Jay Morrison is one of the most successful investors in Israel in recent years and definitely one of the least known. Among the general public, that is. He is known to many in the high-tech district stretching from Herzliya Pituach through Kiryat Atidim. Morrison was one of the first institutional investors to invest in Israeli technology, and he is the one of the most successful, in terms of the number of exits he has been involved in. A glance at the portfolio of the venture capital fund he heads, Newbury Ventures, reveals that Morrison's investments in Israeli companies have been very worthwhile indeed.
Newbury’s successes include Scorpio Communications, the first venture by the founders of Chromatis Networks, which was sold to US Robotics (and in turn was acquired by 3Com (Nasdaq: COMS)); Precise Software Solutions (Nasdaq: PRSE): Netro (Nasdaq: NTRO); Fundtech (Nasdaq: FNDT); Paradigm Geophysical (Nasdaq: PGEO); Jacada (Nasdaq: JCDA); ViryaNet (Nasdaq: VRYA), and Terayon (Nasdaq: TERN). Only Scorpio was not floated. Today, when foreign investors in Israel are once again rare, and demand a host of government incentives, the country seems to have reverted to the early 1990s, when Newbury first began to operate in Israel. The difference is that since then, Israel has become internationally recognized, thanks to the successes of companies like Check Point (Nasdaq: CHKP) and Comverse Technology (Nasdaq: CMVT), and the country has an established venture capital industry.
Erlich's touch
Morrison describes his introduction to Israeli technology. “I met Yigal Erlich, who was Chief Scientist at the time, by chance at the Consulate General in New York in 1992. He was describing a new program he was working on to US venture capitalists. That program became Yozma. It sounded interesting, and we were one of Yozma’s first three funds. In the Yozma program, the government invests a certain amount for every dollar invested by external investors. We founded Jerusalem Pacific Ventures (JPV) with a $12 million investment plus another $8 million from the government,” he says.
JPV invested only $16 million, but gave the phenomenal return of over $140 million to its investors. The success was not anticipated, and Morrison stresses his great esteem and appreciation for Erlich.
Morrison also credits Erlich with Yozma’s success, which led to the establishment of Israel’s venture capital industry. “It may sound easy to you now, and it may seem that the success was completely based on good timing, but Erlich determined the timing. I don’t know if you can appreciate Yozma’s immense importance and success, which Yigal initiated. He knew how to be the perfect mediator between investors and the government, and avoid the conflicts of interest that could have been expected to emerge in such a system. The connection between the government and the venture capital industry succeeded only in Israel. It’s no coincidence that Israel is ranked immediately after the US in many aspects of the technology industries.”
Recruiting Margalit
If the names of the heads of Newbury’s fund, JPV, are known, it is due to their similarity to the names of the managers at Jerusalem Venture Partners. This similarity is no coincidence. Morrison is a silent partner of the well-known Jerusalem fund, and is credited with letting Erel Margalit, who was director of development for the Jerusalem municipality at the time, head the new fund.
The choice was rather surprising. Margalit held a senior position in the Jerusalem municipality, but lacked the normal technological background for a venture capital fund managing partner.
“When we examined Israel at that time, there were no people with practical experience in venture capital, except for the managers of Veritas Venture Partners, which was the only fund then operating in the country. The now well-known managers in Israel were unknown at the time, and they lacked understanding about venture capital. Our starting assumption was that we wouldn't find anyone in Israel with venture capital experience similar to ours in Silicon Valley. We therefore looked for someone with the characteristics that would allow him or her to grow into the job. We met several people in Israel and felt that Erel had the passion for technology industries and the willingness to do what was necessary to make the business succeed. We thought he'd learn the rest, and gain the experience he lacked with our help. The choice has proven a great success,” concludes Morrison.
“Globes”: Were the investors in JVP the same ones who invested in Newbury?
Morrison: “Most of the investors in the fund were investors in our funds who agreed to invest in this specific fund. Erel also contributed to raising capital for the fund; thanks to his connections at Hebrew University of Jerusalem, the university entered as an investor.”
Why does so much of your portfolio consist of Israeli companies?
“We were one of the first US funds to make a real effort to invest in Israeli companies alongside Israeli investors. We began investing in 1994, when the Israeli industry was young and there were many opportunities. We were lucky to invest in wonderful Israeli companies at the early stages. We leveraged our capabilities in the US on behalf of the Israeli companies. We assumed from the outset that Israeli technology was excellent, but it lacked a real home base in the US. We strove, and continue to strive, to provide that home base, and thought the natural market for Israeli technology products was the US, which is our base. Our working principle was also to have someone in Israel watching our backs while we were working in the US.”
Why did you choose to invest in early-stage, rather than more established, companies?
“We thought better opportunities would be found in seed rounds. More established Israeli companies at the time operated in a different business culture from the one we knew. In order to change them, we would have had to invest far greater resources than were needed to establish new companies that conformed to a venture capital-supported business culture.”
What do you mean by a ‘different business culture’?
“In my opinion, there was always capital available for investments in Israel. Yozma’s greatness wasn’t in bringing previously non-existent resources to Israel, but in being the first to bring to Israel the concept of ‘patient capital’. Previously, investors in Israel were Israeli holding companies with private, government, or public institutional capital. The approach was to identify a leading team of army or university graduates and invest in them, but in a manner that retained the actual management and most of the shares in the investors' hands. The entrepreneurs owned very little, and thus had little incentive to invest. We saw many companies suffering from the problem of management being divided between the chairman, who would pay the bills and call the tune, and the CEO, who was the founder. It created questions about who was running the company and in what direction. That's no way to build a successful company.”
Patient capital? This is the most impatient capital in the world, because you look for quick exits, thereby creating companies that are too immature to be strong and fully independent.
“I basically agree, but we're talking about different levels. I think the best explanation of what I'm talking about can be found in what my first venture capital boss gave me. He explained to us the difference between managing an industrial or financial company and technology companies.
He said, ‘In their speeches, all the managers of industrial companies always talked about the importance of human resources to their companies, but when I spoke with them privately after a few drinks, they would tell me what they really thought. Management was the most important factor, and they could manage their companies much better with managers and a bunch of chimpanzees. In contrast, the managers of technology companies, even after a lot of drinks, would tell the truth, that they couldn't manage their companies without the people in them. There's a great deal of truth to this story, because each person in most industrial companies or financial institutions has a defined job, and if he does it well, everything will run. If he begins to change things and improvise, the business will fall apart."
“In early-stage technology companies, everyone has to do 180%, his own job plus other jobs to which he can contribute. He must also contribute constructive criticism about the company. In order for employees to be willing to do all of this, and do it well, you have to be a big shot yourself, but provide strong incentives and make a major commitment to the company as well. This is precisely what venture capital knows how to do: build the right incentives in the team building the company. We didn't find this approach in Israel.”
What about the venture capital funds’ patience and their ability to create substantial companies?
“I didn't say our venture capital approach always works. There are degrees of patience, and venture capital inherently doesn't have an especially high level. I'll use the metaphor of planting a tree. Venture capital has all the patience and all the capital in the world to raise big and healthy roots, but the moment some of the branches sprout out of the soil, we accelerate the company as fast as possible in order to get them out of our hands and make an exit. This was the root of the problems of the 1990s. The stress was on growth. There were companies with 120% growth, but they spent 150% of their revenue to achieve this hyper-growth. The growth model is problematic.”
Did you invest in Israeli companies in 2001?
“We invested in a company that was Israeli in the sense that Netro is Israeli; it was founded by an Israeli here in Silicon Valley. It's called Silverback Systems. We invested in it together with two Israeli funds, Pitango Venture Capital and Gemini Israel Funds.”
At a time when hype alone is no longer enough, questions arise about the ability of a company if it's founded far from its market, unlike Silverback. There are also still questions about the management capability of Israeli entrepreneurs.
“The problem of management doesn't just bother Israeli companies. US companies also encounter difficulties in recruiting first-rate marketing and sales staff. But I believe that before the stage when recruiting these teams becomes a challenge for a young company, Israeli companies actually have an edge in technological abilities, with creative and improvisational talent missing in most of the companies founded in Silicon Valley. I still think that a company must be located close to its customers, however. It’s not possible to live in Israel and respond from there to a customer located in Santa Clara. If the customers are in North America, the senior management, and especially the staff who work directly with the customers, must reside in geographical proximity to them. Past experience has taught me that our most successful Israeli companies were those whose management moved to the US and managed their marketing and sales from there."
“Regardless of the final results, Chromatis’s entrepreneurs, by building a US management team lead by Bob Baron at the early stage, benefited from a significant presence in the US, which gave the company a strong advantage. We should learn the lesson. Proximity to the market and a product development team have to balance the natural tendencies of the R&D staff at Israeli companies. Most Israeli entrepreneurs come from the technology world. You must not build what is technically feasible, but what the customer wants.”
Which means?
“Everything must be in balance. Customers always want products with many functions, and with a coffee-maker, too, if possible. The technical team should not ignore this, but it has to differentiate between the customer’s real problems and its heart’s desire, and then work out the engineering solutions.”
Which Israeli investment gave you the greatest return?
“If you count Netro as Israeli, that was absolutely our home run, the big hit. But the other Israeli companies, with all the sleepless nights they caused us, also gave us very, very, handsome returns.”
If the success was so great, why didn’t you continue with what became JVP?
“We have no official capacity at JVP. Erel founded JVP on his own, and made quite a success out of it. He wanted to run his own show, and we couldn’t keep that from him. We're proud of our role in founding Israel’s successful venture capital industry, and we're proud that others have also succeeded in it.”
So why didn’t you found another fund in Israel, after all your successes?
“Our partnership with Erel achieved what it was supposed to achieve -. introducing the Israeli technology industry to those who should know about it. We didn't want to establish another local organization in Israel. In fact, we thought that if we were to found such an organization, it would only cause us damage, because we would become a competitor and would miss opportunities. We preferred to maintain good relations with all the Israeli funds as their US partner in building companies.”
Why should Israeli funds work with you, bringing you companies, when they now have a reputation, capital, and presence in the US, and can go wherever they want?
“It comes down to longstanding relationships. We were among the first funds to arrive in Israel, and so we're well-known. I met Chemi Peres long before I met Erel, and sat with Peres on many boards of directors while he was still a manager at Mofet Technology Fund Management. In addition, our name precedes us in the industry, so that many entrepreneurs, both Israeli and American, come to us on their own initiative. We present them to Israeli funds. We have a relationship that benefits both parties.”
How do you market yourselves to Israeli entrepreneurs when leading funds such as Benchmark and Sequoia Capital have representatives in Israel?
“I agree that these two funds are wonderful. There are other excellent players. It would be excellent advice for an entrepreneur to seriously consider those funds. But it's not a matter of either/or. In other words, we could invest with Benchmark or with Sequoia. There's no contradiction, certainly not from our perspective, and probably not from theirs. Lately, there have been signs that funds are returning to syndicates, so that no one finances the whole round, but joins with several other funds. This is not only because of the financial element, and a desire to spread the risk, but also because the human resources needed to maintain a company for six or seven years require this kind of partnership. In fact, I have excellent relations with Benchmark’s three partners in Israel, and I know Sequoia’s Benny Hanigal. I'm very pleased when they join us in a deal.”
Published by Israel's Business Arena on 17 January 2002