Why Is Israeli Venture Capital So Unpopular in Its Home Field?

Pitango, Israel’s biggest fund, just raised $270 million from backers as far afield as the Far East, but the participation of locals was minimal

International investors recognize the potential of Israeli high tech, says Rami Kalish, co-founder of Israel’s largest venture capital firm Pitango Venture Capital, but local Israeli investors are not nearly as enthusiastic. "We would be happy if Israel institutions adopt a strategy of more exposure to the field of private equity in general and to its venture capital element," Kalish says.

Last Wednesday, the senior partners in Pitango, which has raised $1.6 billion to date, met with reporters to discuss, among other things, the firm's new $270 million fund, which it completed raising early this month. This is a relatively thriving period for Israeli high tech, as expressed by several large exits and a considerable number of companies on their way to initial public offerings.

"The opportunity for venture capital funds is growing, because the markets are growing and there are more members of the middle class in the world using more technology," says Chemi Peres, another co-founder.

"Pitango is marking 20 years of investing activity," says Peres. "Until now, we've invested in over 180 companies. Beyond the business side of things, we see this as building an economy in Israel geared towards exports and technology, the economic pattern in which we think Israel needs to lead."

But the presence of Israeli investors in Pitango's new fund is minuscule - only two institutional investors and two private individuals - and their share in the fund is marginal. This, despite efforts made in recent years to induce Israel's financial institutions into investing in local venture capital funds.

"There is a problem in how the institutions perceive venture capital funds: We can tell them with certainty that until now the investors in our funds haven't lost money," says Peres. "It could be that in funds from a difficult crop, such as the year 2000, they'll see unexciting returns, but they don't lose money. In any case, there's a perception of venture capital as risky and irresponsible. You can't say we're clipping coupons: We've been working hard for 20 years and contending with many crises.”

"Today, we're seeing new entrepreneurs with outstanding abilities, such as we haven’t seen before," says Peres. "A cultural change has occurred: The race for the exit has changed. People want to build value and markets are much bigger. A wise use of the Internet is closing the gaps between Israeli and U.S. companies: If you have a good product, you'll get enormous resonance on the Internet. All in all, to not invest in venture capital somewhere is to be out of date – a bit backwards."

"At the institutions, too, there is appreciation for what's happening in the Israeli high-tech industry and the role of venture capital funds," says Kalish. "They apparently need to undergo further change and understand that the commitment in these types of assets is for the long run. Venture capital is perhaps one of the least risky fields, because, historically, good funds are making money - but it takes time because you're building value: You start with nothing and end up as a company worth hundreds of millions of dollars. This isn't quick financial manipulation: It takes time."

First investors from Asia

Along with veteran Pitango investors, who make up the lion's share of the new fund, new investors from the Far East have made an enrance. Their entry enabled the fund to deal with a shrinkage in venture capital investments by U.S. institutions following the global economic crisis.

"When we set out to start the fund in 2012, we saw that some of the investors had left the game completely, some had decided to reduce the amount they invest and the rest aligned themselves with specific groups of assets," explains Peres. "It was definitely different from previous fundraising campaigns: A different process, entailing more thought and strategy and less leaning on the Western side. We followed a strategy of bringing in investors from the East. This was a conscious decision, with the understanding that many of the companies will require assistance in the East."

Over the past five years, Pitango has invested efforts in forging strategic contacts in China, India, South Korea and Taiwan - and now these relationships have ripened to produce investments in the firm's new fund.

"Asia is a growing market that has become more relevant to our portfolio companies," says Aaron Mankovski, a managing partner at Pitango. "The U.S. market is important and will continue to grow, but as global investors, we need to look at the markets and we see in the East the opportunity for revenues for our companies. Our investors are interested in investing in Israel and in Israeli funds in order that they can help when the companies reach China – the same model we had 20 to 30 years ago between Israel and the U.S."

The largest exits

"An increase can be seen in company valuations in the latest exits," says Peres. "The founders are now taking the companies to higher values and building substantial companies. When we look towards 2014, we see a fair number of Israel companies coming out with public offerings. This is a change in the trend, after relatively few public offerings in the past few years.

"Revenues and significant growth rates are needed in order to reach the league of traded companies," Peres says. "Some companies follow a dual track, during which they'll receive substantial buyout offers. It is quite hard to turn down offers like those for Waze or Trusteer. Of the companies in our portfolio planning an offering, some have rejected attractive acquisition offers."

"There are two prominent trends," explains Isaac Hillel, another managing partner at Pitango. "One is that the number and size of exits are on the rise. Since we sold Anobit Technologies for close to $400 million, there have been deals like Waze for a billion. The values and quantities are rising. The second trend is that large companies leading in their categories are being formed. In Israel's high-tech market, 15 to 20 companies can be found with sales reaching magnitudes approaching $100 million a year. This hadn't been the situation in the industry for a long time. When companies reach such a stage, it gives them the strength and security to make a stock offering. Therefore, I believe that in the next 18 months we'll see about 10 companies planning to float shares."

Hillel points out that the hot fields for investing in the next few years, reflecting Israeli capabilities, will be software infrastructure, big data, Internet and ad tech. He also foresees resurgence in an area that until now hasn’t attracted venture capital in Israel: consumer goods and the Internet of things – technologies linking objects to the web.

Within the framework of its new fund, Pitango has set up a program for expedited seed investments averaging $250,000 in early-stage startups. Peres says Pitango will try putting half the investments into early-stage ventures and the rest in late-stage companies.

Motti Kimchi