Reprint Permission from Aspatore Inc., All Rights ReservedSummary Bullet Points
The venture capital process in Israel is very similar to the United States. There are a few dozen active venture capital funds which make investments in technology startups identifying emerging market opportunities. Limited partners are mainly institutional investors from the United States and Europe. Exits are made through IPOs in Nasdaq and M&A transactions.
The major players are venture capital funds and entrepreneurs. U.S. and European venture capital funds are active in the market, typically co-investing with Israeli funds. Many entrepreneurs come from elite defense R&D units and established high-tech companies. Most leading corporations, including Intel, Microsoft, Motorola, SAP and IBM, have R&D centers in Israel. Plus, an entire system has been developed to support the VC sector - legal advisors, accounting firms, financial advisors, investment and other related businesses.
Major investors include foreign institutional investors such as pension funds and funds-of-funds. Israeli institutional investors are not significant forces in the market. (Most of them started investing in 2000 and were badly burnt.)
The legal and financial system around the industry is very advanced; laws and regulations are similar to those used in Western developed economies and are fully transparent. Foreign investors are exempt from income tax on their profits. In addition, there are numerous financial support vehicles available to startups and high-tech companies, including participation in R&D by the Office of the Chief Scientist of the Ministry for Trade and Industry, funding from the Bi-National Israel-U.S. R&D fund and government loans or tax exemptions for high-tech companies.Connecting With Investors
The best way for entrepreneurs to access VC funds is by introduction through someone the fund knows and trusts. This is not difficult, as Israel is a very small community. It is relatively easy to find someone you know who knows the person you want to approach. Founders and CEOs of our current and previous portfolio companies often refer entrepreneurs to us. (We are very active, hands-on investors and, as a result, have very close relationships with most of our portfolio companies- founders and management teams.) Our network also includes the big accounting firms, legal firms, executives of high-tech companies and other Israeli and non-Israeli venture capital firms. We also look proactively for promising companies through trade shows, publications and information we receive from our portfolio companies.
Industry specific professionals - very talented technologists - tend to be the core people who receive VC funding - Israel has very strong technologists. Experienced business people and management talent, on the other hand, have been traditionally lacking. Even so, experienced executives are the preferred type of entrepreneurs in Israel. In the past, Israeli venture capital firms supported inexperienced entrepreneurs who, they believed, had potential for becoming successful. Today, more emphasis is put on having an experienced team from day one.Making Deals
We look for exceptional entrepreneurs and strong management teams who know the target market and sizable market opportunities that, over time, will grow to over half a billion dollars. We also look for a protected niche, which the company can lead and dominate. Technology that provides high barriers to entry is also important.
Valuations change according to market conditions. We look at comparable deals (in terms of stage, size and attractiveness of the market opportunity; quality and completeness of the management team; defensibility of the technology and the level of risk) and assess the financial plan. How many financing rounds will be needed before reaching an exit? What are the expected valuations of those rounds and what is the expected valuation at exit? From this analysis we determine the proper valuation for the deal.
Term sheets are similar to the ones used in the United States, although more like those used on the East Coast than on the West Coast. Key areas to watch on term sheets are valuation, protection and the ability to intervene if the company does not perform.
Incentives for management team members are also similar to those in the United States. We typically establish an ESOP pool, which we replenish in subsequent rounds. Typically, all employees receive options in the company, with the amount depending on their seniority and individual contribution. These pools were re-established in recent years, as options were often diluted to almost zero because of down-rounds.
We try to identify major risk areas and evaluate the magnitude of the risks and plan to mitigate them. But, at the end of the day, early-stage investments are largely based on intuition.Role of the Board
A company's board of directors is very important. The role of the board varies, however, according to what each company needs. We perform an entire spectrum of activities: monitor the development of the company; serve as a sounding board for the CEO and challenge his assumptions; help in formulating strategy; assist in developing the business model; help provide access to strategic partners; plan financing rounds; introduce the company to leading U.S. funds; recruit VPs and CEOs; and, when required, plan and execute an exit.Timeline/Exit
It takes five to seven years to develop a company. Development takes two to three years; initial market penetration takes one to two years; and revenue ramps up another year or two. As early-stage investors, we know that one needs patience - this is a long-term game. Exit opportunities depend on the public market situation (mainly Nasdaq). This means we may end up waiting additional time for the markets to open, even after the company is ready for the next level. In later-stage investments, the time to exit is, of course, shorter.
In general, we expect to provide top quartile returns to our investors. When we evaluate a specific opportunity, we expect it to be able to provide a five- to ten-fold return, if successful. Our strategy is to identify potential winners and help them become one. Once they are successful, they do not really depend on the timing of an IPO and can wait for the right public market conditions.
The main ways to exit an investment are through an IPO in Nasdaq or an M&A transaction with a global company. Israel has the largest Nasdaq-listed pool of companies outside North America. Companies such as Texas Instruments, Microsoft, Lucent, Marvel, Broadcom, Siemens, Cisco, IBM and others have acquired Israeli companies. Israeli startups have also gone public in London, Germany and Switzerland.Current Philosophy
We invest only in Israel. We have relative advantage there. We do not want to compete with the best U.S. funds in their own territory.
Israel is now recognized as a valid market for venture capital investments. As a result, we see a growing interest by foreign parties in this market. More U.S., European and even Asian institutional investors are evaluating or targeting Israel for investments as limited partners. More global corporations are actively seeking partnerships, technologies and acquisition candidates in Israel as well.
Some U.S. and European VC funds, such as Benchmark, Sequoia and Apax, have set up local shops in Israel. This means closer integration of the Israeli VC market with the other markets and more competition for deals. There is currently more cooperation between Israeli funds and foreign funds than in the past, as the foreign funds typically look for a strong local partner, especially in early-stage deals.
Many entrepreneurs approach us or are referred to us by others. U.S. funds refer companies that approach them directly for our review. We also look proactively for promising entrepreneurs and companies, trying to meet them and establish relationships well in advance of a financing round.Looking Ahead
Israeli startups tend to be successful in selling to corporations and service providers but not in mass marketing. They tend to be strong in areas where the technology is complex and difficult to copy. Therefore, I believe that in the next five years, Israeli VC funds will continue to invest in new companies targeting opportunities in semiconductors, telecom, datacom, software platforms, wireless infrastructure, life sciences and possibly some new areas - nanotechnology and homeland security.
Israeli companies are not pioneers of new industries. They excel at identifying a change or an opportunity in an existing market and responding to it. They will probably find such opportunities in all of the markets mentioned above.
The main impact of the return of economical growth will be better times for the sector. It will be easier for start-up companies to raise financing. It will also be easier for them to sell to their customers, which will increase their spending so that they will be less conservative and more willing to procure from young companies. As the IPO market opens up, there will be more and more successful exits and M&A transactions. The returns of VC funds will improve. We-ll see more money flowing to VC firms and a renaissance in fund-raising.
Unfortunately, the VC business is cyclical and tightly linked to the financial markets, which are also cyclical. As more money flows to VC funds, a surplus will be created at some point. Valuations will then rise. Late-stage investments will make less sense and late-stage investors will be pushed to early-stage investing. There will be a negative effect on returns.
I believe that 2004 and 2005 will be good years for investing. From 2006 onward, we may again see an imbalance of VC demand and supply, to the disadvantage of venture capital firms.Strategies for the Future
As the market develops and matures, we will see more and more experienced executives founding new companies. They will be more professional in the way they approach venture capital firms. They will study the various VC funds to identify the ones that fit them best; they will prepare better business plans, based on more reasonable expectations; and they will focus more on building a financially viable plan, which can get the company to profitability with a limited amount of financing. Founders of companies should also maximize their cooperation with strategic partners to allow quick access to the market, with limited resources in sales and marketing.
Venture capital firms will have to be able to demonstrate to experienced entrepreneurs that they can bring value to their companies. The General Partners will have to be senior executives who have had successful careers in the high-tech industry and are experienced in business development, strategy, sales and marketing and high-level management. VCs will need to further develop their networks to cover all relevant resources that portfolio companies will need access to.Keys to Success
The three keys to successful venture capital deals in Israel are as follows:
My advice to companies is to look at a venture capital firm as a potential partner. Select the VC that you believe will be the most trustworthy in good times and in bad (and there will most certainly be bad times), and that can really bring you value. Valuations themselves are secondary.
Matty Karp, Managing Partner
Matty Karp, co-founder of Concord Ventures, is a leader in the Israeli venture capital industry.
Previously, Matty served as President of Nitzanim Venture Fund and CEO of Kardan Technologies. Prior to joining Nitzanim, Matty spent fifteen years at Elbit Computers, a leading Israeli high-tech company with worldwide activities in the defense and healthcare sectors. His most recent position at Elbit was Corporate Vice President for Business Development, Marketing and Sales and Head of the Systems and Products group.
Matty has led investments for Concord and has served on the board of directors of Galileo Technology (NASDAQ: GALT), acquired by Marvel (NASDQ: MRVL), Accord Networks (NASDAQ: ACCD), acquired by Polycom (NASDAQ: PLCM), Saifun Semiconductors, Wintegra and other companies.
Matty holds a B.Sc. cum laude in Electrical Engineering from the Technion Institute of Technology and is a graduate of the Harvard Business School Advanced Management Program. Matty served as a jet fighter pilot in the Israeli Air Force.
About Concord Ventures
Concord is widely regarded as one of Israel's leading venture capital firms. In 10 years of investing, Concord has nurtured over 50 companies. Concord is one of the few early-stage, hands-on investors in the Israeli technology market.
Concord's first venture capital fund, Nitzanim, is widely considered one of Israel's most successful venture capital funds to date. Two of its companies, ESC Medical and Galileo Technology (acquired by Marvel), exceeded $1 billion in public market value in the "pre-bubble" years.
Concord's management team is comprised of executives with extensive business and operations management experience. Leveraging their extensive industry experience gained prior to becoming venture capitalists, the partners are very active on the boards of directors of all the companies in which the Concord funds invest. The partners have close relationships with the CEOs and management teams of the portfolio companies, and Concord emphasizes building strong networks with Israeli and non-Israeli industry leaders and venture capitalists.
Areas of Specialization
Concord specializes in the following target sectors: