Given Up for Nearly Dead, Israeli Venture Capital Roars Back to Life

Chinese investors, a new generation of managers and investors, and more serial entrepreneurs are bringing new life to Israel's 25-year-old venture capital industry.

Investors in Israeli high-tech are pleased. If nothing goes wrong, we can expect to continue to see Israeli startups achieving big things in 2015 – and along the way creating quite a lot of value for their investors.

2014 was a record year for the venture capital industry in many ways, including the number of IPOs and the amounts raised for startups and funds, and was an even better year that 2013, which was seen off with a certain euphoria, too.

We can already note a few positive events in the first two weeks of this year, such as the huge $50 million funding round for the public transportation navigation app firm Moovit. The Australian Square Peg Capital’s plans to invest $150 million in Israeli startups; the closing of the $200 million for the 83North fund by the partners in Greylock Israel, and every day more startups are announcing investments they have received, which already total many tens of millions of dollars.

Many veterans of the Israeli high-tech industry feel the situation has never been better, and predict that 2015 will continue this way.

One of the most significant forces in the web that supports local innovation are the Israeli venture capital funds. his industry has been eulogized before, after many of the older funds provided miserable returns for investors, did not manage to raise new funds and disappeared. Foreign investors entered this vacuum to a great extent, and in recent years have made up 75% and more of the investment capital in Israeli startups.

Nonetheless, after a process of natural selection, a change can be seen in the industry: The Israeli funds – which were involved in the success stories and building large companies, such as Magma Venture Partners and Vertex, which invested in Waze, or Carmel Ventures which invested in Outbrain – have succeeded in raising new funds.

In 2014, 12 Israeli funds raised $914 million – the largest amount in the last six years, according to figures from IVC and KPMG released last week. The level of fundraising has returned to the levels of before the crisis in 2008. In light of the renewed flowering of the Israeli venture capital funds, we will map the main trends that are molding the industry today.

2010 was a tough year for Israeli funds. Under the influence of the global economic crisis, no Israeli fund succeeded in raising any new money – which is critical to fueling young and older startups. Since then there has been a recovery, and 2014 was a record year. Some of the new funds even raised money during Operation Protective Edge in Gaza last summer – a rather impressive feat.

IVC estimates that this year the funds will raise $1.2 billion, and puts the funds available for investment at $1.8 billion. A quarter of this will probably be allocated for new investments, and the rest for existing, and growing, portfolio companies.

‘Full size’ funds

One of the central changes is the return of “full size” funds, those of $100 million or more. This comes after the years following the crisis of 2008 in which the fashion was micro-funds, small funds that raised up to $50 million (and usually less) and were devoted to investments in startups at very early stages, mostly in specific businesses. Now, with the creation of a new generation of mature companies and the recovery of the industry, the average fund size rose by 56% in 2014 compared to 2013, rising to $76 million. Four Israeli funds raised over $100 million each in 2014: Carmel, JVP, Magma and Vintage.

The Israeli venture capital industry has operated in relatively fixed cycles and 2015 marks the beginning of the seventh one. Years such as 2004 and 2008 were considered good years in which a number of Israeli funds raised significant amounts. It is interesting to see that in the present cycle a number of the bodies that led previous rounds have disappeared, and they have been replaced by new funds that have moved to the forefront. Investors who succeed in raising new funds are those that have proved themselves as individual investors, or as groups that can produce results.

The young Israeli venture capital industry, which was born less than 25 years ago, has drawn knowledge, capital and experience from its big brother, the American venture capital industry. Some of the main players were funds that started as local branches of the American funds, and benefitted from their well known American brands.

A central trend today is raising independent funds by the Israeli partners who used to work in the American funds, sometimes under a new name. 83North, for example, announced a week ago it had completed raising $200 million for a new fund. Canaan Partners Israel, established by Izhar Shay, who was the Israeli partner in the global Canaan, and Ehud Levy, who left Vertex, are raising $60-$70 million and have already closed $30 million of that.

The Israeli partners already have the experience, connections with investors and are willing to start independently with the backing of the strong brand known as Startup Nation. This is how they can keep all the management fees for themselves as well as the “carried interest” from the exits.

Industry sources say the local branches pay up to 50% of their management fees and other revenues to their American parents. In addition, the local funds have more freedom and are not limited in their decision making by partners who are far away from the Israeli market, and who are not always interested in allocating resources here.

The major challenge of these funds will be to raise follow on funds based on only their own success, without any support from the American brand they started their careers with.

In recent years, Israeli companies have grown to respectable proportions. Ofer Sela, a partner in the technology division at KPMG Somekh Chaikin, says there are over 50 technology firms operating in Israel today with sales of over $50 million a year. Most are worth more than $100 million. These companies will try to reach the $1 billion level, or more, whether through exits or IPOs. When they come to raise money from foreign investors, the Israeli funds can be proud of their portfolios, says Sela.

“The history of the performance of Israeli venture capital funds is not impressive. The problem is that in Israel there is always potential, but it never fulfilled it,” says a partner in one of the funds that completed raising a new fund this year.

But the maturity of the industry in the past two years may very well improve the results of the funds, which in earlier years were lower than the market indices.

Traditionally, American institutional investors – mostly pension funds and insurance companies – funded the Israeli venture capital industry. European and Asian institutions did so too, but were not dominant and remained behind the scenes. One of the more interesting trends over the past year was the moving of Asian investors to the front of the stage, and in particular the Chinese, a process occurring elsewhere in the world too.

Are the Chinese investors replacing American ones, who have given up because of the low returns Israeli funds have shown over the years? This is not what they think in the industry.

Different money

“The American money comes to Israel in different ways than in the past. There is a lot of money of American funds invested directly by the office in Israel or joining follow on investments – in Bessemer, Sequoia, Greylock ... The [limited partnerships] there invest directly in American funds and not funds defined as Israeli. It is not something to worry about,” says Sela.

As time passes, the question of the added value brought to the local industry by the Israeli venture capital funds becomes more acute.

The network of the Israeli funds is strong, they are not just financial institutions – they have managers and former entrepreneurs who have significant experience, says Sela. But the massive activities of American funds and companies in Israel, including operating accelerators for brand new companies, allows foreigners access, too, to young Israeli firms.

Until a tsunami hits Silicon Valley or the gates of Wall Street close, it seems the growth of the high-tech industry will continue, and Israeli venture capital funds have already proven they are capable of riding this wave of success. IVC says some 19 Israeli investment bodies are at various stages of raising funds and expect to raise $1.2 billion this year.