By David Rosenberg
JERUSALEM -(Dow Jones)- Older, more established high-technology companies in Israel are taking the brunt of the decline in venture-capital investment because their huge financial requirements make them too risky, industry executives said this week. Only a year ago, tech companies that were ripe for an initial public offering after two or three year's operating experience were the darlings of the venture-capital industry because investors could earn big returns very rapidly. But with the IPO market now all but dead, these "later-stage" companies have become white elephants.
"A later-stage company is a larger organization with a larger burn rate ... and it's a company that's approaching an IPO," said Adam Fisher, a partner a Jerusalem Venture Partners . "It has to perform, and there's not much room for error. It's the kind of risk a lot of investors are not prepared to take."
A survey released Thursday by VentureOne, a U.S. company that tracks the private equity industry, found that investment in high-tech companies with Israeli headquarters plunged 63% to $58 million in the second quarter from the first.
By contrast, investments in seed-stage companies, usually those in the research and development phase, fell just 12% to $10.3 million, while companies seeking intermediate funding saw investment drop 30% to $157.8 million. Overall venture-capital investment in Israeli companies dropped 44% in the quarter to $398 million, VentureOne said.
The average valuation of an Israeli tech company dropped to $7 million in the second quarter from a record $20 million in the first, because funding for older, higher-valuation companies simply dried up, VentureOne said.
Tamar Zemel, a spokeswoman for the group, said one reason for the steep decline in later-stage investment was that Israeli companies tend to move their headquarters to the U.S. as they emerge from the R&D stage and focus more on marketing. Hence, for survey purposes, they become U.S. companies rather than Israeli ones.
But Israeli venture capitalists say later-stage companies are simply being shunned and that's the main reason why investment has declined. Fisher said his fund, which invests mainly in younger companies, had seen more and more established companies coming hat in hand to him, unable to raise money from their earlier-round investors. "The later-stage companies are burning a lot of money so VCs have to decide which ones to keep and which ones to kill," said Shlomo Kalish, who heads Jerusalem Global Ventures. Seed-stage companies are riskier but a little bit of money goes a long way and they can be steered more easily in the right strategic direction.
As a result, valuations for later-stage companies have fallen by 50% or more from a year ago, as much of the market for high-tech equipment has collapsed while exit prospects via an IPO or a buyout have narrowed substantially.
This has left a lot the funds in Israel, especially foreign VCs which often focused on later-stage companies, holding a lot of businesses for which they paid too much. Having been burned once, they aren't looking for new investments even at today's bargain prices. Some early-stage investors are taking advantage of the circumstances and cherry-picking good companies at knockdown prices.
"You see some very attractive later-stage companies at significantly lower valuations and those are attractive," said Giora Bitan, a partner at Giza Venture Capital in Tel Aviv, which once concentrated on early-stage companies.
"Today the gap between the seed and later-stage valuations has shrunk dramatically. The risk-reward ratio has changed. So now, we're looking at later-stage companies that we can invest in at an early-stage valuation."
However, the problems later-stage companies face don't give startups much to celebrate. All companies are feeling the pain of less capital and lower valuations, and in many cases startups are being squeezed out by the fire sale of older companies.
Roni Hefetz, of Walden Israel Ventures in the Tel Aviv suburb of Herzlya, said many VC managers would rather invest in a really cheap later-stage company, with its product development and management in place and perhaps even a few customers, than a similarly valued startup.
"The competition for a real startup is very hard," he said.
-By David Rosenberg, Dow Jones Newswires; 972-2-537-6985;
david.e.rosenberg@dowjones.com
