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| Seeds of Opportunity |
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It's a tough time for Israel. Israel today is not the same country it was eight short years ago. Then, high tech was booming and the sweet fragrance of peace hung in the air. And the world responded. Israel was the world's darling: Israeli know-how, Israeli technology, Israeli ingenuity. The world could hardly get enough.
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 In Israel today it's more than just the dot-com bubble that has exploded. Amid terror attacks and military action, peace accords have been shattered. And the world has responded. Israel has been vilified around the globe as an aggressor and a heartless occupier.
Now, no matter where you go, what you read, what you listen to, or whom you talk to, there are constant reminders about the "situation" — the security situation. Like an unwelcome stranger, its presence is felt everywhere; its influence goes beyond the fear, the heartache, and the tragedy. Ripples from the epicenters of violence flow outward and touch each and every Israeli.
Each attack, each victim takes a deep emotional and financial toll on the State and its people, and some international media suggest that the attacks strike at Israel's very existence.
But, the country's spirit of perseverance, in spite of difficult, wrenching circumstances, remains very much alive. The country does not and has not stopped. Plans take shape, projects continue, and companies move forward.
| | The Capital of Israel |
It's a tough time for our clients.
Raising capital for early-stage companies is challenging in the best of times. Increasingly, discussions turn from "Jerusalem, the capital of Israel," to the crisis of raising capital. The challenges are severe. Good companies are dying, dying before they truly start the real fight for life: entering the marketplace. If capital is the oxygen of business, Israeli start-ups are suffocating. And the implications are chilling.
Pioneering technological innovations have been Israel's economic engine. The know-how and the ingenuity are still there. But, starved of oxygen, gasping young enterprises must raise money in the face of the country's security situation. If these companies do not thrive, if they do not survive, they will produce a ripple effect with potentially dire consequences. Gloomy indicators do not lurk in the shadows. They stand before us: 12% unemployment — higher in some sectors — is predicted by the end of this year. Emigration is up; immigration isn't. High unemployment and lack of growth translate to a reduction in tax revenues. The country's GDP fell 6.6% in the last quarter of 2001. Unable to cut a staggering defense budget, education and social services budgets are being slashed. The Ministry of Education has announced that it is laying off more than 1,000 teachers. In the months, and possibly years, ahead these effects will flow through Israeli society with long-term costs.
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| A Capital Crisis |
The difficulties facing start-ups pursuing pre-seed and seed funding reach beyond the crisis level and on to a more acute stage. Companies that in non-crisis times would have had no problem raising capital at reasonable valuations are now finding it nearly impossible to raise funds at any valuation at all. Last year's "down rounds" have become this year's "down-and-out rounds." The figures are downright depressing.
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In the first quarter of 2002, following an already weak fourth quarter 2001, early-stage companies raised just $6 million out of the $344 million invested by Israeli VC funds, according to the Israel Venture Association (IVA). That's less than 2% — hardly the breath of life.
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| | | Of the $2 billion in Israeli VC funding in 2001, early-stage companies "could muster only 5 percent of the total funds," the Israel Venture Capital Journal reported in their March 2002 report. That figure represented an enormous reduction from early-stage companies' 10% share of 2000's $3.1 billion.
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| | | Consider this: Early-stage companies' share of funds invested dropped from 10% in 2000 to 5% in 2001 and fell below 2% in the first quarter of 2002; from $300 million to $100 million to...
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These statistics reflect current investment trends: Investors prefer later stage companies to seed, lower risk to higher risk, the nearly known to the unknown. This approach is understandable given the current state of affairs, but if the geese aren't fed, they won't lay any golden eggs.
Israel's technological innovations; its bounty of scientists, engineers, telecom, and biotech experts; and its pool of entrepreneurs preserve the country's reputation as a center of inventive ideas and expertise. Many of those ideas have successfully made the transition from concept to market; many more need an infusion of capital to get beyond the drawing board. Without the funding, they'll remain just that — great ideas.
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| Opportunities Amid Confusion |
The "surprising" first quarter results announced on 14 May — a 2.4% jump in GDP — were trumpeted in Ha'aretz because they "completely contradicted the forecasts, which by and large projected further economic deterioration in this quarter." But take a closer look: It's consumer purchasing motivated by fear of higher prices resulting from a drop in value of the shekel, concern over inflation, and the government's stated intention to raise taxes.
Another pleasant April surprise was a "pop" in venture funding to $145 million, a substantial increase over the first quarter monthly average of $115 million. Again, take a closer look: Larger sums were invested in a smaller number of companies, leaving less money for the youngest of companies.
Trendlines hears the frustrated refrain of the lack of VC funding from its clients whether they are incubator projects or established corporations. With our nearly 10 years of work in Israel's capital markets and an understanding of the country's business and financial communities, we see the quality of the deal flow improving while our clients increasingly experience the lack of cash flow.
That foreign investment is crucial to Israel is beyond dispute. This year, and likely for the year to come, the influx of total foreign investment dollars will be smaller. For start-ups, the bucket is banging against the bottom of an almost empty well. But for the overseas investor who can stand a bit of European antagonism, a smidgen of political difficulties, and some traditional Jewish angst, opportunities abound.
Truly, the future of Israeli technology is not bleak, not at all. We need to be forward-looking. These are the days for investing; these are days for buying, not for selling. Israel's high-tech infrastructure is firmly in place, and there are good projects and managers who can maneuver through the early stage. For some, the capital crisis represents a singular opportunity. Deal flow abounds and access to many of the best opportunities (that in the past were offered only to the leading venture firms) is possible at favorable valuations.
For the opportunity to be harvested later, the seeds must be planted now.
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The Trendletter team welcomes your comments.
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Todd Dollinger
Managing Director
The Trendlines Group
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