Financing the High-Tech Industry (Cukierman, Diamond, Geva, Oron, Rajwani) | DLD Tel Aviv 16

Hi everyone. So a lot of people that are coming to the DLD, and I don't know how many of you are here for the first time in Israel. How many here first time in Israel? Okay, thank you. How many are asking about this? Thank you very much for being first time here. Asking about this, wonder about this ecosystem and how it keeps on funding itself even if the world is changing, and it seems like we don't care about the world is changing, we have our own thing going on here. So we're going to talk in this panel about financing high-tech, and specifically financing Israeli high-tech and the changes that have been going on around the world and in Israel and where are the differences. So I have a very esteemed panel here with me, so please if I can welcome on stage. So please come to stage. So Pauline from Diamond Capital Markets, Yifat Oron from Bank Leumi, our resident FinTech expert, but also Yifat comes from LeumiTech and it's been a major partner in financing the Israeli high-tech and gonna talk about what she sees in the market. We have Uri Raghav, co-head of the high-tech department at HFN, who definitely has a very good view of everything happening in this market from M&As to IPOs to LPs in funds, and we've been helped a lot with our own M&A by HFN as well in the last year. And then we have Eddie Cooperman from the Catalyst Fund that has been driving funding into the Israeli market for a very long time and for great companies here in the ecosystem. So the great panel, thank you very much for joining me here. I want to start with just a few statistics before we're gonna drive in and talk about what these great people know and see about the ecosystem and the trends. So a few things to look at. So on this slide, this is based on IVC and KPMG reports, a little bit of data about financing in Israel. So on the left slide you can look at what are we expecting from funding to the Israeli high-tech, so it's still growing and it's growing at a significant pace. On the right one, it's an eye chart, so I'm sorry what you see there, the red line is actually deals beyond 20 million dollars for Israeli startups which grows again significantly as well. So deals over 20 million increase substantially in both number and total funding. Israel VC funds invested in the last, so these numbers are for Q2 2016, invested 222 million dollars which is only 13% of capital investment at that time. Communication companies have raised 592 million dollars which is pretty significant. Average financing grew to about 9.2 million, growing from 6.5 the quarter before, and again pretty strong numbers for our ecosystem. Another view is international versus local investments, and it's amazing to see in the last few years the growth of international investors, and we're going to talk about the role of international investors, some probably here in the audience as well, and the mix. This changes, we see actually fairly significant mix even inside the investor pool from US investors to more Chinese investors and other kind of trends we're going to talk about. So this is a very interesting phenomena of international money coming into the market versus local funds. And the last thing which is where I'm going to start our conversation is the fact that we are an anomaly, the Israeli industry. Well, we know we have different names to what we are and what we're not, but specifically for this, when I was meeting with many of my friends in the VCs and in the investor community at the end of 2015, many of them said that winter is coming. And I don't know if you stood outside then, sweating here, winter is not coming. And it seems like if you look at the US, and the US has been, you know, the valuation has been getting a little bit fixed there, and we've seen the pressure in Silicon Valley in the last few months. I think Brexit has had its influence on the UK, and London, which is maybe the closest large market to us, has been suffering significantly. And Israel is growing, growing almost like crazy with the funding to high-tech, funding to startups. And I would like to actually start a conversation there. I haven't introduced myself, sorry. So Zac Weisfeld, I run the Microsoft accelerators globally. We exist in eight locations: Bangalore, Beijing, Berlin, London, Paris, Seattle, Tel Aviv. We're going to announce our eighth actually in a few weeks, and very happy to actually run that globally out of here in Israel. It's actually a pretty good view of investors throughout the world. So winter, winter is not coming, seems like it for the Israeli high-tech industry. What do you think? Why are we seeing such a different trend than many other ecosystems are seeing? Pauline, do you want to start?

Maybe just to continue your introduction, I think we're seeing great things that are happening in Israel. The first and foremost, I think which is very important is the fact that we have new funds. I think for a long time we did not have new funds. We had, you know, the blue chips, they used to raise, you know, another fund, the following funds, and then everybody thought that this is, you know, whatever the number was, that this is, that's it, that's the ecosystem. And I think the fact that we have new GPs is wonderful. It's wonderful for the entrepreneurs, but it's also wonderful from the perspective of the LPs that are seeing a, you know, next generation, and this is here to stay. One more thing that I think is very important is that we're getting more and more traction, although it seems like you can't get more traction from the corporate side, but it's, you know, superseding, surpassing itself every time. So we used to be very strong at communication, we used to be very strong in mobile, we used to be very strong in security. All of a sudden we became a powerhouse of FinTech or a powerhouse of food tech. We're reinventing ourselves. And so I think one of the things that, or automotive, cyber, the nice thing about Israel is that we're able to very quickly identify trends and bring in money that is not necessarily the typical, you know, pension fund, American pension fund money that comes here, but rather new strategic, very smart, very professional that helps the companies as well.

I think also it's interesting to look at the source of where the funds come from and how that's impacting the trends. I think when you look at the large over 20 million financing rounds that you were talking about, a lower proportion of those is coming from, let's call it Western capital, the United States in particular, and a higher proportion of that is coming from the East. And I think that's one important trend. I think the other trend that we can't deny is the delay in ultimate exit. And I haven't got stats on this and I'm not sure if anyone else has them here, but some of the money that's being raised is the last, last, last financing round. The, you know, we always hear about the last financing round before IPO, but that now tends to be one or two more after that last round. And I think that's also incrementally impacting the amount that's being raised.

Maybe I'd like to add that the same way that the Israeli technology companies are selling their products globally, they're raising money globally. And this also enables to mitigate the risk when there is a tough period in the market, like there is now in France or even in the UK because of the Brexit. So the Israeli will go to China. We just came yesterday from a conference we organized in China. There were 2,800 Chinese investors for 100 companies, Israeli companies we brought there. So they are very flexible, and when there is a new opportunity in a new market, they are very often first mover.

So I must push back on great answers, thank you very much. But, you know, so we got a little pitch of LeumiTech and we got a little of the Catalyst Fund, great, and the work in China. I want to go back to the question. There's a trend happening out there. There's a reason for the trend. You know, we've seen, I think, I don't know how many have followed the Sequoia announcement that they're shutting down their main US fund, and we've seen a trend going on with VCs and LPs. Again, there is a change. Why is the change happening? It's not just because the elections in the US are going in a certain direction. There's another reason, right?

So I think it's not only we're seeing a change now, I think it will only accelerate. As by the end of this year we are going to see several very large M&As coming from East Asia and China, and that will also just accelerate more and more the financing of companies and companies looking to East Asia for deals. I think the change results from various reasons. One of them for sure has to do with abundancy of capital in East Asia and China specifically, the network that has been created with China which we all experience, and the huge interest in Israeli technology from there. And actually the fit, you know, we were just working on a deal in a robotic company. The deal size also grew significantly. I'm talking about 50 million dollar investments. When we came back from New York six years ago and started working here, these were three to five million. So I think the change is a lot of money coming from China, a good fit between China and Israel, and the network that has been created that is now flourishing. So I think we're moving from a phase of investments where people were testing the water in Israel to the value stage where they buy companies and do strategic collaboration.

So the US money was mostly IRR driven, right? And you say that the investments from the Chinese in Israel is not just IRR driven, it's always strategic?

Always strategic value. Okay, it will always be involved with a commercial contract if they can. Sometimes the company is strong enough to resist that or is not interested.

Yeah, we saw a mix of Chinese investors. We have a lot of LPs from China. And actually just to quote one transaction, we were an investor in Mobileye, and we bought a few LPs and a few investments from China, and none of them are strategic. So you see a diversity of investors in China. Obviously they cannot be, each one of the investors cannot be the exclusive distributor of the technology company. But what you mentioned about the difficulties in the venture industry, I would like to react on that. I think there is a major problem with the venture model in general, and you see that also happening in Israel. In our first fund we were doing 1993 early stage investment, and we shifted to more mature companies. Typically we're investing in companies that are already, they have 10 years of activities. And there is a reason for that. VC-backed companies 10 years ago, you could exit after five or six years after you got your investment in the first round. Today, on average, it takes more than 10 years to get an exit from a VC-backed company, on average. So typically if you have a 10-year period as a venture capitalist and you're doing early-stage, you know, at best you will be able to exit after 10 years. That's very problematic statistics. And that's why you see more and more shifting, difficulties in finally getting financing from the VC community in early-stage. And this shift is also happening in Israel and not only in the US.

You know, I understand the trend you're pointing to. I guess maybe there's more than I'm aware of, but I guess there's three examples I can think of offhand. We have Benchmark that pulled out, we have Sequoia, the example you mentioned, and we have Greylock as well. I do think that those funds are still going to be investing in Israel, but it'll be the later-stage money. And I think the competition at the earlier stage and the money coming in from the East made it very difficult for them. In anticipation of the panel, I spoke to some of the remaining funds here, no names you mentioned, and should have asked them how do they view the trend. And what they said to me is they're very happy here, but they're very, very selective. And, you know, I mean, if you look at the footprint that many of them have, it's not a huge footprint. They can afford to be selective. The costs are high and they are looking for the investments that give them a very high return. So they are relatively few compared to other funds that have replaced the ones that have left, who were willing to go in earlier stage and higher volume. So net-net, I'm not sure that it's such a bad outcome for Israel, because the funds that have replaced them, Aleph and 83North and others, are willing to put their money in at earlier stages.

Great. So let me shift gear a little bit to another subject. So I met yesterday at the chairman event, Asaf from Nasdaq. It's the first time I saw him in jeans and t-shirt, and I thought it doesn't mean anything. Apparently it means something, now that he's back in a suit now this morning. But IPOs versus M&As in Israel, are we going to see any IPOs? Where are the new markets for IPOs for Israeli companies?

You know, before we talk about Israel, we've got to talk about trends overall. Through the first half of this year, IPOs in the United States were down over half compared to the year before at this point in time. I think we were around 68-70 IPOs, which is still about half of last year. So the markets are depressed overall, and Israel always has a disproportionate reaction. In 2014 there were 15, 13 IPOs of Israeli companies. 2015 there were 5. This year there have been either none or very few, and if they have been, they've been very, very small. I do think the market is going to reopen next year, but my expectation is it's going to be for a very small number of companies. We're going to continue to see the market be dominated by M&A. I think there's an excess of funds with private equity, so Israel is going to continue to see growth equity and private equity coming in and buying companies, whereas in the past it may have been only strategic acquirers. But my expectation, you can hold me to this, is that next year I would have thought there will be three or four IPOs of companies that have been waiting in the wings. And biotech is a completely different area, but I'm talking more about the tech companies.

I'll add to that. I agree with the analysis, but I'll add something which is an interesting trend we're seeing right now. These are M&As that are actually leading to IPOs. And again, talking too much about Asia, maybe, but that's the whole thing now. So if you look at Israel currently, I think you will see, for example, a few Israeli companies that are currently listed on Nasdaq and Tel Aviv Stock Exchange that might become private soon and then become public through an acquisition in China, because the multiples on the Chinese stock exchanges are much higher than in New York and in Tel Aviv. And this is a trend that is happening and is extremely interesting. So you could view it as M&A instead of IPO, or even taking companies private, but there's a public aspect to it.

I don't know if you agree to that, but interesting. I think obviously the fact that there are so many Israeli companies traded overseas, we have 250 Israeli companies that went public on the NASDAQ, about 100 went public in Europe, and now there is a new trend looking at China and Hong Kong in particular. But we have to be aware, in China, I will not say it's much more complicated. First, an Israeli company can't go public in China, the only way to go public is in Hong Kong. And regarding the reverse merger in China, traded company, but they call to get shares in order for a Chinese company to acquire an entity, they need the approval of the Chinese SEC, and typically they would not get the approval if they're buying stocks at a multiplier of above 20 times net profit. So even though those companies are traded at 100 times net profit, it's very complicated to do a reverse merger with a Chinese company. You need first merge it into a Chinese entity, as a foreigner cannot be holding a share. So we have not seen that happen yet. Something that we are exploring, it's complicated, but maybe in the future we would see this type of exit.

Let me just add that that's going to be a shock for many companies, because being acquired by a private equity fund is very different from being acquired by a strategic acquirer. And it's something which in Israel, of course, it has occurred. We saw it with Keter outside of the technology space, and with Eden Springs and others. But it's still very different from selling yourself to a strategist. And so the ones here that are considering this, what is it, what do you mean it's different? Different in what aspect? It's different because it's a very return-driven acquisition. And on that basis, if you are selling the company and there is going to be a competition between a strategic and a private equity, the strategic should always win, because they should always be willing to pay more, because they're not going to be return-driven in terms of how the company is managed. Because it is return-driven, there may be leverage involved in the acquisition as well. They are going to be very focused on costs, and also in terms of the way they incentivize, the incentive structure is going to be completely different. You're not going to roll over the option plan and just suddenly find that the next morning you hold options to acquire shares in Microsoft. It's going to be a completely different structure which people are less familiar with. I think it's a very exciting opportunity, it creates more competition in acquisitions, but it's something that is largely new for the tech community in Israel.

This trend of M&A from strategics is clearly shown. You see that from China, you had, you saw 15 billion dollars of acquisitions made by the Chinese in the last four years. But if you look at the bulk of the transactions, they were made on mature companies. It's very difficult for a Chinese strategic buyer to look at a startup from Israel, especially. And you need also to remember that the main challenge is really to bridge a gap in terms of the management culture between the Chinese strategic partner and the Israeli entrepreneurial company. So you see this trend, but mostly in the big and the larger and more mature companies.

So when I present a different trend, because we've made some significant acquisitions in the last year and a half. Actually, Israel was, I think, their number one place for us to acquire new companies. And, you know, fewer earlier than others, but I think a lot of the big corporations are sitting on a lot of cash. You know, since 2008, people are sitting on a lot of cash. And I think the fact that markets are fixing themselves and valuations are getting a little bit more in line, I think is a big opportunity for strategic acquisitions. For a lot of tech companies, I think early or somewhat early still makes sense for us and for people like us.

So yeah, I think one of the things that corporates like yourselves is seeing is the success stories. So they acquire companies selling 20 million dollars a year, all of a sudden three years later it's 500, 600 million dollar a year line of business, which obviously makes them want to buy more. So I think most of the companies become serial buyers, right? They do one, they see it's great, culturally, you know, return-wise, and then they start doing it again and again.

So that's great. So let's talk a little bit about areas of investments. What do you see as the trends in the last year or things that you already know that are coming in areas of investments that are getting a larger share of funding here in Israel? I thought, I think you had some.

So obviously VR remains a very hot field. We saw the company to Facebook last year, Pebbles. I think we will see more and more acquisitions in that field, including big ones. Artificial intelligence across all sectors, FinTech, FinTech for insurance, these are very hot trends. And if you're looking at non-US deals, more around industries, industrialization for all, and robotics. Again, it's I think a question of geography. If you look at what's interesting, for example, for the Chinese investor, you will see a very strong interest in the medical field, whether it's medtech, biotech. Out of the 100 Israeli companies that came to Go4Israel, there were 44 biotech and medtech companies, and 9 venture capitalists from Israel that are focused on life science, which is quite amazing. The VC community in life science is very developed in Israel. What is invested in early-stage in medtech in Israel represents half of what is invested all over Europe put together. So this is why you see a lot of interesting deal flow for the group from China, in particular. And in medical, of course, for the audience of DLD, I think the application, of course, is the big data for medtech, which we see a lot of action in, bioinformatics, etc.

One more thing I forgot to mention is, you know, if you want to know what's hot, follow the corporates who are coming here for the first time. So for example, automotives, which two years ago I think the only word for automotive would be mobile, we didn't use that word automotive. Now it's huge, and we're seeing companies like VW investing 300 million and get a taxi, but we also see a lot of other ones are coming here quite secretly and scouting for companies. This is a whole new sector which we are very, very big on in Israel.

Yes, secretly in Israel is a challenge because everyone, we meet each other in all these meetings. So anyway, so I've learned a lot about, I've been very optimistic about what's coming next. You know, seems like things are still gonna go well even with not that many IPOs, but a lot of probably interesting new M&A activities coming in, great new set of investors. Anything that we missed or anything you think of that from a financing of the local startup ecosystem this audience should know or think about?

I totally agree with that, by the way. Having an Israeli VC on board is extremely important for the communication and management of the expectations of the foreign VCs or the strategic players. So it's a very fair point. You know, I would just say in structuring the investments, try to think for the long term. We're involved with a number of companies where they have complex ratchet arrangements with investors. People have been very focused on valuation, almost to the point where they're not really putting their capital at risk, because they have arrangements that guarantee them a certain return, but that's at the expense of other investors. I think people should consider carefully whether getting the highest possible valuation on terms that are ultimately going to make it very painful to exit is worth getting that higher valuation, and whether it is wiser to take a slightly lower valuation on better terms, because in the long run if your VCs can't reach arrangements amongst themselves that facilitate an exit at a reasonable valuation, then the valuation is not that helpful.

As we mentioned, the difficulty to raise funds when you're an early-stage company from the venture capital community. But on the other hand, we didn't speak about the incubator ecosystem in Israel, which is very developed. You have 24 incubators backed by the government, but also another 20 private incubators. And as I see there is a larger audience from overseas, there is even an incubator for new immigrants, which was funded by FEMA, a nonprofit organization, and we helped through the Hive's talent from all over the world to start their own startup. So I recommend for those who are interested to establish their activity in Israel to look at these incubators.

This is something that's close to heart for me, the whole incubators, accelerators space. I have to say, part of the challenge I think that startups are facing, it's the easiest time in history to start a startup. And what we see is it's getting to be a little bit too easy, and you get to the point that there are so many new startups that then fail to get their next stage investments or fail to get the business contracts that they need to grow. So just a word of caution. Yes, it's a great, great time to be if you're an entrepreneur, there are lots of these platforms to go and play with. But it's becoming, I always say it's the easiest time in history to start a startup, it's the hardest time in history to be successful. But if you want to be successful, you want to get funded, be in Israel versus other places, which I think it's a good note to maybe to finish this part. Any, I don't know if there are any questions from the audience. We have a couple of questions that people want to ask this audience. I think this could be a good time. Any question? How do you have a question? Okay, great. So I want to thank the panel, thank you very much for coming. I want to thank the audience, thank you very much for coming and listening.