VCs to start-ups: Show us the money, or how you plan to get it

VCs to start-ups: Show us the money, or how you plan to get it

If you want a venture capitalist to back your great new idea, you'd better figure out how to make a profit before you ask investors to pony up, say Israeli experts

Yossi Vardi (right) with Hubert Burda at a recent DLD conference. Burda is chairman of Hubert Burda Media, a sponsor of the event (photo credit: DLD/Hubert Burda Media)
Yossi Vardi (right) with Hubert Burda at a recent DLD conference. Burda is chairman of Hubert Burda Media, a sponsor of the event (photo credit: DLD/Hubert Burda Media)

Here’s a cool start-up idea: A tagging system for videos that allows you to attach names to faces, as you can do with Facebook (that technology was developed by, an Israeli start-up that was bought earlier this year by Facebook).

Or how about this: An app that lets you collaborate with online friends to combine and merge photos — letting you mash up pictures of skyscrapers in different cities, or of people with nature scenes, enabling you to create a new photo that others can add to in a merger of photo sharing and social networking.

They both sound as if they would make great products, but don’t bother running out to hire a programmer: Someone beat you to it. Both of those ideas are already past the concept stage and are now the central technology of two very early-stage start-ups operating in Tel Aviv. They are part of an explosion of new tech companies that have taken off in the past several years in Israel — and especially in Tel Aviv.

According to the Israel Venture Capital Association Research Center, there are currently no fewer than 800 early-stage tech start-ups inside the city alone, and there are hundreds, perhaps thousands, in the rest of the country. Many of these start-ups have great ideas and breakthrough technologies, part of the recipe that makes Israel the “start-up nation.”

But the road to high-tech success only begins with an idea. Even having a working model that is really innovative — or a finished product that, in beta, has created a lot of buzz and has thousands of users — is not enough. In order to survive, much less thrive, start-ups need money, and that money is not going to be forthcoming unless an entrepreneur has a solid business plan, say some of Israel’s top venture-capital folks. “I need to see a clear business model,” said Yariv Lissauer, an associate at Synergy Innovations, who has, for over a decade, worked both sides of the aisle — at start-ups seeking funding, and later at investment firms the start-ups seek to get funding from.

A “business model,” said Lissauer, is a clear plan that shows how the technology or product is going to make money. “It’s a matter of risk management,” he told The Times of Israel on the sidelines of this week’s DLD (Digital Life Design) festival in Jaffa, which saw the cream of the high-tech world descending on Tel Aviv for dozens of conferences, meetings, and workshops. Considering that the money you are using belongs not to you, but to investors, “you have to balance the risks. Even if they can’t tap into an income stream at the initial stage, they need to have a clear and practical vision of how they are going to make money later on.”

Lissauer said he might even pass on what is likely to be a breakthrough technology — one that “everyone” knows is going to be the next big thing — unless there is a real plan to monetize.

In the past, VCs may have been a bit more liberal. In recent years, however, VC money has been hard to come by, said Eran Yarkoni, one of Israel’s most seasoned VC pros, who has helped start-ups and established companies raise a total of $100 million from numerous sources, including venture capital funds.

“VCs look at three major things,” Yarkoni said: a good business and monetization plan, and technology — or at least a good idea that can be monetized and is unlikely to be duplicated, like Facebook. And, he added, “they are very interested in the team — whether they are flexible enough to handle changes in the market and technology, to deal with crises, etc.”

But the return on investment has to be primary, explained Yarkoni. “VCs generally look for companies that are going to be potentially able to give a return that is 10 times that of the initial investment.” In other words, the business plan must show how the company is going to make enough money to support operations, staff, and marketing costs, and pay back investors. And the plan has to make sense, showing clearly who the customers are, how you’ll get them to pay, what you plan to do with the income, and so on.

It’s a tall order at any time, but especially in the current financial atmosphere, Yarkoni went on. “Ever since 2002, VCs have been doing very poorly on their returns,” due to numerous factors — not the least of which is the hit high-tech took when the tech bubble burst at the beginning of the decade, and the ongoing recession. “Once bitten, twice shy” has become a watchword for many investors, who, having been burned, seek safer havens for their money, even if the returns for stocks, bonds, and bank investments are nothing to write home about.

“A lot of Israeli VCs have run out of money, and the major investors today are foreign funds,” asserted Yarkoni. Not that they are necessarily more conservative in their choices of companies to invest in, but they can afford to be more picky: There is a high demand for money, and the returns have been quite low in recent years.

The same strategy holds true of Israeli VC giant Pitango, said Eli Novershtern, a principal at the firm and a veteran of Israeli VC Canaan Partners. “One of the things that we try to do is to fund the outliers, the companies that have new and innovative technologies. We naturally prefer companies that are going to be able to monetize their concepts and products and ensure that we get the returns we are expecting.”

With that, he said, Pitango was willing to make exceptions for a really good product or technology, even if the company hasn’t figured out how to make money yet. “We have had a number of companies that started out with a technology or an idea, that went on to become great successes. Sometimes you only figure out how to make money later on.”

But sometimes an investor can outsmart himself. At a DLD presentation on angel investments (where individuals or small groups put up their own money to invest in a start-up, instead of taking money from investors in a fund), Yossi Vardi, a successful high-tech entrepreneur, told of how the folks behind traffic-intelligence app Waze asked him to invest in the company a few years ago. Vardi, the grandfather of Israeli high-tech — who scored the country’s first big tech buyout when he and his partners sold ICQ in 1998 — demurred, for various personal and business reasons. When he saw the phenomenon that Waze had turned into, “I went back to them and offered to invest… but by then it was too late, and they didn’t need my money anymore.”

The result? Vardi may have missed out on his biggest investment ever — if the rumors that Apple has licensed Waze’s crowdsourced road maps for its own driving app are true. In the VC business, you can’t be too careful — or maybe you can?

read more: