PART 1 - Thinking like a Venture Capitalist
In the 1990s, the Internet bubble was expanding, prompting a wave of tech startups in Israel and globally that continued well after it burst. These startups brought new energy and ingenuity to the venture capitalist (VC) scene, with investors facing a glut of eager startups that needed to be assessed, understood, and guided through their lifecycle.
We’re familiar with the startup perspective, but not necessarily with the VC point of view. That’s why we sat down with Yuval Cohen, founder and managing partner of StageOne Ventures, and fairy godfather to numerous startups, to get a better understanding of the experience of a VC.
The Birth of a Venture Capitalist
Yuval says he got started in the VC business “by mistake.” He joined the Capital Market division for IDB (at that time, Israel’s largest conglomerate) in the early 1990s, dreaming of being an active player in the stock and options markets. But after the market crashed, the group had to reinvent itself and look for new revenue sources. Yuval and two other partners spent several months learning and scoping the industry and later on founded one of the first corporate VC funds in Israel.
In the mid 90s, Yuval and his partners were entrusted with an initial fund of $18 million, backed by the IDB Group. Today, that’s barely enough for an incubator, but at the time it was one of the largest funds in Israel. As Yuval describes it, timing was perfect and the fund was very successful, which gave the IDB group greater appetite to launch a much larger fund in 1998. While the second fund was less of a success given its larger size and over-diversified portfolio, it was at this point that Yuval felt that he’d gained enough experience to strike out on his own. At the age of 35, he left IDB and set up his own fund called StageOne, together with a successful entrepreneur he had backed in the past. With StageOne, Yuval found his calling.
As Yuval explains, it’s important to understand the terms private equity and venture capitalism, as there is often confusion between the two and several important differences:
- Private equity refers to any privately owned asset, including real estate and growth companies, that hasn’t yet floated on the stock exchange.
- Venture capitalism is the smallest sub-segment of private equity that invests only in new businesses, which are technology driven and are considered risky investments.
It happens that in Israel, VC funds appeared a good ten years before the first private equity funds. Yuval speculates that this is because there are so many tech startups in this country, so the primary form of private equity investment was in a startup.
Three Principles for Successful VC Investing
A successful VC fund is one that generates a return to its investors of between three and five times the initial investment. It can take at least five years to see initial returns on VC investments, and about two thirds of the startups fail in the process.
StageOne is based on three principles of venture capitalism, which Yuval believes should be the foundation for any fund or investor.
#1 Invest in People
Although StageOne invests in startups, its first rule of thumb is to relate to the people behind the venture. Yuval explains that this is an integral part of StageOne’s principle of investing in people. “A startup depends on the people who run it. When you are dealing with many startups, you realize that the major difference between them isn’t necessarily about the technology, it’s about the people behind the idea. That’s why understanding the people is absolutely key.”
Another element to investing in people is focusing on Israeli Startups, meaning startups that are either based in Israel or founded by Israeli entrepreneurs. For StageOne, it’s important to invest in a local market where you understand the culture. “We understand the mentality of Israeli entrepreneurs and what sets them apart. They’re a product of a unique environment and cultural melting pot, and as Israelis, we are well placed to assess Israeli entrepreneurs, wherever they’re based in the world.”
#2 Invest in a Single Segment
StageOne focuses on a number of verticals, but they are all in the segment of B2B infrastructure, encompassing cyber security, cloud computing, AI technologies, storage, IOT and FinTech. These are leading sectors in Israeli high tech, and the ones that StageOne’s team knows best. “That’s what we’ve been doing for 20 years. When you analyze the Israeli high tech industry, those are by far the ones that generate the most interesting stories.”
#3 Invest Early
The final pillar of Yuval’s strategy is to invest early, preferably at the inception stage. As Yuval admits, this sometimes means investing in a long-term vision and commitment of entrepreneurs, but for StageOne, it’s part of their philosophy and a principle that has paid off again and again.
How to Build a Successful VC Fund
According to Yuval, creating a successful VC fund relies on a couple of major abilities, but the most important ones are to be able to spot rising market trends, and to get the timing right. Guardium, one of StageOne’s successful investments, is the perfect case in this point.
When Yuval met the entrepreneurs behind Guardium, they were so early in the process that they didn’t even have a product yet. The entrepreneurs presented a project that they were developing for a local customer, which Yuval described as, “a cyber security solution to sit on top of the firewall and protect a very specific database”. Yuval and his team found it interesting enough to spin-off that idea and form a company around it. They named the company Guardium and relocated it to Boston. “We bet on securing the database five years before the large players like IBM and Oracle would even think about it.”
Guardium proved to be a huge success and the precursor of today’s cyber security companies. It was acquired by IBM in 2009, in what represented the largest exit in Israel for that year.
Although Guardium generated a nice return for StageOne’s investors, it also illustrated Yuval’s second point about timing. While his fund made a good profit when Guardium exited, they would have made even more if they’d waited another two years. Finding the right moment to exit a failing startup is equally important. As he points out, “70% of startups will never exit, which is why it’s critical to admit your mistakes as soon as possible and move on to more promising investments.”
Venture Capitalism Comes of Age
Thanks to Yuval, we’ve defined the nature of venture capitalism, briefly covered its short history, and discussed the signature traits of a successful VC fund.
The burning question now is, what happens once successful VC funds hear about promising startups, and what happens when they choose to invest?
In Part 2, Yuval shares his experiences as an active investor in startups, and reveals his predictions about trends and changes in the VC scene. Stay tuned.