One of the most worrying trends in Israeli high tech in the past three years has been the growing difficulty of early-stage start-ups to obtain financing. This trend has worsened since the outbreak of the global economic crisis.
Although the disappearance of exits may be a more worrying problem in the short term, the repercussions of the drop in venture capital investment in early-stage start-ups, which will be felt in a couple of years, when there won't be enough Israeli mid and late-stage companies to invest in, will be far more dramatic.
In early 2006, venture capital investment in Israeli start-ups was more or less balanced in terms of company stage: one third of investment went to early-stage start-ups, one third to mid-stage start-ups, and one third to late-stage companies. However, things have changed. An analysis of capital raised in various financing rounds by Israeli high-tech companies indicates that, in the past three years, early-stage start-ups have been attracting an increasingly small amount of venture capital investment. Early-stage start-ups accounted for 32.5% of total capital investment in the first quarter of 2006, but only 13.1% of total investment in the fourth quarter of 2008.
The situation is no better for mid-stage start-ups. From a record 54.7% of total venture capital investment in start-ups in the third quarter of 2006, the proportion of capital raised mid-stage start-ups has steadily diminished, and reached 40.1% of total investment in the fourth quarter of 2008.
In contrast, late-stage companies have attracted an increasingly large proportion of venture capital investment. They accounted for 46.8% of investment in the fourth quarter, nearly half the total.
The trend is clear, no matter which way the numbers are compared, contrasted, and cross-referenced. In the first quarter of 2006, 31 early-stage start-ups raised capital, compared with 15 companies in the fourth quarter of 2008. In contrast, the number of late-stage companies that raised capital rose from 48 in the first quarter of 2006 to 65 in the fourth quarter of 2008.
IVC general manager Koby Simana says, "The facts are undeniable. There has been a decline in the amount of capital raised by early-stage and mid-stage start-ups both in dollar terms and proportion of total investment. A multiyear analysis of investment by company stage was fairly stable until 2008, when the situation changed. I believe that the trend will continue and even intensify during 2009.
"Globes": What is the significance?
Simana: "Venture capitalists are choosing to focus on later stage companies. This has already happened. The numbers show that investors are focusing on the present and neglecting the future. If they invest in early-stage start-ups, they won't have companies in which to invest in 18 months time. The big question is whether this is a passing episode, or whether it will persist and become a real problem."
Shimana's pessimism is not exaggerated. The number of Israeli start-ups is declining, from 700 at all stages in 2000 to 450 today. At the same time, the number of active Israeli venture capital funds has dropped from over 50 to around a dozen, at best. It is not certain if the Israeli venture capital industry will be able to justify its existence if it contracts even further.
How do you explain this contraction?
"Venture capitalists are sitting on the fence. Uncertainty is high and they're investing in their portfolio companies that need cash now, or in which they have confidence. Venture capital funds have reduced their investment in new companies, both because most of the venture capital firms have just completed the raising of new funds and have decided to defer the start of return. The funds are struggling, which is affecting companies. The global venture capital industry is seeing its whole feasibility under review.
"While public technology companies are traded at huge discounts, what financial logic is there in investing in technology companies? When companies operating in large markets, which have demand for their products, are traded at ridiculous multiples, obviously there little chance of reaching four or five-fold return on investment in start-ups."
Published by Globes [online], Israel business news - www.globes-online.com - on February 15, 2009
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