Click Here for the Missing Ingredient

Despite a great deal of enthusiasm towards Israeli innovation, in practice, American VCs have closed precious few deals here. Eucalyptus think they know why, and what is the perfect recipe for happy Americans.

The American venture capitalists whose big money and connections are needed by many Israeli start-ups to really make their presence felt in US markets are not eager to cope with the geographic and cultural distances needed to invest in Israeli companies, says Bruce Crocker, the American partner in the Eucalyptus fund.

Crocker has a clear interest in presenting this case because his is one of the very few funds that can supply this missing ingredient. But everybody knows that the fervor of American VCs has dimmed considerably since they first started to discover Israeli tech firms about 18 months ago, and relatively few major deals have been made -- not for the want of trying.

Back in the summer, Shlomo Kalish from Concord said that American funds were driven off by high valuations. Now that valuations have dropped, in some cases drastically, the Americans have not come back. Why? There are several reasons. Crocker says a Silicon Valley VC must have a really compelling reason to invest an Israeli company that is 10,000 miles away with a different culture and a terrible time difference. In other words, the company must to have either absolutely amazing prospects or be very cheap, preferably both.

There have not been cheap and amazing companies around since Check Point's founders went around cap in hand to find a few hundred thousand dollars. Crocker says that the poor performance of many Israeli companies after their IPOs always made its impact, possibly because many VCs can sell their stock only long after the company has gone public.

The problem is real. American funds are bigger and invest the massive chunks of capital needed to take start-ups over the almost mythical hump that separates so many local start-ups from success. They also have the connections needed to make this success easier.

This is where Crocker and his partner, Aaron Mankovski, claim to have their ace. Eucalyptus is partially owned by investment bankers Tamir Fishman who are in turn partially owned by Hambrecht and Quist. Crocker himself worked for H&Q for 15 years and says he can bring the full weight of the American investment banker around to help the Israeli start-ups funded by Eucalyptus. Mankovski, the Israeli partner, has a long record of success at Orbotech, including eight critical years in the US when he was successfully selling the goods of a relatively small Israeli company on the American market.

If Mankovski has a clear bias in the kind of companies in which Eucalyptus would like to invest, it is companies most likely to make future Orbotechs. Orbotech is the product of a merger between very similar companies that had the same key to success: a combination of interdisciplinary technologies that made a high entry barrier for any present or future competitor. Israeli companies, he says, had best get over their inherent disadvantages by creating these high technological barriers.

So far Eucalyptus, a relatively new $50 million fund, has made only three investments. The last of these was in XaCCT, an Israeli start up that specializes in tools that allow ISPs and other vendors of to bill customers for the actual bandwidth they use. XaCCT, one of two Israeli companies to win "Data Communications" hot start-up of the year award (the other was Allot), got its latest round of funding not only from Eucalyptus but also from an American fund, Trident. Crocker says that Eucalyptus' presence, both on the West Coast and in Israel, gave the American fund the "comfort level" it needed even though XaCCT has moved its headquarters to the valley while leaving it development crews in Israel.

Still, when viewed in an American context, the same $50 million that give Eucalyptus a respectable standing among Israeli VCs make it tiny in Silicon Valley terms where the newly crop of funds run into hundreds of millions of dollars. Crocker thinks they can overcome this problem by investing in earlier stages (though not, it seems, at the seed stage) and through the advantage that the association with H&Q gives the fund.

It's also a question of context: a Eucalyptus funded company like XaCCT is Israeli and so could presumably make do with Israeli levels of funding, but it is based in the valley with an American CEO and presumably needs valley-levels of funding to target the same emerging market that dozens of other start-ups are pursuing. One part of the solution might be in roping in American funds with the assurance that there is somebody back in Israel (Mankovski) who is keeping a close eye on the shop. Another, unsaid part of the equation might work out if indeed valuations of Israeli start-ups have dropped enough to make $50 million in Israel much more than the same amount of money in the U.S.

There is yet another possibility that neither Crocker nor Mankovski explicitly mentioned. XaCCT was originally funded by Israel Seed Partners, probably the most effective small fund in Israel because it has kept focused on its name -- seed finance for companies -- leading to stakes in companies that are considered hot like Foxcom, Compugen or XaCCT to name just a few.

In the same way that Israel Seed concentrates on the earliest stages of a company's development, other funds like Eucalyptus or DS Polaris could concentrate of creating the bridge between Israeli start-ups and the funding and networking capabilities of the valley. The average investment by VCs on the West Coast is over $6 million -- a sum that nearly all Israeli funds would not like to place in one company. One of the reasons this figure is so high is the enormous sums needed to compete in second and third round financing. Earlier stage financing is still at levels Israelis could possibly afford.

If Israeli VCs want their portfolio companies to compete with Silicon Valley at this level of funding with all-Israeli financing they would have to go back to the unsatisfactory syndication of financing that characterized the Yozma era funds. We have already seen a few signs of this trend towards co-investing in companies that needed a lot of money like D-Pharm. It works for some companies, but in too many cases creates a board of directors with conflicting interests and feuds.

Another problem is in the geography of time -- the 10-hour difference between the West Coast and Israel, a topic that came up a lot in the conversation with Cocker and Mankovski because they live it all the time. Consistently running a business with a start-up whose management are hardly ever in the office at the same time as the investors leads to communication problems because nobody really likes to work all of the time at night with partners or investors on the other side of the world after a long day's work. This might be one of the major reasons that so many Israeli technology businesses are choosing now to locate on Boston rather than the West Coast because a seven-hour time difference is just easier to handle.

If Crocker and Mankovski show they really can bring more West Coast investors into Israeli companies, they will become a hot fund for those Israeli start-ups that need both the money and connections that come with a major investment from a Silicon Valley VC. They might also invent a new kind of fund, the on-the-way-to-the-Valley-Fund.

Published by Israel's Business Arena December 17, 1998

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