Israeli VC Cools Down As Tensions Heat Up

While political tensions have reached a fevered pitch in Israel, the amount of venture money being disbursed there has significantly dwindled over the past year, says a recent PriceWaterhouseCoopers survey.

Indeed, venture capital investments dropped in 2001 to $1.6 billion, just half the amount VCs had disbursed in Israel a year earlier.

Adding to the dismal picture, 36% of the 76 venture funds that participated in the PWC survey didn’t invest at all in the nation during the last quarter of 2001. Just 17% of the survey participants had refrained from investing in Israel in Q4 of 2000.

At first blush, some cynics would likely believe that the happy-go-lucky VCs who insisted they would go on investing in Israel despite the political strife had finally figured out that even the almighty dollar isn’t strong enough to fend off the effects of the civil turmoil that can wreak havoc on operational facilities and disrupt business.

Actually, nothing could be further from the truth, said Charlie Federman, a partner with Fort Lee, N.J.-based BRM Capital, a venture firm that invests primarily in early-stage communications and infrastructure companies in Israel. The firm also has offices in Jerusalem and Herzelia, Israel, as well in Pleasanton, Calif.

“Oftentimes, the venture market does the best investing in the future when today doesn’t look so good,” he said.

So why the tremendous drop-off in investing in the country last year? The answer, Federman said, is that the slowdown the U.S. and Israeli venture capital arenas experienced was strikingly similar.

We know that in the U.S., 2001 was a year when VCs spent more time and energy nurturing their existing portfolio companies or shutting them down than ferreting out new deals. Well, it may not come as much of a surprise that VCs in Israel were doing the same.

“Many funds planned to make two rounds of investment in a company and take it public or get it sold,” Federman explained. “With the change in the market, those companies required three or four rounds. Therefore, with many venture firms pulling back, portfolio companies looked to their existing funders to continue to support them.”

As such, Q4 2001 saw a resurgence of later-stage deals in Israel, which up until last year would have been considered somewhat of a strange phenomena, since many investors there have historically focused on seed- and early-stage transactions. In the fourth quarter alone, 11 late-stage companies raised $92 million, compared with the eight such firms that received $78 million during the previous quarter.

Nonetheless, Federman said he believes seed deals will rebound in 2002.

“The growth spurt in later-stage deals did not happen because people said, let’s do later-stage deals,'” he added. “Last year, early-stage investors had to face the reality that they couldn’t hand their investments off to someone else, because those someone elses were all busy with their own portfolios. It’s mostly worked its way through the system now. Therefore, [many] funds are getting back to their early-stage roots.”

With regard to the abrupt drop-off in investing in the fourth quarter, Federman said that disbursements have been slowing in Israel for the past six months.

“The only thing special about the last quarter was the effect of Sept. 11 with the financial markets closing for a period of time,” Federman said. “Everyone took a wait-and-see attitude with world commerce, because there was the question of whether this was going to throw the global economy into a steep recession. It had a bit of a slowing effect.”

Still, when investors did open their wallets, they pumped more money into companies’ coffers. The average investment per company in Israel was $3.6 million in the fourth quarter, up 29% from $2.8 million in the previous quarter.

Communications and networking companies captured 48% of the total investments for the quarter. Thirty-three such companies pulled in $183 million, while 41 firms raised just $126 million in the third quarter.

“Barring any unforeseen events, a sense of balance should be restored to the industry,” Federman said.

Robyn Kurdek can be contacted at:Robyn.Kurdek@tfn.com