Globalization of Venture Capital and the Future of Israeli Venture Capital: Globalization of Venture Capital and the Future of Israeli Venture Capital IVA Conference 2007 Paul A. Gompers Harvard Business School and Spur Capital Partners


The challenge: The challenge Globalization of venture capital is a fact. This is not some trend of the day Will profoundly impact the entire VC world, even Israel Key challenge for the Israeli VC community is to: Determine core competitive advantages and build on them Professionalize partnerships and recruitment Differentiate a value-added strategy that can sustain the industry and help it prosper


Core Themes of Workshop: Core Themes of Workshop Five important areas to consider Macroeconomic trends driving globalization Examination of strategies that many players are taking. What is special about Israel How can Israeli VC firms adapt successful early-stage investment strategies? Maximizing exit valuation and returns to LPs. Providing the foundation for managing the relationship with LPs to maintain solid funding base. Building, managing and growing the venture capital team.


Slide4: 1) Globalization of Venture Capital Growth in new venture markets around the world. Variety of strategies by US venture players seeking to enter the market. 60% of US firms say they want to increase their investments outside the US Deloitte Venture Capital Survey (2006)


Slide5: Where Do US Investors Want to Expand? Source: Deloitte Venture Capital Survey (2006)


Slide6: Reason for Desire to Expand Globally Lower cost location Higher quality deal flow Emergence of entrepreneurial environments in non-traditional locations Diversification of industry and geographical risk Access to quality entrepreneurs Access to foreign markets Source: Deloitte Venture Capital Survey (2006)


Slide7: Strategies of US Players Going Global Develop strategic alliances with foreign based firms Invest only with investors that have local presence Require partners to travel more Require partners to transfer to foreign locations Relocate certain portions of portfolio companies to be near firm Open new offices Hire investment staff with expertise in target country Source: Deloitte Venture Capital Survey (2006)


Slide8: Impediments to Globalization Safety and security concerns Travel time and effort Regulatory environment Intellectual property laws Foreign currency concerns Unstable political environment Lack of skilled workers Lack of expertise of business environment Lack of experienced local investors Lack of quality deals that fit investment profile Difficulty achieving exits Source: Deloitte Venture Capital Survey (2006)


Slide10: 10 Forces that Flattened the World The Fall of the Berlin Wall – 11/9/89 Nescape’s IPO Workflow Software Open Sourcing – Self Organizing Collaborative Communities Outsourcing – Y2K Offshoring Supply Chaining Insourcing In-Forming The Steroids – Digital, Mobile, Personal & Virtual Source: The World is Flat


Slide11: Areas of Opportunity? Israel China India Europe Other Markets


Slide12: Israel POSITIVES Well Established Venture Market Equal in size to greater Boston Been through boom/bust cycle Emergence of Serial entrepreneurs > 4,000 hi tech companies > 100 NASDAQ IPOs Source of New Tech Innovation Civilian R&D = 4.2% GDP Highest ratio of PhDs per capita Generous R&D grants Democratic Government NEGATIVES Political Instability Palestinian (Hamas) Externally (Hizbollah) Small Population Base Negligible Domestic Market


Slide13: China POSITIVES Large Population: 1.3 Billion Growing middle class Migration to the Cities Strong in Fundamental Science Projected GDP Growth: 10% p.a. World Class Infrastructure + Heavy Capital Expenditures Transitioning to Open Market System: Joined WTO Efficiency of Central Control Sea Turtles: Returning Chinese VCs Success Stories: Baidu, et al. Positive Trade Balance: $150 Billion NEGATIVES Single Party State Legacy as a Closed Society Few Disclosure Requirements Due Diligence Seen as Intrusive Uncertain Legal Framework: VC Rules Evolving Need for Banking Reform Environmental Degradation + Increasing Resource Needs VC Explosion Funding bubble? VC turnover


Slide14: TITLE


Slide15: India POSITIVES Large Population: 1.1 Billion 8% p.a. Projected Growth in GDP Expanding Middle Class: ~300M Youthful Population: >50% < 25 yrs India Institute of Technology: ~100K grads per year Established Rule of Law World’s Largest Democracy Economy Transitioning to Free Enterprise, Open Market English as a Second Language Large Pool of Successful Indian VCs & Entrepreneurs NEGATIVES Social Inequalities Bureaucratic Administration Multi-Party Parliamentary System Massively Inadequate Infrastructure Growing Venture Base Still in Flux Alliances being formed Possible short term bubble? Deal volume up 3X yr on yr Rash of new funds being raised


Slide16: Europe POSITIVES New Early Stage Players on the Scene: Accel, Benchmark, Index Improved Exit Routes AIM, et al. Notable large acquisitions: KISS Technology, Skype ($2.6B) Broadband Pervasive Cutting edge wireless & wireline Video on demand, VoIP Large (Economically) Unified Market Modest But Stable GDP Growth, Inflation & Exchange Rates Steady NEGATIVES Early Stage Venture Ecosystem Less Well Developed Small number of tech-focused VCs: poor early stage performance Buyout & late-stage funds predominate Labor Inflexibility High Tax Structure – But Changing Low GDP Growth Rates Opportunistic Rather Than Core Target Market


Slide17: Conclusions The World of Early Stage Tech Investing is Truly Global Experienced VCs returning home with resident skill sets Top quality US firms establishing collaborations ROW Now Offers: Technical expertise (PhDs, MSEEs) Increasing managerial and executive experience Growing middle class Large and expansively growing markets Improving IP protection & rule of law


Slide18: Future Trends Industry will be truly global Continued role of new, targeted funds in a variety of sectors Industry composition will change and will be harder to predict Returns will vary considerably, but for the long-run investor, these returns likely to be quite attractive as compared to other asset class.


2) Successful early stage investment strategies: 2) Successful early stage investment strategies The US venture market has a much longer history than Israel Top tier players have emerged and sustained their performance over many years. Research demonstrates that returns are “sticky”, i.e., top tier funds generally tend to remain, top tier funds.


Persistence of performance: Persistence of performance High likelihood that the next funds of a given partnership stays in the same performance bracket  Persistence. 1% boost in past performance → 0.77% boost in next fund’s performance.


Identify Key Elements of Top Tier Funds’ Strategies: Identify Key Elements of Top Tier Funds’ Strategies Investment focus Board construction Co-investors CEOs Contact with acquirers Company building


3) Maximizing Exit Valuation: 3) Maximizing Exit Valuation The continuation of performance of top-tier funds can be tied to maximizing exit valuations Much higher cash on cash multiples for their winners. What strategies are employed? Negotiations with acquirers Continuation of post-IPO performance Don’t pump up stock too high on day 1 after IPO Credibility with institutional buyers Better distribution strategies


Need to Be Opportunistic: Need to Be Opportunistic More choices (AIM), but is there liquidity for LPs? LPs care about ability to sell the stock. Relationships with acquirers matter. In US, prior portfolio companies are future acquirers. Long-run reputation matters. Don’t unload the dog food at too high a price. Performance of acquirers of VC-backed companies typically outperform industry peers.


Distribution Policies Matter: Distribution Policies Matter Distributions are (would be) a nice problem to have. Wide dispersion of distribution policies and practice. What is value of distributed shares? What happens after the distribution?


4) Managing GP-LP Relationships: 4) Managing GP-LP Relationships Far too often, LPs are only really considered every three years Don’t call me, I’ll call you. Part of the professionalization of venture capital firms involves understanding better the LP perspective.


LPs’ Perspective: LPs’ Perspective Valuation and distribution policy Communications Annual meetings Avoiding surprises Investments Team departures Write-offs


Does the LP Perspective Differ by LP Type?: Does the LP Perspective Differ by LP Type? Role within the VC Food Chain matters a lot. Endowments Pension Fund Gate Keeper Fund of Funds Corporate Individuals


5) Building, Managing, and Growing the Venture Firm: 5) Building, Managing, and Growing the Venture Firm Recent headlines in the US have chronicled the falling apart of some old and venerable venture capital franchises Loss of direction Poor returns Embattled younger partners Critical for Israeli venture firms to manage this process


Who do you hire?: Who do you hire? People that are similar to existing team or different? Young vs. old? Operating background? Technical areas? How are they included in decision making? Who mentors the younger investors? Give them their own checkbook or have them second a senior partner? What is the sharing of fees and carry like?


Decision making processes: Decision making processes How is the decision making process codified and analyzed both ex ante and ex post? Who participates? What is the approval/rejection rule? Unanimity? Majority? Significant minority?


Managing the Portfolio: Managing the Portfolio Portfolio management as an area of expertise What are the key risks in the portfolio? How are they managed? How does portfolio management relate to deal selection and exiting?


Overall: Overall Venture capital will always be a “craft” business But… The Israeli venture capital community can learn a lot from experience of the “best in breed” In order to sustain itself, the Israeli venture capital community will have to adapt and “professionalize” Not institutionalization!!! The seeds of success have been planted