Chemi Peres is still optimistic. Venture capital funds are closing or merging, mergers are failing or being postponed, companies are closing or downsizing, but Peres, the managing director of Israel’s largest venture capital fund Pitango Venture Capital(formerly Polaris Venture Capital) is optimistic.
This “is the best time to invest”, and “I have no doubt that technology will continue to grow.” Peres’ optimism is a family trait. It is a genuine, heartfelt optimism that believes unapologetically that its vision will be justified over the next hundred years. He does not easily let facts cloud the issue.
“Globes”: Pitango III is two-and-half years old, and raised $500 million. How much has been invested? And how much lost?
Peres: “We’ve invested almost $200 million. It’s true that we’ve closed companies, but the amount lost from these closures is relatively small, due to our investment method. We initially invest small amounts in a company, increasing the investment over time. Luckily - or rather, unluckily - the companies that closed were only in the early stage.”
You closed the companies before they burned all their cash.
“It’s correct that there was money in GoRefer.com (a start-up that wanted to build a platform to link buyers and sellers, which closed in January 2001), but we saw that its customers were disappearing and the company had no chance on the basis of its business model. Together with the other investors and company’s founders, we decided, wisely in my opinion, to shut it down. Our cash loss from GoRefer.com, as with our other closings in general, was small by any measure.”
The loss is not just the immediate impact on cash. It is also derived, maybe mostly derived, from the fall in the value of the companies in your portfolio.
“It should be remembered that investment in start-ups is a process. Even if you lose at in a particular financing round, there are mechanisms for retroactive correction in follow-on rounds. When a venture capital fund invests, it usually has protective mechanisms from down-rounds, even full protection in some cases.”
But lower values aren't always due to external factors. There are companies that lose their value, but haven’t yet held a round that would confirm their claims.
“We’re very conservative. In many cases, we decided to hold the financing round at different company values for various reasons unrelated to external factors. An example would be if a company failed to meet its business plan. I won’t give specifics here, but I can say that our limited partners receive full transparency about our portfolio companies and their values. Relative to the market climate, we’re pretty pleased from our situation. While the market climate affects us, since its doesn’t matter whether you’re the Queen Elizabeth or a fishing dory - we’re all on the same sea. We don’t fly above the waters, but we try to do our best under the circumstances. I won’t say we’ve never made mistakes. We're just like everyone else.”
Check Point won’t come
Peres has been one of Israel’s prominent venture capitalists for a decade now. he will be appointed Israel Venture Capital Association (IVA) chairman at the end of the year. He already manages the new government seed fund. In 1992-96, he managed Mofet Technology Fund Management which supported VocalTec Communications (Nasdaq: VOCL), Orckit Communications (Nasdaq: ORCT), NiceCom and others. In 1996, Peres teamed up with Pitango managing director Rami Kalish to establish Pitango II Fund, and in 1999, he founded Pitango’s office in Palo Alto, hoping to ride the software wave that had earned venture capitalists millions. Peres’ experience cost him Shopserve.com and GoRefer.com, which closed and were removed from Pitango’s portfolio.
Despite his infectious optimism, Peres was one of the few to predict the venture capital collapse. He was already predicting in early 2000 that start-up valuations would plummet, and was proved right.
The venture capital market seems to be vanishing. Where there were once 100 players, now there are only 40. “That’s reality. The market’s changing. The industry boomed, and booms contain inherent anomalies. The same holds for venture capital, and the market is now undergoing a correction. On the other hand, one of the best things about the crisis is that it is correcting the anomalies, learning from the mistakes and improving. In my opinion, the long-term trend is positive. The gradient isn’t 80%, but it’s positive, and faster than the country’s growth rate at 6%, 7%, or 8%. It isn’t 6,000% a year, nor zero to $10 billion and 1,000 companies in a decade, as happened here,” says Peres.
Meanwhile, the market crashed.
“The market may have fallen too far, but it will stabilize at 5-7% growth. Venture capital must meet the needs of companies riding this gradient. The gradient suffered from upward distortions when it was hitched to the capital market, and it is now distorted downward for the same reason, plus the security situation. The government must see to a stable gradient that will enable the founding of Israeli companies and venture capital funds. Emphasis must be placed on the fact that we’re talking about global Israeli companies, because their markets are overseas. In the long term, this is Israel’s only socio-economic engine of growth.”
Social? I thought the gaps only increased during the boom years.
“It’s true that at some point the sector became detached from reality and soared into the stratosphere. Money flowed like water. When regular people saw the way employees at companies that were acquired for a bundle chose to celebrate, it was problem. But the industry’s engine is economic success. It cannot exist without it. When the industry posts reasonable, prudent and positive growth, everyone benefits. The whole economy benefits, even though only the legendary profits by certain entrepreneurs makes the headlines.
“It’s true that there was less of an effect on the outlying areas of the country, and it’s true that the insane rise sometimes generated social gaps and resentment, but everyone benefited from high-tech growth during the boom: aviation, transport, tourism, journalism, real estate, service providers, cellular, even the Income Tax Authority. High-tech generated income that trickled down to every level of society.
“This industry creates the greatest interest for foreigners and foreign companies to come to Israel. Except Jews and pilgrims, no one comes to Israel. What alternative is there to high-tech? Diamond exports? I doubt it. Defense industries? I doubt it. Agriculture? I doubt it. Everything is important, but high-tech is our jewel. The only sector in which we are counted among the top five countries in the world is high-tech development. Every other attitude toward the subject is emotional, rather than economic, and those who feel that way don’t understand the asset. We have immense potential, and the ultimate model is Check Point (Nasdaq: CHKP).
So why didn’t you invest in Check Point?
“They didn’t contact me. I met them only later, through Nir Barkat, when they were already looking for leading US funds. In all honesty, I can’t claim that if I had seen them I would have invested.”
Where to Chiaro?
The $125 million Pitango II Fund yielded successful exits such as ITXC (Nasdaq:ITXC), Radware (Nasdaq: RDWR), AudioCodes (Nasdaq: AUDC), VCON Telecommunications (Nouveau Marche:VCON), and BackWeb Technologies (Nasdaq: BWEB). The fund’s portfolio currently includes promising private companies such as Voltaire , Mysticom, CTI² , ClearForest , and Gilian Technologies which have already paid back their investors in full.
Pitango III was raised at lightening speed in early 2000, just before the high-tech bubble burst. Pitango III has invested in 54 companies to date, including Chiaro Networks, Cash-U Mobile Technologies, Proficiency, and Scopus . Peres says less than $200 million of the fund’s $500 million has been invested to date, although no exits have yet been made.
Can investors get their $500 million back on a vintage 2000 investment?
“We’re not managing the fund in order to lose money. If we thought we’d lose money, we’d close down the business. We have a large team that works from dawn to dusk. If we said the money was intended for Internet infrastructure, telecoms or optical networks, then the business would be too risky and I’d put a dramatic end to the fund. But we also invest in semiconductors, software, communications, medical equipment and biotechnology. We’re very balanced. You won’t see $500 million going to one sector, and definitely not a troubled one.
“All in all, we don’t see any great difference between the management of Pitango II and III. Then we had 35 companies in our portfolio, of which five have held IPOs and 20 are waiting for their turn, including CTI² and MystiCom. Pitango III will have 35-50 portfolio companies. The difference between the funds will be in the amount invested in each company. If Pitango II invested $3.5 million per company, we’re now talking about $7-8 million each. This will allow us to protect our portfolio much more strongly, and reach much higher equity positions.
“Whereas Pitango II owned 3-4% in Backweb and 6-7% in AudioCodes for example, we will now be able to protect ourselves and make follow-on investments to reach the finish line with much greater holdings.
“Another difference is that a $500 million fund has much greater room for error. It’s possible to close five companies and invest in five others.”
Where have you gone wrong?
“We don’t like talking about our mistakes. In any event, a good measure of modesty is needed talking about such matters mid-way, because you can invest in a company that looks great now and awful tomorrow, and vice versa. Take ATM switches (high-speed transmission protocols) for example. Many people believed in them, generating some handsome exits such as NiceCom [which was acquired by 2Com (Nasdaq:COMS) in the mid-1990s]. After a few years Ethernet protocol took back the market and the ATM-switch companies disappeared.
“The same thing has happened with 3G cellular. Billions has been spent to buy licenses, and there were claims that 2G and 2.5G companies were unnecessary - and today they’re back. Investment quality chances with the market climate. There can be great companies whose markets collapse making them bad investments, but there are also quite a few horrible companies in exploding markets, making them industry darlings.”
Since you don’t want to talk about mistakes, I’ll tell you where you went wrong. You erred when you invested in Chiaro in September 2000 at a company value of $400 million, before money, after the Nasdaq crash. Chiaro’s company value was slashed at its last financing round in late 2001. By the way, Chiaro is a company without sales or even a product.
“I won’t discuss details, because I sit on Chiaro’s board of directors, but I can say that you act differently when working companies with especially great potentials. Just as Churchill once said, ‘If you want to cross a chasm, it’s better to do it in one leap than two small steps’.”
Is Chiaro a chasm?
“This is a company with immense potential. Chiaro’s test will be its results. Chiaro’s story isn’t over, and in fact all its shareholders supported the company in its last financing round. In retrospect, we might have invested too much at too high a valuation, but I’m not sure that can be determined at this time. It should be remembered that Chiaro’s large round gave the company the means to survive the market changes and restructure. It is an excellent company, and reports of its death are premature.”
Undoubtedly premature, since it raised $80 million only six months ago.
“What can be said about Chiaro is that it is an exception, both in terms of the size of the investment and its latent potential. At exit, if we discover we erred, we have to give answers. We still believe it was a good investment.
“All our portfolio companies are our children, and we don’t abandon them. We also devote time and effort to those in trouble until we have no choice. If a company cannot raise capital, its market has vanished, or it’s obvious that another cash injection would mean throwing good money after bad, then we withdraw and sometime even close the company down.”
Shai Schiller, for example
Recent months have been a time of bad news for Israeli venture capital funds. Capital markets have been shrinking for two consecutive years, previously promising technology sectors have collapsed, and IPO opportunities are few. These factors came together at BRM Capital , which returned $100 million to investors, in the Platinum Venture Capital and Neurone Ventures merger, and Argoquest which applied for protection from creditors. And this is only a partial list.
Despite the difficulties, Peres says Pitango has no plans to reduce its fund. “We ask ourselves what the fund’s standing is and what we want to do. There used to be billion dollar funds in the telecom market, which raised money in one year and planned to invest it in six months. There were funds that were halved, quartered or abolished altogether. We’re not cutting back or closing, because this is a great time to invest.”
Convince me.
“There are three main reasons. First is that it’s easier to invest when Nasdaq is at 1200 instead of 5000, because there’s a higher correlation between companies’ market values and their estimated company values for investors. Second, is that we have a lot of experience, and we can better help companies become better, more efficient, and focused on winning customers, revenue and profits. Third, is diversification. We aren’t swayed by bubbles, nor are we exposed to any particular sector. We believe in our ability to identify opportunities.
“It should also be remembered that today’s companies are simply better because they’re being built much more seriously. Companies used to be different. Yossi Sela, who sits in the office across from mine (he is managing partner of Gemini Israel Funds, which is located on the 11th floor of an office block on Hamanofim St. in Herzliya Pituah), called them ‘Mickey Mouse companies’. Those times were unreal. Some of those companies even held IPOs or were sold, but if they hadn’t been sold, they wouldn’t have survived another three months.
“Today, in contrast, we make sure that companies raise money properly and hire good teams. We link them up with customers, and see to it that it’s a real business that makes money. We’re not looking for exits. CTI² is a good example. It is truly a lean, mean, low-cost, customer-oriented company. It is properly positioned to become a market leader. It had three seats on the board of directors, but still decided to bring in Shai Schiller, who has experience in the relevant field, and knows how to build a business. By the way, we’re seeing results. Our companies are showing considerable interest in West Coast venture capital funds.”
If everything is so great, when will you raise money for Pitango IV?
“When we think it’s possible. Our rule is not to think about the next fund until we’re certain investors agree with us that a new fund is needed. There’s no problem if that takes another decade. There’s no rush. We won’t begin raising money until we know we have a stable portfolio and the companies we’ve marked will have great success.
“Pitango III was raised very quickly, because investors believed in us and gave us money. Without investor confidence, there’s no point. We are first and foremost committed to them. We are also entrepreneurs, run a business with plans and a business model. If we don’t make a profit, investors will leave. There are funds that won’t get money the next time, because they exploited their investors, and investors were dissatisfied from the use of their money, reporting and strategies. Investors in certain funds have told me in private that there are certain funds they won't invest in again. We must remember that a fund’s continued existence is not assured. It requires hard work.
Do you work hard? You say that all the time but people still think all you do is play golf.
“People say a lot of rubbish. Golf is the most exhausting game in the world. All our investors play. Golf is a great way to do business. I’m a hack golfer, but I can tell you that after I’ve played with someone, our relationship is not what it was before. Golf builds a relationship that cannot be created in any other way.
“In any event I’m at my office by 8:30 am, after a round of golf. People think that venture capital is work for high-tech retirees. A 9-to-5 job. That’s true for pensioners. But a man who is committed works around the clock, day and night, including holidays. You’re needed all the time, and must travel a lot. There are no hours. I finish here at 8 or 9 at night, and there are days when I then work from home until 4 am. I’m not asking for pity, but I don’t want you to get carried away by an image born out of misunderstanding or lack of knowledge.
An Israeli conflict
You talk about Israel as one of the five leading countries for technological development. Nevertheless, hasn’t the fact that there hasn’t been an exit here for 18 months cost Israel some of its luster?
“No. More and more investors are coming to look here. Top-rated West Coast funds have recently invested in Israel. It’s true there are very few IPOs, but that is a worldwide trend. Besides, what’s the alternative? I’m Israeli. I don’t want to live outside Israel. That’s not an option for me. Israel is our place, the answer to what has happened to the Jewish people in the past. My life is easy by comparison. I simply have no choice. As someone who's decided to live in Israel and work in venture capital, it’s important to me that we build it right, and it’s not being built properly now.”
You claim that the global market is the reason for the slowdown in the venture capital industry. What has been the effect of the war here?
“It would be easy to deal with the effects if all was well in the world. But there is terrorism, fraud, a high-tech crisis and trouble in South America. This uncertainty affects everything. We are losing companies because of the market climate, not the situation in Israel.”
The situation here doesn’t affect foreign investment?
“Foreigners are worried about the situation in Israel, but we explain to them that the customers, strategic investors, exits and managements of Israeli companies are overseas. In most cases, the companies aren’t even registered in Israel. I am unaware of any company that collapsed because its R&D center in Israel was affected by the security situation. The phrase ‘Israel-related’ is important in this context, as a testimony to Israeli know-how. The company, however, is global.”
You don’t see any conflict between your personal declaration of Israeli-ness and the hiding of your companies’ Israeli-ness?
“I’m not repudiating anything. I’m not trying to hide our Israeli-ness. I’m making a proper business presentation of the facts. The industry is inherently foreign. A company can’t sit in Herzliya, when the center of its operations is in California, just as a Hollywood actor can’t live in Kfar Sava.
“There is no conflict. That’s just how it is. You can’t stick a ‘Made in Israel’ tag on a company, beyond saying it’s ‘Israel-related’. That’s the nature of the industry. It has no geographical limitations and operates where the market is.
“There is, however, a major dilemma. If Israel wants its high-tech to be its engine of growth, it must understand that it is competing on a global level. It must act sagaciously, which is not happening. My new job as IVA chairman is with the understanding that a revolution is needed in the country’s perceptions. I’m not taking this job in order to argue with some Ministry of Finance clerk about some tax.
“IVA was founded in order to create an understanding that high-tech and venture capital are in-depth infrastructures that have to handled right. If we act unwisely, the industry will flee Israel, and we’ve already seen this happening. If we don’t handle high-tech and venture capital wisely, they’ll leave and sever their relationships with Israel, except for speaking Hebrew.
“If we preferred economics over Zionism, we’d have founded Pitango in New York, and Americanized our portfolio companies. It’s easy to do that, leaving Israel with nothing. High-tech would then not be a part of Israel’s GDP, exports or employment. Everyone would leave. The Made in Israel element is important to me as part of the stable gradient I mentioned earlier: Israeli R&D centers, companies and venture capital.
I was recently asked about my dream for Israeli high-tech. I replied that I want a situation in which Israeli entrepreneurs want to found a company, their lawyers and accountants will recommend they do it in Israel. Vertex Management Israel president Yoram Oron corrected me, and said the vision is that US entrepreneurs will want to found companies in Israel. A fundamental change is needed in taxation, regulation and state intervention for that to happen. We must be attractive, rather than looking for favors.
“There are good examples, such as the Ministry of Industry and Trade’s new seed fund, in which I am involved. We’re preparing a model to encourage funds to invest in Israel. It’s the right thing to do to develop a tool that will provide incentives for funds to invest in Israel seed-stage companies. We’re therefore building a model in conjunction with industry. We work professionally, efficiently and with quick responses. I love this work.
“On the other hand, there is the Office of the Chief Scientist, which is ostensibly a wonderful reason for Israeli companies to stay in the country. But to keep technology in Israel, the government built a very questionable mechanism of converting loans to shares in event of an exit. Despite opposition by many people, this clause appears in the Encouragement of Research and Development Law - 1984, and it’s a problem. Instead of being an incentive, it’s a hurdle that keeps foreign enterprises from developing relationships with companies associated with the Chief Scientist. So instead of an incentive to get money from the Chief Scientist, there’s a disincentive.”
Instead of the usual criticism of this or that tax, you’re criticizing the entire structure. What do you propose?
“High-tech industry is like water. If flows around barriers, or it evaporates. This has to be understood. Israel must revolutionize its thinking about high-tech. It’s not a marginal or minor industry. It’s headline-grabbing and must be treated accordingly. It should be remembered that the high-tech economy is naturally nomadic, and for it to stay in place, there must be an intelligent incentive policy.”
Will the business sector support a candidate for prime minister who will deal with these problems?
“The high-tech industry is always involved in politics, but I can tell you that it is feeling increasingly helpless in its relations with the political system.”
Does politics beckon?
“I cannot comment about that personally. I can say that it’s troublesome when people seek a messiah. Regrettably, things don’t work that way. Those who want to be in the front lines must be visible and not in the shadows.”
Is Haifa in the shadows?
“I didn’t say that. I’m not referring to [possible Labor Party candidate Haifa mayor Amram] Mitzna.”
So where are the shadows?
“In my view, the main problem is the immense gap between the qualities needed to be elected and the qualities needed to be prime minister. Many people think they can run the country, but very few have the ability to do it. The lack of supply has created a desire for new stars. We need a people with a record of achievement, not those who think they’re suitable. We used to have such people.”
Is the system to blame?
“To some extent. I wish our electoral system was more like the US, where the candidate is exposed [to public life] for a longer period in advance, and there is a long road toward the job. Unsuitable people can get elected in the US, but I think their system is better.”
Published by Globes [online] on August 27, 2002