Unleavened Media: Angel investing in hard times

In the new book Start Up Nation- The Story of Israel's Economic Miracle, Dan Senor and Saul Singer cite the importance of entrepreneurs, and their investors, in building a robust Israeli high-tech industry. The sector represents 16% of GDP and 25% of exports.

That model is now under siege, however, as venture capital firms (VCs) in Israel are bleeding money.  According to PWC's "Money Tree" report, $10 billion in venture capital was raised this decade but less than $1 billion earned back through IPOs and acquisitions. With returns like that, VC's are becoming more conservative toward riskier, seed-stage companies. According to the Israel Venture Center, venture investment tanked by 50% compared to the first three quarters of last year.

IVC Chairman Zeev Holtzman said in an October 20 press release:

The future is expected to be even worse. There is a major shortage of capital for new investments by Israeli VCs, and as foreign VC funds fail to find Israeli co-investors, they will further reduce their exposure to Israel... The entire high-tech industry is at risk."

In this environment, start-ups are relying even more on seed funds and proven Angel investors. However, sometimes even Angels hit turbulence.

"There have been changes in the last 12 months" to Angel investing, says Carmel Vernia, CEO and Founder of Angel group Startup Factory. "We are seeing experienced entrepreneurs come to us who in normal times would have raised $3-5 million from a VC." Startup Factory began investing in 2007 and includes sixty prominent high-tech executives like Dr. Orna Berry (former Chief Scientist of Israel), Shai Agassi (CEO of www.betterplace.com, the man behind the electric car grid) and Dov Moran (CEO of www.modumobile.com and inventor of the flash drive). For each investment, one of the members takes an active management role as chairman.

Although investment basics remain constant, the economic environment has necessitated change. "Deals are smaller," says Vernia. Typical deal sizes have shrunk from $1 million to around $600,000. "In the past, we would have invested $350,000 of our own money and then looked for outside investors. Now we will not put our money in until we are sure the company can raise the balance... It takes longer." Startup Factory has also begun investing in follow-on investment rounds for their companies. "Originally, we planned to invest only in seed rounds with no follow-up whatsoever. This year we changed our charter and can now provide bridge loans until the next round."

One Angel who has not scaled back his activities is legendary investor and prankster Yossi Vardi. A prolific seed-stage Angel investor since 1996, Yossi's successes include ICQ (sold to AOL), Answers.com (went public) and Tucows (went public). "I made seven investments in the last year," he says, all in verticals with low capital requirements.

Yossi brings more than just money to the table. He serves as a connector between small-scale Israeli start-ups and international companies with large resources. He does this through a variety of industry events in Israel and abroad. One is an annual gathering for technical and creative talent on the shores of the Galilee called Kinnernet. In addition, together with Burda Media in Germany he co-chairs the annual DLD (Digital, Lifestyle, Design) conference in Munich. Vardi is also co-chair, with WPP Chairman Sir Martin Sorrell, of the annual Stream Unconference in Greece. Vardi co-hosts ICUC - Internet Cowboys UnConference in Jackson Hole, Wyoming. These events stimulate business partnerships and provide an environment where small companies can meet established partners with more resources. "My companies are like tomato seeds," he says - there's a lot inside but they won't grow into a plant on their own.

Dr. Vardi is not a typical Angel. There are roughly 6,000 people in Israeli with liquid assets in excess of $1 million and roughly 10% of these dabble in Angel investing. Since 2005, Sharon Weshler, founder of GlobalMarketTeam, has been matching the more sophisticated Angels with technology start-ups seeking money. "We now have a network of over 280 such individuals whom I met personally, in most cases," he says. Recently, Sharon has been particularly active in the clean-tech sector.

Of course, recession equals opportunity for some start-ups. Donanza is a global, online aggregator of free-lance and project work postings. They partner customers with the online version of the local print newspaper, which can then offer a more extensive online listing and share a portion of the ancillary classified revenue. CEO Liran Kotzer says the company uses their own service. "We are three guys in Israel and everyone else - the programmers, graphic designers, engineers - are free-lancers that we located through the Donanza service and contracted on a project basis,” he says.

Yossi Vardi invested in the seed round and another prominent Angel group recently signed a term sheet. "We have been fortunate with our timing," says Kotzer. "Free-lancers need the service and online publishers are motivated to find new revenue sources."

Recessions also bring hard choices. In some cases, this means restructuring senior management and business models at portfolio companies. For example, After Dox partners are finding themselves in more hands-on roles than originally envisioned. Recently, a partner from After Dox (former Head of the Israeli branch of Computer Associates, Arie Offner), became the Active CEO at one of their portfolio companies. "We needed to take the company in a different direction," he says.

After Dox is an Angel investment group composed of (mostly) former senior executives from Amdocs.  These are seasoned veterans who view a down market as an opportunity. Last month, After Dox invited me to attend their investment meeting, managed by Moshe Koslovski (former Division president at Amdocs) and interview several partners. Avigdor Yeger (former VP at Amdocs) says, "Our process is not to find the next Google. We want companies that have a good shot to be a success. Old-timers like us have the skills and knowledge for managing this process."

Adds Irit Israeli-Kahana (former VP at Amdocs): "This economy helps people like us. Our money and experience has become more valuable compared to two years ago. It allows us to get better value."

Artzi Benkuzari (former VP at Amdocs), also prefers to focus on the basics. "It's the simple stuff that matters, like expenses vs. income. If we can do that, then I am not pessimistic."

For each investment, a director is appointed from within the group of forty-six partners to assist the management team. The accumulated wisdom of After Dox members enables the companies to enjoy a wealth of experience in management, marketing and finance - all extremely important in these rough days.  Dovi Levanon, who most recently served as General Manager for the EMEA (Europe, Middle East, Africa) business of ECI Telecom, holds the role of chairman for portfolio company Todacell. "I remember thinking two years ago that we could really help this company with sales and marketing, opening doors, preparing the company for high valuation investment. Now sales in the US and EU are doubling month over month and we have customers like Google and Yahoo," he says.

Nissim Ben Oz (former VP at Amdocs) is practical about the role of the Angel. "Our main concern is raising enough money to support a company. This is what stands between us and success. The first two years are critical." He agrees with Gady Munz , former Managing Director of  Manpower, Inc: "The government could drive money to this channel by providing tax breaks. That would put our pension money into something that actually helps the whole country." 

Recognizing the money crunch facing Israeli seed-stage start-ups, Yaron Samid, founder of Tech Aviv - a network of 1500 Israeli hi-tech entrepreneurs that meets each month in New York, Tel Aviv, Silicon Valley and Boston - announced on October 21 a new Angel group, called Tech Aviv Angels. This includes thirty successful Israeli technology entrepreneurs as well as individual investors working at VC firms.

Even this may not be adequate. After Dox reviews 100 business plans for every single investment. Israeli start-ups who are too early for VC's and have not had success with Angel groups could also try these grant sources:

1)      Israel Internet Society Research Grants (http://www.isoc.org.il/scholarship)

2)      US Israel Binational Industries R&D Foundation (BIRD) (http://www.birdf.com)

3)      US-Israel Binational Science Foundation (BSF) (http://www.bsf.org.il/BSFPublic/DefaultPage1.aspx?PageId=21&innerTextID=21)

4)      Intel Annual Research Grants Progrma (http://www.intel.com/cd/corporate/education/emea/heb/intel_education/highered/385461.htm)

5)      Technion Research and Development Foundation (http://www.trdf.co.il/Eng/redir.asp?PageId=RnD/fo_det&S=0&FODID=124)

6)      Israel Science Foundation (http://www.isf.org.il/english/default.asp)

7)      Incubators Program - Office of the Chief Scientist of the Ministry of Industry and Trade (http://www.incubators.org.il)

8)      Israel-Japan call for Proposals: Ministry of Science and Technology (http://www.most.gov.il/English/Services/Calls+for+Proposals/Call+for+Proposals+in+the+framework+of+scientific+cooperation+IsraelJapan+2009/default.htm)

Angel groups are needed in this economy like never before. That doesn't mean it is easy for them either. The famous Tom Waits song Mr Siegel could have been written about the current economic conditions for Angel investing: "How do the Angels get to sleep when the devil leaves the porch light on?"