Pitango Venture Capital will soon close its fourth $300-350 million fund. When they launched the fund raising round a few months ago, no one at Pitango or anywhere else believed it would be so easy. Unusual among venture capital funds, Pitango did not carry out an interim close. Pitango already had $200 million pledged a few weeks ago, but preferred to keep quiet for a while longer and to close the entire round for the fund in one shot. Pitango met its target and then some, without the need to approach Israeli institutional investors, even those that had invested in it and other venture capital funds previously.
It's hard to say whether the achievement is due to the market improvement or because US venture capital funds are raising smaller funds than in the past, which means that American institutional investors are seeking alternative investment channels. Or maybe Pitango's impressive record attracted investors. Then there is the fact that Pitango cofounder and managing director Nechemia (Chemi) J. Peres and the firms other partners simply know how to go about raising money. Possibly all these factors came together, in addition to one final factor: Pitango is the best-known Israeli venture capital fund in the world, even if Dr. Meir Barel's Star Ventures manages more money, Jerusalem Venture Partners has more offices around the world, and Gemini Israel Funds has had more successes of late.
Israel's venture capital industry is pleased, especially the other funds now raising capital. Pitango's close encourages Gemini, Concord Ventures, Challenge Fund - Etgar, Giza Venture Capital, Vertex Venture Capital, Yozma and others to redouble their efforts. Everyone was waiting for the close, believing it is a sign that they too can raise follow-on funds.
Can Pitango stay on top? That is not so certain. Although praise is being heaped the company for its success, some Israeli venture capitalists think that Pitango III's performance was far less impressive that that of its two predecessors. Pitango is seesawing between the sweet smell of success and the bitter taste of failure.
Like all the other funds, Pitango keeps its performance confidential. The only available figures come from California Public Employees Retirement System (CalPERS), which published its second annual report on its venture capital investments a few weeks ago. CalPERS pledged to invest $5 million in Pitango III. An analysis of the CalPERS report indicates that Pitango apparently wrote off $107 million in 2003 on $305 million in investments. Its internal rate of return was 20.6%. The previous year's report shows that Pitango made a $66 million provision against investments totaling $225 million.
Peres has said more than once that a venture capital fund's performance cannot be measured in a time period of one year, even though he, in his capacity as chairman of the Israel Venture Association (IVA), heads the effort for venture capital funds to make limited public disclosures of their performance.
Pitango managing general partner Isaac Hillel naturally does not comment about performance. The fund only has to give regular accounts for their actions to its investors. But Hillel is quite happy to discuss Pitango's investment policy, fields of investment, and guiding spirit.
"We remain focused on the same direction. We don’t jump from one field to another. We have a strategy and we stick with it. Pitango focuses on investing in Israeli early-stage companies in IT, telecommunications, and the life sciences, although we also invest in later stage companies. We mostly invest in IT: telecommunications, networks and storage, enterprise software, services and semiconductors. Life sciences, mostly medical devices, accounts for no more than 25% of our investments."
Hillel says the emphasis is on finding companies with the potential to grow large and become independent. "This is our greatest challenge: to find companies that will become leaders in their fields, creating new market segments. That's why there have been quite a few mergers among our portfolio companies."
As a result, several mergers have taken place, especially among Pitango III portfolio companies. Belying Hillel's comment, some claim the mergers were an attempt to avoid writing off struggling portfolio companies. Examples are the merger of Valis and Celltrex to form Axis Mobile, and VCON Telecommunications' (Nouveau Marche:VCON ) acquisition of RemoteAbility and Netmount, all of which are Pitango portfolio companies.
"Globes": You know that people claim these mergers were intended to avoid write-offs.
Hillel: "Everyone knows that the exits made during 2000 were at much lower values that those made in previous years. The important thing is the size of the investment in a company until it matures, up to the point at which it generates a profit for investors. Effective and wise management is therefore critical. Everyone knows that it will be harder for companies in which $100 million or more was invested in to generate a worthwhile profit. We believe that software companies can and should achieve break-even and start making a profit after an investment of $15-20 million. Semiconductor companies need $40 million until they achieve independence and can hold an IPO."
Pitango, like other Israeli funds, prefers to collaborate with other Israeli and foreign funds. Hillel says investment partnerships in companies provide a kind of insurance for the companies and their investors. "We believe a syndicate can ensure that there will be a number of investors accompanying the company at every stage, and will invest in all its financing rounds. We usually lead rounds alongside an Israeli or US fund. This is the right model as far as we're concerned, one that provides the added value for the company and future profits for the investors."
Hill knows that Pitango has a good reputation. When Pitango signals that a company is a worthwhile investment, that encourages other funds to participate. "Our colleagues in Israel and worldwide, as well as the companies themselves, know that when we invest in a company, we'll be there for the long haul and we'll support it so long as we believe that it has a chance in its target markets. We therefore make sure that every investment achieves a significant interest in the company, i.e. 15-20%. That's the interest that justifies the investment for us, while giving the entrepreneur the assurance that the company will have financing, that we'll bring in partners for follow-on rounds, and that we're committed to ongoing work. I think that is one of the most important factors for us. We consider our investments as a long-term commitment."
Size counts
One constant source of tension is between the size of a fund - $500 million in Pitango III's case - and its ability to stay sufficiently involved in its portfolio companies to provide added value. The naysayers will claim that $500 million is too big, and prevents adequate involvement in the portfolio companies.
Hillel, unsurprisingly, demurs. "We absolutely take care to be dominant in our portfolio companies. Pitango has 12 people - partners and managing partners - who handle current investments. We believe this enables us to preserve a proper level of involvement. It's true that some people believe that a small fund with a small team is better, but we think otherwise. Our methodology is for each partner to simultaneously handle four to eight companies at various stages of growth. In addition, the Pitango team is professional with experience in their fields. People know the markets and they have global relationship networks." That's true, even though no Pitango partner ever managed a start-up.
Hillel says that although Pitango's partners divide up companies according to industry in order to contribute as much as possible to them, "this work structure enables the partners to be deeply involved in several companies, while everyone knows all the companies and is always present to contribute their experience. This is also true for the portfolio companies. It's often the case that several companies are active in the same field and we're able to link them up in a way that helps them penetrate markets or improve their capabilities."
Hillel says Pitango's added value is not just its ability to provide connections in specific markets, but also in the fund's organization capability. "We were the first fund to focus on helping with personnel, especially at the executive level. Furthermore, organizational assistance is significant for companies at the early growth stage, especially when the entrepreneur is inexperienced. We believe this is one of the paramount roles of a venture capital fund: helping a company set itself up in an organized and proper manner. Israeli companies have to turn themselves into international companies quickly, and they have to learn how to do this."
Please elaborate.
"It is necessary to ensure that there is the proper management at each stage in the company's life. It is necessary to know how to choose managers, how to build the company so that it knows how to manage products, marketing and sales. These are major challenges."
Is that why many entrepreneurs know that if Pitango invests in a company, at some point it will insist on replacing the entrepreneur/CEO?
"We don’t always demand that. We take each company on its merits. We definitely recognize the importance of the entrepreneur and his presence in the company. Obviously, an outside CEO will always be less enthusiastic than the person who founded the company. Entrepreneurs are usually the guiding spirit, and we always prefer keeping this spirit alive and kicking. On the other hand, entrepreneurs themselves sometimes know that other managers are needed for the good of the company. I must stress that this depends on the company and management. Look at Red Bend Software chairman Sami Totah Discretix chairman Aharon Aharon for example. Both have proven track records and rich experience. It might be that the model of an active chairman alongside the CEO is best. It's necessary to understand that these issues are important in the later stages of a company's life. In any event, our involvement in a company does not interfere with the management's work. We're there to help, not to do their work. That's why we talk with some companies almost every day, but we're satisfied with a weekly update from others."
All fields will converge
No far-reaching changes are expected in the near future, at least as far as Pitango is concerned. Hillel says, "We believe that the coming year will good for investing, especially in companies founded by experienced entrepreneurs. We'll invest in the first rounds, if the company's entrepreneur has experience. The markets are recovering.
"Technologies that a few years ago were still immature have become consumer goods. Broadband Internet connections are constantly on the rise and mobile devices are becoming more usable. In our view, all the fields will converge in the near future. We compare it to the revolution in television when color screen became available. It's true that some markets are already crowded, but new markets are also being created.
"Pitango scrupulously keeps its finger on the industry pulse. A few months ago, it established a joint team with Star Ventures and Battery Ventures of the US to carry out a study of the homeland security market. A few weeks ago, Peres said Pitango was studying the sector, but that he wasn’t sure if Pitango would invest in it."
What about return on investment?
"Everyone knows that there won't be ten-fold returns on investment, but there will be exits at three or four times the money. Quite a few companies that struggled in the past three years are now showing signs of growth. On the other hand, Pitango didn’t invest in a lot of Internet companies like the American funds did, so we didn’t make a lot of write-offs. In addition, over the years, we made sure not to invest at too high valuations. That's why we think we're in good shape."
Published by Globes [online] - www.globes.co.il - on June 9, 2004