Nadav Zafrir, managing partner and co-founder of venture capital platform Team8, was not alarmed by the recent sharp declines in high-tech company valuations. On the contrary, he confesses, he breathed a sigh of relief when the party died down. "When times are flush, and everyone’s competing over who’s value is higher, and who’s made a brilliant exit, it’s not good for a model like ours. We’re more focused and in-depth. We target a sector, establish companies, and also invest in them. We definitely felt it was harder for us to recruit the entrepreneurs we wanted."
Weren't you tempted by the "public auction" effect, to pay more at a valuation higher than you’d estimated?
"It was tough and led to difficult discussions, and we had arguments that were not at all easy. If we held back, I can't take the credit for it. I have a variety of partners, like Yuval Shachar, our strategist, who knows how to rein me in, and Rakefet Russak-Aminoach (formerly CEO of Bank Leumi, S.L.), who understands a thing or two about risk and market fluctuations, plus others. That’s what enabled us to keep our feet on the ground and remind ourselves that, with patience and determination, we would eventually find the entrepreneurs we needed."
The Team8 model for initiating and founding companies involves entrepreneurs and investors, researchers and consultants from the industry who are also potential customers, in an attempt to identify big opportunities and find the exact balance between a technology and the needs it can meet. Team8 started out in cybersecurity, then added a venture capital fund, Team8 Capital, and platforms in data and fintech, and most recently, digital health. In the eight years since its founding, Team8 has grown from $42 million to 25 times that, and is estimated to have $1 billion under management.
During the wild times, did you invest in any company at a value you thought was excessive?
"In the companies we found, we have to be very focused, because ours is a terribly expensive model, and if I invest at an insane valuation, the model won’t justify itself, even if the companies succeed. In the venture capital fund, we compete more with the regular market. Did the valuations have an effect? Yes. Did we get carried away? No. We took a calculated risk."
Things did get "carried away" in April 2021, when Team8 Capital joined an unusual $26 million seed funding round, (led by US-based Lightspeed Venture Partners and with the participation of Zohar Zisapel and other investors), in a company that was only two months old, with just a few employees and no product. That company is Talon Cyber Security, which is developing a secure browser, "A topic we understand well and with entrepreneurs we know (Ofer Ben Noon and Ohad Bobrov), who have each founded successful companies. It was worth it for us to bend our rules for them."
In August, after things sobered up, Talon raised $100 million, in a round in which you joined. Do you feel reassured that apparently you weren't wrong?
"That we managed to raise funds at a higher value doesn’t get me excited, because I know there’s still a long, hard road ahead. In the end, success - when my partners and I, along with our investors will see money - means only one of two things: either we’ll have a successful IPO and the company will have become stable over time, or we'll make an exit and sell to another company. And even when that happens, I won't call it a success until I see what becomes of the people, the company, and the technology over time."
Is this a sentimental thing? ‘My baby has left home but he’s still my baby’?
"Obviously, I regard every single one of the companies as my baby. But that's not the reason. We want to create an impact, to have an effect on industries, and above all - and this is the opposite of altruism - we believe this is how you build a brand. We’re a new Israeli brand that wants to attract entrepreneurs. Because this entire industry depends on only one thing: which entrepreneurs will choose to work with you."
Zafrir talks about three prominent Team8 exits, but omits a fourth company that was sold. When I ask about it, he says, "This was our only failure to date: Hysolate, which we sold in March of this year to Perception Point, an Israeli cybersecurity company. We didn’t disclose the amount, but the price didn’t justify the investment, and I say candidly that it’s a failure. We failed to build the product we thought we would. We wanted to split the operating system into several systems in a way that would be transparent from the user's perspective, but from the attacker's point of view would be completely different systems (and protected differently, of course). It was a monumental task. We were too optimistic. Every time we encountered a problem, we believed it could be solved, and we didn't realize that mounting problems form a critical mass that require a complete rethink."
"Cybercrime will continue to grow"
Speaking of challenges, your bread and butter, the Israeli cybersecurity industry, is being shaken up quite a lot. Is cyber less attractive than it used to be?
"Some companies in this industry have no customers, others have customers but are losing money on them. And of course, valuations have fallen for some. But demand for this technology has not declined; it is on the rise, and will increase even more when the war between Russia and Ukraine ends.
"Currently, Russia has a strategic interest in confining its cyber activities to Ukraine, but as soon as the war ends, this interest will be reversed. This is because the agreement that ends the war won’t end the economic sanctions against Russia, which will lead it to increase its cyber-attacks, primarily because it will view this as a way of bringing the world back to the negotiating table on the sanctions.
"But there is another element: what will all those Russian programmers who worked at Google up until six months ago do? (Google Russia went bankrupt because of a large government fine; Microsoft and IBM liquidated their businesses in Russia and fired hundreds of employees - S.L.) People need to feed their children. So, they will turn to cybercrime. Another element is the international cooperation against cybercrime, which has been wiped out. All of these will lead to a situation in which, in the coming years, the threat will grow."
From South America to the IDF
Zafrir was born in Kibbutz Kiryat Anavim but grew up mainly in South America. His rancher father was dispatched to bring Israeli agricultural innovation first to the Dominican Republic, and from there to Ecuador, where Zafrir grew up for most of those years. At the age of 18, he returned to Israel to enlist in the IDF. Later, his parents returned in stages; first his mother, then his father.
He is the father of three, the youngest is in kindergarten, the middle one is 14, and the eldest, Zohar, 17, is starting eleventh grade. "Thanks to her or because of her, we returned to Israel a year ago. We moved in 2017, after I realized that I didn’t know anything about go-to-market and wouldn’t learn about it in Tel Aviv. But Mia, my wife, and I realized that we were on borrowed time, because it was important to both of us that the children should be Israeli. I didn't want Zohar to experience what I had; coming straight to the army and landing in paratrooper boot camp was a tough experience."
In 2005, Zafrir transferred to Unit 8200 as deputy commander, and in 2009 was appointed unit commander, a position he held until his demobilization from the IDF in 2013. He also received a medal for a covert operation, but Zafrir dismisses this with a shrug and says, "It was a long time ago." At age 43, after 25 years of service, he was released from the army. Israel Grimberg had just ended his service as head of Unit 8200’s Cyber Division, and two weeks after the release they both travelled to the US to say goodbye to members of the National Security Agency (NSA), with whom they shared many secrets and experiences. "On the way back, on the train, I asked Israel, ‘What are you going to do?’ And Israel answered, 'I don't know, but I have an idea about creating innovation through wisdom of the crowd.' Then he asked me, ‘And what about you?’ I said, ‘I don't know, but maybe we'll do it together.’"
They coopted Liran Greenberg, a younger man whom they also knew from 8200, and set off on a truly unprecedented journey. "It was very difficult to raise money," Tzafrir explains, "because our idea wasn’t a simple one. We wanted to found a startup that founds startups. We visited every fund in Israel - at the time they were all in one building in Herzliya Pituah - and every of them gave us a two slaps in the face, some politely, others not politely."
Sometimes you have to throw a million in the trash
The turning point came when they met Yuval Shachar, then a partner at the Marker LLC and Innovation Endeavors funds, who became their chairman and first investor. Nearly four years ago, Shachar joined Team8 as a managing partner.
"With Yuval, we’ve expanded the model beyond cyber. I have the same relationship with him as I had with Guy Sella (the late founder of SolarEdge who was also Zafrir’s 8200 commander - S.L.). I need someone alongside me with more experience and strategy than I have in order to carry things out. Yuval's vision was that we would take the model and replicate it in new areas, and also add a venture capital fund. In each of our target sectors, we build one to two companies per year. The venture capital fund allows us to invest according to our ideas, beyond our ability to establish companies."
Have you ever had to close down a company?
"Sure. A lot. To build one company, we come up with at least five ideas. Only one of them will become a company, and this company has milestones at which the entrepreneurs have to convince us why they should continue."
Team8's typical investment in a company on each of its platforms is $5-10 million, allocated in stages according to milestones. "Up to the first milestone," explains Zafrir, "we invest a million dollars and more. And after the first milestones we close almost half of the companies."
Meaning, your way or operating includes throwing a million dollars in the trash from time to time?
"Yes. Because it's better to stop."
"The need for innovation has risen and will keep rising"
Zafrir does not agree with the word ‘crisis’ as a proper description of what is happening in the tech industry. "It doesn’t describe the situation correctly. There is a substantial shift in trend, which even has many advantages, he says.
"Several parameters have changed significantly and are leading to a global slowdown. One is the hangover from Covid-19. We went into the pandemic in a kind of depression that, after a few months, turned into a mania accelerated by unprecedented money printing following a crazy period of zero interest. This resulted in readily available and cheap money. Manic depression makes valuations rise and fall in a matter of minutes, but it’s not good for building a future-facing technological infrastructure. At the beginning of the pandemic, we were depressed and stopped investing in infrastructure. But then the opposite of what was expected, happened: consumption increased and a huge gap was created between consumption and output. This led to a dramatic supply chain problem, exacerbated by the war between Russia and Ukraine, which sit on some of the most important natural resources known to humanity. Along with this, inflation rears its ugly head, interest rates rise, and the upheaval immediately affects both investor morale and valuations.
"This has led to a change in trend, but not necessarily a substantive change. Because essentially, in my view, the need for technological innovation has not declined, but has risen and will continue to rise in the coming years. If we as an industry need to take stock, it’s about the almost blind belief that some of our friends followed, that valuations are what lead the industry, which has become an industry of valuations and not of value."
And what is the change in trend?
"In the last 20 years - putting aside the 2008 crisis, which was very focused on the US and banking - we’ve become a more global, more prosperous world, with increasing technological influence and zero interest rates. Today some of these things have been reversed. The world is becoming less global, with what’s happening between the US and Russia, the tensions between the US and China, and - on our regional level - with Iran. The other two changes are the rise in interest rates, and the global supply chain crisis, including in software, which is based on chips.
"But I believe that in the coming decade, tectonic technological shifts will occur. Entire industries will be transformed, and Israel has the core capabilities to become a transformation nation - if we know how to preserve and grow these capabilities. The Israeli market will become more attractive, because in a world like this, everyone wants good technological manpower".
What should Israeli companies do?
"Understand that customers, not investors, finance the companies in the long term. Second, you have to get used to the fact that the idea that there will always be someone who will assign a high value to something that is shiny enough, no longer holds water. Companies need to create a culture of measurable parameters from day one. Growth is important, but it is not the only thing that matters."
Are you worried about the waves of high-tech layoffs?</i?
"Absolutely. As far as I understand, the number of people employed in Israeli high-tech has not fallen, but the rate of growth may have fallen. It has to be said honestly that some companies have taken advantage of the situation. When a company grows, there are always people that it wants to replace, and the public and economic atmosphere gave some companies the opportunity to do so. There are also companies that have built pie-in-the-sky businesses, and right now their situation is not good. They’re rightly trying to prolong their lifespans in order to reinvent themselves, and to do that, they must reduce manpower."
Will these things bring foreign funds that will want to buy companies cheaply and compete with you?
"Yes. The foreign funds are here, and there are even foreign funds - some of them huge - that invested in the early-stage companies out of lack of choice, because the valuations of the more mature companies have rendered them irrelevant. But the bottom line is that it makes us both sharper and humbler, and for the State of Israel it is fantastic. The more the merrier."
- Nadav Zafrir (52)
- Personal: Married to Mia and father of three, lives in Tel Aviv.
- Professional: Founder and managing partner of the Team8 group, chairman of cybersecurity company Claroty and chairman of SolarEdge. He was the commander of Unit 8200. Holds a master's degree in business administration from Tel Aviv University and a bachelor's degree in law from the Interdisciplinary Center - Reichman University (IDC Herzliya).
- One more thing: "I keep telling Mia that I don't have any hobbies, someday I'll have to adopt a hobby. Maybe my hobby is getting out of my comfort zone"
Published by Globes, Israel business news - en.globes.co.il - on October 25, 2022.
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