StageOne Ventures manages $40 million. This can be considered a small and marginal amount for a venture capital fund. There are funds that manage far greater amounts of money, have more partners, bigger offices and large portfolios. But if one bothers to check beyond the money, it would appear that Israel's venture capital industry needs small funds at least as much as it needs the large ones.
The large funds' ability to found more than one or two early-stage companies is limited. The large funds must invest their investors' money in later stages. Smaller funds such as StageOne create the dealflow for the large funds. The small funds can invest their time in creating companies at the presentation stage, and closely accompany the entrepreneurs.
StageOne has understood this for years, and that's what it does. Last year, they made their model even more sophisticated by acquiring the Nitzanim Initiative Center, renamed it Lab-One Innovations, and turned it into a factory of companies.
StageOne was founded in 2001 by managing partners Adoram Gaash and Yuval Cohen. Gaash has ten-years of entrepreneurial experience in communications. He founded and managed Radwiz, later acquired by Terayon Communications Systems (Nasdaq:TERN), as well as holding number of senior positions in RAD Data Communications, where he was involved in Radlan and Radware (Nasdaq: RDWR; TASE:RDWR). Before that, he held a senior position at ECI telecom (Nasdaq:ECIL).
Yuval Cohen was previously a general partner in Israel Infinity Venture Capital, specializing in communications investments. Before that, he was VP at Isal-Amlat Investments (TASE:ISAL), and was involved in the establishment of venture capital funds at IDB Holding Corp. (TASE:IDBH).
"Globes": Didn’t you have to be crazy to found a venture capital fund for communications in 2001?
Gaash: "It's true that no new seed investment funds were founded at that time, certainly not funds focusing on telecommunications. The idea wasn’t to ride the wave of hype, but to wait for the crisis to end, when such an investment model would be needed. The crisis enabled us to work quietly. It was clear to our investors that this was an opportunity to make a long-term investment, taking a into account return to sanity.
"You can't imagine that Joseph Riback, then CEO of Discount Investment Corporation (TASE:DISI) didn’t know what he was doing. Our investors and we knew we were heading into the wilderness, and that there were greater investment opportunities than during the bubble."
Gaash says his model was to make seed investments, locate entrepreneurs with ideas, and accompany them from the outset. "We decided to focus on communications and IT. It should be remembered that there was almost no investment in new communications companies at that time. Everyone believed communications was finished."
So why did you enter it?
"We believed that in order to develop successful companies it was necessary to start at the beginning. We weren’t worried by the crisis, because this was clearly a natural cycle, and that communications hadn’t stopped developing. We set ourselves the goal of starting with early-stage companies, which is what we've done ever since, without exception. We didn’t diversify into later-stage companies, although we had offers. We went forward step by step. We made three investments in 2002 and four in 2003, as well as acquiring Nitzanim.
Why does a small venture capital fund need an incubator?
"We realized that it would be harder to accompany more than one company a year, because doing this closely requires time and energy. That was the case with our first investment, Crescendo Networks. When Yiftach Shoolman founded the company, he came to us and we began working. We had another company based in our offices at the time, and we the bottom line was that we all couldn’t work in the same place. We realized that the model was right, but we needed separate premises nearby for the new companies. An incubator was the best solution. It took almost a year, but we acquired an incubator that is located across from our office. The model hedges the risk and enables us to establish companies.
"Seed investment was very common during the 1990s, and vanished altogether after 2000. It was a radical shift from one extreme to the other. When the crisis erupted, there was simply no financing for new companies. Everyone shut their doors and took care of their portfolio companies. We also know that it's hard to grow more than one company a year. We can now grow three of four companies a year through the incubator, which also creates dealflow for us for first financing rounds. Most of our eight portfolio companies were founded in our incubator."
What kind of companies and entrepreneurs do you look for?
"We look for entrepreneurs with a technological orientation. The marketing element was important for ventures during the capital market boom. In those days, ventures were chosen for their technological capabilities, in other words, on content. The role of the entrepreneur, in cooperation with us, is to develop a working prototype at an investment of $500,000-800,000, and to have at least one customer testing it and testifying about it. The fund then reviews the company and the investment in it.
"We need to cooperate with venture capital funds with deep pockets for the later financing rounds; funds that rely on us to raise companies properly up to that stage, making them worthwhile for larger follow-on investments on a scale we cannot do alone. That's why we invest in earlier stages at low valuations, acquiring a substantial stake of up to 20% in the early stages. Our goal is to reach a situation in which we own less than 10% of a mature company."
Is there a future for small venture capital funds with limited capital?
"Absolutely, I think, although there will be some kind of interaction with larger funds. A sort of food chain. They can't manage without us, and we equally need them. The crisis led to many good things for the small funds. Our money was worth a lot more, and we believe that we can repay our investors their principle, and a lot more."
Gaash's belief relies on StageOne's portfolio companies. "We have some companies that we believe we do well. Crescendo Networks will have millions of dollars in sales in 2005. Investors from all over the world are interested in it. Remember, that when we began working with Shoolman in 2001, it was considered ridiculous to finance a company that worked on improving the performance of server companies, but over time, it has become apparent that Crescendo has created a new field, in which it is the leader. It has strong management and almost no competitors. All our companies have carried out follow-on financing rounds at higher valuations. I think that proves we're right."
What's next?
"We'll raise a new fund in 2005. We're confident about it. We'll look for investors who love our model; investors who want to diversify their risk, and not put $20 million in one fund, but $5 million in smaller funds.
"We'll look for financial investors who want to be close to the market, to the earliest-stage companies. The new fund will be similar in size to our present one, which will enable us to continue using the same model. It's quite possible that when we begin raising money we won't have a fantastic exit to crow about, but we feel that we can display our promising portfolio to smart investors, who can examine it and calculate its value. We have no hype to sell; we have a portfolio and model that we feel can be a significant anchor."
Published by Globes [online] - www.globes.co.il - on November 17, 2004