Taking Stock / The Kalish Effect

The years 2001 and 2002 are going to be bitter memories for the founders of Israel's start-ups for years to come.

The brains behind cutting-edge young companies toppled from their pedestals and found themselves dragged through the mud. From being the darlings of the business sector, their names were suddenly anathema. One moment they were the envy of all their friends, the next they were pitiful shadows of themselves, wondering what sorrow the morrow would bring.

No more jet-setting around the world, closing deals, hiring manpower and raising millions armed with a wave of a PowerPoint presentation. Now they are scurrying like mice for crumbs, being humiliated by venture capital funds that had invested in them, required time and again to defend their business model. Even then, all too many are forced to close up shop.

The years 2003 and 2004 are going to be bitter memories for Israel's venture capital fund managers for years to come.

After two years of struggling to persuade their portfolios that times had changed, that the easy money was history and that there were new rules governing the game, after ordering the companies to cut back, pare down, lower wages, accept equity dilution and mainly, forget their gauzy dreams of easy money, they find themselves in the same position as their hapless start-ups.

They are under attack by investors demanding they defend their business models and explain why their financial results are so measly, why they have not reduced their pay, and why on earth they need so much money in their coffers.

The charges the investors level at the venture capital managers are remarkably similar to the accusations the funds aim at the start-ups. Your business model is lousy, they say. Your remuneration is unrealistic and excessive, you don't need that much capital in reserve. It's time to stick your head out the window and realize that the world has changed.

Psst... Not fair

Until a few months ago, most of the investors and funds managed to wash their dirty laundry behind curtains. They secretively negotiated reductions in pledged investments and management fees, and nasty letters flew back and forth - but only between lawyers, not to the press. In most cases, compromises were reached.

Yet in recent weeks, the tremendous anger the investors have been accruing against the funds has burst forth.

The first affair to reach the courts was Bruce Rappoport versus the Challenge fund. Rappoport, a major backer, managed to prevail over fund chairman Joseph Ciechanover, who returned most of Rappoport's money.

But a far bigger battle that unfolded last week will have much more impact on the industry. Symbolically enough, its architect is Shlomo Kalish, the man behind the defunct Internet incubator Yazam.com and star of the high-tech bubble years.

Kalish, who manages the Jerusalem Global Ventures fund, cut his mutinous investors no slack. Investors who balked at capital calls, refusing to infuse pledged money into the fund, would be treated exactly as stipulated in their investment contracts: Every cent they had already invested in the Jerusalem funds would be seized.

The investors claim that the management fees Kalish charges are exorbitant, losses are mounting and he refuses to explain his results or acknowledge the new circumstances in the high-tech arena.

Kalish rebuts: Gentlemen, we have a binding agreement. You are unilaterally breaching it. You are trying to extort me, and it's time that some fund manager told all these rebelling investors: That's it. No more.

He has a point. His investors signed standard agreements, as do most investors in Israeli venture capital funds. The agreements are copies of the accords used in the American venture capital industry over years.

Venture capital investors are generally sophisticated, major-league players armed with top-tier lawyers, who knew perfectly well to what they were agreeing. In most cases, they simply don't feel like honoring their commitments to the funds and are taking advantage of the funds' weak status and abhorrence of scuffling in public.

You need guts to seize NIS 12 million from investors such as the IDB (TASE: IDBH) group, controlled by Nochi Dankner, after it refused to infuse more money. Kalish is performing a service for all his venture capital cronies by sending a message to investors far and wide: You cannot step on us just because we are down.

But neither are the investors' claims paltry or empty. The high-tech and investment worlds have changed from head to toe. Accepted practice in 2000 is not suited to the colder world of 2003. Management fees have become dissociated from the sorry reality of today's market, and relations between partners involve more than written contracts. Sometimes the parties to agreements would do well to deviate from the black on white.

The skirmish between the venture capital funds and investors makes neither look good. The investors are turning out to be short-term speculators who failed to understand the inherent risks. They do not balk at bailing out in the trough and leaving the funds, and companies, to founder.

The fund managers are turning out to be people who recoil at taking the medicine they're forcing on their start-ups. They are lying in beds they made themselves: They were happy to take money from all comers in the fat years, and accepted pledges from opportunists hopelessly devoid of experience in venture capital investing.

The entire process is nothing but destructive for Israel's start-up industry, which, despite all its mistakes and arrogance, is still one of the only positive things to develop in the last decade.

The entire business chain of the industry should come to its senses and try to rediscover something of that spirit found in the garages: the joy of creativity and innovation, and all those other values that evaporated in the heady bubble days.