Stagnant market may mean trouble for local VCs in 2008

Additionally, a VC Indicator survey indicated a change in VC sentiment to the most pessimistic levels in five years.

By MATTHEW KRIEGER
Despite the country's status as a world leader in technological ingenuity, industry leaders predict that Israeli start-ups in 2008 will not succeed in raising more than the $1.7 billion in venture capital seen generated this year, as advances in international competition draw increasingly more capital away from the local market. "I do see a lot of difficulties ahead as funds can't raise the needed money. And while the opportunities are there from the high number of start-ups that are producing great technology, I think that the amount of foreign competition will hurt the local market," says Joseph Fellus, senior partner, and the hi-tech practice leader and advisory leader of PricewaterhouseCoopers, Israel - Kesselman & Kesselman. "In 2007, we saw more or less $300m.-400m. in venture capital raised each quarter and I think that in 2008, it will be the same, maybe there will be slight growth, but not a huge amount." Dr. Orna Berry, chairperson of the Israel Venture Association, tells the Post she expects no increases in the local VC market, predicting that local and foreign VC funds will invest a total of about $1.5b. in 2008. Dr. Ed Mlavsky, chairman and founder of Gemini Israel Funds, one of Israel's largest VC firms, thinks a number of funds will close in 2008. "There is an automatic slowdown when a fund invests all of its money and I don't expect it to be much different than this year. There is a lot of competition against Israel and as the international competition gets stronger, it attracts more money away from here," Mlavsky tells the Post. He believes, however, the historical trend of local and foreign venture capital investments being almost evenly split will continue. "Historically, there has always been between 45 and 50% of all money that goes into local VC coming from Israeli VCs and the rest from abroad. This has stayed pretty constant, but it is pretty difficult to predict, and I actually think that there will be a drop-off from abroad as the competition here continues to rise," Mlavsky says. "There are many more choices from abroad, but local VCs have been raising more money. I suspect that domestic sources will increase as foreign capital drops." In contrast to Mlavsky, Fellus expects to see more foreign venture capital injected into the local market as local VC funds struggle to raise money. "I think that more foreign investors will invest directly in Israeli start-ups and less local money [will be invested]." Additionally, Fellus expects the number of initial public offerings by local companies to increase in 2008. "In 2007, I think that there were less than 10 IPOs from local companies and we will see more exits in 2008, as a number of companies have waited to be more mature," he adds. According to the VC Indicator Survey, released in late October by the accounting firm Deloitte Brightman Almagor and conducted among the country's leading VC firms, 81% of those surveyed believed that Israeli companies that go public on Nasdaq tend to do so too early. Additionally, the VC Indicator survey indicated a change in VC sentiment to the most pessimistic levels in five years as 33% of respondents believed the overall economic climate would worsen over the last quarter of 2007 and over the first three months of 2008 while just 17% believed the economic climate would improve over the same time period and 50% predicted no change. "With venture valuations on the rise for quite some time, more venture capitalists are worried that we are in a much-hyped market. These fears are accompanied with a negative shift in the overall economic climate expectation and might indicate that it is time to be a bit more careful and cautious in the coming months," said Asher Mechlovich, partner and head of the Technology Media and Telecommunications industry at Deloitte when the survey was released. Yet, as 2007 comes to an end, Ze'ev Holtzman, chairman of the IVC Research Center and Giza Venture Capital, is optimistic. "Third quarter figures indicate 2007 may set a five-year record with hi-tech investments reaching $1.7b.," he said in the IVC's summary of third-quarter capital raising. "In order to complete the positive picture, we hope that the intensive investment activity will be expressed in substantial exits of over $500m. in the upcoming year that will enable the Israeli VC industry to show significant returns on their investments." In the third quarter of 2007, said the IVC summary, 108 Israeli hi-tech companies raised $414m. from venture investors - both local and foreign. The quarterly amount was 9% above the $381m. raised in the third quarter of 2006, but down 5% from the $436m. raised in the previous quarter. In the first three quarters of 2007 Israeli hi-tech companies raised $1.256b., 10% above the $1.145b. raised in the corresponding period of 2006. Over the quarter, Israeli VCs invested $9m. in nine foreign companies, compared to $6m. invested in foreign companies in the third quarter of 2006 and $18m. invested in the previous quarter. All nine investments were follow-on investments. In the first three quarters of 2007, Israeli VCs invested $36m. in foreign companies. Ofer Nemirovsky, managing partner, HarbourVest Partners, speaking at the Globes Israel Business Conference earlier this month, said that while these are impressive numbers, in order to achieve real growth, Israeli venture capitalists must increasingly look outside the local market. "Most venture capitalists here focus on software. It's impossible to have a $1b. IPO from software companies. They need to focus on cleantech and alternative energy - this is where they will make tremendous returns," he said. "They need to think more globally. My advice to Israeli venture capitalists - you need to continue to think globally, you need to know what is being sold around the world, you need to invest more on your own and less with partners." Mlavsky, meanwhile, widely recognized as one of the founding fathers of the local hi-tech and venture capital market, suggests that the key for Israel in maintaining its standing as the world's second largest VC market also rests with foreigners, but with a twist. "Our best public relations is from the foreign companies who continue to set up operations here," he says. "We need better publicity that you get more bang for your buck here - those who have come here can say it the best - that will allow small companies to lure big money."