Now that China Is the New Israel…What's Israel?

761 Tel Aviv, Israel—When I moved to Silicon Valley in early 2000, I quickly became fascinated with Israel. A very tight relationship had formed between the holy-land-for-all-things-tech and the actual Holy Land, bolstered by the success of people like Yossi Vardi and Checkpoint’s Gil Schwed.

The rapid pace of liquidity in the late 1990s meant Valley investors couldn’t find enough start-ups to stuff their money into, and unlike dot com fluffiness that was roaming around San Francisco, Israelis were hard-core techies with a work ethic that seemed to defy basic human needs like sleeping and eating. Most of all, Israelis, particularly those in high-tech and cosmopolitan Tel Aviv, had a reputation for living like there was no tomorrow, because when you’re surrounded by hostile neighbors there may not be.

The 1990s were a period of a lot of structural change in the venture business. It was no longer about families and private money investing—money came from big public pension funds and endowments, and more of it was coming online as the baby boomer retirement accounts swelled and the American stock market made everyone richer. That kind of scale forever changed the venture game. Meanwhile, the Internet enabled companies to be flipped in under two years—also unheard of before. Similarly, Israel represented one of the first times the cozy boutique Sand Hill Road firms ventured overseas and made money as a result. For a time, Israel had more Nasdaq-listed companies than any other country in the world.

Then the crash, happened here and there. Only Israel got a double whammy of the Second Intifada and a resurgence of violence starting around the same time. The talk was always that Israel would come back as a hub for brilliant, crazy, ballsy entrepreneurs, and the returns would come back too. Weren’t these things just cyclical? A positive sign was how many Israeli VC firms were opening their doors. For much of the last ten years, investments in Israeli companies by Israeli VC firms has roughly equaled foreign investment in Israel, according to stats from Ben Gurion University’s School of Management. That’s a huge strength, as Valley and Boston investors always like to invest with local partners, and a lot of developing economies don’t yet have that local infrastructure.

By 2004, an executive from Silicon Valley Bank was quoted in the San Francisco Chronicle after leading a contingent of VCs back to the Holy Land saying Israel was poised to explode again. He crowed that the crash and violence aside, Israel was getting more venture money than anywhere other than Silicon Valley and Boston and it was only ramping up.

But it turned out, he was wrong. Money continued to invest along the same $1.2 billion-to-$1.4 billion a year range, and returns fell off a cliff. Israeli companies have raised just over $10 billion since the beginning 2001, but acquisitions and IPOs have returned just over $860 million over that almost eight-and-a-half-year period. Bear in mind, the industry tends to measure performance over ten-year periods, and not many people expect a roaring acquisition or IPO market for the rest of 2009, and arguably 2010.

Compare those numbers to start-ups in Europe, a continent that has long been characterized as risk-adverse, thanks in part to labor laws that work against start-ups. Sure, Europe is a bigger place, so its to be expected that European companies have raised a much bigger 36 billion in Euros since the beginning of 2001. But European companies have returned $6.3 billion. If you do the percentages, Israeli companies have returned 8.6% of the money invested over the last eight-plus years. I don’t know how to account for Euro-to-Dollar conversation rates over eight years’ time, so let’s pretend for a moment that it was 36 billion in dollars invested in Europe. If that were the case, European companies would have returned 17.5% of the capital invested. The real percentage is undoubtedly much higher, although still pretty poor as an industry. Most investors like to get all their money back, and then some. (All stats are from Dow Jones VentureSource.)

Ten years after the peak of the last bubble, it’s clear that when foreign investment fell in Israel from about $4 billion a year to $1 billion a year, the country wasn’t just weathering a recession. Somewhere along the way, the entrepreneur scene here lost its mojo.

Now, before the hate mail starts, let me be clear, that numbers aside, I still believe Israelis are singular entrepreneurs. There is interesting stuff here and always will be. There’s an element of risk taking that even the Valley can’t rival, and it’s no secret Israelis are brilliant technologists. They also share a lot of qualities with some of the best entrepreneurs I know: They’re born hackers. They love to work within constraints  to make something happen. They love when odds are stacked against them. They’re ballsy. They’re brash. As I said in this interview with Loren Feldman yesterday, they start companies like they drive. In either case—you don’t want to be in their way.

So I don’t say this to trash Israel, but facts are facts. In sheer numbers, Israel’s place on the global scale of investing has been dwarfed by China, and matched by the United Kingdom. And after three days of talking to dozens of entrepreneurs and investors in Tel Aviv, this seems like a country wandering in the desert, looking for a new tech movement to own and dominate.

What happened to Israel is a bit like what happened to Boston—the story and opportunity moved away from what the city’s entrepreneurs were good at. In the case of Israel, security and encryption was always a strength, but that’s not the growth industry that it was. In the case of Boston, enterprise technologies and telecom were always strengths. Now, as media has become the story of the last boom, it’s not a surprise New York surpassed Boston in the amount of venture capital raised.

Internationally, China has become the new obsession, with India a close second. It’s not that Chinese entrepreneurs are better than Israeli entrepreneurs. And so far, there are certainly a lot of concerns about returns in China. But when it comes to international entrepreneurship—at least in terms of attracting those billions in U.S. venture dollars—entrepreneurs need to give VCs a compelling reason to come to them. In the 1990s, Israel gave them superior technologists. Now, China is giving them an exploding demographic that needs all manner of goods and services.

Was a booming Israel just a relic of the 1990s boom like Webvan and the sock puppet? I don’t believe so. But I’m in Tel Aviv for the next two weeks looking for the company and the tech movement that will prove me right. If you find it, drop me a note.