At Top Tier Capital Partners (TTCP), we seek to invest in the best venture capital managers throughout the world. While assessing our portfolio weighting, whether by sector or geography, the team at Top Tier evaluates the risks associated with each of our managers, from market dynamics to personnel changes. Historically we have not invested directly into Israel, however, coming out of TTCP’s most recent trip to Israel, we are now more bullish on Israel than before as we risk-adjust performance across venture capital regions.
When evaluating Israel in the past, we have found a lack of performance when ranked against other regions like the U.S. and China. The LP community expected successful Israeli-backed companies to ultimately relocate to the U.S. and seek funding from U.S. managers, therefore eliminating the need to invest directly in Israel. As for the funding landscape, consolidation among Israeli VC firms coupled with the instability of the economy and infrastructure caused by conflict have deterred outside investors.
A lot has changed in the country and many of the aforementioned negatives have been mitigated or eliminated. TTCP has seen performance improve, companies acquired without moving to the U.S., VC consolidation in the region, and the venture market become more stable. Additionally, the venture industry within Israel has matured to a level deserving of investment. Here are some of our thoughts on the transformation:
Venture is Growing Up
There are now 6,000 start-ups in Israel garnering funding from a new generation of venture funds made up of both spin-outs from existing firms and new VCs. In 2014, there was $3.4Bii of venture capital investment in Israel, second only to Silicon Valley. Venture funds affiliated with U.S. brands have slowly started to rebrand: Benchmark Israel has become Aleph; Greylock Israel has become 83North; and Canaan’s Israel team has raised their own dedicated Canaan Israel fund, to name a few.
The venture ecosystem that exists in Israel is undergoing an evolution. The market has historically been small and domestically focused, failing to attract outside attention. More recently, entrepreneurs have emerged throughout the country to the point that entrepreneurship was recently described by one VC as “Israel’s National Sport.” The cycle has flourished when entrepreneurs have seen their peers gain success, which entices them to start a company of their own. As more companies see successful exits, more VC and Angel dollars enter the ecosystem and the cycle continues. Over time, we expect more and more successful founders to pay it forward, and the ecosystem in Israel will benefit.
Government Backing Start-Ups
Conscription exists in Israel for all citizens over the age of 18, resulting in the majority of citizens serving in the military at some point. Military veterans are taught to overcome obstacles and withstand constant changes and less than optimal working conditions, preparing them for the hard work and long hours associated with entrepreneurship. In addition to training the entrepreneurs, the government offers IP created by the military up for use by all citizens (as long as the result is not for military purposes). Because of this, the vast majority of start-ups in Israel have some military connection. Noise cancelling technology, time release medicine and GPS tracking were all instances of technology the military created and then made available to others to develop into companies. Within this market, the military has helped numerous companies by putting its resources into the creation of technology.
A number of factors contribute to keeping valuations low in Israel: lower expectations, less competition for deals, and less hype for Israeli companies than of Silicon Valley based companies. VCs on the ground have noted that the companies in Israel with pre-money valuations of $3-$4 million would yield valuations of $15-$18 million in the U.S. An added benefit in the region is that companies can do more with less capital. Cheaper labor and affordable office space have led to companies remaining capital efficient. Companies can last longer on less investment, leading to greater payoffs for early investors who are able to avoid dilution after investing less money for more ownership.
As exit values have been increasing, and the quality and quantity of deals has improved, it is possible for local VCs to yield a 3x fund. In fact, when looking at the performance of our indirect exposure through our underlying managers, Israel has emerged as our best performing region. Multi-national corporations (“MNCs”) have also seen their own model work. MNCs (i.e., Google, Facebook, and Intel) have acquired companies at rapid pace, opening R&D offices in Israel furthering the scouting process for the next big companies within the region.
Herzliya is Silicon Valley 2.0
In Herzliya, there is a tech campus that emits a Silicon Valley feel. Engineers are in all of the restaurants and coffee shops talking about the newest technologies and gadgets. VCs are located in the middle of the campus, in one of four buildings, akin to the close proximity of Sand Hill Road. The mood on the street was the most similar to Silicon Valley that we have seen; accents from all over the world talk of the newest trends or gadgets and the culture has started to accept failure in the same way the Bay Area tech scene has, promoting its business people to develop new business ideas and raise venture funding. A majority of the locals we spoke to wanted to start a company, have started a company, or are working for a start-up.
The Top Tier Perspective
It is the combination of all of these factors that have helped make Israel an attractive potential investment for LPs looking to invest internationally. This culture, acceptance of failure, support of the government, strong university and MNC presence, and existence of venture capital and liquidity makes for an extremely attractive market dynamic.
TTCP has not invested in an Israel-focused fund to date but is actively monitoring Israeli funds given the positive trends and high performance. We believe Israel could produce risk-adjusted returns that are higher than other markets thereby making Israel an attractive “emerging market” to supplement our current exposure to more mature markets such as U.S. and Europe. Our intent is to watch the region closely with the intent of potentially investing in a local Israel fund over the next 12-24 months.