Country Focus: Despite Slowdown and Violence, Israeli VC Market Remains Confident –

Appetite for risk has dried up Silicon Wadi, the cluster of young Israeli technology companies fueled by international venture dollars. The slowed investment pace mirrors the tech meltdown worldwide, say Israelis venture capitalists, an economic reality that has little to do with the security crisis that has gained international headlines since February.

“We do not have to walk in lexicographic order,” said Dr. Avishai Braverman, president of Ben-Gurion University of the Negev in Be’er Sheva. “When we have security problems, we know we have to work simultaneously on other issues. The security issue will be resolved and the peace process will move forward. Meanwhile we’ll move on the reforms to make Israel attractive for investors.”

Ray Rothrock, a general partner with Venrock Associates, said his firm has executed 2 deals in Israel and politics didn’t figure in any of them. “The violence is troublesome, but people have grown up with it and life goes on largely unaffected,” he said. “Our strategy with regard to Israel has not changed at all: Fund really good technology-based applications either with U.S. headquarters or a company that’s a little farther along with no revenue and no product.”

Following the Six-Day War in 1967, after which the French government began to limit the supply of weaponry and military technology to Israel, the Israeli government launched a policy of technological self-reliance in defense-related industries. When the government itself began incubating high-tech start-ups in 1991, the Israel Defense Force already had created a generation of entrepreneurs through elite intelligence units specializing in network security and Internet support systems.

Engineers began to spin technologies out of military research projects, just as the climate for VC began to climb meteorically, said Ezra Zuckerman, associate professor of strategic management at Stanford Graduate School of Business. In 1990, virtually no VC had reached Israel, but by 1999, the figure had ballooned to $1 billion, then $3 billion by 2000 – with firms like Sequoia Capital and Benchmark Capital peppering the landscape.

Indeed, the U.S. capital markets infused liquidity into Israel’s technology sector during the late 1990s. More than 120 Israeli companies were listed on the Nasdaq in 2000 – placing it third after the U.S. and Canada. Last year, Israel ranked second in the world in the number of high-tech start-ups per capita, noted Zuckerman. Much of that steam was generated by foreign capital sources like Venrock and Apax Partners.

While venture investment in Israel surged to an all-time high in 2000, investment in Israel’s technology sector slowed with that of Silicon Valley during the first quarter of 2001, according to Israel Venture Capital (IVC). Based on a survey of 87 VC funds active in Israel, IVC found that during the first quarter 117 private Israeli companies raised $447.4 million from both foreign and domestic VC sources. In the previous quarter, Israeli start-ups raised $797.5 million from investors, a drop of 44%. Year-over-year, VC raised by Israeli companies declined 31% from $645.2 million during the first quarter of 2000.

Strong companies that have long attracted the attention of investors – seed- and early-stage companies working with compression, Internet, imaging and security technologies – continue to woo VCs.

As with the U.S., business conditions for young technology companies are worrisome: liquidity has abandoned the U.S. IPO markets, capital expenditure is down and VCs themselves are retrenching inside existing portfolio companies. Early-stage investing, then, continues at a steady pace, but companies out for mid-stage rounds of venture financing – a segment in Israel dominated by U.S.-based venture firms – has slowed.

Like their U.S. counterparts, Israeli start-ups are coming to market for mid- and late-stage round of financing at lower valuations.

“People are investing in seed deals still, but companies in the middle stage, the limbo stage, are struggling,” said Micah Avni, partner with Jerusalem Global Ventures. “There’s significant problems for companies in that limbo stage, B round or C rounds, and we’re seeing those companies doing significant down rounds.”

The shakeout is hitting weaker companies, but VCs working in Israel seem unwilling to abandon their position – believing it is business as usual and testifying to the strength of Israeli’s core technologies.

“We’ve heard no stories of people pulling out of Israel,” said Eric Grossberg, an associate with Jerusalem Global Ventures. “Broadly speaking, VCfirms are sticking to their core competencies and not over-extending themselves.”

At the same time, optimists like Braverman are sure that when the market begins to rise, venture capital investment in Israel will return to 2000 levels and the country will emerge as a dominant entrepreneurial force in the knowledge economy.

“Given the decline in the Nasdaq and the American markets, some slowdown in economic activity is to be expected,” he said. “It’s times like these to start looking for new opportunities. Israel still remains the place for knowledge capital in high-tech, biotech and medical technology.”