The Israeli high tech scene is going through an interesting shaping debate. A lot has been argued about why Israel has not been producing “a Nokia” or “a new CheckPoint” during the past 15 years. I have put most of the blame on the financial structure of the Israeli start up scene, Shai Tsur and Daniel Cohen wrote their own pieces and have argued that the overall atmosphere and entrepreneurial motivation contribute to early exits even more. The bottom line, though, is unanimous - Israel is underselling its high tech potential and this is a very dangerous trend.

As much as I’d like to blame the overall atmosphere, geography, management and personal greed, I just can’t. These criteria are not new. As a matter of fact, Israel’s situation has never been better in terms of ease of global reach and of management maturity. The “get rich fast” motivation of Israeli entrepreneurs is not different than anyone else’s. What has gone to extreme is the dependency on VCs.

Here’s a fact - a typical Israeli start up must get VC money and usually at an early stage. In order to satisfy the VC benchmark for the definition of potential, the typical Israeli entrepreneur must come up with a ridiculously ambitious dream - one that usually contradicts every bit of operational and marketing common sense.  A dream that factors exponential year by year growth, global market reach, horizontal AND vertical relevance and most importantly - unique and patentable technology. She needs to present as many “$250M+” exit scenarios even if the company has yet to produce a single dollar or customer. Now, everyone knows a company can’t discuss billion dollar dreams before having created hundred dollar realities, but If the dream is too small, it’s not a VC company and if it’s not a VC company, there ain’t no start up. So instead of focusing on the future one can actually see, the debate shifts to whether the company can break the glass ceiling of a “$50M exit bracket”. This is, well, stupid. Nobody, not a single person on earth, has any idea of what company will be a billion dollar company in 5 years. Your guess is as good as anyone’s.

In reality, the entrepreneur doesn’t care about the grand scheme at the moment of marriage to a VC. She cares about getting through the first year so she doesn’t have to fire anyone and go back to moon-shining. So she is pushed to producing a plan of very little merit hoping that things somehow work out. The plan, needless to say, never materializes. The entrepreneur busts her ass and, if lucky talented, gets a few big customers which create growing revenue. Then, all of a sudden, it becomes evident that sales and delivery cycles are much longer than expected, that costs are much higher than planned and that the actual niche is really, really smaller than envisioned. The entrepreneur starts feeling the pressure of having failed to deliver and is developing hypertension. After all, the mortgage may not be paid in full after all and if “only the VCs would understand that this takes time”. Friction is imminent and when an exit becomes the only way out and the focus shifts to ”getting a $200M exit as long as we can”. An effort that usually ends up resulting with a $80M- $120M exit at best, after which everyone happy its over.

Sounds familiar? While this is schematic, shallow, cynical view with a lot of exceptions, I’ve been seeing this happening time and time again, like foretold chronicles. I have many entrepreneur friends and as may friends in the VC circle - all of them are usually very smart - why does this keep happening?

The missing piece, in my humble opinion, is with two elements. One is the creation of growth funds. A fund that invest in growing businesses and not in developing an exit. A fund that looks to solve mezzanine type stages when companies reach the stage of having real, not virtual, potential.

The other piece is with rewarding entrepreneurs so they can be personally calm. Here’s a big secret: if the founders get comfortable when the company is already half successful, chances of real success grows dramatically. They won’t be tempted to dump their shares before it’s too late and they won’t be facing all or nothing situations. Need an example? Take a look at Mark Zuckerberg. He’s a rich a guy but he ain’t going anywhere soon.

      

This is a pessimistic post.

Last week Traiana made a fantastic exit. Interwise was sold a week before for about par value. Saifun was dumped roughly around that time for the cash register and change. 3 Israeli stories, different IRR, similar long term outcome. Founders walk out with money, companies merging with American entities to slowly fade out.

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.

This is no news, but the big question is why. Why do so few Israeli High Tech companies stick to the gold old business of producing goods and generating a profit. Why do so many high tech companies think of nothing but the exit to a large, fat, rich, American uncle. Did we forget how Nokia started? how Samsung came about? Can’t we see how inspiring CheckPoint and Amdocs can be? Or more importantly, do we not understand that this exit frenzy will vert quickly dry out the Israeli high tech mud pool?

As a start-up-ist I’ve been thinking a lot about that issue. I find the major cause to be the financial structure of the Israeli start up scene. 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.

A Solid, profitable, growing business has many advantages. For one, it can finance itself. It can organically grow. It can always be sold. Maybe not always for $250M at a minimum (as if), but the opportunity is continuous. Anywhere else, most investors would fancy investments in such companies.

Contrary to popular belief, it is possible to grow a company without thinking about the Exit. It is possible to grow the business and to develop good operational practices. It is possible to compete for real customers and win. It is possible to grow a Nokia in Israel. The Israeli high tech ground will not stay fertile without a few of those. If you’re unsure, take a look and India and China and see why it is only a question of time.  As a startupist, this means you need to scrutinize your investors and not just “take money when you can from whoever you can”. easier said then done, I know. In away, this is contrary to the old text book approach. I just hope we all gather to update the text book before it’s too late.