Early Stage Funding in Israel

I had coffee recently with Amir Genosar, a very talented and creative Boulder entrepreneur. Amir has no less than three medical device start-ups underway; including aespironics and SteadyMed.

Having started his career in Israel, Amir now calls Boulder home. Why then does he, while surrounded by Boulder's angel and VC investors, still rely on Israeli investors to fund his businesses? Amir contends that Israeli investors are willing to accept more risk in return for lower valuations. These investors are more interested in the technology, even if unproven, than they are in the business model.

A business plan submitted to an Israeli investor for early stage funding must be heavy on technology and light on marketing and business model. How could this be? Are Israeli investors that unsophisticated? I have a few theories: there are many sources of funding for product development in this country such as the federal SBIR and STTR programs, state funding programs to commercialize university IP, corporate R&D or the entrepreneur's own resources. If a product does not receive funding from one or more of these sources, how viable could it be?

There are certain categories of products that provide exceptions to this. In new and evolving markets such as Web 2.0/social networking where products traverse their entire life cycle in a period of weeks, investors may take on less developed products simply to get in on the action. No federal program could possibly keep up with the pace of development in this arena, but the impressive valuations of Web 2.0 companies are hard for VCs to ignore.

In categories such as medical devices and enterprise software however, the number of developed products is high providing ample opportunities for investors to forego the risk of product development. Although valuations are higher, more capital is available than in a small country such as Israel.

It wouldn't surprise me that Israel does not have government programs that support commercialization and that this is a role taken on by private investors. Given the non-dilutive product development resources available to the entrepreneur in this country it may be less desirable for the entrepreneur to go the Israeli route.

CTEK Angels Live 2007

Time once again for the annual CTEK Angels Live! event, where the public is invited to observe entrepreneurs pitch and field questions from a panel of angel investors. And, most importantly, listen in on comments and criticisms from the angels after the entrepreneurs have left the room. For anyone involved in pitching to investors, this is an invaluable learning experience. This is the second year for this event and it appears popular enough to make it a regular event.

Three companies presented yesterday, all software based although quite different in their business models:

Myplacemat.com is a travel site specifically for frequent flyers. They aim to become the "amazon for travel" aggregating many travel related products in one site. They offer a frequent flyer points management system where a traveler can view the balances from all of their rewards programs in one display. Myplacemat intends to gather information on this valuable target market of frequent fliers and sell it to the travel industry.

Next up was Villij a recent graduate of TechStars and a cutting edge Web 2.0 company. Although the Web 2.0 community is alive and well in Boulder, this company is a bit of a stretch for CTEK. Villij is building a recommendation engine, they feel that the current state of art search, ala Google, will be replaced by a technology that leverages information on the individual performing the search to provide more targeted search results.

Last but not least was AWhere a business version of Google maps. The pitch was made by AWhere's president, and former director of CTEK's Boulder Venture Center, Jim Pollock. AWhere's technology combines a geographical information system with a company's business intelligence to present results on maps so that information can be quickly interpreted. The product is a desktop application sold to enterprises.

CTEK Angels is an angel investor network, pooling their resources to improve deal flow and screening, but each investor acts on their own. Each investor has his or her own criteria for investing based on their business background and comfort zone. This leads to some pretty lively discussions after the pitches where investors will express wildly divergent perceptions of the presenting companies.

Market Risk

In a previous blog I pointed out three major risks a startup company faces: Management Risk, Technical Risk and Market Risk. I want to dig a little deeper into those risks and have selected Market Risk to start with. I further divided the Market Risk into three risk categories:

1. high risk market
2. lower risk market
3. transitional market

The high risk market would be a poor choice to enter unless there were changes in the market. The lower risk market mainly requires a marketing campaign to get the word out on the product. The transitional market would be a poor choice to enter unless modifications were made to the new product thereby transitioning the market from high to lower risk.

This outline was originally created with a software product in mind but other products may fit the same pattern.

1. It would be very difficult to enter a market with a new product if:

• An existing product meets the needs of the customers.
• Customers do not currently do what the new product does.
• The new product does not provide sufficient value to the customers for them to buy it.
• Customers find that building their own product to do what the new product does is more cost effective.
• There are not sufficient numbers of paying customers to make the new product commercially viable.

2. The new product can be successfully introduced to the market if:

• The new product will help customers but they do not understand the product.
• The new product will help customers with a task that customers are not aware of doing.
• Customers are not aware of the new product.
• Customers have invested in another product that does an inadequate job of satisfying them.
• Customers perceive that the new product won't help them.
• The new product will help customers but they have higher priority issues.
• The new product is not in use by a sufficiently large community.

3. The new product should be modified before it can be successfully introduced to the market if:

• There are regulations that the new product must meet.
• There are administration issues that the new product must overcome.
• There are integration issues that the new product must overcome.
• There are technology issues that prevent the new product from being used.
• The new product has not reached a sufficient level of development.
• The new product does not satisfy a sufficient number of the customer's requirements.

Three Risks of a Startup

In a conversation with Duane Knight the CFO of Denver Biomedical, recently acquired by Cardinal Health, he mentioned the three main risks of a startup company. Although you may be saying "just three?" I thought these summed up the topic, I like lists of three and no one would read this blog if I listed fourteen. So here goes:

1. Management Risk
2. Technical Risk
3. Market Risk

Management risk encompasses all the risks involved with the management team: do they have experience, can they execute the business plan, can they work together and can you even round up the right people. Startups are especially difficult because highly qualified people may not be available or may not want to quit more stable jobs for the volatile environment of a startup.

Technical risk is the risk involved with the product or service the startup intends to sell. A startup by its very nature is usually trying to do something that hasn't been done before whether that's a new drug compound or new food product. New drugs have especially high technical risks due to the uncertainties when administered to humans. In comparison, software is relatively low risk. That may come as a surprise to those organizations that have pumped millions into IT systems only to have them scrapped. But software is more adaptable and, when managed properly, most IT projects eventually hit their targets.

Market risk is the risk associated with all those things concerned with selling the product/service: does the market need such a product, are there competing products, will the market buy enough for the company to eventually make a profit?

The startup company must deal with each risk and develop ways to reduce these risks in order to build value in the company; the lower the risk, the greater the value. Eventually, with enough work, patience, money and luck, the risk can be managed to the point where the company can actually forecast their revenues and profits a month, quarter or even a year in advance. A sure sign that the company's ready to go public.

A Blessing for Angels

The Access to Capital for Entrepreneurs Act of 2007, (H.R. 578) was introduced to congress last January. This bill would provide a 25% tax credit on up to $500,000 in investments per year in start-up businesses. So far the bill has received favorable response from the Kauffman Foundation, the Angel Capital Association, Women Impacting Public Policy and the National Association for the Self-Employed.

The beauty of this bill is that it provides tax incentive at the front end of the investment, where the incentive is sorely needed, rather than the partial capital gains exclusion given investors now. The Wall Street Journal quoted Susan Preston of the Kauffman Foundation as saying that the bill would double the number of angel investors.

Will this type of incentive cause investors to throw caution, and cash, to the wind? Does spending $500,000 to buy $125,000 in tax credits sounds like a good deal to you? Although the tax incentive reduces the upfront risk, getting a return on the investment is still essential. But with the reduced risk, maybe more investors would be willing to pull their money out of CD's and invest in the next Google.