"Not all unicorn valuations are real"

Dovi Frances/credit: Courtesy Group 11
Dovi Frances/credit: Courtesy Group 11

Lone venture capitalist Dovi Frances thinks more startups are unicorns than makes any sense - he puts it down to over excitement.

In recent months, the capital market has witnessed a disconnect between technology companies and traditional industry. The Covid-19 pandemic hit the global economy hard, but technology stocks are breaking records. Does that make any sense? Not necessarily. Investor Dovi Frances of venture capital fund Group 11 tries to explain the interplay between the macroeconomic situation and the high-tech industry. He describes a two-way process - on the one hand, GDP is not growing as in the past. This, surprisingly, may actually benefit technology companies to some extent, as these help implement automation processes that make companies more efficient, - highly necessary in the face of an economic crisis. But later, Frances warns, "This will hurt high-tech. You can say 'software is eating the world,' but if the global economy is in trouble, then software will be as well."

This contrast, between rising unemployment rates, global debt and collapsing businesses, and optimism about the high-tech industry means one has to step back and think, and understand all of the factors in that industry, including of course investors and entrepreneurs. Frances, for example, froze raising money for his latest fund for 150 days, until recently closing it.

"I started raising money in January, but people were afraid they were going to die, so I didn't try to raise money for a few months," he tells "Globes". Exactly at that time, while people were fearing for their health and financial well-being, the start-ups in which Frances is invested - all in fintech - have flourished.

In recent weeks, several have announced funding rounds: digital insurance company Next Insurance has raised $250 million at a more than $2 billion valuation; Tipalti, which has developed technology for automating payments from companies to suppliers, raised $150 million at a valuation of about $2 billion; Papaya Global, which has developed a cloud payroll management system for companies, raised $40 million, a year after its previous round; and Lili, which provides mobile banking services to freelancers, has raised $15 million.

"Investor over-excitement"

"The aggregate value of unicorns [companies worth $1 billion or more] stands at $1.5 trillion. About 300 of them, close to two-thirds, have appeared in the last three years. I argue that this isn't real, that it's related to investor over-excitement. There is a revolution happening, but we shouldn't get too excited, because the number of unicorns doesn't make sense. It can't be that there are 500 companies that define a category, because there aren't 500 categories. We have to remember that we have a market here that has stopped growing," he says.

What about the unicorns you're invested in?

"In my opinion, they're genuine. Most of them are in huge markets, are growing like crazy, bring in recurring revenue with an almost zero churn rate, and have unique technologies."

Part of the optimism about the private market stems from the rise in publicly traded technology stocks, which are benefitting from a rise in revenue multiples. Frances's explanation, however, begins with the bond market: "It's a market that's ten times bigger than the stock market. These days, it's impossible to get a proper return on investment in government bonds, for insurance companies, for example, which forces them to transfer investments to other channels. Their money goes to companies like Apple and Microsoft, where the investment is not based on the revenue multiple, but on dividend yield. Intuitional investment in venture capital has also increased, and that explains why funds have raised so much money."

Frances (42) grew up in Holon and currently lives in California. He served in the IDF in the Nahal Brigade, studied for a bachelor's degree in behavioral science and management at Ben-Gurion University of the Negev, and a master's degree in business administration at UCLA. Since then, he has dealt in capital management, first at Deutsche Bank for high net worth individuals, and now in a venture capital firm. Along the way he also set up a mortgage company and a life insurance company. In Israel, he is known for being one of the investors in the local version of "Shark Tank", the program where entrepreneurs present their ideas to five different investors, in an attempt to obtain investment from them.

"I don't believe in joint decision-making"

Frances raised $75 million for his new fund, following two funds of $50 million apiece. "I invest 70% of the money within two years, and I still have no desire to raise hundreds of millions of dollars. I like our boutique positioning in the market, so I choose not to raise more than $100 million. Raising a larger fund would require me to speak differently, and bring in more partners. The average fund size is $300 million and the big funds are getting even bigger. This creates an opportunity for me, because big funds find it hard to invest a million dollars in a seed round, which allows me to lead these sorts of rounds. It's interesting to see that many good investors like Battery and Lightspeed do join us in these sorts of investments."

Still, why not bring in more partners?

"I don't believe in joint decision making. I have my intuitions and I don't necessarily see how another partner would create added value, certainly not at a fund of this size."

Although Frances is based in California, he maintains close ties with Israel, with 70% of the start-ups in which he invests being related to Israel (i.e., a start-up with its development center in Israel, or an Israeli entrepreneur). "Despite this, the only Israeli institution that has joined me is Hachshara Insurance Holdings, whose chief investment manager is Roi Kadosh. I believe things will change because investment institutions understand that they need to build up their underwriting capabilities, and also invest in US funds. There aren't a lot of funds specializing in fintech, and we're one of the best around."

Unusually, Frances is willing to reveal his funds' returns: the first fund, which was small ($14 million), has a 2.2 times rate of return and in IRR of 20%, internal rate of return (IRR) after deducting the fund's management fees and share in the upside. The second fund has a returned the money 3.5 times and has an IRR of 38%. . The third fund, launched two years ago, has returned the money 1.9 times, with an IRR of 70%. All figures are correct to the present, and the funds still include active companies, which could improve the returns. "In my opinion, the first fund will reach times five, the second fund times ten, and the third fund times seven. My goal, ultimately, is a single one - to find companies that will make the Fortune 500. I'm not looking to make five times the money.

"We're in a world where all the paradigms are shifting. Companies are going to the cloud, using artificial intelligence, processing a great deal of information, and implementing automation, along with offering a better user experience. I think in the changing of the guard, this is what is going to win. When I worked at Deutsche Bank its share price was $108, and today it's $9 - that's a joke. On the other hand, there are banks with no branches at all that are priced the same."

"There's no area that isn't being disrupted"

The recent capital raising activity by fintech start-ups, including those in Frances's portfolio, reflects optimism for a field that had appeared stagnant over the past few years.

"The fintech revolution began in 2008-2009, when governments prevented banks from lending at high interest rates, allowing fintech companies to create products around loans. That gave rise to companies like Lending Club. I think we're in the second wave, at the point where legacy systems are being replaced, and the ways in which life insurance policy underwriting and money transfers are carried out are changing. There's almost no area that isn't undergoing disruption," Frances says, meaning it positively.

And yet, the challenges faced in recent years by companies in the field cannot be ignored. Competing with traditional banks and insurance companies is not easy, requiring complex regulatory approvals, gaining customer trust, and vast expenditure on customer acquisition. Many have come to the conclusion that the way for start-ups to succeed, at least for most, is through working with traditional financial entities, rather than competing against them. Frances only partially agrees with this idea.

"I think there's excessive hype around neo-banks [digital banks U.Z.]. Everyone is fighting for the same private customer in a world war where LTV (lifetime value) is low and unsustainable. There aren't enough financial products. Companies that really change something - that don't just take an old product and build something new on top of it - those are the ones that are shifting the paradigm. Shopify, for example, which has grown at an insane rate recently, isn't competing against Walmart. It's simply looking differently at how to open digital stores."

Lili is a digital bank and Next Insurance is a digital insurance company. They also have to spend lots of money on marketing, gaining public confidence, and obtaining licenses.

"True, but Lili appeals to freelancers and Next Insurance caters to small businesses. This means they sell to businesses that are profit units. I think the licensing requirement changes the economy scale, because if you get a banking license, for example, you also enjoy benefits like the ability to extend loans. Licenses also provide a competitive advantage. It's difficult to obtain licenses for direct banking, so nowadays most digital banks use the licenses of other banks, but looking ahead - the weakening of (traditional) banks will also weaken their power in Washington DC.

"Think what monsters Deutsche Bank and Wells Fargo used to be. But the generational change means that young people don't care about the name; what interests them whether they can do transactions over mobile, and your interface. Banks will lose their exclusivity around licenses, in favor of technology start-ups. Uber and Lyft built an empire and then recently mobilized lobbyists to pass a law in their favor [concerning the need to pay social benefits to independent contractors -- U.Z.]. The same thing will happen in fintech and banking. "

Dovi Frances

  • Venture capitalist, founder and head of Group 11, where he is the sole partner
  • 42 years old, married with one child, born in Holon and currently living in California
  • Holds a BA in behavioral sciences and management from Ben-Gurion University of the Negev and an MBA from UCLA
  • Worked at Deutsche Bank in wealth management for high net worth individuals, where he met the Russian billionaire Sergey Grishin, who hired him to manage his personal capital
  • Group11 was established for Grishin as SGVC, but Frances acquired it from him and changed its name.

Published by Globes, Israel business news - en.globes.co.il - on November 18, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

Dovi Frances/credit: Courtesy Group 11
Dovi Frances/credit: Courtesy Group 11
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