Yuval Shachar experienced the three most recent major crises in the high-tech industry. Twenty years ago, when the dot.com bubble burst, he was heading a one-year old company he had founded when complacency in the industry was at its peak. That company had a compelling technological solution, but no customers to pay for it. During the financial crisis of 2008, he was working at Cisco, where he experienced a different reaction to a crisis: a big ship adjusting to a new reality.
Shachar came to the current crisis as an investor in and chair of Team8, which builds new companies and invests in them. Three crises. Three different positions.
"I usually see myself as the most optimistic person in every setting in which I find myself. Today, however, when I talk with younger entrepreneurs, I am no longer so optimistic about how soon this crisis will end," Shachar told the RoadShow podcast. "In the foreseeable future, customers will definitely have less money. Take the aviation industry for example. It's in a terrible crisis. Boeing alone has 700 suppliers on the verge of collapse, with many high-tech companies selling to those same suppliers. These effects are just beginning to emerge. Things will not be resolved in the next 1-2 years."
Do you feel the younger generation has not internalized the crisis? What is your advice to them?
"Some entrepreneurs ask me if they should send home half their team, or if they should put aside money for three years. There are three things I tell them: a crisis demands of us to overreact, since we cannot tell how big, deep and long it is. For this reason, what now seems like an overreaction may turn out to be an under-reaction. Secondly, they need to over-communicate, to let the people around them feel they know where the crisis is heading. The third thing is transparency. Transparency is a principle that guides me in general, and even more so during a crisis. Transparency helps people cope.
"I urge entrepreneurs to provide me with a very sober estimate of where we are now. Some assumptions say China is already is out of the crisis, that the summer will slow down the coronavirus and that the Americans are nearing elections, so a lot of money will be poured into the economy. These assumptions may be correct, but if you overreact, you will definitely be able to recover. Recovery is not certain if you underreact. Some companies will be wiped out altogether."
"Israelis tend to put off making layoffs"
You founded a startup at the height of the dot.com bubble. How stressful is it when the technological world around you is collapsing while you are holding onto the money you’ve raised from investors and employees, and onto a solution which you don’t know if anyone will buy?
"There’s something very challenging in hitting the road when the market is in a bubble and experiencing how the bubble bursts. The technology developed by P-Cube, which we founded in 1999, helped Internet providers prioritize and streamline network traffic. For example, it prioritized video over e-mail, which could take a few more seconds to land in the inbox. At the time of the bubble, no-one thought it was interesting. Companies focused on growing their client base and market share. People have been talking the same way recently. This way of thinking is typical of every bubble. However, one day the rug was pulled from under our feet. In our case, the bursting of the bubble helped us to thrive, since companies realized they could not afford losing on every customer they acquired, and started looking for new models.
"The first thing that needs to happen is to internalize the fact that you are in a crisis. Israeli entrepreneurs have this ‘it’ll be alright’ mentality. ‘How bad can it get?’ they ask. It takes a while to internalize the fact that you are inside an event that might take years to complete its course, that it will not be over in weeks or months. This was the case in the crises of 2000 and 2008, and I think it is true today too. However, at the time of P-Cube, we realized something very big had happened, so we reacted fairly fast. We had to let go of 20%-30% of the people. Sending people home is always very difficult, in particular for Israeli entrepreneurs, who tend to build a ‘family of fighters’. Israeli entrepreneurs tend to put off making layoffs, especially when the layoffs impact many people.
"Another thing we did was to change direction. The impact of when the bubble burst in the US was so strong that our clients needed our solution but had no money to pay. They had other troubles to attend to. We finally took off via Asia, and moved from there to Europe and the US."
But what about the stress?
"As far as stress is concerned, a bigger group has the edge over individual entrepreneurs, strong as they may be. At the end of the day, a group helps you make tough decisions. Being an entrepreneur is a lonely job. You cannot share your doubts with the management team because they are part of the equation. You can share them with the board, but you would still like to keep some of the questions to yourself because the board influences the decisions being made. You can share your concerns with your partner at home, but they don’t quite understand what you want from them. So finally you are there alone having to make the decisions. At times of crisis, the sense of community is very important. At Team8, we have a group of companies, a family of sorts. Once every two weeks, we meet with them to consult."
What did you learn in 2008 about the dynamics of large corporations during a crisis?
"The margin of error is slightly wider in larger companies. Yes, we had to send people home, which is never easy, but it is easier than when you are the leader of a small company with no extra fat or big enough financial leeway."
How is it for an entrepreneur to go through the crisis?
"They say the tide lifts all boats. If you are an excellent manager but not much of a leader, or alternately, if management is not your forte, but you know how to set a direction and make decisions, the market will roll you forward, like the tide. During a crisis, you need both the traits of a leader and management capabilities. Many entrepreneurs do not have this combination. My leadership traits were far better than my management skills. I am a mediocre manager, or worse. A crisis demands more effort and attention from you."
"I wouldn't have invested in Facebook"
They say that as far as the high tech industry is concerned, the current crisis is more similar to the one of 2000.
"That’s correct. The 2008 crisis was more about finance, whereas the 2000 crisis was about the technology bubble. The technology companies were insanely overvalued, with too much money trying to find its way into the market. The current crisis is not precisely a high-tech crisis, but I think the high-tech industry was experiencing a bubble before, irrespective of the Covid-19 crisis. There were signs of overvaluations, too much money flowing to fuel companies that do not necessarily have a raison d’etre. The coronavirus is an extraneous event helping to reorganize the high-tech industry. I also think that crises inadvertently optimize global innovation and channel it to the places where it is needed the most. This optimization places the high-tech industry at a better starting point."
Everyone knew there was a bubble but continued to invest nonetheless. Even the world’s blue-chip funds invested in startups that have no raison d’etre.
"Peter Lynch published a book about Wall Street, in which he says, 'let me explain how to tell a bubble is about to burst.' In the foreword to his book, he relates that when the 1987 bubble burst, he was at sea on his yacht because he just didn’t see it coming.
"Before a bubble bursts, everyone inside knows they are in a bubble, but they keep telling themselves that it will take much longer. As far as the funds are concerned, if you invest in a company at an unreasonable p/e ratio, and then sell it off at an unreasonable p/e ratios for $1.5 billion, you make a fortune. It works, as long as the music keeps playing."
VC investors are financial investors, but isn’t it about rolling the bluff forward and hoping it won't be called on your watch?
"I understand what you mean. It's for this reason that had I had the opportunity to invest in Facebook, at the time, I would not have invested. It was a company with hardly any revenue and a market cap of hundreds of millions. Many things turn out not to be a bluff, but you can only know that in retrospect. History is written by the winners. Let’s say you invest in a company that makes digital dog food, and it grows into a multi-billion company. So you write a book about how you always knew digital dogfood was going to be the future."
Managers were educated to emphasize fast growth and now they are forced to cut back on expenses. Is this paradigm a fallacy?
"The fast growth paradigm came into being because technological generations last 2-3 years. Unless you make it to market fast, new companies will emerge tomorrow, perhaps starting from a better place than you did. Growth is important. It also indicates that the world wants what you have to offer. No one can afford to take ten years to bring a product to market today.
"Nonetheless, some market developments were utter fallacies. A lot of money was poured into driving growth at any price. Many companies were founded to grow, but cannot reach profitability in the foreseeable future. We are now going to have fewer of these companies. But some companies can still stop stressing growth and become profitable. They do so to become a significant market player as soon as possible, and they will continue to receive the higher p/e ratios."
"It takes a village to raise a startup"
Team8 has developed a unique investment model. Instead of raising capital from investors and invest it in companies that entrepreneurs present, it chose to work differently: identify the problems, brainstorm the solutions, and then look for the entrepreneurs with whom to start a company. Concurrently, Team8 put together 40-person team that helps these companies with business development, sales, recruitment, etc. Team8 was founded in 2014 by graduates of IDF signals intelligence unit Unit 8200 - former unit commander Nadav Zafrir, Israel Grimberg, former commander of the unit’s cyber team, and Liran Grinberg. Shachar, today Team8’s executive chairperson, supported the company from its first day.
"I met Nadav Zafrir shortly after he left 8200. We talked about what happens to entrepreneurs when they complete their military service. As an investor, I’ve seen many companies with brilliant entrepreneurs who wanted to start a company but their perspective on life was not yet broad enough. So they solve a relatively small problem and get sold for $150 million. It felt like a waste of money to me. Nadav told me, ‘I had a critical mass of people capable of solving almost any problem in the universe, but then they are discharged from the military and go about solving small problems.’ That is how the Team8 idea started rolling.
"Some people laughed at us when we founded Team8 and decided to found companies serially, and justly so. They were saying, ‘finding one good idea is hard enough, and you think you'll be able to find lots of them, one after the other?’ We explained we were not in the idea-finding business. Rather, we designed a method that takes big issues, understands them and finds a way to solve them. They say it takes a village to raise a child. We thought it takes a whole village to raise a startup. For this reason, we collaborate with managers of large corporations from all over the world. The help us make sure we are building something with real value, then look for loopholes in our thinking pipeline to generate additional insights.
"It takes us 12-18 months to build a company, from finding the issue to setting up the team. We have an opportunity that other entrepreneurs do not have, for a strategic discourse. We may identify an issue, which other companies rank as number 100 on their list. However, when the dialogue starts, they realize that it's a major problem. Besides, our customers tell us about problems that no one is dealing with, so we feel we are mitigating risk significantly in at least three categories - team, technology, and market."
Are you glad the crisis caught you with the Team8 model rather than with an ordinary fund?
"Yes. Our companies are well funded, and the risk has been mitigated in advance. The companies are operating on solid ground. In the classic model, funds raise one fund after another with a close correlation between the fund’s results and the year in which it was started. I believe that the results of investments made by funds two years ago will not be as good as before. Funds that invest now get an opportunity to invest in companies with more realistic valuations. The VC category was born in the 1970s and 1980s when capital was scarce and entrepreneurs who wanted to start a company had to wait in line. Today, however, capital is a commodity. Too much money is trying to push its way into building new companies. Today’s rare commodity is talent. A cohesive team of entrepreneurs will have no problem raising capital. Indeed, through these rounds, you often get experienced partners who can mentor you. However, under the classic VC model, you cannot build teams of 40 people, let alone of 100-200 people who work 100% for the company.
"I wanted a broad platform of the best people from every discipline and together to build a series of new companies as part of a new model, in which we mitigate the risk. In other words, the idea is not to invest in 30 companies just to have two of them succeed and yield an ROI while the others disappear. We want to pay back a high return to our investors, but also to grow a series of large, independent companies that will not exit."
Last year, we reported that you recruited Rakefet Russak-Aminoach, former CEO of Bank Leumi, to lead your fintech operations. We haven’t heard anything about it since.
"The essence of what we do at Team8 is an infrastructure for large technology companies. We believe the model can be applied to additional areas such as fintech. digital health, and more. When this happens, we will gladly tell everyone about it."
The Team8 model
- The research team ponders a technological problem.
- The problem is presented to Team8’s strategic partners, which include multinationals and investors, to obtain their feedback.
- A search starts to identify an entrepreneur or team to build a startup.
- The outline of a possible solution is presented to the strategic partners.
- Employees are recruited for the new company to develop the solution and implement it with initial customers.
- Team8’s team, which covers business development, technology, sales, HR, and more, supports the new company.
Published by Globes, Israel business news - en.globes.co.il - on May 20, 2020
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