Why 3i got serious about Israel

3i is growing its footprint as a limited partner. Following its strategic investment in Russia-focused Quadriga Capital Russia Private Equity Fund II last month, the London-listed private equity firm has followed up with a $20 million investment in Giza Venture Capital’s fourth fund.

Tel Aviv-based Giza began marketing Giza Venture IV in 2005 and closed the fund recently on $150 million (€126 million). 3i joined a number of high-profile international investors in the LP base, including HarbourVest, CalPERS, CalSTERS, the Bessemer Trust and Taiwan Development Fund.

The Israeli technology start-up sector is looking globally almost from inception as the domestic market is very small. Zeev Holtzmann, CEO, Giza Venture Capital

Fund IV will follow its predecessors’ strategy of focusing on Israeli seed and early-stage companies in the communications, enterprise software, semiconductors and medical devices sectors.

“Historically, we have made one or two investments in Israel, but it’s fair to say that this is our first serious entry into Israel,” Patrick Sheehan, a partner in 3i’s London office, tells PEO. Sheehan will manage 3i’s venture interests in Israel alongside fellow London partner Ali Erfan.

“Having filled out a substantial piece of our global network, we’re naturally driven to complete that map and Israel was one major missing piece of our global jigsaw,” adds Erfan.

As well as investing in Giza’s fund, the relationship will also allow 3i to co-invest directly in the region. “They are a big financial investor that can co-invest and strengthen the financial activities of our firm,” says Zeev Holtzmann, CEO of Giza. “The relationship also opens many opportunities to our portfolio companies to have a global perspective that can bring added value to their positioning outside of Israel.”

That can work both ways, says Efran, who admits that the relatively small size of the Israeli tech market limits the opportunities for 3i’s portfolio companies to expand into the region. Still, “it will prove useful in terms of benchmarking technology services”.

Holtzmann: smaller but more mature industry now

The size of the early-stage technology sector in Israel suits a more international approach, says Holtzmann. “The Israeli technology start-up sector is looking globally almost from inception as the domestic market is very small, so having a co-investor or relationship with a global investor such as 3i from the beginning is a big advantage,” he notes. Sheehan and Erfan agree, pointing to the limited size of the domestic market as a key driver for international expansion.

After several difficult years following the 2001 market crash, technology investing in Israel has bounced back in the last two years. According to a report from Tel Aviv-based venture capital and high-tech research center IVC earlier this year, investments in the sector reached $1.35 billion in 2005, 32 percent above 2003 levels but eight percent lower than 2004 – the result mainly of a slow fourth quarter. The research also showed that Israel was the most active country in Europe for technology investment in 2004, just ahead of both the UK and France.

In the aftermath of the dotcom crash, the Israeli venture capital industry underwent a process of consolidation which is now proving beneficial, says Holtzmann. According to IVC’s research, support from local limited partners has reduced and will continue to lower the number of regional VCs in the sector, opening up opportunities for foreign investors.

“It’s a smaller industry in terms of numbers of active funds, but it’s stronger in terms of maturity and experience,” says Holtzmann. He adds that a number of foreign investors are now represented or directly investing in the region, including US firms Battery Ventures, Vantagepoint Venture Partners, Lightspeed Venture Partners, Greylock, Sequoia Capital and Benchmark Capital.

Sheehan: first serious entry into Israel for 3i

While these and other international firms clearly see opportunities in Israel’s high tech sector, one firm is moving in the opposite direction. Holtzmann says that Apax Partners Israel’s decision to cease investing in the early-stage sector won’t make much of an impact on the industry. Apax confirmed the move this week, but stressed that it was in line with its international focus on growth financings and buyouts, and not a reflection on the Israeli early-stage tech sector.

“It’s a missed opportunity for Apax as they are a major name and one of the first in this market, but they haven’t left a major mark on the industry,” Holtzmann says. “As such, it won’t make a great deal of difference, especially as there are so many international newcomers to the Israeli market.”

3i declined to comment on Apax’s strategy, Erfan, meanwhile, is bullish about 3i’s commitment to both the region and the sector: “Will Israel continue to produce world class IT companies? The answer in our opinion is yes. Is it blessed with a pool of very mature, skilled and talented serial entrepreneurs? Yes. Do Israeli VCs believe that tech companies today need to think internationally a lot earlier than they have ever had to do? Yes. We think that this is an excellent time to enter the Israeli market.”

If 3i’s take on Israeli high tech proves correct, other international investors may soon try to follow in its footsteps.