Thursday, June 13, 2013

Shalom Israel VC 2.0

I spent last week in Israel which was fortuitous timing given Magma Venture Partners' $1.0 billion+ exit for Waze by Google. Congratulations to the guys at Magma Venture Partners for reminding all of us why LPs should be taking a hard look at Israeli VC.  In only four days, you can meet with every single fund in the country and get a pretty good perspective on the market.  A few observations follow...

First, I think that Israel is prime for a wave of big exits. It didn't really start with Waze but with Adam Fisher's Intucell acquisition in February which returned $221 million on an $8 million investment, with Bessemer as the only investor in the Company's Series A in 2011. If you haven't heard of Adam, you should, because he's arguably one of the hottest VCs in Israel and an incredibly nice guy.  Wix, the leading website development site in the world, has filed to go public and is likely going to trade at or near a $1 billion valuation.  Kudos again to Adam Fisher, as well as Michael Eisenberg at Benchmark Israel. This is going to be a massive company and it was spawned out of Israel.  I can count at least seven companies that are doing over $100M in revenue and are all going to be huge home runs for Israeli VCs and their LPs: IronSource, Outbrain, Adap.tv, Trusteer, Conduit, Borderfree and Matomy.  

Second, most of the VCs firms established following the Yozma program of the 1990s' $100 million initiative to seed 10 venture capital firms with $10 million a piece, are mostly gone. Most of the VC firms established in the run up to the bubble took Israeli born entrepreneurs or operators and raised a fund around them.  It's taken nearly fifteen years and two to three funds to realize that the first wave of Israeli venture capital funds didn't work out as well as expected.  A lot of this has to do with the fact that the first generation of Israeli VCs weren't venture capitalists and didn't have mentors who had been there before in what is largely an apprenticeship business.  I think this is why you constantly hear the refrain that Israeli entrepreneurs prefer not to work with Israeli VCs, or at least VCs in Israeli that think like Israeli VCs of a prior generation...  

The Israeli market has moved to a bifurcated world with a few very good local venture firms and a few U.S. firms with dedicated teams on the ground in Israel with dedicated allocations to the country.  In the next three years, I believe we're going to see only four to five domestic funds in Israel actively investing there, with the usual cast of characters from the U.S. investing in Israel with differing degrees of significance (e.g., Bessemer, Lightspeed, Battery, USVP, Accel, Canaan, Blumberg).  What Israel is in need of is a new crop of firms that are Israel-based but have all of their networks for adding value and taking businesses to market outside of Israel. There is no domestic market in Israel (save for the need for Wave's traffic congestion mapping in Tel Aviv - brutal traffic there!) and that has been one of the greatest missing links for a decade in Israel: local VCs who know how to scale businesses in the U.S. and globally.  

Because there is no domestic market in Israel, entrepreneurs have to build businesses that other people need in global markets.  I also think that Israelis have a different view on the world than American entrepreneurs, in part because they all have 3-4 years of extensive training with the Israeli Defense Force (IDF) and in part because they are very hard working, proud people.  A flight attendant on my flight to Israel told me that when you ask Israelis to form a line, they don't queue up in a vertical fashion, but rather a horizontal line with each person being first...  It's a bit tongue and cheek, but also representative I think of the Israeli culture to be outstanding. The greatest export for Israel is its citizens' intellectual property and R&D expertise.  There is a reason why Google, Microsoft, EMC, Intel, HP, Samsung, IBM, Apple, Facebook, Boston Scientific, Cisco, and countless others all have a presence in Israel.  For example, Intel has over 7,700 employees in Israel and built its first R&D center outside of the U.S. in Israel.  Intel has invested over $7.3 billion in Israel and made acquisitions of over $2 billion to date. One of the most important things about Israeli entrepreneurs is that they aren't building a bunch of apps and insignificant iterative innovation like so many "me too" entrepreneurs in the Valley.  Israel is a country of technical engineering entrepreneurs.  

The other important thing I didn't mention about why Israeli is really attractive right now, is that the companies getting started and funded in Israel (at least by the top local VCs) are not what they used to be.  Gone are the funds comprised exclusively of asset-heavy, telco, semiconductor, hardware and comm services deals.  With the global ubiquity of open source, cloud computing, freemium business models and cloud-everything, Israeli entrepreneurs are building the same companies that U.S. entrepreneurs are.  Also, little known fact, but R&D doesn't happen in Israel because the workforce is cheaper, in fact Israel is an incredibly expensive place to hire workers.  Keep in mind, everything is imported there, even the LP capital.  R&D happens in Israel for the Fortune 500 and huge companies are getting built there because Israeli entrepreneurs are incredibly talented and think globally right out of the gate.

One of the biggest hurdles that the next generation of Israeli venture capital funds will have to fix, is the problem of selling too early.  For the past decade, there haven't been that many blockbuster exits because many local VCs have been hesitant to hold for home run, fund-returning exits for fear of not being able to raise another fund and the need to put some points up on the board.  Many of those funds are dying or gone thankfully because Israel needs to and can produce VC funds that outperform the U.S. as long as these funds ride their winners.  Thanks to Alan Feld and Abe Finkelstein at Vintage Investment Partners, they're doing later stage direct secondaries and providing some liquidity for founders to help them pay off their mortgage and bunker down for multi-million and billion dollar exit outcomes.  There is virtually no mezzanine or direct secondaries market in Israel and there should be. The smart VCs who have the gravitas to invest heavily in their winners and are playing for carry and not future management fee royalties on successor funds, are the only VCs in Israel worth investing in.  

Safe is to say, Israel has been smartly overlooked for years, but it's alive and booming and prime for the next generation of young and hungry VCs to become what Israel VC should have been all along.