With the phenomenal one-billion-dollar sale of Waze, the opening of Facebook’s first research and development center in Israel and a record number of startups sold in merger and acquisition deals or floated on the stock exchange, 2013 will go down as a milestone year for the country’s high-tech industry.
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But the surge has served to paper over the gradual decline in financial resources at the disposal of Israel’s venture capital industry over the past decade. The industry, whose demise was predicted just two years ago, is managing to chalk up high returns on the wave of profitable exits, but it is struggling to raise new capital.
“Israel’s venture capital sector will thrive for the next 10 years in a way that has never been seen,” claims Zeev Holtzman, founder and chairman of research firm IVC Online and of Giza Venture Capital. “The investors, 95% or more of them foreigners, will earn loads of money. Israeli startups in which local funds are investing are operating in today’s most attractive technological fields.”
However, Holtzman doesn’t foresee a resurgence of Israeli venture capital. “Israeli VC funds are in a slump in terms of the amount of capital managed,” he says. “Only a handful will manage to raise new funds in the next year or two. Foreign funds will fill the resulting vacuum.”
A presentation by IVC reveals a complex picture. On the positive side, there has been a distinct growth in investment. IVC predicts investments by VC funds and other investors in Israeli startups will reach $2.2 billion in 2013, compared with $1.9 billion last year. The total amount generated by exits involving VC funds will reach $4.9 billion, up from $2.8 billion in 2012, which itself was considered a banner year.
IVC also points out a dramatic improvement in the ratio between the proceeds earned from exits and the amounts invested, estimating transactions worth $10.2 billion for 2011 to 2013, 1.6 times the amount of venture capital invested. In the U.S. this ratio is 0.71. The difference can be partly explained by the fact that 93% of Israeli exits occur through mergers and acquisitions, whereas in many U.S. companies investors cash out via an initial public offering.
“The performance of Israel’s VC sector shows improvement compared to four or five years ago,” says Holtzman. “I believe the ratio between total M&As and total investments will improve. The scale of acquisitions by multinationals in Israel is on the rise and, as a result, the performance of funds investing in Israel will improve.”
IVC also points to a growing presence of Asian investors, both individuals and corporate, particularly from China and South Korea, such as Huawei Technologies and Samsung. The fact that Apple and Facebook have set up their first local R&D centers attests to the worldwide appreciation of Israel’s innovative powers.
“The news is that we’re also attractive on the financial level,” says Koby Simana, IVC Online’s CEO. “The returns here are good. While companies are sold for lower sums than U.S. companies, they also raise considerably less money.”
Less initial investments
“We are starting to see Israeli companies being built up to considerable size and much larger success stories,” says Erez Shachar, a founding partner at Qumra Capital, which is now raising money to launch a new fund. “It’s not one exit or two that suddenly made headlines but three consecutive years of serious M&A activity and IPOs at advanced stages. Without a doubt, we’re making genuine headway here." Shachar and Boaz Dinte left Evergreen to establish Qumra Capital, which earlier this year said it had raised $40 million towards its first fund, which is expected to start investing at the beginning of 2014 in late-stage growth companies.
One of the less positive figures in IVC’s presentation shows a drop in capital available for investment among Israeli VC funds, that is the difference between the capital they have raised and the amount they have already invested in their portfolio companies. In the years 2010 to 2013, the $600 milion raised in each of those years by Israeli funds is identical to how much they invested. This means that the number of investments that they will be able to make going forward will have to shrink, unless the trend changes.
“The amount of money available for initial investments in startups is in sharp decline,” says Holtzman. “This means that startups, particularly those which will want to do a first round of funding for $3 million to $5 million, will have a hard time doing so. Money for early rounds is in relative shortage.”
There has also been a reduction in the number of active Israeli funds. According to IVC data, the number of Israeli active VC funds fell from 50 in 2005 to 27 this year.
Holtzman foresees a bleak future for Israeli VC funds, with the main victims being the young companies looking for their first round of investment. “The big challenge is getting the foreign funds, which mainly invest at later stages, to increase their investments in early stages,” he says. Holtzman anticipates that within several years 95% of investments in Israeli high-tech will be by foreigners, compared with 73% today.
“Israel’s high-tech sector will continue expanding, but the Israeli element will be greatly reduced,” says Holtzman. “This is because some of the foreign financial institutions have cut back on their venture capital allocations, including their investments in Israeli venture capital. Another reason is that Israeli financial institutions don’t invest in Israeli venture capital.”
Simana, however, is more optimistic. “It’s a passing phase,” he insists. “The period of new investments raised by funds in the 2007-2008 harvest has ended. Due to the debt crisis over the following two to three years, the funds weren’t very successful in raising money. Now a window is opening and we’re seeing new funds. I believe the good older funds – those involved in recent exits that have showed their investors nice returns – will raise further capital. At the same time, we are seeing attempts by new investors to create funds. Some will succeed, even though it’s a difficult environment.”
The existing situation will affect a group of Israeli VC firms – old and new alike – that are in the process of raising capital for new funds. Among the established funds are Carmel Ventures, Vertex Venture Capital, Gemini Israel Ventures, Giza, and Jerusalem Venture Partners. The group of new players trying to enter the arena includes Qumra, Moshe Lichtman’s and Haim Shani’s Israel Growth Partners, and Pangaea Capital Partners. New funds are also being established by Sharon Kedmi and Shalom Simchon and by Pinchas Buchris and Eden Bar Tal.
“Ultimately, it doesn’t matter much whether an Israeli or foreign fund invests in an Israeli company in terms of creating value for Israeli high-tech or the Israeli economy,” says Shachar. “A strong core of funds with a strategy of continuing to invest in Israel is needed, and I think it exists. This includes funds like Sequoia Israel and Greylock Partners Israel. These are funds dedicated to Israel and managed by Israelis located here and investing.”
Like many in the industry, Shachar complains about the absence of Israeli financial institutions. “One of the biggest missed opportunities for Israeli industry and Israeli pensioners is the fact that Israeli VC funds are actually foreign, because the investors behind them are overwhelmingly foreigners,” says Shachar. “When you look at an amazing exit that the whole world gets excited about, like Waze, you see that the share ultimately reaching Israeli financial and pension investors is negligible. It all goes to European or American investors.”
The absence of Israeli financial institutions also affects the abilities of Israeli funds abroad, claims Shachar. “When raising money the question always comes up – mainly among uninvolved investors – why there is no local support for the industry. The fact that the investment institutions invest in funds abroad certainly doesn’t help.”