BloGiza

Duck and Cover

The other day, I was talking to a friend of mine in New York who works in the financial services industry. I asked him how things were going there. His (sarcastic) answer, “Everything’s great! The dollar is strong, oil is cheap, Wall Street is looking sound, we’ve got a morally upstanding governor, and I just bought a large position in Bear Stearns. What could be better?”

Indeed, these are scary-type times for those of us in the finance world. This last month has been turbulent. The US economy is teetering at the moment, as the subprime mess starts seeping into many areas of the financial world not directly related to mortgages. At the same time, the dollar is weaker than it has been since the mid-$80s.

This last fact is especially striking when you compare the dollar to the state of the shekel. Sometime over the last couple of years, the humble shekel has transformed itself into an international monetary powerhouse. Since the beginning of the year, the dollar has lost more than 10% of its value relative to the shekel.

So, what does this mean for those of us who ply our wares in the local venture capital trade? Mostly bad news, but there may be a thin silver lining hiding in there somewhere.

The bad stuff: With the financial markets currently in a state of chaos and the US economy slipping (if not already slipped) into a recession. From our perspective, this has three main ramifications:

1. It will be very hard to exit portfolio companies in the States this year. A lot of big players will likely hold off on M&A activity while everything settles. At the same time Wall Street will also take a while to get over its jitters, meaning a rougher environment for IPOs.
   
2. Portfolio companies, especially those in the IT/Software space who sell to financial institutions are liable to miss their revenue forecasts as these institutions implement cost-cutting measures.
   Funds who have recently started fundraising may encounter problems with LPs getting cold feet.
   
3. The dollar-shekel situation presents a host of different problems for portfolio companies in Israel. This from the simple fact that they raise money in dollars but a lot of their expenses are in shekels. Which makes these currency fluctuations a big deal. Just to give an example, one of the portfolio companies I am involved with “lost” nearly NIS 750,000 shekels from the time the investment process started based on the amount they raised and the difference in the exchange rates over the last few months.

All this means that we need to help portfolio companies operate as lean as possible for the foreseeable future.

So, is there a ray of hope anywhere in here? Presumably, the new situation presents an opportunity for companies who can provide real cost savings to customers and present a compelling ROI in a relatively short time frame. As in all times of crisis, these companies can prosper.

From the VC front, all we can do is content ourselves with a bit of schadenfreude. For the past few years, as the markets soared, we VC types watched in envy as private equity and buyout funds posted huge returns. Now, as things swing the other way, we can smile to ourselves.

The online year that was

As today is the last day of 2007, it’s a little hard to resist looking back at the past year and trying to sum it up. So, I won’t resist. Unlike last year, 2007 is hard to summarize with one handy tag such as “the year of online video” or “the year of social networks”. There was a lot of activity in a number of different areas, the rise of a major player in the social networking space, and the rise of a new form of communication.

So, herewith a few highlights IMHO of the online industry in 2007

Story of the year: The consolidation of the advertising industry
Y’all thought I was going to say Facebook, right? Now, while the rise of Facebook is certainly the most hyped story of the year, my vote for the most significant development  (not to mention the biggest source of M&A activity) is the rapid consolidation of the online advertising space.

During the last 12 months, Google bought out Doubleclick for $3B. Shortly thereafter, Microsoft acquired aQuantive for a staggering $6B. AOL bought out targeted ad firm Tacoda, as well as Quigo which. Yahoo acquired Blue Lithium, as well as a majority stake in Right Media. WPP bought 24/7 Real Media. And the list actually goes on.

The M&A hyperactivity in this sector is an indication of the fact that online advertising has reached a certain stage of maturity. Beyond that, the consolidation is likely to have long-term ramifications, especially in regards to the rise of Google as the behemoth of the information age as well as the development of new business models online. And that’s what makes this, at least for me, the biggest development of the year.

Phenomenon of the year: Facebook
Obviously, I couldn’t not mention Facebook which gained momentum extremely rapidly this year and became the go-to social network for those of us who aren’t musicians, 14-year-olds, or skeevy perverts. Facebook only opened itself up to the world outside the university sphere towards the end of 2006. I joined up early this year. Before long, almost every high tech-ist I knew (and many I didn’t) was on it. Lately, the sphere has expanded further and everyone, their parents, and their parents’ friends are connected. Clearly we’re on to something.

Of course, it will be interesting to see whether Facebook will be an ongoing concern for most people or just a passing fad. I like it for business purposes, as a tool for microblogging, and as the communications platform of choice for a number of my friends. On the other hand, I have a hard time answering those who complain that there’s nothing to do there. We shall see.

New technology: Microblogging
The rise of Twitter and its clones provided us with probably the only real new media form we’ve had in a few years, viz. microblogging. At first, the concept seemed a bit stupid. After all, why would I want to blog in tiny, one- or two-sentence bursts? But then you start getting into it and discover that Twittering (or updating your Facebook status, which I tend to do more) is a nice complement to blogging for those times when you have something small and/or clever to say but which doesn’t warrant an entire post. Plus, it’s the first Internet app that makes perfect sense for the mobile. It’ll be interesting to see who snaps up Twitter and for how much.

Interesting development in local tech: The renaissance of the Israeli internet scene
Three or four years ago, it seemed that the Internet industry in Israel was close to dead. During the days of the ’99-’00 bubble, the high tech scene was awash in Internet startups looking to be the next ICQ. Then the bubble burst and most of the companies went under. Worse, the VC industry was burned on the subject and it subsequently became almost impossible to get a new Internet startup funded.

As recently as two years ago I regularly had colleagues in the VC world lecturing me that Israel was incapable of producing Internet companies and, besides, these types of investments weren’t suited for VC anyway. What a difference a few years and a YouTube (and a Facebook) later make.

Once again, we are seeing dozens of new Internet companies each month. What’s more, there is a real feeling of an Internet scene here, helped along in no small part by Facebook, the work of groups like the Co.ils and the Geek Garage, and of course Jeff Pulver’s social activities. Let’s hope this continues to develop and mature.

Case of possible overhype: Online video
I’ll catch some crap from friends about this, but the online video space has become somewhat overhyped in the last year. Actually, that’s kind of unfair. What has happened is that in the post-YouTube age, online video has become ubiquitous. This has led to a lot of noise and a sense of, “Ok, what do we do now?”

Towards the end of last year, it looked like the field of mid-tail, independently produced video content (e.g. Ask a Ninja, Rocketboom, Ze Frank) would be the next big thing. As of now, that has failed to happen. There haven’t been any real breakthroughs this year. Even projects as big and as hyped as Joost have yet to take off as a mass-market application.

I still have big hopes for this sector, but it may have to wait until sometime in mid-2008.

Predictions for 2008
You’ve got to be kidding me. Only fools make predictions in this online age where what you write will forever haunt you. Still, I’ll make some safe and predictable ones for the upcoming 12 months:

• There will be a number of huge-size Internet exits that will have people scratching their heads
• The whole notion of privacy will continue to erode as Google finds out more and more about you
• Mobile internet will remain where it has for the last three or four years, i.e. tantalizingly around the corner as the Next Big Thing
• Some technology or company that you’re not thinking about will be the big story of 2008

So, for all my celebrating friends and colleagues out there, I want to extend best wishes for the new year and hope that 2008 brings health, happiness and success to us all.

The return of Gary Snoman

He's baaaaack!!!

As they've been doing the last couple of years, the guys at Blueprint Ventures have sent out an animated clip for the holiday season featuring Gary Snoman, everybody's favorite ice-based VC. This year, Gary takes a trip to all the major international high-tech hot spots, including... Israel!

"Forget Silicon Valley, this is Technion search technology. You guys can't compete, I mean, you don't even have compulsory military service." Hee.

Explaining VCs part 3 - The Investment Process

Last time we looked at the investment parameters that VCs look at in general. Now let’s look at the actual process of how an investment gets made.

You can envision the VC investment process as multi-leveled pyramid. At the bottom of the pyramid are all the companies which pass through the fund each year, be it at the level of sending a business plan, pitching to a VC at a conference, or being contacted by us. At the top of the pyramid are the small handful of companies that receive investment in any given year. At every one of the levels in between, the fund will decide to pass on the majority of the companies coming in.

The numbers can be pretty daunting. To give you a rough idea, in any given year, something like 1,200-1,500 companies enter the process with a fund like Giza. We will actually meet with maybe half these companies. And the number of new investments that the fund will actually make is something like 6.

Roughly speaking, the process can be broken down into the following stages:

1. Locating potential investments – it all begins with what we call deal flow: finding the companies that are looking for funding. This comes from a wide variety of sources.

   Giza has a full-time investment manager (Aaron Rothenberg, who many of you already know) whose job it is to find companies and contact them. Other new companies come in via our personal networks. Still others contact us, occasionally submitting their business plans to the Giza website.
   
   In addition to identifying new companies, we also spend a lot of time re-evaluating companies that we have seen in the past and who have made progress with their technology and/or their business development.
   
   We drop a certain percentage of companies at this stage which are clearly not suitable for us (sectors that we don’t invest in, not high-tech, etc). Those that pass go to the next level.

2. Screening and reevaluation – Each week, the fund holds a screening meeting where the investment professionals discuss new opportunities. We look at 20-30 companies, discussing the main points of their business plan or presentation. At this meeting, team members request to meet with those companies that seem interesting.
   
   About a third of the companies make it through the screening committee and actually meet with the investment team.
3. Initial meetings – Following screening, Giza team members (often in teams of two or three) will hold an initial meeting with the company. This is usually a 90-minute meeting where the entrepreneurs present themselves, their idea, and their vision. At the end of the meeting, the VC team will discuss whether the company is worth moving forward with.
   
   About a quarter of the companies that make it to initial meetings willpass this stage.
   
   
4. Due diligence - This is the longest and most involved part of the investment process. Depending on the type of company and the complexity of its   technology, the due diligence process can take anywhere between a month   (in the case of companies going through Giza’s fast-track “Ofek” program)   to four or five in the case of companies with more involved technology.
    
     During this stage the company will be called in for more meetings at the   fund to delve further into its technology and market. Often, the VC will   call in outside experts to help the fund evaluate a company’s technology.   The company will also make a presentation to all the investment   professionals in the fund to allow them to decide whether or not to   invest. At the end of this stage, if the investment still looks good, the   VC issues a term sheet.
    
     About 5 percent of the companies which enter the due diligence process   emerge with a term sheet in hand.
    
    
5. Closing   process and investment – The final stage of the investment process   involves negotiations about the terms of the investment. The VC will   perform additional legal and financial due diligence on the company. Some companies will still drop out of the process (usually due to the company   deciding to reject the term sheet) but the rest emerge as the winners of   the VC sweepstakes.

It’s a long process, and it can be an arduous one. As one startup-ist once said, the odds of becoming a pilot for the Israeli Air Force are better than these. However, we would like to think that the results are worthwhile.

Explaining VCs part 2 - The VC Model

Last time around I gave a general introduction to what venture capital is. This let’s look at how VCs make money, which in turn influences which companies we choose to invest in.

I’m talking about the infamous “VC Model” which (if you’ve been reading the blogosphere in recent months) a lot of people claim is broken.

Marc Andreessen explains the model very succinctly:

The whole structure of how the technology industry gets funded -- by venture capitalists, angel investors, and Wall Street -- is predicated on the baseball model.
Out of ten swings at the bat, you get maybe seven strikeouts, two base hits, and if you are lucky, one home run.
The base hits and the home runs pay for all the strikeouts.

Say we raise a fund of $150-200M from our investors. With that money we will make, something like 20 investments averaging $8-10M over the lifetime of the company. In order to make the returns that our investors expect we assume that of the 20 investments:

•    Two will be huge successes and return 10X on the money
•    4-5 will return 2-3X their investment
•    The rest will either just return their investment or else get written off entirely

The successes, as mentioned above, need to be big enough to cover the inevitable losses from those companies that fail.

So how does this influence our investment decisions? For one thing it means that we need to focus on those companies which we believe at least have the potential to be home runs and return 10 times their investment.

One of the most common reasons we have for passing on companies – including a lot of companies where we think the team is great and the idea is solid – is that we feel that the opportunity is too small.

(How small is too small, you may ask. We don’t have any fixed rules, but if your total addressable market – in other words the total revenues that you could theoretically get if you cornered your target market – is less than at least half a billion dollars if not a billion, it’s probably too small for VC).

While the investment multiple is important, it’s not the only consideration. The actual amount of money which is returned is important as well. Small exits (let’s say under $40M) can be very good for a company’s founders but not so great for the VCs who invested in them. In other words, if a VC makes a seed investment of $2M and the company exits for $20M, this is not considered a big success even though it had a multiple of 10.

Why is this? Even if the VC held 30% of the company at exit (which is on the large side) it only got back $6M. In order for a $150M fund to make the returns is investors expect, it would have to have 30 or 40 exits like this, which is unrealistic. So, again, we look for exits we believe will be have the potential to be in the $100M range or greater.

Obviously we know that most companies will not have $100M+ exits. But since 7 out of 10 companies that we invest in are likely not to succeed as hoped, we need to know that the three who do at least have the potential to succeed big time.

So, why are we hearing that the model is broken?

There is a feeling that the size of exits has shrunk over the course of this decade. Fewer companies are going public, and the ones who do are doing so at a much late stage after much more money has been invested in them. With fewer IPOs, more companies exit by being acquired, which often means smaller exits.

It’s unclear to what extent these assumptions are true, but if they are then the number of exits that return a 10X multiple shrinks, which affects the model greatly. On the other hand, the costs of starting up a company, especially in the Internet world, are a lot smaller. Perhaps a larger number of companies will produce moderate exits, which will cover the ones that don’t.

So we may find that the VC model will have to be adapted. If it’s not broken, it may yet have to bend.

Explaining VCs - Part I

In the world of high-tech in general, and Israeli high tech particularly, venture capital is the main avenue for funding new technology companies. This remains a fact even today when startup costs are lower than they’ve ever been and where angel investors can provide alternatives to a lot of deals. However, despite the prevalence of VCs in the startup world, I find that there are a lot of misconceptions about the field. A lot of entrepreneurs don’t quite understand who the VCs are and how we operate.

Although the subject has been covered before in many places, I think it’s worth reiterating with a multi-entry series about how VC works.

Let’s start with what VCs are and what we aren’t.

Quite often, I hear complaints along the lines of, “You VCs say you like risk, but you’re really only looking for the next Google and other sure things.”

Contrary to popular opinion, we are not wild-eyed gamblers nor do we particularly “like” risk. I think part of the confusion here is local and comes from poor translation. In Hebrew, the term “venture capital” is hon sikun, which literally means “risk capital”. (A more accurate translation into Hebrew would be something like hon yozma.) In other words, we are in it for the venture, not the risk.

Venture capitalists are first and foremost financial investors who specialize in investing in technology companies. All startups carry some degree or another of risk. The earlier you invest in a company, the greater the risk. The risk is just part of the business.

It’s also inaccurate to say that we are looking for “sure bets”. While it would be terribly nice to invest in the next Google, who can tell what the next Google is. (As the old cliché goes, back in 1997 who would have thought that the world needed another search engine?)

Another big misconception: although we are seen as haughty, we are not the masters of our own destinies. To paraphrase an old Bob Dylan song, we have to serve somebody. And that somebody is our investors. The majority of money in VC funds comes from large institutional investors such as pension funds which manage tens and sometimes hundreds of billions of dollars. These investors earmark a certain part of the money to high risk/reward vehicles like venture capital. In return we try to provide a high rate of return.

What does this all mean?

First, this setup dictates our business model and what types of opportunities we tend to invest in. More about this in the next part of this series.

Secondly, it means that every few years VCs have to go hat in hand to our investors and try to raise a new fund. Yes, we do know what it feels like to be the ones asking for money. We also have to sit through endless series of meetings, go through a rigorous due diligence process, and then wait around impatiently for an answer. This probably won’t win us any sympathy points with the entrepreneur community, but it’s worth mentioning anyway.

So, that’s us. Next time: the VC model and how it affects our decision-making.

The art of picking winners

Guy Grimland wrote a piece (Hebrew link) in The Marker the other day about highly promising Israeli startups not backed by Israeli VCs. The piece came after reports that targeted ad serving company Quigo has been bought by AOL for around $300M. (Quigo founder Yaron Galai, it should be mentioned, strongly emphasizes that this is still a rumor).

Alongside Quigo, the piece looks at a couple of other high-flying Israeli startups like Oberon Media, Mobileye Vision Technologies, and SuperDerivatives. These have variously raised extremely large financing rounds and/or have significant revenues. And, like Quigo, each managed to make something of itself initially without VC financing.

The question is whether there we can learn a lesson about the structure of the Israeli high-tech market -- and specifically about the way VCs work within this market -- from the success of these companies. I'm not entirely sure.

First off, I think Ori Kirshner (my boss) gave the best answer in the article by pointing out that while Israeli VCs did miss the ball on Quigo,  there have been quite a few other success stories recently that were VC backed.

Beyond that, to say that VCs dropped the ball on Quigo, Oberon, et al. is oversimplifying the case. VCs look at many hundreds of companies a year. Each rejection is its own story. Sometimes, the companies themselves reject VCs, because they find they get what they need from angels or they have chosen to bootstrap it.

If there is a lesson to be learned here it might be one of broadening our horizons. Each of the companies mentioned above operates outside the "traditional" realms like communications technology or enterprise software that Israeli VCs historically invested in. Quigo and Oberon are Internet/gaming plays; Mobileye does technology for the auto industry; and SuperDerivatives provides a software solution for the financial world. The fact that most of them were set up in the post-bubble period (during which a lot of VCs became more conservative in their decision-making process, especially with regards to Internet companies) probably contributed as well.

At any rate, I hope the rumors surrounding Quigo are true. Not only because I wish the founders well (which I do), but also because it will help further establish new sectors in Israeli high tech as "interesting" from the financial perspective.

Early exits

A little while back, Aner Ravon wrote a heartfelt post about the state of Israeli high tech, specifically the fact that Israeli startups tend to exit too early (generally via acquisition) instead of developing into large, mature companies.

The Israeli high tech scene fails to produce sustainable, ongoingly growing, companies. The problem is not the Israeli landscape, the problem is probably with having a wrong dream.

When it’s all about the Exit, focus shifts from succeeding as a company to succeeding as investors, speculators. From creating to trading. Operational record is overlooked for dream weaving. This is why Boaz Eitan walks out with $100M for having successfully sold a multi billion dollar balloon to investors despite having no operational evidence at any point.

The question why this is so often comes up for discussion by people inside the country’s high-tech industry. (Daniel Cohen addressed it in a piece about “The Quest to Create an Israeli Nokia”). While Israel has shown itself capable of creating international category leaders – Teva, Check Point, and Amdocs spring to mind – the actual number of these is small, and none have really sprung up for nearly 15 years.

Aner lays most of the blame with the money guys:

Most Israeli startups are funded by VCs, Israeli and American, who in turn get most of their funding from out of Israel investors. This is good and bad. The VC model is based on selling their share for the highest amount in the shortest time. The fundamental focus of a “business” is to create a profit. Unfortunately, these two foci’s correlate less often then they do. An IPO may mean such correlation, as the VC can sell it’s share and the company can grow. However, very few companies fit the IPO model, and most companies are forced to think about their “business” in different terms. Terms such as “comparables”, “size of the (exit) opportunity”, “exit strategy” and “fitting the investment portfolio” take precedence and management attention away from real business decisions. Innovation becomes more important than operations because ideas can be sold earlier in the lifecycle. This means the company must be sold to a company who believes it can turn innovation to operations. Sold to, not become one.

I don’t want to argue that he is wrong, because a lot of these points have merit. The venture capital model does present certain problems (mainly the time horizon) when it comes to growing a big company. There have certainly been cases where investors have pressured companies to exit when they had the potential to become much larger. And yet, at the risk of being an apologist for the VC industry, the situation is a lot more complicated.

Other factors contributing to the relative paucity in the development of large-scale tech companies in Israel include:

• The entrepreneurs themselves – In some cases, as mentioned, investors will push entrepreneurs into exiting too early. But in many other cases it can be argued that VCs try to keep entrepreneurs from going for exits in the mid- ten million range that might be good for the entrepreneurs but lousy for the investors.
  
  To put another way, it is the rare entrepreneur (especially in Israel) who won’t give in to the temptations of a $200M exit. Very, very few people have the cojones of a Mark Zuckerberg.

• The lack of a local market – The fact that Israel has managed to grow a tech industry at all is impressive given its basic situation. We are a tiny little country, whose inhabitants speak a native tongue that nobody else does, cut off geographically from all of its potential markets. All this means that Israeli companies need by definition to be oriented towards overseas markets. As a result, a lot of non-technological functions end up being shipped off overseas instead of staying in Israel. This leads to…

• Management issues – Israel has traditionally had problems growing management capable of making the jump from a $100 million-level company to a $1 billion level company. The situation has improved in recent years, ironically as more Israeli executives have served time in international companies. But there are still way too few international-grade managers to go around.

• The financial environment – You should also remember not to discount the general financial environment. The wild IPO environment in the late ‘90s and beginning of this decade has been dampened for years. And while the TASE is growing continuously, it is still considered a backwater financial market. Meanwhile, investment banking and other financial services are still relatively primitive. All this has led to greater M&A (well, A) activity rather than IPOs.

It should also be pointed out that Israel doesn’t necessarily want a Nokia, in the sense that Nokia completely dominates Finland’s technology industry.

The question is whether this is all leading in one direction – as Aner suggests – that direction being downwards. But that is a question for another day.

On the Changing Web Investment Landscape

A recent blog post by Y Combinator’s Paul Graham has caused a fair deal of buzz around the VC end of the blogosphere. In his essay, Graham points to a number of trends that he sees in the software/internet startup world and makes a number of predictions as to where the industry is headed.

In Graham’s view, we can expect to see a lot more startups founded by younger entrepreneurs needing a lot less funding; a standardized process on the part of investors to streamline the investment process; a more sophisticated attitude towards acquisition by major players; as well as a decrease in the importance of a college degree compared to technical skills and experience.

On the heels of the piece, we’ve seen numerous blog posts analyzing Graham’s points, focusing on the changing landscape (when it comes to Internet companies), and openly suggesting that the traditional VC model is broken and that we need to adapt ourselves to the new world order.

Graham, I believe, is spot-on with a lot of his analysis even though I don’t fully accept his conclusions. Here at Giza we’ve seen the local Internet scene develop greatly over the last couple of years. Our deal flow is filled with the types of companies Graham describes: young guys (and gals) with great ideas who don’t need a lot of funding to get started.

Our Ofek seed-stage program is designed for this environment: provide the relatively small initial sums for a company to reach pre-defined milestones and then decide whether to continue on to a major Round A. So far, we have made four investments this year under the auspices of the program, with Koolanoo Group having already graduated into a full portfolio company.

Like I said, I have a couple of caveats about Graham’s piece and the Y Combinator approach in general. A big part of it is the model and the potential scale. Y Combinator’s business model (also shared by investors such as First Round Capital) is predicated on making small investments in each particular company, then enjoying potentially good returns even on small-scale exits.

In theory, this should work fine. In practice, it runs up against issues of scale. Again in theory if you fund enough startups like this, one or two of them might be classic VC-grade home runs (say $100M plus exits). The question is how many you have to fund.

Graham talks about what happens when Y Combinator has to deal with 10,000 companies. Obviously, they’ll never be able to deal with 10,000 companies, let alone 1,000. Unless you’re planning on being a source of capital c’est tout, you need to provide some management attention to each of your portfolio companies. This is feasible for 20 or 30 companies at a time, depending on your staff size and the amount of streamlining you are able to do. It becomes increasingly hairy after that.

So you have to then wonder what types of returns – not multiples, but actual objective money – you can get from a strategy based on a few dozen companies with relatively small exit avenues.

And then there is the matter of follow-on funding: few are the companies that grow into significant Web properties without some degree of marketing. Which means that you go from investing a few hundreds of thousands of dollars to investing two or three million.

In short, big questions indeed. As a rule, I think that seed-stage investment approaches like Ofek are the right way to go for many of the Internet companies that we see. (And even then, I should point out that since the model is relatively new we have little data on the actual outcomes). Whether it will completely take over the VC biz, count me skeptical. 

"It's Rod Stewart on line 2. He's calling about the term sheet."

Given that Israeli venture capital is relatively staid both in terms of business models and investment focus. So it's always nifty to hear about people in the biz trying out much more inventive ideas.

For example:

A boutique London investment bank, Ingenious Media PLC, is financing comeback albums. Last month, it signed UB40, a reggae band that had a No. 1 hit in 1988 with the song "Red Red Wine." Other artists working on CDs for Ingenious include veteran rocker Peter Gabriel, and the techno punk band the Prodigy.

The firm, which specializes in media and entertainment deals, pays for the acts' music production, marketing and CD distribution. Its partners came up with the idea to start two funds to back faded groups three years ago. It has raised $79 million.

Fans often fill up concert venues to hear older acts perform their hits, but they typically shun their new record releases. Ingenious figured with the music industry suffering its worst downturn ever, record companies were reducing spending -- and some veteran acts would be eager for more support.

A different way of skinning a cat to be sure. Which leads to the obvious question: which has-been musical act would you like to fund?

A Digg for startups

I recently discovered an interesting Web site called Killer Startups. Their basic idea is to function as a social community for the startup space. Or, in other words, they are like Digg but totally focused on startups.

Entrepreneurs can submit their startups to the site. You submit a link to your site and your elevator pitch. The Killer Startups guys posit some questions and analyze why the startup might be a killer. And the users of the sites give votes to the startups.

Interestingly, there are four Israeli-based companies in the list of Top 10 Killers: SuTree, 5Min, MatchMyPet.com, and G.ho.st.

This could possibly be a good source of deal flow.

At the Com.Vention

The Marker kicked off its second annual Internet Com.vention (a.k.a. "Vardi-gras") today. As it was last year, the convention was the local Internet event of the year, a decent mix of Israeli entrepreneurs, investors, and local and international figures from the Internet world.

So what was the story this year?

• Many, many entrepreneurs. At last year's conference, it seemed that the ratio between investors and startups was, if not exactly even, then not extremely lopsided. This year, the entrepreneurs definitely outnumbered the money people. There were easily several hundred internet entrepreneurs -- many of whom we have seen at Giza over the last few months -- which is the clearest sign of how the Internet has exploded here recently.
  
• The morning panel on "hot trends in 2007" turned up basically what you would expect: video, semantic web, convergence, and user-generated content.
  
  Two interesting comments: Dr. Nicolas Bussard made an interesting point about how changes in Web design make it easier for people in developing nations to build sites and start accessing the net. And Mike Marquez of CBS Interactive spoke of what he called the "open content ecosystem," which is the interplay of all the technologies -- from mobile video to trend analysis to vertical search -- that will allow people to consume content wherever/whenever they want.
  
• The most piquant panel was the afternoon discussion devoted to the question of "So, is it a bubble?". Here, the panelists -- Angels and VCs, including Giza's Eyal Niv -- were split. Some say it is, some say it isn't. Everyone agrees that valuations are climbing, and that the influx of money into the sector increases the danger of companies getting venture funding who really shouldn't be. (Thus siphoning off the talent and time of people who might be otherwise engaged in better companies).
  
  At any rate, the panelists basically agreed to disagree. We may be in bubble land, but at least it seems that everyone is a bit more reasonable than they were seven or eigh years ago.
  

Ali G. pitches a company

Special for Purim, here is one of the funniest investor-related clips I've come across courtesy of Sacha "Ali G" Baron-Cohen:

Going Small

In The List the other day, I linked to this article from Business 2.0 about the Incredibly Shrinking VC Model. The article deals with a trend that is becoming increasingly common in Venture circles: small investments.

Charles River has started up an early stage fund which parcels out $250,000. Y Combinator picks out a few promising startups and gives them $20,000 seed investments. 

Giza itself has the Ofek project, where we do small seed investments with an eye to putting in more serious money during Round A. In the last year, we have done five such deals, and we have a handful of others in the pipeline at the moment.

Why all the seed funding all of a sudden? Obviously, it's a reaction to the way the high-tech market is going. Internet companies are hot commodities again, but Internet companies are relatively cheap to start (given the drop in bandwidth costs as well as the availability of open-source software).

Also, a lot of VCs got burned badly during Bubble 1.0 by companies whose burn rates were wildly disproportionate to revenues. This time around, the emphasis is on lean and mean startups. All of which means that a lot less money is needed at first.

The model makes a lot of sense. As opposed to semiconductors or telecom equipment, with Internet companies, you can usually get some idea if the product will work in a relatively short time period, a year or less. The idea is to put down a small bet, see if it has traction, then put down a bigger bet later.

The only downside, of course, is that we have limited bandwidth as far as our ability to help manage our portfolio companies. And a $250,000 investment involves as much work going forward as a $2,500,000 and sometimes even more (smaller companies with less experienced entrepreneurs often need more help and guidance). So it would be very difficult to invest a large-size fund of $100M or more just on these types of deals.

However, we have high hopes for this model. In the end I think it's good for both VCs and entrepreneurs. And I hope to be proven right.

In our Backyard

I spent the day at the Israel Internet Association's annual conference at Airport City. I noticed that VC representation at the conference was almost nil save for myself and a few of my colleagues from Giza. I suppose this has something to do with the general tone of the ISOC-IL conference, which seems to be geared a bit more towards academics than entrepreneurs.

At any rate, the discussion was fairly interesting, especially an afternoon session dedicated to blogs, forums, and talkbacks. The bottom line here: Israelis like their talkbacks, which are seen as a combination of national sport and healthy venting of steam that might otherwise endanger society.

One of the participants at the session was a journalist named Dvorit Shargal, who blogs under the name Velvet Underground. Apparently, her blog has been making a lot of noise in the local Internet space over the past year. She routinely gets dozens of comments on each post. And for a while she was the subject of rampant speculation before she revealed her true identity.

Until this afternoon, I hadn't heard of her.

In fact, I probably couldn't name any of the big-league Hebrew-language bloggers. This fact ties into a growing realization I've been having lately. I've been doing a lot of work with one of our portfolio companies which is working on piloting its Internet product in the Israeli market. As a result, I have been meeting with a host of local portals such as Tapuz and Nana.

In the last couple of years, it appears, a rich and varied world of local, Hebrew-language sites has developed in Israel: search engines, portals, social networks, gaming sites, blogging platforms, videocasting sites, you name it. Israel has dozens of local Internet brands, which are as readily familiar to local Web surfers as MySpace and Flickr are to surfers overseas.

Except that I'm willing to bet that most of my colleagues in the local venture world have not heard of half these sites, and have probably visited even fewer.

Of course, there is an explanation for this. We are by nature focused on investments that promise major returns. Israel, on the other hand, is a small, relatively closed market which doesn't hold much potential for creating huge companies. Which means we are much more in tune with the Internet culture than we are of the one that is happening in our backyard.

I suppose this isn't necessarily a major tragedy, although it does make you wonder whether we're not missing out on some potentially interesting companies.

Startup Lessons for 2007

I started a post the other day about specific trends and types of companies that we have been focused on recently. And then I came across this post in Read/Write Web which did the job for me. The author (who is the founder of a geek social networking site called Shuzak.com) lays out 6 lessons that nascent Internet startups should heed.

In order they are:

1. Differentiate yourself - find a category you can conquer rather than trying to take on the world
2. The smaller the niche, the more loyal the users
3. Focus
4. No small market is small enough
5. Keep everything simple
6. The bubble burps - stick with your category and try to hold onto it

On the whole, this is good advice for anyone trying to develop a social-network/user generated application or site. From the VC perspective, I can wholeheartedly recommend following numbers 1, 3, and 5.

(As for 2, 4, and 6, while it's true you can make a good living from a very highly targeted site, if you are running a social network for, say, owners of Persian cats, the chances that you will become a major player aren't great)

I think the Web still has plenty of untapped potential. IMHO the real winners of the next few years are going to be those companies that find an unserved niche or target vertical (of a relatively decent size) and focus on providing them with a simple and attractive solution.

Things we look for (a partial list)

As many of you may have noticed, the Internet has become a hot commodity in the local high tech ecosystem over the last year. After five or six years of drought, we are suddenly awash in interesting Internet companies. We screen dozens of Internet companies a month here and meet with a large percentage of those. We have put in place flexible investment models, ranging from traditional Round A investments to "lab-style" seed-stage financing.

We have a dedicated Internet team seeking out the best of the bunch. But what exactly constitutes the best?

Regarding this question, we are still working on our investment thesis. We have come up with a few things we like to see in an Internet company:

1. An understanding of (and passion for) the Internet - This is not as trivial as you might think. Unlike with other high-tech sectors (think semiconductors or enterprise software) everybody thinks they know the Internet. But in the last year and a half of actively living and breathing this industry I have learned that it's not that simple. You need to understand the Internet from within, understand how the value chains work, and how people use the Web today.
   
2. A product/service that provides a clear value proposition - This can be a whole host of things from a new way to consume media, to a service that helps migrate offline activities online, to a product that serves the unmet needs of a specific vertical.
   
3. A solid revenue model - One of the biggest differences between Bubble 1.0 and Bubble 2.0 is the existence of proven revenue models.  If you have a product that can be monetized a number of different ways (for instance, some combination of advertising revenues, subscriptions, and e-commerce potential) then all the better.
   
4. Knowing how to market and monetize your product - This ties into points one and three. The Internet financial ecosystem is far more complex than it seems at first. We look for entrepreneurs who can navigate through the world of SEO/SEM, viral marketing, affiliate programs, advertising networks, etc. etc. etc.
   
5. Understand the importance of good UI - Going back to the first point again. The key to success in the Internet world is getting and retaining users. The key to doing the former is providing a clear value proposition. The key to the latter is good user interface.

These are pretty much the basic "must haves". More on our investment thesis as it develops. In the meantime, if you have a startup and you're looking for funding (or even advice and input) you can email me here.

iDrink You Drink

| wanted to add my belated $0.02 about the iDrink event from the other night, and also to extend my thanks to Ouriel for organizing it.

The event was a big success, with a small handful of us evil money types getting together for drinks with assorted entrepreneurs and other local Internet visionaries.

The setup was relaxed and fun, and the bar chosen as the venue was pretty cool. All in all, it made for a good atmosphere for networking, meeting new people and hearing new ideas, as well as catching up with friends.

(Why, here I am with Yaniv Golan of Yedda and Hello World. Props to Sagi for the photo and also for finding the weirdest angle he could.)

I'm hoping that everyone had as good a time. Now that the glove has been thrown down, I also hope that we will try to organize one of these events every month or six weeks.

(BTW, props also go to Orli Yakuel for designing the iDrink logo).

Greylock on Web Investments

Here I go again giving other funds free publicity...

The Marker had an interesting interview (in Hebrew) the other day with Henry McCance, the chairman of Greylock partners. Along with some facts that we already knew (for example, that a lot of the investments made during Bubble 1.0 were bad and that some of the larger VCs have a competitive advantage over the others), he had some good points to make about the current tech investment atmosphere.

Some key quotes:

[Currently] in order to IPO you need a market value of $250-300 million and to raise more than $100 million. On the other hand, an M&A strategy seems more attractive to entrepreneurs. Although it should be noted that there is a certain cyclical motion at work. There are some years in which public offerings are more attractive and some that aren't. Entrepreneurs want to build successful companies and to benefit from teh success. You can achieve this through M&A. Ten years ago it was the opposite. I'm not sure when it will switch again.

On home runs:

There weren't any home runs this year, and this is true for the States as well. [Um, YouTube? - eds] As far as Greylock is concerned, our investment does not depend on home run deals.... If we sell a company for $150-200 million and this gives us a good return then great. In order to aim for home runs you need to take a greater than average risk, to invest in unknown areas. And then the chance that you will fail rises as well. This isn't Greylock's strategy.

On the Web:

We have invested in a number of Internet companies: Facebook, Digg, LinkedIn. We think this is an attractive field, even though these companies do not need much funding. This industry has changed since the bubble. A lot of people were excited by the promise of the internet but it didn't work during the first phase of the industry. Now, in 2006, there are companies which change our lives. Companies like eBay, Google, Amazon, and YouTube. I believe that the next generation of Internet companies will enjoy great success in the field.

As someone who specializes in Internet investments it's nice to see the industry getting a thumbs up from the likes of Greylock. After all, it wasn't that long ago that local VCs were shunning the Internet altogether. Certainly a lot has changed since Bubble 1.0. Perhaps Web companies have yet to fulfill the promise of the Internet, but at least they tend to be a lot more realistic about their revenues.

As to the business about home runs, I will put my natural cynicism on hold here and take McCance at his word. Perhaps Greylock doesn't focus on home run investment. On the other hand, Greylock belongs to that rarified group of funds who have the capability of directly influencing their own exits.

Let's put it another way: even if you declare you're not looking for a home run, the home run mentality will influence your decision making to some degree or another. If nothing else, VCs look at the potential size of the market you are addressing. If your company doesn't have at least some theoretical potential for a home run, we will most likely pass on it.

This is certainly true for early stage investors.

How to deal with VCs

I came across this post while browsing the Tech Crunch forums. It comes the blog of a company called AdvisorGarage, which bills itself as a "dating site" for entrepreneurs to meet business advisors and investors.

The post is a handy "how to" site for dealing with  VCs. It's one of the best and most concise lists about what VCs look for, what kind of deal to expect, what kinds of VCs are out there and how they work. Plus, it manages not to brand us all as evil (which is a plus, at least in my book).

At any rate, you should pay especial attention to the section about what VCs look for:

3) What Were the VC’s Looking For?
The obvious answer is ‘well that depends on the VC’…this is true, to a degree.  We probably met 25 different VC firms and they all seemed, at least initially, to want very different things.  But after a time, a pattern seemed to emerge…they all seemed to be interested in nearly the same things but the weightings they placed on each differed.

What were they?

i) The Team
The strength of the team was almost everything!  Even the best business model with customers clambering for the product can still fail if the wrong team is at the helm. Likewise, the right team can take a mediocre business and make it shine.
ii)  The Opportunity
How big could this business be?  Will it be a $10M or a $100M business in five years?  How defensible is it?  Who are the Competitors?  Who are the potential customers?VCs are trying to determine - Risk VS. Reward.  VCs need to deliver a return on their investor’s money…as a certain number of companies fail, they need a 3 or 5 or 6 X of their original investment.  The actual number obviously depends on a number of factors.
iii)  The Differentiator/Uniqueness:
Why is this business different? What does it have that other companies do not?  What will make customer buy from this company?

iv)  Exit Strategy: How can we (as VCs) realize our investment? Read - How can we get our multiple back? Will this company be acquired? Can it be a candidate for an IPO? Or will it bumble along for many years make a steady but unexciting profit?  Guess which ones the VCs will invest in…

The importance of the management team can never be emphasized enough. Take two companies with the exact same idea and you'll find that one might succeed and the other fail solely on the basis of the management.

They have some good tips about what you can do to prepare yourself for meeting VCs as well. Check out the full post here.

Is bad news the new good news?

I've been thinking quite a bit about a post that Michael Arrington had up the other day. Basically, Arrington was looking over his Dead Pool of recently closed Web 2.0 startups and addressing the Big Bubble Question (i.e. are we in a bubble again).

According to his analysis, we are seeing something akin to a bubble, but Internet companies have a much more solid basis than they did in the past. The main problem continues to be low barriers of entry and a difficulty in differentiating ones self.

Money quote (from our VC perspective):

So there are too many review sites (Yelp, Insider Pages, Riffs, Judy’s Book). And too many Q&A sites (Yahoo Answers, Live.com Q&A, Yedda, Answerbag, Askville, etc.). And too many customizable home pages (Netvibes, Pageflakes, Google, Live.com). And so on. Most of these will fail. Some will win. Hopefully, the total return on investment to the winners will be greater than the sum of all investments in all of the startups. If that ends up being the case, we all win.

As these companies fail, the markets take note. This lets off steam and settles things down. Venture capitalists are less frothy. Fewer investments are made. Valuations go down. Things equalize.

I tend to agree with Michael that the Internet scene today is a lot more sane than it was 7 years ago. But where he sees the positive side of Web 2.0 companies calling it quits, I have to look at it from the viewpoint of someone looking to invest in them. In which case, it ain't such great news.

Obviously, none of us has a foolproof solution to the conundrum of how to invest in Internet companies. However, as a general rule we try to look for a couple of things:

1. Users: How are you going to get users to come to your site/use your service? How are you going to keep them coming back?
2. Revenues: What is your plan for effectively monetizing the users you have? Do you have more than one revenue stream? (Multiple revenue streams is not a must-have but is always useful to see)
3. User Experience: Do you understand what the user wants? Or, if the user doesn't know what he wants, can you show him? Is your site/application friendly and easy to use?

In our opinion, companies that can provide good answers to all these questions have a shot at succeeding.

The C Word

Now, the people here at Giza will probably flip when they see the above image. After all, putting up a competitor's logo on the site is not the best thing for branding. And yet, the news coming out of Jerusalem Venture Partners is interesting enough to warrant it. I think.

Earlier today, JVP announced that it was changing its focus completely. The fund is shifting its activity away from traditional Israeli tech investments (enterprise software, communications, semiconductors) towards New Media and content. Now, this doesn't come as a complete surprise to anyone who has been watching JVP for the last year and a half or so. The fund has made a number of investments in the gaming space (most notably Double Fusion) and operates an animation lab.

JVP's move seems to fit in with a trend I've been seeing lately, namely the great Content Comeback. In the last two or three months, we've been seeing dozens of new companies whose value proposition is based mainly or exclusively on content rather than technology. What's more interesting is that we have started to look at some of these companies as serious investment prospects.

In other words, we're back to the doctrine of Content is King

I say surprising because just one year ago the prevailing mantra was "we don't do content." Israelis - the logic went - could not compete with Americans on the basis of content and thus the thinking was we should focus only on technology.

You can look at the change of heart in a number of ways. If you want to be uncharitable, you can claim that VCs are like sheep and that we are now just following the post-You Tube herd. This is probably not completely wrong, but I think it misses the point.

As I've argued before, Israel's Internet scene has matured greatly since the days of Bubble 1.0. To the point where there are a large number of Israeli entrepreneurs who understand the Internet world as well as anyone out there. And this includes content.

I'm not sure that I personally would stake my entire fund on it, but I'll be happy to see JVP prove me wrong.

Tips for Local Entrepreneurs

Ouriel had a post last week noting the curious custom of some local entrepreneurs to send business plans adorned with the Hebrew letters bet samech daled as a religious/superstitious good luck charm. (This led to an interesting religious discussion; the comments are worth checking out).

At any rate, it got me to thinking about other cultural quirks around here. Which led me to the idea of presenting some tips for local entrepreneurs about how better to present themselves when sending material to VCs. The tips are certainly relevant for us at Giza, but I'm pretty sure you'll find them relevant to the rest of the local venture community as well.

These tips are not meant to be a critique (although if you feel I am being too snotty feel free to comment below). Rather, they are meant to help facilitate the dialogue between entrepreneur and investor.

And so, the first of what I suspect will become an ongoing project:

Tips When Sending Material to Local VCs

• Send material in English - Many people who join the Israeli high-tech world are surprised to discover that almost all written communication is done in English rather than Hebrew. The reason for this we are part of a larger, English-speaking global ecosystem.
  
  Which is why we prefer material in English. It makes you look a lot more professional to us. On a practical level, it helps if we are thinking of syndicating the investment with a foreign VC. And on a slightly more abstract level it shows us that you are thinking beyond the narrow confines of Israel. If you have dreams of succeeding overseas, then you should really take the time to write up your material in English. (I'll save the list of tips when writing material in English for another time).
  
• Management Bios - VCs have a cliche that we invest in a team as much as we invest in a technology or product. Therefore it is absolutely critical that you send us material about your management team.
  
  Also, when providing management bios, be detailed. Many times we'll get a description to the effect of, "The CEO has worked in a number of successful startups over the last ten years." We would like to know which startups and what position he/she held there.
  
• Competitive Landscape/Analysis - This is another key item we look for in your material. The competitive landscape and analysis is important to us beyond finding out  who your competitors are. It also demonstrates thought process and how you see your company positioned. At the very least it shows whether or not you have done your homework.

As I mentioned, more to come...

Frosty the VC

So true, so true...