Israeli VCs brace for consolidation

Despite relatively stable dealflow, fundraising is proving tough for a number of technology-focused venture capital groups in Israel. By Robert Venes.

The Israeli technology venture capital industry has bounced back from the technology crash as well as, if not better than, most regions. There is a concern, however, that a number of smaller technology-focused venture capital firms will face difficulties raising fresh funds going forward, with consolidation the likely end result.
Despite a small decline, technology investing in Israel was largely on track in 2005. According to a report by IVC, a Tel Aviv-based venture capital and high-tech research centre, investments in Israeli technology companies reached $1.35 billion last year, an eight percent decrease on 2004 but 32 percent above 2003 levels.
“The eight percent decline in 2005 reflected a slow fourth quarter,” says Efrat Zakai, director of research at IVC. “Q4 was the weakest quarter for [venture investing] in two years. We believe this is only a temporary decrease and project a return to earlier levels in the coming quarters.”
Those earlier levels are impressive too. According to the report, Israel was the most active country in Europe for technology investment in 2004, during which capital injected into Israeli companies totalled $1.465 billion, compared to the UK’s $1.349 billion and $784 million in France, which came third.
Zakai adds that, over the last few years, activity in the Israeli venture capital industry has been fairly stable, with “relatively few dramatic highs or lows”.
Less comforting is the suggestion that a number of domestic venture firms may fall by the wayside if support from limited partners is proving elusive. This in turn is likely to open the market for foreign investors. “The composition of venture capital investments in Israel is expected to change over 2006, with an increase in foreign investment activity as the number of local players diminishes,” says IVC general manager Guy Holtzman.
Zakai says that, although larger and more established Israeli venture capital firms – Carmel Ventures or Gemini Israel Funds, for instance – have survived the fallout from the tech crash over the last few years, a number of smaller firms are having problems. “Not all of them, but a number of them have had trouble raising funds,” she says.
The net result, says Zakai, will be fewer local firms investing in domestic companies, and more investment from abroad, particularly from VCs headquartered in the US.
According to IVC’s report, approximately $682 million of investment in Israeli high-tech companies in 2005 came from overseas, compared to $655 million invested by domestic firms.
IVC says that there are currently 35 Israeli venture capital firms in the process of raising funds across all sectors.
Other European countries have witnessed periods of consolidation in the venture capital industry over the last five years as well. These include Germany, where a number of smaller venture capital funds rushed into the then attractive dotcom sector in the late 1990s only to get burned or bought out later on.
Even today, fundraising for Germany’s remaining venture groups remains challenging. Late last year, German venture capital firms Triangle and TVM Techno Venture Management successfully raised capital for new funds, but reported difficulties attracting the attention of US and European LPs who were preoccupied with buyout funds.
Whether or not Israel’s venture community base will face similar difficulties in the future, its technology industry is unlikely to suffer greatly. Given the level of interest in the country and sector, fewer domestic groups should be able to raise larger funds. In addition, foreign VCs will be ready to step up to the plate.