Sunday, November 22, 2009

A Farewell to the Walking Dead

If recent headlines are even somewhat accurate concerning the pending sales of multiple Israeli start-ups, Israeli high tech should be feeling a great sense of relief. I know of at least 10 start-ups in advanced stages of concluding M&A transactions, with all but one at a loss or near loss to their investor base after many years of toiling in a challenging market environment.

So why should we feel relieved with such depressed prices?


Many of these companies are at least 7 years old, and fall into a forbidding category of start-ups that I call the “walking dead.” They are very much alive in that they have a fully functioning business, working products, satisfied customers and perhaps even modest year-over-year growth. But they no longer exhibit any of the cutting edge or hyper growth characteristics expected of venture-backed start-ups. Time has not been kind to them, and is no longer on their side. Their successful sale as a going concern is essential to sustaining the Israeli entrepreneurial ecosystem and a much preferred to a slow demise. More specifically, such M&A transactions provide vital liquidity for shareholders, release entrepreneurs to pursue their next dream, and free up the capital and time of venture capitalist to hunt for the next great deal. Furthermore, if done properly, such transactions will bring the company to a multi-national level, generate more jobs, and allow employees to expand their careers and horizons in a larger corporate environment.

Some of Israel’s fastest growing companies are approaching the end of their first decade, so I would not want to imply that all aged start-ups are condemned. However, these are often few and far between. More often, entrepreneurs and VCs unwittingly convince themselves that time will prove them wise, and that there is a light at the end of the tunnel. Unfortunately for most, it is a another tunnel that is at the end of the light and time and money are running out. Recognizing the direction a company is heading and forcing early action will avoid the painful existence of a walking dead company.

For companies past their 7th birthday, I propose a simple litmus test of two questions to determine if a company is walking dead: 1) Can the company find a buyer today were it to put itself up for sale? 2) Is it clear that the company’s value will appreciate as time goes by? If the answer to both of these questions is ‘no’ or produces a pensive stare, then there is a real risk that the company may already be walking dead. Once trailblazers, these companies are now laggards, passed up by the more aggressive and nimble competition. Once the undisputed leader in a promising market niche, these companies are still the undisputed leader, but in what is arguably now a much less promising market niche. Unfortunately, those asking these questions are also the very people who have invested too much time, energy and dollars, to arrive at impartial conclusion to the above questions.

As a result, many of these companies are in fact dead weight in a VC’s portfolio, consuming precious time, energy and resources. For employees, the board’s persistence can turn a start-up stint into a bottomless pit on a resume. And for the Israeli high tech market as a whole, these companies tend to crowd out new start-ups that might otherwise have been created and funded (sometimes by the very same entrepreneurs and VCs).

Aside from the demonstrating their pitiful grasp of investment return analysis, the Israeli media miss the point with their headlines bemoaning exits at valuations below the sum of the total funds raised to date. They too should see such activity as a healthy catharsis, which will pave the path for new start-ups in the next cycle. Larger and more exciting exits will follow the sale of the walking dead, so the Israeli high tech still has a lot of headlines to look forward to.