During the first half of 2015, mergers, acquisitions and initial public offerings by Israeli companies pumped a record $5 billion into investors’ pockets, creating an atmosphere of celebration that everyone wants to join.
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The dream of investing in a startup that will be sold for a billion dollars, like Waze, or even for tens of millions of dollars, is the gold rush of our times. But despite the enticing headlines, investing in startups is a complex, high-risk business that’s only for people with patience and money they can afford to lose.
TheMarker examined for whom startup investing is appropriate, what are the risks involved, how one gets access to interesting investments and what alternatives there are for those who want to enrich their portfolios with technology investments, but with a lower risk.
Whose can invest in a startup?
In principle, startup investments are open to anyone; in fact, it’s common for a startup to raise its initial capital from what the field refers to as FFF – friends, family and fools.
What’s important to know before making such an investment?
Startups are for gutsy investors who love to take risks. Headlines about huge exits are misleading; the overwhelming majority of companies will not be great successes. The rule of thumb among experienced and professional venture capitalists is that of every 10 startups, three or four will fail, three or four more will return the original investment, and only one or two will bring significant returns.
The reality may be even worse: According to a study by Shikhar Ghosh, a senior lecturer at the Harvard Business School, three of every four venture-capital-backed startups never return their investment. Among companies that don’t raise money from venture capital funds, the results are even worse.
Companies that are not venture-backed fail most often within the first four years of their existence, usually because they don’t have the required capital to continue operating, Ghosh says.
According to a study published in January by the high-tech research company IVC, of the 10,000 startups established in Israel since 1999 that it examined, only 480 succeeded (by the IVC’s criteria, which include acquisitions) and 46 percent failed. Of the more than 5,400 companies still active today, only 139 companies are defined as successful – about 2.5 percent. In other words, the Israeli startup success rate isn’t for those with weak stomachs.
“People with capital, like those who made a lot of money in real estate, want to invest but don’t always understand high-tech,” says attorney Simon Weintraub, a partner in the Yigal Arnon law firm who specializes in finance, mergers, acquisitions and venture capital in high-tech and the life sciences. “There’s no doubt that there are a lot of risks, and we have to protect the rights of investors.”
He adds that private investors who invest in a company in its early stages often have an opportunity to cash in even before the firm is sold, by selling their shares in the company to an investment fund that steps in at a later stage.
How do you reach interesting Israeli startups?
One of the main challenges facing private investors willing to take the risks is identifying interesting opportunities. There are a few places worth checking. The first are equity crowd-funding platforms, which enable investors who meet certain financial criteria to invest in startups in return for shares in the company. (A typical criterion for eligibility is having 12 million shekels [$3.15 million] in liquid capital to invest.) Platforms operating in Israel include PrivatEquity.biz, OurCrowd, iAngels and AltaIR, which have created a secondary market for startup shares.
The advantage of investing through these platforms is that the due diligence process on these companies has been performed in a professional fashion, which reduces the risk. Another advantage is that these platforms have a unified contract with the target companies, so there is no need to negotiate the terms of the investment.
Another way to find out about investments is through events at which startups present themselves, including competitions and demo days, at which companies that are alumni of business accelerators present themselves. It’s wise to get to these companies at an early stage, before they mature, because the terms will be better and the company valuations lower.
Professionals who are in regular contact with startups, like lawyers and accountants, can also connect investors and companies. Friends and family may also have knowledge of startups. In the virtual community established by the Aleph venture capital fund, one can register as an investor (stating the size of your planned investment and your interests) and be contacted by relevant companies. One can also register with the Angelist website as an investor or join an investment syndicate through the website.
Are there any tax benefits for startup investors?
In 2010 the Angels Law was passed, which aimed to encourage private investors to invest in high-tech startups. The law, however, was worded in a way that makes implementing it impossible, particular for those investing in Internet and media companies, which tend to develop much faster than, say, hardware or life sciences companies. The law has been returned to the cabinet for revamping a few times, and is once again with the cabinet for further tweaking.
Under the new version, one will not have to wait three years to establish whether the company meets the criteria for an innovative company that invests in research and development, has most of its outlays directed to R&D, and does most of its production in Israel, among other criteria. The new version is expected to pass by the end of the year.
How can one join a venture capital fund?
Today most Israeli venture capital funds are closed to individual investors. The funds raise most of their capital from large institutional investors, and most of the money that reaches Israeli venture capital funds comes from abroad.
There are a few funds, mainly smaller ones managing only tens of millions of dollars, that do solicit capital from private investors, but even these are not open to the general public, only to individuals with substantial resources who can invest relatively large sums and are somehow connected to the funds’ partners.
Naturally, anyone who thinks himself suited to investing in a fund that is at the fundraising stage can contact its executives to discuss it. One can also invest in the few Israeli venture capital funds traded on the Tel Aviv Stock Exchange, such as Maayan Ventures and Xenia, but to date this model has yet to prove itself.
The TASE is looking into setting up public venture capital funds that individuals can also invest in. These funds will operate along the model of mutual funds, TASE officials say. These funds will be able to invest in public technology companies here and abroad, as well as in smaller private companies. This track is expected to become available next year.
So how can one get into technology investments?
An investor seeking to benefit from the fruits of the startup nation but who also wants to reduce his risk can choose more solid investments in the field, like investing in public Israeli or foreign technology companies. Instead of investing in a trendy but risky startup in the field of cybersecurity, one can invest in one of the Israeli information security companies traded on the stock exchange, like CyberArk, Imperva or CheckPoint.
One can invest directly in companies, or in indices or certificates linked to Israeli technology companies, like the Tel Aviv Tech-Elite index or the TA BIGITech index, which the TASE announced in March and includes Israeli technology companies or those that are connected to Israel and are traded in Tel Aviv, New York or London.
The TASE is taking other steps to expand its available tech offerings. In recent years it has liberalized regulations for R&D firms. The TASE is also preparing to list companies at earlier stages than what is customary on Wall Street. If these processes succeed, local investors will have access to more tech firms.
What new options are expected?
The Knesset is in the process of advancing legislation that would open the startup field even further to individual investors who don’t have oodles of money.
Under a bill originally sponsored by former MK Avishay Braverman, which has been merged with a government bill, companies will be able to raise up to 2 million shekels from a large number of investors without being considered public companies (the law currently defines any company with more than 35 shareholders as a public company). This would allow investors to sink as little as a few thousand shekels into a technology initiative.
“Naturally, to protect the average citizen, there will be restrictions on the amount of such investments and the type of such investments people can make in this format,” says Aviram Zolti, the Economy Ministry’s deputy chief scientist for commercialization and investments. “Under the new regulations, the chief scientist will have to ensure that such initiatives meet certain criteria to be sure it’s a real technology initiative and not fraud.
“The chief scientist, of course, will not in any way be able predict or make a recommendation regarding the initiative’s success or its economic potential,” he continues. “The risks are clear. The chances of a tech initiative’s success are not great. In contrast to more solid investments, investors can lose all their money. That’s why the mass-funding format will have protections for small investors.”
According to Zolti, as part of this initiative a Web platform will be set up to connect investors with new projects.