Above: The curse of the small company
Israel’s start up economy is hotter than ever. But a question haunts entrepreneurs there: Why are Israeli start-up hits generally so small? Where is their version of Instagram, the Silicon Valley-based photo-sharing company that Facebook just bought for $1 billion within 18 months of its launch?
That was the question of debate during my visit to Tel Aviv two weeks ago. It’s not quite as bad as the Curse of the Bambino that haunted the Red Sox for 86 years, but the baseball analogy is apt: Israeli entrepreneurs are hitting base-hits all year long but they can’t seem to get into the World Series. In fact, they’re hitting lots of home runs, and occasional grand slams. Taken as a whole, Israeli entrerpreneurs are an awesome team, perhaps the best in the whole world league. Look at CheckPoint Software, the early security company, now publicly traded and valued at $12 billion. Or ICQ, the early instant messaging service, sold to AOL in the 1990s, and which inspired a generation of IT entrepreneurs. I’ll say more about Israel’s prowess shortly.
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The good news is, Israel’s start-up ecosystem is still very young, especially in the area of the consumer Internet. Many entrepreneurs and investors I talked with vow things will change, but they caution it could take at least five or more years.
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For now, though, several factors have conspired to keep Israel’s hits relatively small. Local venture capital firms, and some more engrained elements in Israeli culture, play a role here. Several entrepreneurs put it this way to me: The country started out poor, and still has far less wealth than other nations. It’s also small, and is surrounded by hostile neighbors. These factors push entrepreneurs to go for the small, safe bet.
Arye Schreiber, an entrepreneur who picked me up at the airport in Tel Aviv during my first visit to Israel (I attended the Innovation Marathon event hosted by BootCamp Ventures), explained to me that many entrepreneurs curtail their aims from the outset. If they can make a few million dollars first, that reduces the risk going forward, even if it means continued entrepreneurship. “Ask someone on the street, what’s the Israeli dream?” Sharon Tal, another entrepreneur asked me rhetorically. “They’ll say: It’s to open a start-up, sell it after one or two years, and become a multi-millionaire. Every small kid will say, ‘That’s what we want.’ … People are after the exits here. They’re less interested in building an established company and making money for the long-term.”
Israel is a country on fire with entrepreneurship. After I got back last week, I read the 2009 book about Israel’s start-up ecosystem, Startup Nation. It lists some amazing stats: There are more entrepreneurs, venture capital investments, and research and development per capita in Israel in than any other country in the world — and by a large margin. A unique mix of the Jewish chutzpah gene, bonding by engineers during service in military units, the high priority on education, a strong Zionist drive, and the influx of diverse talent among Jewish immigrants from Russia and elsewhere — all have created an entrepreneurial culture that is second to none. Israel has more Nasdaq-listed companies than any outside country outside of the U.S. (…continue reading)
Above: Dinner in the West Bank
However, the size of the results, in terms of dollars produced per company, and per dollar investment, lags behind other regions, including the U.S. and Europe.
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When Israeli companies exit, they do for smaller amounts of money. Israeli companies raised about $4.2 billion in venture capital in 2009-2011, with exit values of about $7 billion in that same time frame by Israeli venture-backed companies. That compares to Europe, where venture-backed companies raised $18 billion and had exits of about $40.7 billion, and the U.S., which raised $86 billion and had exits totaling $194 billion. So while European and U.S companies returned well above 2X the amount they raised in the time frame, Israeli companies returned about 1.6X. What’s more, Israeli companies actually had more exits per company funded, so the amount per exit is far less in Israel than in other countries.
The data comes from Dow Jones, which compiles the best stats on venture capital and exits, and this data is very similar to the data offered by Israeli research group IVC. To be clear, the data does include companies that are founded by Israelis, and which continue to have an office in Israel, but where the headquarters have since moved abroad. Now, I certainly realize that this data could be skewed by the specific timeframe selected. But even if you take the years 2001-2008, you’ll see that Israel’s ROI was just slightly more than 1x (Israeli companies raised $13 billion, and returned $14.7 billion), whereas Europe returned more than 1.5x (raised $51 billion and returned $88.5 billion), and the U.S also returned more than 1.5x (raised $226.5 billion, and returned $381.7 billion). By the way, there’s been plenty of discussion of the period between 2001 and 2008, but I checked that out, and it turns out it was based on faulty data by all sides. Some were trying to include data from the year 2000, which is not a good year to include. That year was a bubble year, and most of the value created by exits then were quickly lost. I’d argue 2001-2011 represents a balanced decade for measurement.
So what else is behind this tendency for Israeli entrepreneurs to sell quick and small?
Well, having so many companies and entrepreneurs is itself an indicator of the challenge. By default, if you’ve got a culture that encourages entrepreneurship, it’s harder to get other smart people to join your company. “Anyone who is an engineer starts a company,” explains Eisenberg, the Israeli venture capitalist with Benchmark who hosted me at his winery, in a good blog post on this subject last year, “making it more difficult to find engineering and product talent with which to scale companies.” More entrepreneurs end up going it alone and staying small. And if you’ve already beaten the averages on the actual number of startups created, there’s just no guarantee you’ll do better on the outcome side. Indeed, the vast majority of startups in any country end up failing. But even here, Israel does ok. Take the years of 2009 to 2011. For every venture-backed Israeli that reached an exit, there were five companies that got funding in that same period. In the U.S and Europe, for every company that reached an exit, there were six companies that got funding. In other words, Israeli companies exited at a better rate, during that time frame. So to be clear, I am not doubting the success of Israelis. Instead, this essay is attempting to hold Israelis to a higher standard: They’ve done very well, but can they go really big?
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I don’t know if that’s a fair question. This is a very small country, with just 7 million people. So consumer Internet companies haven’t been Israel’s specialty. Fast-growing, megasized companies — the Googles, the Facebooks, the Zyngas and Instagrams — tend to be consumer-facing. And while you can argue that technology knows no borders, and in theory it doesn’t matter where a company is based these days, it’s indisputable that the U.S., specifically Silicon Valley, still has a natural advantage as a base for big consumer plays. Not only is the entire U.S. market a natural default target, entrepreneurs surrounded by ambitious and experienced peers here are quickly programmed to think big from the beginning. YouTube and Instagram show you don’t need to make any money at all to be successful. Few, if any, other markets have truly appreciated this difference.
Also, Israel only recently entered the Internet and digital media industries. “We have not matured in that area yet,” says Danny Cohen, a partner at venture firm Gemini Israel Funds. He, like others, points to promising companies like Wix and OutBrain. But these companies need a few more years to grow.
But Israel has excelled at other, deeper technologies in the area of chips and security. (Incidentally, Israel’s military, a source of many of Israel’s top entrepreneurs, didn’t help matters when it standardized on an older software stack, leading with Microsoft. Benchmark’s Eisenberg argues this is why it’s so difficult to find programmers focused on the newer, more dynamic Ruby on Rails.)
Another cause: Israeli investors. “Investors do not hold on long enough. They sell early,” Eisenberg told me, echoing what others said. Israeli venture firms have been good at fostering early innovation, but not at the scaling part. Part of that is because Israel’s VC industry is so nascent; it first emerged 1993. Starting with smaller funds, they’ve remained small, and are more focused on raising their next funds, so they don’t have as much experience in scaling companies.
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Israel remains engineer-heavy, and is relatively weak in sales and marketing — another ingredient key to scaling. Overall, entrepreneurs and VC firms simply find it more difficult to grow. They then need to make the step abroad to continue their growth, but that adds time and complications. For whatever reason, Israeli VC firms are struggling. In 2010, local VCs did not raise any money at all, leading one VC to write that the local start-up industry was “heading for collapse.”
Why, if logic tells them that “holding” is going to lead to a bigger exit down the road, are Israel VCs unable to hold? Eisenberg responds with the following bullet points:
- Israel in general is a place of short term thinking. It is true in politics as well as in planning.
- Local VCs are always concerned about raising next fund, so they try to put “runs” on the board.
- They can’t imagine that companies can scale. You should see the reaction here to Instagram deal — people were saying it is stupid to pay up for photo app. No understanding of scale.
- 7 million people in a country makes you think smaller than a country of 300 million people.
- VCs in the past were really inexperienced. U.S. VCs have changed the dynamic entirely.
Of course, Eisenberg, who represents a U.S. venture firm, may be biased, but his views ring true. And the arrival of scores of new investors could be about to change the game. Back to Sharon Tal, the entrepreneur with the hot social gaming company DragonPlay. Just last week, when he raised a large $14 million round of capital, he did so from Accel, he said, because of its perceived ability to help him scale. He bonded well with the Accel partners, and even before doing the deal, those partners introduced him to contacts at Facebook and other key companies. Moreover, Accel has experience backing big players in mobile and gaming, including Rovio, Admob and Amobee, which also impressed him. “I realized that if I wanted to get big, and then sell company or go to IPO, I needed some professionals with me, mentors, people who could help me with business development,” he told me. His company was seeded in 2010 by Entree Capital, a London-based firm. (…continue reading)
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The limits of local money, and arrival of foreign money, is felt everywhere. Just look at some of the latest news on Israeli deal activity. Of the exit returns that are going to Israel, Israeli VC firms appear to getting little of the action. The biggest exit recently was Cisco’s acquisition of video software company NDS for $5 billion. Started by a group of ten scientists in 1988, NDS was sold within four years to the U.S. based News Corp for a mere $15 million. London-based private equity firm Permira subsequently joined News Corp in taking a significant stake. So when NDS finally realized its full value, most of the value went to foreign owners, not to the entrepreneurs. Then there’s the pending IPO by Objet, a leader in 3D printing, with an expected market value of $500M [Update: Less a day after publishing this story, Stratasys, of Eden Prairie, Minnesota announced it is acquiring Objet for $1.4 billion]. It marks continuation of Israeli dominance of wide-format printing. However, that company too was also founded long ago (1999), and the majority shareholders are all external entities, based in the U.S. and the Netherlands (its largest investor is Elchanan Jaglom, an Israeli who lives in Switzerland).
Meanwhile, foreign capitalists, seeing the opportunity in Israel, are pouring in at a very fast rate. During my trip, I bumped into a hedge fund investor, who requested anonymity because of SEC guidelines around fundraising, but who is in Israel prowling for local opportunities. He told me Israeli opportunities are like manna from heaven. In the U.S., he combs through hundreds of deals, but competition had bid valuations to stratospheric levels. “It’s a ***ing miracle if you can find a decent company,” he told me. In Israel, valuations are lower. Acquisitions in the $150-$200M range seem to be happening weekly, he said. One of his most recent investments, he said, has now gotten four offers at a price that could peg it at about $150M, a year after investing. “That’s a ten bagger in less than a year,” he said.
Foreign investors now outnumber local venture investors in making new investments into local companies. A foreign firm, Innovation Endeavors, led by Google’s Eric Schmidt, is leading the pace with eight fresh investments last year. Last year, Apple acquired Israeli flash memory controller startup Anobit Technologies $390 million, with Israeli firm Pitango Venture Capital sharing the win after investing early in the deal. A majority of the late-stage funding, however, came from outside investors, including from Battery Ventures and Intel Capital.
This all is great news for Israeli’s hoping for more grand slams. People list a number of other companies they hope are aiming to go big. There’s Conduit, founded in 2005, backed by Benchmark, which offers publishers toolbars and mobile apps. Conduit last week was reportedly valued at $1.3 billion after an investment by JP Morgan. And then there’s Better Place, an audaciously ambitious electric vehicle company, started by former software executive Shai Agassi. Agassi surprised everyone four years ago, when he left the software giant SAP, where he’d been seen as a CEO-in-grooming. He wants to equip electric vehicles with replaceable batteries, saying this is the only way to make all-electric vehicles viable in the short-run. He’s raised $750 million from investors — mostly foreign — to start with national projects in Denmark and Israel. Agassi claims to have spent almost $500 million, and says that’s helped create jobs in Israel. There’s mobile ad company Amobee, founded in 2005 by Israelis, which patiently built its business, expanded to the U.S, and sold in March for $321 million, with foreign investors again being the sole backers. Imperva, started by Shlomo Kramer, the co-founder of CheckPoint Software, one of Israel’s early big successes (and one of the few, if only, companies that managed to scale), went public late last year, and is now valued at over $800 million, after raising $53.7M from outside investors.
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Granted, not all investors see Israeli’s lack of big exits as a problem. Ed Mlavsky, considered one of the founders of the Israeli venture industry, after he set up Gemini Israel Funds in 1993, says bigger companies become sclerotic; he lists slow-moving mobile giant Nokia as an example of something Israel should avoid. Moreover, Israeli entrepreneurs tend to go on to form new companies 35 percent of the time, compared to 5 percent for U.S entrepreneurs — something he and others have ascribed to a Zionist penchant among entrepreneurs, i.e, that they’re starting companies for the good of Israel. Also, Mlavsky counters the notion that Israeli engineers — because of limited management and sales experience — are unable to scale. Something like 80 percent of entrepreneurs in Israel are still in control of their companies at the time of acquisition, he said. However, one could argue that the reason entrepreneurs are running their companies so long is precisely because they were unable to figure out a way to truly scale, and so exit at modest valuations. Indeed, Mlavsky’s argument that small is good is considered a cop-out for others. Zohar Zisapel, a well-known investor and entrepreneur, argued at the Innovation Summit that Israel does need bigger companies — they’re better for the overall economy because they employ more people.
My own thoughts on this are as follows: It’s only a matter of time before Israel gets its Google or Instagram. Until now, the odds just haven’t been in Israel’s favor. With thousands of companies launching every year in the U.S and Europe, the odds are simply higher that hits will happen in those larger regions first. But Israel is such an entrepreneur-focused country, and the distribution of money and experience is being flattened and democratized at such a fast rate, that there’s nothing stopping Israel’s success flowing outside of its borders in a bigger way. If Israelis start believing they can be big, and then planning for it, I’m sure their time will come.
[Update: Here’s my separate piece about the 35 Israel startups that presented at the recent Innovation Marathon event in Tel Aviv]