An Israeli venture capitalist tells about being invited to speak at a conference with another investor. The moderator asked the second investor to tell the audience what his fund specializes in. “So he started to describe it – cybersecurity and artificial intelligence, enterprise software, automotive and a few other things. I couldn’t hold myself back and asked him: ‘But you can only specialize in one thing. Right?’”
In the past, specialist funds were usually smaller players without the human and financial resources to spread themselves wide. But that has begun changing as Israeli high-tech has grown more mature and sophisticated, says Ronen Nir, a partner in the Viola Ventures fund. Funds are becoming small and focused by choice.
“Specialist VC funds are part of a larger thesis that holds that during the first 20 years, the world of technology focused on creating a broad foundation – mobile, cloud computing, AI, etc. Gradually the industry is moving to verticals [specific market segments] and specifics, such as Uber,” he said. “Since the world is moving from horizontal infrastructure to vertical technologies, there is clearly room for investors who specialize.”
Viola is one such example. The company has one general fund as well as a fund founded in 2017 with $112 million to invest focused on financial technology.
“In an evolving venture capital industry, there’s room for large and small funds, seed funds and growth funds, as well as generalist funds and specialized funds,” said Nir.
In Israel, there are funds specializing it automotive, agricultural technology, internet of things and cyber, he noted. In the coming year, he expects to see four or five other specialist funds. Fundraising for them is already underway.
One of the new specialist funds is FinTLV, which raised $30 million last year -- a fraction of the $150 million to $250 million traditional VCs raise -- to be invested exclusively in insurance technology startups.
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Gil Arazi, a cofounder and co-general manager of the fund, joined the VC business after a career at Migdal, Clal and Phoenix, three of Israel’s largest insurers.
He says that a lot of Israeli VCs have sub-optimal performances because they don’t have the resources to master the business, technology and corporate management sides of their portfolio companies. “If I invest in a business that I don’t understand, the chances of it succeeding are low,” he said.
The other advantage a specialist fund has is in deal flow – the number of proposals from startups that land on its managers’ desks. In the high competitive deal flow environment of today, being an acknowledged expert in a field gives you an edge.
“If you have an automotive-tech funds, certainly all auto-tech companies will turn to you first,” said a venture capitalist at one of the big generalist funds, who asked not to be identified. “A specialist fund knows how to link up with the bigger funds to complete a fundraising round.”
Noga Kap, managing partner of the i3 fund, which is focused on internet of things startups, says being a specialist is important in a place like Israel, where high-tech industry is flooded with startups and investors.
“Funds, like start-ups, have to find a way to differentiate themselves. Instead of saying that I’m an index fund that knows how to invest in everything and at any stage – which sounds very improbable – you have to find a way to differentiate yourself,” she said.
Another edge specialist funds have over generalists is their industry connections. For instance the Maniv Mobility Fund, which specializes in smart transportation, counts among its backers the auto parts makers Lear Corporation; InMotion Ventures, a subsidiary of Jaguar Land Rover; and the French company Valeo. Its next fund is expected to line up the Renault-Nissan alliance as a backer. i3 is backed by global companies such as India’s Tata group, General Electric and Temasek Holdings of Singapore.
“Our investors are part of our due diligence process. We won’t invest in a startup if we can’t find two corporations that are interested enough in its product to consider using it themselves,” said Kap.
“After we’ve invested, they help startups to focus their product and pushing it forward. Sometimes they join us in investing directly,” she said.
One of i3’s portfolio companies, a smart city startup called Zencity, was able to reach deals with 41 local governments in the United States because Microsoft had invested in i3. It later invested directly in the company too.
Does that all result in better returns for investors than general VCs can produce? It’s a sensitive issue and one that Alan Feld, whose Vintage Investment Partners invests in other VCs. He has examined the issues and at a private conference held at the end of 2018, came to the conclusion that their performance was superior to the generalists. Among other things, it pointed out their abilities to better help their portfolio companies to succeed.
Not everyone thinks the Vintage model for assessing funds is fair. “Of course, a $70 million fund has a better chance of return capital than a $150 million fund,” said one VC investor, who asked not to be named. Against that, he said, a small fund doesn’t have the resources to invest a unicorns (startups with a valuation of $1 billion or more) or to continue investing in a growing company that needs follow-on investments, among other things.
There is something to what he says. Many of Israel’s veteran specialist funds eventually expanded their portfolios to include other segments.
“Why do I prefer the generalist model?” asked Yaniv Golan of the Lool Fund. “Because the world is changing quickly and at an increasingly rapid pace. There’s a disconnect between the life of a specialist fund – let’s say 10 years – and the rate of change.”
Some areas, such as enterprise software , are broad enough that they will be around a long time, he said, but others may become hot, leading to a surge of startups and investment, only to flame out after three or four years, said Golan.