
Although VC funding rounds are less sizable in Israel as compared to abroad, there’s still pressure to have large exits, and funds are holding on to companies longer, said Ronen Nir, partner at Carmel Ventures. A typical holding period in Israel is five to eight years, Shay said. Examples are Wix, Conduit, SolarEdge, and wireless battery charging company Powermat, whose founders have spoken openly about their desire to build billion-dollar companies without premature exits, according to media reports.
Many companies start in the R&D stage and choose to raise smaller amounts to reduce dilution. Partly as a result, smaller rounds are leaving VCs with extra cash that they are unable to deploy in the lifespan of the fund, said Yoel Haron, Managing Director of investment group Darya Ventures. In addition, an increase in the number of investments in early stage companies is not helping increase their ROI either, he said. Most Israeli VC funds have negative ROIs, he noted. Investors such as CalPERS, the California pension fund, has had losses in most of its investments in Israeli VCs, including the 1999 Apax Israel II Fund and 2005 Giza IV fund, and plans to stop investing in Israeli VCs, according to Globes.
CalPERS is not the only investor to stop investing. Israeli VCs have struggled in recent years to raise new funds. In 2010, no Israeli VC funds raised capital, while in 2011, 14 funds raised a total of USD 796m, including seven raising USD 87m, according to Israel Venture Capital (IVC) Research Center. Between 2000 and 2010, the local VC industry decreased from 70 VCs in 2000 to 15 VCs in 2010, according to Israeli newspaper Haaretz.
Alternative funding sources
Of the USD 2.14bn in VC funding raised by Israeli companies in 2011, a quarter of it was from Israeli VCs while the rest was from foreign investors, according to IVC. A lack of funding is forcing Israeli companies to look abroad and seek alternative sources for capital, such as micro-funds, incubators, strategic investors, and private investors, said Haron. Israeli VCs are also moving abroad and opening up offices in the US, a move that is less about deal flow than gaining a more active role in the VC community and creating relationships with potential clients, said Tal Chalozin, CTO and co-founder of INNOVID. “It takes more than cash,” he said.
In 2011, 50% of investments by Israeli VCs were in early stage companies, according to IVC. Israeli VCs’ funding tends to fall into earlier-round buckets because of the smaller VC market, Chalozin said. However, as an Israeli company grows, it has access to bigger VCs, like Sequoia and Accel Partners, which actively invest in Israeli start-ups, he said. Skiller CEO Nir Orpaz recently told this news service that it will first look for VC funding in Israel and then in Silicon Valley for its current fundraising round.
Another solution could come from companies such as Liquidnet, a global network of asset managers. Liquidnet is looking to bring institutional investors into fast-growing companies to mitigate the pressure to sell while allowing the start-up more control over growth prospects, said Seth Merrin, founder and CEO.
Support from the State
Originally the initiative of the Israeli government, Israeli VC funds were established in the 1990s. Shortly thereafter, they were adversely affected by the tech bubble and then recently by the subprime crisis. As Israeli companies seek alternatives to Israeli VC funding, the government is beginning to look for alternative local solutions.
In the field of health, the Israeli government has launched an initiative to attract overseas investors that could establish funds in Israel, this news service previously reported. New York-based OrbiMed, a global health VC, recently closed a USD 222m fundraising in Israel by teaming up with the Israeli government. California-based Burill & Co, another large health industry fund, is also in the process of raising a similar-sized fund, and could be assisted by the government, according to media reports.
Foreign governments are looking into what role they might have in providing startups with funding using their countries as a launching pad. The Island of Jersey is currently exploring a joint fund in Israel that would invest in Israeli startups and enable them to test their products on the island and launch to markets in Europe, Economic Development Minister, Senator Alan Maclean said on the sidelines of a UK Israel Business event in Tel Aviv.
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