No favors

They've decided to go it alone, without venture capital. Meet some Israeli bootstrap start-ups.

In recent years, there have been quite a few entrepreneurs wandering around with good ideas (at least in their heads), but unable to raise capital. There are no more angels willing to invest hundreds of thousands of dollars. The number of venture capital funds making seed investments has sharply contracted, and those still willing to invest do so only after long and painstaking study, especially in cases of entrepreneurs without prior experience.

The chasm between the supply of technology entrepreneurs and the demand for them is evidence that the great high-tech and venture capital crisis did not suppress the spirit of the average Israeli entrepreneur. Last week, Walden Israel general partner Eyal Kaplan told "Globes" that following a lecture at the Israel Center for Management (MIL) start-up forum, he was handed 17 business plans by new companies seeking financing. The situation is similar at other funds that have announced plans to make seed investments.

But it turns out that there is another way, too: "bootstrap companies" in the venture capital jargon. These are entrepreneurs who simply go it alone rather than making the rounds from one venture capital fund to another. To those who wonder, the phrase originated in the tales of Baron Munchausen, who described how he saved himself from drowning by using his own bootstraps. Translated into the language of high-tech, the concept refers to a company that finances itself. No venture capital and no directors. Can you imagine?

It was possible to find such Israeli companies in the late 1980s and early 1990s, before the domestic venture capital industry began to flourish. Dov Moran's M-Systems Flash Disk Pioneers (Nasdaq: FLSH) and Yanki Margalit's Aladdin Knowledge Systems (Nasdaq: ALDN) were just two of the companies that established themselves almost without external financing. They developed an idea, then a product, and initial sales were miniscule. Company growth was directly related to success on the market.

"The funds were in the bunker"

Nir Ben-Halevy and Oren Rossen are the entrepreneurs and sole employees of start-up Huminity. Rossen was previously an analyst at Investec Israel (TASE:INSI) and Ben-Halevey was a member of the high-tech team at Deloitte and Touche - Brightman Almagor. Over a year ago, they decided to found a company based on the concept of a social networking product that combines chat and instant messaging, enabling users to share their personal networks.

After a brief round among the venture capital funds, they realized that they could not raise money and decided to go it alone. Ben-Halevy reminisces, "A year ago, it was simply impossible to raise money from the funds. They had gone down into the bunker. We believed that if we had a working product, their attitude might change. We believed that we could get it up and running on our own."

Ben-Halevy and Rossen left everything behind, moved to Turkey to lower costs and for the past year dedicated themselves to developing the product. Last month, they announced that they had raised $2 million, at a company value of $10 million, after money, from the same venture capital funds they had approached previously. The deal is now being closed. This time, they came to the funds with a working product and 400,000 registered users.

"We did everything very cheaply. We developed the product on an open source code system. It's true that Oracle's (Nasdaq:ORCL) system is more stable, but on the other hand we dont pay a $5,000 a month license fee," says Ben-Halevy. Huminity's open code-based product also allows the company to obtain the help of the operators community. "Why pay a lot when you can pay a little? We slashed costs. We didnt buy a big computer the size of a washing machine. We work with clusters. In the US, it's possible to rent a server for $100 a month, instead of buying a server for tens of thousands of dollars."

Huminity's entrepreneurs were also creative in the design of the user interface. They didnt hire a leading design studio, but turned to the designer community. Ben-Halevy relates, "We found the sort of kids who know design and have a strong gut feeling about it, kids whose designs had been downloaded by tens of thousands of users. We hired one kid from Australia and another from Turkey, and paid them with $100 in gift certificates."

Ben-Halevy and Rossen translated the site in a similar manner. "The site went up in eight languages. A translation company quoted us NIS 18,000 for the job. We looked for translators on-line, and it cost us only $100."

Ben-Halevy says he and Rossen realized that the moment they had a working product, Huminity would have a higher value in future financing rounds. To date, they've spent $30,000 of their own money, and the company's cash-burn rate is $3,500 a month.

"Globes": Why are you raising money now, if everything is going so well?

Ben-Halevy: "We know that the funds have added value, and we need more capital to grow faster. The point is that when a fund enters the picture, the company has to change."

What changes?

"No fund will let me travel around the world. We'll have to become more established. That's how it is. We'll have to hire a staff, but we won't waste money."

The price of slowness

Ben-Halevy and Rossen's future depends on the success of their product. But its possible to find in Israel's high-tech industry veteran and successful companies that started out the same way. One is Aladdin, which was founded without venture capital and has been listed on Nasdaq for years. CEO Margalit is sympathetic toward entrepreneurs who work alone. He says, "It's not impossible, but it's a lot harder now to found a company alone, because time frames have shortened. Aladdin operated for years without external financing until its IPO, but the price was slow development during the first eight years. Venture capital investment shortens the time to market and helps with experience and connections."

Margalit says it's nevertheless possible to do without venture capital. "We developed our first product at night at home on the sofa," he reminisces. "Our first product was ready in 1985. We had sales from the outset, and the revenue was translated into growth. During the months where we had sales, we paid salaries, and in the months without sales, we didnt. We were therefore highly motivated to be customer-oriented. Aladdin was built as a customer-sensitive operation.

"Employees at a start-up with financing dont have to worry; money goes into the bank every month. When you dont get your salary at the end of the month, you and your employees know it really well. You invest less in planning and more in practical matters."

Mid-way between newly-founded Huminity and successful Aladdin are other companies that established themselves without venture capital. One example is Shunra Software, which was founded in 1997, and now has 30 employees. Shunra now has $10 million a year in sales. In November, Deloitte and Touche - Brightman Almagor ranked its seventh on its Israeli Fast 50 list.

The Israeli Fast 50 list also included Ex Libris, which reached $20 million in annual sales; Rony Ross's Panorama Software Systems, which sold the intellectual property to its technology to Microsoft (Nasdaq:MSFT) for $20 million in its first year of business, continued to operate as an independent company and recently raised external financing; and Ericom Software (TASE:ERCM), which was founded in 1994, and never raised capital until its IPO.

"Accounting for every penny"

TeraSync president and CEO Eran Peled is another example of the stubborn entrepreneur. TeraSync develops synchronization and timing solutions for telecommunications networks. "We began in a basement in 1995 and stayed there for seven years," he relates. "My father and I financed the entire product development with our own money. We received $500,000 from two angel investors in 1997, and that's it. Except for a government grant, up until now we've financed ourselves."

Were you unable to interest any venture capital funds, or did you simply not want to?

Peled: "Of course we wanted to. We looked around, and reached an agreement in late 2000 with Jerusalem Venture Partners. When we contacted them we were already able to maintain the company from sales and aid from the Office of the Chief Scientist, the Israel Export Institute and the Ministry of Industry, Trade and Labor. JVP was supposed to invest $5 million at a company value of $18 million, before money. We were already formulating the final agreement, when everything came to a halt."

How did you do it? How were you able to survive when scores of companies backed by venture capital funds closed?

"We struggled anew each day. Things look better now, but we had some really tough years. The moment we learned that JVP wasnt going to invest, we fired half our employees, cut the salaries of those who remained by 30%, and I halved my own salary. We moved to a smaller and more modest place. Since then, we always consider each potential relationship several times over, and we'll always look for the cheapest deal. We're applying for government grants and we've asked the banks to reschedule our debts. We account for every penny."

In retrospect, do you regret not raising money from venture capital funds?

"Truthfully, not at all. I think that had they invested in us, there's a good chance that TeraSync wouldnt exist now. They'd have killed us, like they killed a lot of other companies. If they dont see a quick exit, they have no reason to waste their management fees on a company. Had they invested in the company, they'd have forced us to appoint all kinds of American marketing people; their kind of people. They'd have diluted us altogether at the second financing round, and if they didnt see an IPO on the horizon, they'd have simply closed us down."

You've got quite a poor opinion of venture capital funds.

"Yes. I've been burned, but beyond that, I saw that it was possible without them. It's true that I'd have preferred creating a company calmly and with money, without butterflies in my stomach and without struggling to survive from one month to the next, able to pay our debts on time without rescheduling and reaching arrangements. On the other hand, the funds would have given us the money, but I might now have nothing. I'm not one of those entrepreneurs looking for the big score. We now burn $80,000 a month, and when we reach $150,000 in sales a month, we'll survive. We survived the crisis and we sense an improvement. All these years, even when times were hard, we insisted on investing in developing our products, so we're up-to-date and now lead the market."

Are you trying to raise capital now?

"Of course we're trying, but not from venture capital firms. In order to reach Nasdaq, our dream, I believe we'll have to link up with other companies. In order to reach the really big customers, we have to prove to them that we're a company with $10 million in annual sales. In order to increase our power, we'll have to examine all kinds of possibilities. I'm not looking for investors who'll want to sit on our board and destroy us."

Published by Globes [online] - - on December 1, 2003

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