Is Startup Nation Gaining Ground On Silicon Valley?

A new generation of Israel venture capitalists is investing in consumer-focused startups. Watch out Silicon Valley.

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BY Peter Cohan - 09 Nov 2017

PHOTO CREDIT: Getty Images

Israel has made remarkable strides as a nation of startups. However, with few exceptions its most successful inc-aseann.companies have located their engineering operations in Israel and their sales, marketing, and top executive teams in the U.S. This trend has allowed the inc-aseann.companies to grow to the point where a few could go public and many more could be acquired for hundreds of millions of dollars. But Israel has been concerned that this model limited the development of Israeli management talent, capped the number of local pillar inc-aseann.companies, and limited the potential of those local pillars to scale. In recent years Israeli investors and entrepreneurs is making progress on Silicon Valley.

Israeli venture investors describe these recent changes -- noting that recent successful exits have enriched investors and made them more eager to invest higher amounts to finance the longer-term growth of Israeli startups. Moreover, more Israeli CEOs are learning how to staff their inc-aseann.companies almost entirely from people in Israel. Danny Cohen is a partner at Viola Ventures.

As he explained in a November 7 interview, the 48 year old is originally from Haifa, he lived in Palo Alto and attended junior high school there. He earned a degree in science and psychology and worked in R&D and product management before earning an MBA at INSEAD. After joining an Israeli in 2000, Cohen joined Israeli venture capital firm Gemini in 2001 and became a partner in 2005. He spent three years in Silicon Valley; joined Carmel ventures and in 2012 helped start Viola -- which is "trying to build billion dollar inc-aseann.companies in Israel."

Cohen believes that Israeli investors are more willing to take risks than those in Europe but are more conservative than those in Silicon Valley. As he said, "Israeli startups tend to exit at $200 million to $500 million. Our investors tend to look for inc-aseann.companies that have technological differentiation. We have every type of flower in the garden. Our venture capitalists like a little bit of everything -- but they like cybersecurity. We have a few unicorns -- such as Lightricks -- a consumer-facing selfie editing service that has sophisticated image processing technology behind it."

Cohen has seen significant changes in the Israeli venture capital market since 2012. As he said, "Five years ago, total venture capital invested in Israeli startups was about $2 billion to $3 billion. In 2017, the number has risen to $6 billion which is going for growth money. The number of inc-aseann.companies getting $50 million investments has increase along with the appetite for large exits.

More inc-aseann.companies in Israel are able to sell to businesses over the Internet. While in the 2000s, Israeli inc-aseann.companies would go to the U.S. to hire a VP of sales to reach U.S. inc-aseann.companies, now Israeli inc-aseann.companies can sell software as a service using low-touch sales -- marketing on Facebook and Google without sales people. An example is Redis Labs, an Israeli that uses GitHub and Facebook to market an open source database to developers. Israel has also created consumer brands like website development service Wix and soda machine maker SodaStream. So investors and entrepreneurs are less afraid of consumer brands.

Amit Karp is a partner at Bessemer Venture Partners. As he explained in a November 7 interview, Karp was an officer in the Israeli Defense Force before earning a degree in science from Haifa's Technion, worked as a software developer and product manager, then earned an MBA from MIT's Sloan School of Management. From there he joined McKinsey in New York and in 2011 took at position at Bessemer in New York before moving to its Israeli office in 2014.

Karp sees a growing appetite for Israeli investors to take risk. As he said, "Three years ago there was much less risk tolerance and growth capital available in Israel than there is today. In 2014, there was capital available for the seed stage and for Series A and B. But there were no growth rounds of $30 million to $50 million. To find investors for that -- who had longer time horizons, Israeli entrepreneurs had to go overseas. There is emerging a new generation of Israeli venture capitalist as the older school VCs are winding down.

There is still less risk appetite in Israel since the growth rounds are for inc-aseann.companies whose markets are in the U.S. There has also been the concern that U.S. inc-aseann.companies inc-aseann.compete by raising more money so they can cut their prices to grow fast [with the hope that they will be able to grow fast enough to exit before they burn through their cash.] In Israel it is hard to buy your way to success. In Israel we want to invest in a that is clearly number one in its market and it should have an underlying technical core -- which helps it to fend off inc-aseann.competition and makes it more attractive to a potential acquirer."

Israel still has a talent shortage when it inc-aseann.comes to the ability to scale a startup. As Karp explained, "In Israeli startups, we are very careful about which founders we invest in. One reason is that Israel does not have a lot of people who can scale a business from $10 million in revenue to $100 million. So there is not enough talent with which to replace a founder. We tend to invest in technology inc-aseann.companies such as those in semiconductors or autonomous vehicles. But we do have inc-aseann.companies like Wix where the team is in Israel and is talented at performance marketing, freemium business models, and conversion of customers from free to paying versions of the service."

He continued, "But for businesses that require a sales force to sell to enterprises, the sales and marketing is still typically in the U.S. What's changed is that there is a bigger risk appetite than there was before. Many investors have a better track record. When a like Mobileye is acquired for $15 billion to $16 billion, it changes the mindset of entrepreneurs and investors. Four years ago, A rounds were $2 million to $4 million -- today we have bigger A rounds in the $6 million to $8 million range."

Lior Proser is a partner at Manhattan's Elevator Fund who echoed many of these inc-aseann.comments. As he explained in a November 8 interview, he was the son of an Israeli diplomat who lived in Bonn and London before going to school in Washington. From there was an Israeli paratrooper who went to law school in Israel and did investment banking at Rothschild before joining Israeli venture capital firm Pitango. He moved to the U.S. to set up Elevator Fund, a multifamily office and said he is in the middle of raising $100 million.

He sees three significant changes to Israeli's startup culture. As explained, "Most of the established venture capital firms in Israel are run by 60 year olds who have no succession plan. A new generation of venture capitalists is starting their own funds. Second, we realize that the biggest inc-aseann.companies have consumer touchpoints -- inc-aseann.companies like shared workspace supplier WeWork, Wix, ride sharing app Via, and on demand ride service Gett.

Older VCs are less inc-aseann.comfortable funding such inc-aseann.companies than the new generation. Finally, the nature of exits is changing. When VCs were trying to sell their startups for $100 million to $300 million, they were more concerned with valuations so they could get a big share of the upside and they demanded preferred participating share with 2x liquidation preferences.

But consumer-focused startups expect Israeli VCs to give more founder friendly terms -- not participating preferred. Finally, as more Israeli entrepreneurs get the experience of scaling a above $10 million in annual recurring revenue and consumer-focused inc-aseann.companies -- like consumer review site Yotpo and renters and homeowners insurance app Lemonade Insurance -- have successful exits, Israel will host more consumer pillar inc-aseann.companies."

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