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Globalization of Venture Capital and the Future of Israeli Venture Capital

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Title: Globalization of Venture Capital and the Future of Israeli Venture Capital


1
Globalization of Venture Capital and the Future
of Israeli Venture Capital
  • IVA Conference 2007
  • Paul A. Gompers
  • Harvard Business School and Spur Capital Partners

2
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

3
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.

4
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)

5
Where Do US Investors Want to Expand?
Source Deloitte Venture Capital Survey (2006)
6
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)
7
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)
8
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)
9
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10
10 Forces that Flattened the World
  • The Fall of the Berlin Wall 11/9/89
  • Nescapes 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

11
Areas of Opportunity?
  • Israel
  • China
  • India
  • Europe
  • Other Markets

12
Israel
  • POSITIVES
  • Well Established Venture Market
  • Equal in size to greater Boston
  • Been through boom/bust cycle
  • Emergence of Serial entrepreneurs
  • gt 4,000 hi tech companies
  • gt 100 NASDAQ IPOs
  • Source of New Tech Innovation
  • Civilian RD 4.2 GDP
  • Highest ratio of PhDs per capita
  • Generous RD grants
  • Democratic Government
  • NEGATIVES
  • Political Instability
  • Palestinian (Hamas)
  • Externally (Hizbollah)
  • Small Population Base
  • Negligible Domestic Market

13
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

14
TITLE
15
India
  • POSITIVES
  • Large Population 1.1 Billion
  • 8 p.a. Projected Growth in GDP
  • Expanding Middle Class 300M
  • Youthful Population gt50 lt 25 yrs
  • India Institute of Technology 100K grads per
    year
  • Established Rule of Law
  • Worlds 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

16
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
17
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

18
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.

19
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.

20
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 funds performance.

21
Identify Key Elements of Top Tier Funds
Strategies
  • Investment focus
  • Board construction
  • Co-investors
  • CEOs
  • Contact with acquirers
  • Company building

22
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
  • Dont pump up stock too high on day 1 after IPO
  • Credibility with institutional buyers
  • Better distribution strategies

23
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.
  • Dont unload the dog food at too high a price.
  • Performance of acquirers of VC-backed companies
    typically outperform industry peers.

24
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?

25
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26
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27
4) Managing GP-LP Relationships
  • Far too often, LPs are only really considered
    every three years
  • Dont call me, Ill call you.
  • Part of the professionalization of venture
    capital firms involves understanding better the
    LP perspective.

28
LPs Perspective
  • Valuation and distribution policy
  • Communications
  • Annual meetings
  • Avoiding surprises
  • Investments
  • Team departures
  • Write-offs

29
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

30
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

31
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?

32
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?

33
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?

34
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
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