BRM Capital, the first fund founded by the Barkat brothers, was raised in 2000, two years before the great crash. Today, four years after it was founded, it is in another place altogether. After a bitter, well-publicized dispute with one of the fund's investors, several partners quitting for various reasons, heavy losses and what appeared to be a loss of direction, BRM is trying to shake itself up and reposition itself with a face-lift.
BRM is not talking about raising a new fund, and will only begin considering it in another year. The present fund has enough money for investments, and BRM will undoubtedly want to show its investors something good before it tries to raise a new fund. Meanwhile, BRM is getting used to its new office and maintaining cautious optimism.
BRM is first and foremost a Barkat family business. In the mid and late 1980s, Brothers Nir and Eli worked with Yuval Rakavy and other private investors through BRM Technologies, which generated both phenomenal returns and a slew of failed companies.
BRM Technologies Ltd. was a private investment firm that permitted itself to run wild. They gained a lot and lost a lot. That's how it is when you invest in start-ups at the presentation stage and hope for the best. If the gamble pays off, you win Check Point (Nasdaq:CHKP); if it fails, you write off millions.
BRM Capital functions as a rather more calculating investment entity, making twelve investments over four years. Eight of the companies are still operating, and some might even be great successes, such as Passave Technologies, Whale Communications (which Gartner Group valued at $280 million in early 2003) and Schema.
In Israel's venture capital industry, BRM is considered a benchwarmer. It isn’t that fund's partners lack talent, they just have to demonstrate it after two years of vacillation. Like other funds, BRM reduced its capital by $100 million to manage $150 million.
Spirit of the times
BRM Capital managing director Eli Barkat resided in Palo Alto for the past eight years, where he managed one of the fund's more successful investments, BackWeb Technologies (Nasdaq:BWEB), before returning to Israel to manage BRM. Two years earlier, Nir Barkat quit the fund in favor of politics. Eli Barkat says, "We went through a period of trials and tribulations, and kept a low profile. But BRM has a new generation now, and its situation isn’t so bad.
"We think that the fund's composition suits the spirit of the times. BRM is the midst of a generational change in management. None of us were here three years ago. I joined a few months ago. We're undergoing a renewal after ten years during which the same people managed investments. We've a new generation. It's natural and necessary."
"Globes": What changed?
BRM Capital managing director Menashe Ezra, who basically managed BRM in the hiatus between Nir Barkat's departure and Eli Barkat's arrival: "We're trying to keep a simple operation. There's little hierarchy here. There are three partners each of whom has investment managers for different sectors. We aim to keep things simple."
Eli Barkat: "We don’t have a huge team, human resource or marketing managers. We learned that it's better for each company to do things for itself. That was one of the lessons we learned from the bubble. Let companies manage themselves, while we provide whatever assistance we can."
One of the reasons for the change was that BRM also manages investors' capital and not just the private family money. Barkat says, "BRM Capital is an independent venture capital fund that operates under the usual format. We manage investors' money and not just our own and private capital. I don’t want to sound conceited, but we firmly believe in this fund, which began operating in 2000, when the crisis erupted. I prefer making cautious prediction, but we available capital to make eight new investments."
Your investment rate hasn’t been particularly rapid.
Ezra: "We're more cautious. We didn’t make any investments in 2000. We again made careful investments in 2002. We've made only a few investments."
Barkat: "The fund was raised from wealthy private investors and Israelis and foreign strategic investors. The problem arose when people inexperienced with venture capital changed their investment strategy midstream. People expected returns within two years, rather than in the normal timeframe. BRM still has a group of entrepreneurial investors who helped stabilize the system."
We'll see you in court
Barkat is referring to Israeli institutional investors, including Bezeq (TASE:BZEQ), which invested in BRM Capital, but refused to transfer capital on the fifth call in October 2003. Instead it filed a $2.3 million lawsuit with the Tel Aviv District Court, claiming breach of the investment contract.
Bezeq claimed that BRM founder Nir Barkat was the guiding spirit and dominant figure in the company who persuaded Bezeq to become a limited partner in BRM in June 2000. Bezeq undertook to invest $4.5 million in BRM and transferred $2.3 million. Bezeq claims that Nir Barket was in breach of his contractual obligations when he left BRM to run for mayor of Jerusalem in November 2002.
In its defense, BRM says Bezeq's lawsuit was a legal maneuver to counter BRM's demand that it honor the contract and transfer capital slated for subsequent investments. Barkat asked the Tel Aviv District Court to dismiss Bezeq's lawsuit, since the contract between BRM and Bezeq included no personal obligation by Nir Barkat to "serve as the fund manager forever."
Nir Barkat says he personally invested millions of dollars in BRM, which he did not abandon when he left the company, relying on the professionalism of the fund's managers. The dispute was settled three months ago in a compromise. BRM and Bezeq withdrew their lawsuits against the other, and Bezeq has pulled out of BRM. The details of the settlement have not been disclosed, and BRM does not care to discuss the matter. Ezra says, "There was a dispute and it's been settled. We're moving forward."
In BRM's favor, it should be remembered that BRM wasn’t the only venture capital fund whose investors invested during the bubble years and didn’t know what hit them when the bubble burst.
Exits depend on the business climate
Ezra adds that the crisis caused venture capital investors to change. "I assume that when we raise our next fund, it will reflect the market change, although things might change again several times until we do so. It's hard to predict. I assume that current investors in venture capital are much wiser. Venture capital is sometimes depicted as something detached from reality, but this model has proved itself in the US in the long term."
Barkat says, "It's premature to make predictions about Israel, but things look good. Israeli funds are as good as the US ones. The level of entrepreneurship is high and there are enough successes to create a snowball of good companies."
Even the 2000 harvest?
Barkat: "The economy is improving and large companies are again buying technology, but the exits won't happen quickly. I see improvement, although exits will clearly be different. Issue channels are still closed to small and medium-sized companies, so it's clear that more exits will be made through acquisitions. Newly profitable large companies will have to show growth, which they will partly achieve by acquiring new companies."
We already see that companies are prepared to pay far less than before.
Barkat: "You should remember the exits of the mid-1990s, before the bubble, averaged four to five times their initial investment. Although there were a few companies that returned ten or 20 times the investment, these were rare cases. I believe that a four or five-fold return is now possible now that the market has sobered up. But you must first build a portfolio. Exits are a question of timing.
That's just the point, and Barkat can sign off on it. 11 years ago, BRM Technologies invested $300,000 to acquire half of a small company. That small company, called Check Point, returned $220 million when it went public. A large part of the investment was private money.
Not relying on Check Point
Will you have another exit like Check Point?
Barkat: "You can't rely on such an exit. A fund cannot make a million investments in the hope that one will make such a spectacular exit. A fund must make investments that will give it a return of three to four times the money. No one will complain if there's another Check Point, but you can't work like that. You must take calculated risks and invest in companies with less risk and greater potential for success."
But that also means less chance of creating especially high returns.
"True. Investing in virgin markets like Check Point's market 11 years ago are riskier. You should remember that Check Point began operating when the Internet barely existed. We'll continue to invest in companies with fewer question marks about their market readiness, because we have the entrepreneurial experience and capability to built more companies like that."
Ezra cites BRM's portfolio for examples. "In the past three years, we invested in Passave when it was completely uncertain whether its technology would catch on. Now it's obvious that it was a good investment and the company is in excellent shape.
"When we invested in Passave, cyber-to-home technology was in its infancy, and it was uncertain whether the company's choice, Ethernet, would catch on. That was a high-risk investment, especially in 2002, when the industry was dead. That's why we acquired no more than 15% of the company, when we usually acquire 20% of our portfolio companies.
"On the other hand, we invested in Oplus when it was a mature company in a market that was clearly happening. Our expectations from Oplus are therefore more modest than for Passave. In any event, we try to invest in companies that operate in unfashionable sectors. We avoid hype, and try to identify sectors before they happen, because that's the way to obtain a higher return."
Barkat says, "Experience shows that when everyone understands the potential of a particular technology, it's already too late. You have to be there first. We focus on investing in early-stage companies; an early entry is made at a much lower company value, and the chance of being the first to market is greater. When you're not first to the market, the potential return is at risk."
Closing gaps
BRM mainly invests in three sectors: software, communications and components. It is also examining other fields. Barkat says, "We're constantly examining future industries. We're interested in security in the broad sense, and we're also well-connected, so we can examine the readiness of security-related concepts. Also, I personally believe in e-commerce architecture. It's obvious to everyone that its happening, and there are still technology gaps that need to be filled. There are problem-solving opportunities in search engines and billing.
So, when you close gaps, you create companies with new gaps!?
Barkat: "Check Point's firewall was considered a small niche eight years ago. That's how it is. That's the trick. Not every investment has to make a 1,000-fold return, and in any case, these 'holes' are in multi-billion dollar markets."
One of BRM's unique features is its high sensitivity to investors. Its partners are former entrepreneurs and they haven’t forgotten what it's like.
Ezra says, "We believe that companies should be run by their managers. We strongly believe in allowing entrepreneurs to raise their companies and find a suitable executive position for themselves."
Barkat says, "We believe that the entrepreneur is the soul of the company and they always bring added value. There has to be a very good reason for hurting an entrepreneur, and we do everything so that they will have a pleasant experience. It's not always possible to maintain the atmosphere of a picnic, but even hard decisions can be taken in a good spirit. We try not to create conflicts between the fund and the entrepreneurs. We're careful to be on the same side and every partner handles no more than five companies simultaneously."
Barkat states BRM's philosophy as follows: "We try to write simple contracts when we invest; contracts that are easily understandable and especially create a sense of cooperation. That always helps us work in good spirit with the companies."
Published by Globes [online] - www.globes.co.il - on August 24, 2004