Sunday, November 20, 2011

Sliding Into First: Why Israeli Start-Ups Need to Keep Running


(see the Hebrew version in TheMarker.com)



In baseball, players often slide into the base in order to avoid being tagged out, but almost never slide into first base. The reason no one ever slides into first is not because it’s illegal, but because it slows down your momentum if you want the option of running onto the next base. A lot of Israeli high tech companies unwisely “slide into first,” yearning for safety and calm after years of uncertainty and hard work, but inadvertently end up losing the precious momentum necessary for continued growth. With fewer late stage companies generating the kind of momentum and scale that late stage investors look for, it is little surprise that Israel has an underdeveloped growth financing market relative to the US. Maintaining the growth momentum is how big companies are created, and is arguably one of the biggest challenges now facing Israeli high-tech.


Straddling both the US and Israeli venture markets it is clear that later stage Israeli start-ups don’t often share the growth characteristics of their US counterparts. For a variety of reasons, many Israeli start-ups tend to become more risk averse as they grow more successful. Each case is unique, but in general such companies see profitability on the horizon, cringe at the thought of additional dilution and a larger board, and balk at the idea of making bold moves so close to reaching safe ground. 

In contrast, US start-ups are more likely to see signs of success and decide to take on additional risk by hiring faster, expanding abroad, making acquisitions and launching multiple new product lines in parallel. Many people claim that US start-ups are simply better at fundraising than Israeli start-ups, but this is mostly because they are also more effective at spending those funds to generate growth.




PSYCHOANALYSIS


There are multiple factors at work that cause Israeli companies to “slide into first.” First of all, maintaining the growth momentum often requires inorganic growth and therefore moving out of our “comfort zone.” This may include hiring non-Israelis into key executivea positions, hiring lots of sales staff in far off geographies, developing partnerships and making acquisitions, each of which can create a sense of losing control. Product acqusitions in particular are difficult for technology savvy Israeli companies to pursue due to intense NIH (not invented here). American companies don’t have the same cross border cultural challenge, have a much larger talent pool with which to grow, and often see their core competence as busienss rather than technology (making technology acquisitions more straightforward).


Secondly, investors in Israeli start-ups are often investing out of smaller fund vehicles, and as a result have a tendency to shy away from growth plans that require financing far in excess of what they can provide going forward. Fundraising apprehension of this sort can be an enormous barrier to growth because momentum requires consistent investment in development, product and sales, well in advance of knowing what will be successful ….and in advance of knowing who will fund it. Trying to raise growth financings after your company’s year over year growth has slowed to 20% is as good a parachute designed to open on the second bounce.


A final reason we tend to slide instead of accelerating is eagerness on the part of founders and VCs to “cash in” their investment rather than “double up” on their investment. It’s not simply that Israeli start-ups sell early, but that we avoid taking more aggressive and accretive steps earlier on, which would made rejecting an acquisition offer all the more obvious. 

CHANGE IN THE AIR


The Israeli market is changing before our eyes and this is something to be excited about.  This post comes on the heels of several growth stage financings that have rarely been seen in Israel before. Israeli start-ups in clean tech, consumer tech, semiconductors, adtech and consumer Internet have announced financings ranging from $25M-$50M for businesses that are growing fast and don’t want cash constraints to limit their potential. Some of these companies could ostensibly survive without additional equity funding, so these entrepreneurs and board members truly represent a new mode of thinking big.  


One example of the new mode of thinking is the growing acceptance of founder liquidity. Many of these larger financings involve the sale of a fraction of the founders’ holdings, and sometimes the holdings of angels and veteran employees. However difficult it is for some to accept this trend, it is exactly the kind of move that enables key decision makers in a company to “double down” in the form of several more years of hard work in order to focus on the long-term growth.


Not everyone realizes it, but growth equity investors are well represented in Israel and BVP intends be a major player locally, just as we are in the US. But while capital availability is necessary, it is far from sufficient to producing Israeli growth opportunities. That depends on entrepreneurs and existing shareholders taking a long-term view to company building that emphasizes calculated risks for growth and not simply patience and perseverance (which can often be just pigheaded if growth is elusive or margins poor). Israeli companies need to keep running fast, focusing on how to reach second and third base well before reaching first. And it’s ok if you over run first base.  Just don’t slide into it.

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