January 1, 2001

For the past few weeks, Erel Margalit has spent most of his time handling his affairs beyond the borders of the country. If he isn't attending a board of directors meeting at one of his portfolio companies in Palo Alto, he could be checking out the new office he has opened in London for the JVP venture capital fund. He may even be on his way to business meetings in New York and Zurich with potential investors for his new fund, JVP4.

Every now and then, he stops over for a visit to the head offices of Jerusalem Venture Partners, in the technology park in Malha, Jerusalem. From there, he tries to explain to foreign investors that the shots being fired at the nearby neighborhood of Gilo, clearly heard from his office, are having no effect on the Israeli high-tech industry. Interviews with Margalit take place at times when he truly appears available - in the car, on the way to or from the airport. This is the time and place to hear his sighs as well: "Times are tough. We are raising capital for our fund at a fast pace, but it is very difficult to explain to the foreign investors that the Israeli high-tech plants aren't in the territories. We have become ambassadors for Israel and find ourselves spending a lot of time explaining things. We have become little 'Ehud Ya'ari's' [Arab affairs analyst and commentator]," he says.

Under the shadow of the current unrest in Israel, Erel Margalit, 39, and his partner, Yuval Cohen, are trying to manage one of Israel's most prominent venture capital funds, Jerusalem Venture Partners. Today, JVP manages three funds, with an asset value of some $260 million, and is diligently working on raising a sum of $500 million for its fourth.

Until recently, Margalit had remained relatively anonymous, familiar primarily among other high-tech executives. Oh yes, he was approached by hundreds of entrepreneurs who wanted to show him their business plans and ask him to invest in their companies, but it took the sale of Chromatis Networks to communications giant Lucent for $4.7 billion to bring Margalit out into the limelight.

JVP was the biggest investor in Chromatis, with a 15 percent stake in the optics company. If the fund had realized the options it had held at the time of the deal, it would have turned a profit of $630 million - $130 million of which would have gone straight into the pockets of Margalit and his senior partners.

Since the deal, however, the price has dropped out of the bottom of the Lucent shares, thereby slicing Margalit's profits in half, according to various estimates. Nevertheless, the deal did turn Margalit into a wanted man, adding him to the long list of directors of Israeli venture capital funds who are favorites with the international media, up there with Shlomo Kalish, Chemi Peres and Nir Bareket.

Margalit has spent the last few months making changes to JVP's business strategy. The new and huge fund he is busy putting together, JVP4, won't just be an Israeli fund in character; it is slated to become a global fund spanning four continents and comprising branches in Britain, the United States, Japan and Israel. "We will continue with our specialty - early-stage investments in companies operating in the fields of communications and optics," Margalit says. Many in the venture capital business aren't enamored of the new strategic approach that Margalit is trying to adopt, seeing it as Israeli chutzpah and a reflection of the megalomania of the local funds. These funds are convinced they have something to offer the world, the deriders say, and are constantly boasting about their alleged advantage in the international arena. On the other hand, there are those who believe that Margalit is not afraid to express the things that many in Israel's developing venture capital industry fear to say: The experience accumulated in Israel over the past decade and the trend of globalization that has crept into the American funds are allowing the Israeli funds to play on the same field as the large international ones, and even to compete for the affections of the most successful start-up companies in the world. Supporters of Margalit's business strategy will remind you that most of the companies in which the Israeli funds invest now fall under the definition of "Israeli-related firms." These companies are Israeli owned or have their development centers in Israel, but their managements and principal operations are in the United States. Margalit doesn't view his desire to compete with the international funds, on their own turf, as Israeli chutzpah: "Would the same thing be said about a leading fund from Silicon Valley that started operating in Japan or Europe?" he asks. "One is allowed to dream of turning an Israeli start-up into a leading international company. From the outset, we teach our companies not to be afraid to dream. Israel is one of the largest venture capital centers in the world. It may be more prominent on a development rather than a business level, but it is undoubtedly very powerful."

Margalit believes that the experience of JVP will give it an edge in the competition abroad. "Israel," he says, "has great technological ideas. We specialize in turning this local ingenuity into an international company. Recently, the American funds have also come to realize that the next big optics company could spring up anywhere around the world and not necessarily right under their noses, in Silicon Valley."

Of the 45 companies in which JVP has invested to date, Margalit says, 15 were foreign firms. According to him, the biggest advantage of the Israeli and American funds that enter the European market is the experience they have accumulated in nurturing companies from their initial stages. "The Israeli funds," he says, "have a work discipline advantage when it comes to working with technology entrepreneurs who lack business experience; [the Israeli funds] help the entrepreneur with the process of building the company and not only in terms of financial investment."

The American funds from Silicon Valley, Margalit continues, have been spoiled for too long. "Although the venture capital industry is moving forward from the point of view of its business perception," he says, "up until now, most of the leading funds have been local rather than global. The Americans became accustomed to focusing on convenient investments, within a mere 60-mile radius of the company in the valley. That era, however, has come to an end and globalization is taking over the industry.

"Sure, the desire to preserve the heritage taught to us by the American funds - according to which companies are built up from the seed stages and then developed in a global manner on international markets - is quite a challenge. JVP is going to do it as a single, global fund; no one does it like that today. Yes, there are American funds that operate in Europe, but they have turned their operations there into European funds. With us, we are speaking about a single group."

Margalit sees Europe as fertile soil for expanding JVP's operations. "Up until now," he says, "the investors in Europe have acted as trust funds. They only invested money in companies and refrained from helping start-ups to develop and grow. In my opinion, Europe lacks the ability to build companies because, among other reasons, the lion's share of the investments of the specialized European funds went to Internet rather than technology companies, the field of expertise of the Israeli funds." Speculating on JVP's position in 10 years time, Margalit says: "It will be one of the leading international funds in the fields of communications and early-stage companies." Taking a moment to think, he continues: "Actually, it's going to happen in far less than 10 years." Despite his global worldview, Margalit remains "an ardent, local patriot," as he puts it, albeit somewhat bitter. "What troubles me is the question of how to keep the commercial heart and not only the development centers in Israel. There are enough second and third generation Israeli entrepreneurs today who have acquired experience and can now keep marketing centers in Israel alongside additional centers in markets abroad. I believe it is very important to concentrate production operations in Israel. After all, we aren't talking about a form of mass production industry that requires sending to the East."

Margalit says the government isn't doing enough to ensure that the production centers remain in Israel. "The entrepreneur," he says, "must stay close to the development and production operations. If the state were to make the necessary arrangements, we could get to the outlying areas as well, to Jerusalem and to the North. The lack of long-term thought is a problem. Look at the tax rates in Israel for example; instead of encouraging investors to stay in Israel, they decided to hit them with an extra tax. The fact that foreign investors are required to set off 20 percent for the Israeli income tax authorities reflects a shortsighted viewpoint."

Margalit's anger stems, in part, from the dispute with the Israeli income tax authorities over the tax to be exacted from the Chromatis deal. "The demand of the tax commissioner is an accurate representation of the absurd situation that exists here," Margalit says. "Chromatis is an American company that wanted to set up a large development center in Israel. But now the entrepreneurs and funds are being hounded by the income tax authorities because one of the fund managers speaks Hebrew. It's scandalous. The tax authorities must realize that they are not the only ones out there in the world; the American tax authorities are now arguing that their Israeli counterparts have encroached on their territory and are trying to claim a slice of the pie.

"Why don't we take a lesson on how to attract entrepreneurs from Germany? The German prime minister came to realize that venture capital would open up the industry. He determined that the taxes would be paid by the employees and the companies, promising investors that the tax authorities in the country would not hound them. This approach helped Germany to become the venture capital center of Europe. Now is the time, with the security situation as bad as it is, for the authorities [in Israel] to take similar steps. Without them, the industry won't stay here, and Israel will become one large laboratory for the companies abroad."

Margalit, who lists a long line of measures that the government should implement to promote the industry, reveals himself to be more public oriented than he is business minded. He admits that the public industry is an old bug he caught from his time working for the Jerusalem Development Authority, to which he intends to return in the future, he adds.

He avoids responding to the question of whether he intends to take over from Stef Wertheimer as the industry's representative in the Knesset, but continues to enthusiastically outline his socio-economic theory: "Israel must undergo changes in the fields of taxation and industrial incentive. The tax rates in Israel must be put on a par with those in the United States because in a certain way, we are almost another of its states. This is a prerequisite; but it is not enough. The entire issue of benefits for approved enterprises needs revamping.

"The state must understand that its most vital capital is its human capital and it has to implement practical measures to provide incentive. There is a need for legislation that provides tax breaks on options to directors and entrepreneurs living in outlying areas or Jerusalem. Implementing such a program wouldn't require any financial investment on the part of the state. The benefits would be afforded only when the company was sold and the options were realized and would be enjoyed by all people living in the same area as the entrepreneur. The law would be based on the same principle as preferential mortgages in national development areas."

Margalit's frustration is clearly evident when asked if he had ever shared his ideas with the government. "Only once?" he exclaims. "On many occasions - the problem is that the only ones interested in listening are the bureaucrats and they want their pound of flesh. You need to step over the bureaucrats. I was also one once, at the Jerusalem Development Authority, and I am proud of it. The choice is in the hands of the official - he can remain a bureaucrat or he could be a public entrepreneur who leaves a mark and does great things."

Some three months ago, the high-tech magazine, Red Herring, published an interview with Margalit that opened with a quote: "We prefer to go by the name of JVP and not Jerusalem Venture Partners." Coming from a seventh generation descendant of a Sephardic family of Jerusalem, Margalit's words surprised many and even stirred up some anger. "He should be ashamed of himself. If that's what he feels, he shouldn't be here," is just one reaction that was heard recently.

Margalit feels ill at ease with the quote and tries to correct the impression it made. "We are still Jerusalem Venture Partners and we will remain so as long as I am one of the senior managers of the fund." Despite his statement to Red Herring, Margalit continues to call Jerusalem home and he is still trying to promote projects similar to those in which he was involved 10 years ago, when serving at the Jerusalem Development Authority. His activities to promote areas for high-tech industry in Jerusalem began as soon as he returned from Columbia University in New York, where he was about to complete his doctorate in the philosophy of logic and was working as a lecturer.

"When the solar energy company, Luz International Ltd. from Har Hotzvim, declared bankruptcy," Margalit says, "I brought the international high-tech entrepreneurs to Har Hotzvim to sell them 24 plots. Then I was among the initiators of the technology park in Malha." Today, Margalit is trying to promote a plan to establish a center for art schools in the heart of Jerusalem.

"Among the young generation abroad," he says, "you can clearly see how a variety of intellectual backgrounds that create as a team can inspire one another. In contrast, here in Jerusalem, with its various population groups, there is no sense of a connection between the creative residents. The city is like a cultural melting pot, which, in my opinion, is one of the best indications of enterprise.

"When someone from Tel Aviv comes to Jerusalem and sees the variety of cultures, it appears oppressive. I think that this diversity actually contributes. Perhaps everyone won't like this, but in my opinion, studying the Torah is also a kind of cultural asset. This is why there is a need to encourage creativity in Jerusalem and allow businesses and high-tech to finance the activities of unprofitable organizations such as theaters and film schools. A project like that appeals to me because it constitutes a creative mixture, an answer that illustrates the extraordinary strength of Jerusalem and of the different populations that live there."

The fact that four of the most prominent venture capital funds in Israel operate out of Jerusalem is no coincidence, Margalit says. "The coffee bars in the Sharon region," he says, "do not reflect it all. The culture of the Jerusalem neighborhoods, Beit Hakerem and Rehavia, is deep-rooted and without materialism. The group is very strong and could, I believe, lead the country."

Despite his proclamation of love for the city, up until now, Margalit and the fund that he manages have hardly invested in Jerusalem-based companies. "We looked, but we didn't find suitable companies in the field of optics. Today, now that there are two successful companies operating in Jerusalem in this field," he says, "we cannot invest in them, since we have already invested in their direct competitors."