Israel’s Venture Scene Heats Up Again –

When Shuly Galili, executive director of the California-Israel Chamber of Commerce, leads a dozen U.S. and European venture capitalists on a three-day tour of Israel later this month, they’ll find a landscape of budding startups between the deserts and beaches.

After a three-year drought of venture capital, investors say deal flow and fund-raising in the region are up, and there’s enough emerging technology to sustain a boom. Seed-stage companies stand to gain the most, and if recent history is an indicator, then mid-stage companies will likely benefit, too.

“Despite the geopolitical issues, despite the decline in the global markets, the companies who always benefited from investing in Israel continue to invest,” Galili says. “Lots of international venture funds active in Israel are increasing their activity there. I want to be optimistic and say the trend will continue.”

Israel continues to attract investors and technology developers because of its highly educated workforce and government-sponsored research, which startups often leverage to create commercial applications from military technologies.

The country boasts 145 Ph.D.s for every 10,000 people vs. 85 doctorate holders per every 10,000 people in the United States. And Israel spends $260 million annually on academic scientific research, according to Israel’s Ministry of Foreign Affairs. Add corporate and government research programs into the mix and Israel spends 2.3% of its gross national product on R&D. More than 60% of that goes into the electronics industry, a broadly defined category that includes telecommunications, data communications, medical electronics and defense systems and software.

Combat Sandals?

The nation also pours unknown millions into military R&D each year, resulting in inventions that trickle into commercial applications. For example, venture-backed startup RichFX uses video compression technology developed for the military to entice consumers to buy sandals at Neiman-Marcus’ online boutique.

Israel’s combination of talent and government-supported research has not gone unnoticed by the world’s technology companies. Intel Corp. maintains a research facility there, as does Hewlett-Packard and IBM. In fact, an Israeli team developed Intel’s Centrino wireless chipset. All these factors create a climate ripe for entrepreneurs and investors.

Now that the stock market is coming back and corporate spending is up, venture capitalists are coming out of the dark. This time around, investors see seed-stage opportunity. There is $1.5 billion of uninvested venture capital sitting in Israel, half of which is earmarked for seed-stage investments, according to the IVC Research Center, a research firm based in Tel Aviv.

Last year 372 Israeli companies (37 of them seed-stage) raised $1.01 billion in venture capital, according to an IVC survey of 125 investors that included 66 Israeli venture capital firms and 59 foreign investment groups. In 2002, 352 Israeli companies (110 of them seed-stage) raised $1.1 billion.

Bullish about Israeli startups, a growing number of venture firms are raising new funds targeting the region. Ten Israeli venture firms are in the market raising new funds.

“We forecast they will succeed in raising $1 billion in 2004,” says Zeev Holtzman, chairman of IVC. “Therefore, we foresee an increase in the pace of technology investments in light of the more buoyant capital markets in Israel and abroad.”

That doesn’t even take into account the interest from investors who aren’t based in Israel. In March the New York State Common Retirement Fund committed $200 million to private equity investment in Israel, including a $100 million investment to anchor Los Angeles-based Markstone Capital Partners’ $250 million fund. Accel Partners has earmarked part of its $510 million European fund for Israel. Motorola Ventures put a man on the ground in Israel last year, so did Nokia Ventures, leading to one new investment. Greylock is said to be making a new push into the country’s wireless sector.

The pace of investment is picking up. Adam Fisher, a principal with Jerusalem Venture Partners in Israel, report that his firm has closed two deals since the beginning of the year, investing in one early-stage materials company and a later-stage enterprise software one. Micah Avni, a general partner with early stage investor Jerusalem Global Ventures, says his firm is negotiating term sheets with three seed-stage companies. One of those startups has “literally been coding in their garage for the past two years,” says Avni says. “They are signing an OEM agreement in parallel to the funding. It puts the thrill back in the business.”

Deal flow, too, is on the rise. Enterprise software, network security, data storage and wireless technologies are generating the most interest.

“We have not seen stronger deal flow in years,” says Tali Aben, a general partner with Gemini Israel Funds in Palo Alto, Calif. It plans to close three deals in the first quarter.

Venture capitalists are also reporting some activity in life sciences, especially in the formation of new medical device companies. For example, Glucon, a 3-year old Tel Aviv startup developing non-invasive glucose monitoring devices for diabetes patients, raised its first round of venture capital in January. Investors in the $13 million deal included Israeli firms like Giza Venture Capital, InnoMed Ventures (JGV’s life science fund), Infinity Venture Capital and a strategic investor from Japan. Another life sciences company, Fluorinex, has developed a gel to prevent cavities. That company, based in Nazareth, closed a $100,000 seed round in February financed by NGT Incubator.

“People have been sitting on the sidelines cooking up ideas and waiting to better understand the market dynamics,” says Aben of Gemini. “Now there’s an awakening in the venture capital market.”

At the height of Israel’s technology boom four years ago, 513 companies raised $3.09 billion. That figure fell steadily over the next three years, in tandem with a decline in U.S. venture capital markets. Israel’s Internet startups were the hardest hit. While 102 Internet companies pulled in $330 million in 1999, just 14 Internet companies raised $41 million last year.

Israeli investors responded like their U.S. and European counterparts – by sorting through their portfolios and sustaining only those companies believed to have a real chance of surviving the downturn. VCs continue to look for previously funded companies that show promise.

Identify Software, for one, closed a $15 million round in February that included commitments from Israel’s Star Ventures and Evergreen Partners, as well as Intel Capital and UBS Capital. It’s the second round of capital that Identify has raised since it was re-launched and renamed in 2000. Founded in 1996, the company raised $20 million from venture capitalists before it shifted its focus away from software developers’ tools to launch a system that allows IT managers to monitor and troubleshoot across an entire enterprise network.

Take a Second Look

“There’s an abundance of later-stage deals out there,” JVP’s Fisher says. “They’re companies with initial revenue that somehow survived the boom and bust, and they’re now ready for financing at valuations that look like early-stage deals.”

Mid-stage rounds like the one for Identify account for the bulk of Israeli venture capital deals. VCs put close to $500 million into 127 Israeli mid-stage companies last year. (Mid-stage companies grabbed 47% of the overall funding pie.)

Investors seem to be heading on a similar track this year, putting $47.2 million to work in second and third rounds. These include companies like Discretix Technologies Ltd. of Herzliya. It raised $9.5 million in a series B round co-led by Israel’s Pitango Venture Capital and Silicon Valley’s Accel Partners in February. The company makes chips that provide security for wireless devices and protect them from viruses. Another, OpTier Inc. of Ramat Gan, closed a $7.5 million series B round in February led by Silicon Valley-based Lightspeed Venture Partners. Its technology secures online transactions.

Companies like Discretix and OpTier are just a taste of what venture capitalists are planning for this year. In February EyeBlaster of Ra’anana closed its first round of funding with an $8 million commitment from Insight Venture Partners. Although it is the company’s first time in the venture capital market, the company was attractive to investors because of its maturity. EyeBlaster has been in business for four years, has offices in 10 cities across the globe, and 500 advertising agencies use its technology to create online displays.

“A lot of companies are gaining traction with customers and are looking at increasing their revenue in the upcoming year,” Fisher of JVP predicts. “Investors will get a better feel for [these startups] over the next 12 to 18 months.”