Israel has acquired a reputation as a “start-up nation” because of its large number of innovative entrepreneurs, and venture capitalist Nechemia “Chemi” Peres has been involved in funding them from the very start. When the Israeli government rolled out its initial initiatives, Peres was one of the first to take advantage of them, launching the Mofet Israel Technology Fund, a venture capital endeavor that traded on the Tel Aviv Stock Exchange. Today, he is co-founder and managing general partner of Pitango Venture Capital. The nature of the game is changing, he told Israel Knowledge@Wharton in an interview conducted late last year, and the country needs to diversify both its sources of funding and its markets.
The first part of the edited transcript of the conversation appears below. To read the rest of the interview, check out part two, Venture Capitalist Chemi Peres: Building a Vehicle to Finance Entrepreneurial Dreams.
Knowledge@Wharton: What are some of the key issues facing the Israeli economy?
Chemi Peres: In 2012, Israel shifted its economy from an emerging market to a developed economy. During that year, Israel was accepted as a member of the [Organisation of Economic Co-operation and Development] OECD and our GDP per capita crossed $30,000. I think the challenges are related to how you grow an economy in a country that has very small local and regional markets. It needs to focus on global markets. So the challenge is to build an economy that is based on exports. Until recently, we did not have a lot of natural resources. We have now found some [natural] gas in the sea, which becomes very significant. But it’s still an economy that is not based on natural resources. The issue is how you build an economy that needs to compete on a global basis. This [also creates] challenges for the educational system: How do you build a state [focused on] science and technology and continue the growth when you also have a limited number of people who can be employed in the high-tech sector?
If you look at the high-tech sector in Israel, it employs roughly 10% of the workforce. Half are working for multinationals that set up offices or R&D centers in Israel. They try to buy more startups in order to grow the critical mass and focus on major challenges in innovation. Lots of multinationals are really focused on deep innovation in Israel. The other half of the high-tech workforce is working in start-up companies. The ability of these companies to scale locally is limited.
So the second challenge will be to scale some of these companies and you need to recruit a lot of people quickly [to do that]. I think that what we’ve seen in the past 10-15 years is that the number of customers who are globally buying products in the technology sector has grown from one billion to two billion. So the opportunity to build a bigger company today as opposed to 20 years ago is changing dramatically. Today, we are also on an accelerated mode, because more people will join the middle classes and increase consumption of technology products. But the challenge is to overcome competition, to be able to focus on the right pockets of growth, and maneuver and scale through different cultures and different geographical locations.
I want to add another challenge that I’m worried about — the fact that we have natural resources. Once you can benefit from natural resources, you become lazy. I think what keeps Israel so vibrant is the fact that we don’t have natural resources. We have, therefore, to focus on innovation. I hope that that atmosphere — the culture of the start-up nation — will keep going.
Knowledge@Wharton: From what you have described, there are two very interesting forces at work in the country: The first is the need for Israeli companies to go global relatively early, because of the absence of a domestic market. This implies the dependence of the Israel economy on the export market. But the primary markets of Europe and the U.S. are both slowing down or have already slowed. How do you think this is going to affect the prospects for Israeli companies? What strategies do you see them adopting to adapt?
Peres: The strategy is basically to be open to new markets and to develop the same kind of relationships [with other nations] at the strategic level that we have had with the U.S. or Europe. We have to develop that in the Asia-Pacific region, Latin America and other areas. And the venture capital [VC] community and the entrepreneur community are investing more time and effort today in going to China, India, Russia, Brazil and other places. At the end of the day, when you start a company in Israel and you set it up globally, it doesn’t really matter if you go to the airport and take a flight to New York or San Francisco or Beijing or New Delhi.
You still have to build the kind of cultural bridges that we have so easily done in the U.S. and Europe. Israeli society is based on European immigration and the U.S. has always been a target for our educational system and job fulfillment. So Israel is much more geared toward the Western world. But I think that we’re very quick to adapt. As VCs, this is something that we do. In our previous funds, 80% of our investors were U.S.; 20% were European. In the new funds, we’re raising money in India, China, Russia, Korea and Brazil. We try to address those global networks in order to help our companies grow into those areas.
At board meetings in companies like Pitango, 10 years ago you would hear the pitch analyzing the sales of the company by dividing the world between the U.S. and the rest of the world. Today, the sales analysis is much more globally oriented.
I think that more than other countries that have a strong local market, we are oriented toward moving and changing direction to suit different pockets of growth in different geographies. And Israelis are trained to travel and to adapt to new cultures and new environments very quickly.
We’re also a society of immigrants. We never had a deep tradition that we had to break. I think what is important in the new age is your ability to adapt to a change very quickly. Israelis are quite good at that. It gives us some kind of advantage when we talk about addressing new markets and new cultures.
Knowledge@Wharton: When you talk about the sources of funding becoming more global, where is the money coming from? How is it changing the kinds of products and services that Israeli companies can provide to the global market?
Peres: A start-up company depends on venture money and angels. At some point in time, they need to start depending on customers. When the stock market was hot and strategic global players were inquisitive, funding came either from a global player buying a company or a NASDAQ offering. But these days, companies need to build their funding upon customers. They need to be focused on the kind of business model they will develop and the need in the market. But they still need the initial funding from the VCs.
What has happened is that the IPO opportunity has gone away. But global companies are still inquisitive. In the venture market, we are seeing more funding done in the early stage, but also in the later stage. In our portfolio companies today, we need to build a longer runway if we want the company to get to an IPO at some point in time. There is a balance between how we fund them as VCs and how they manage to sell products and get money from customers.
If you want to focus on the way venture funds are financing companies, I think the sources of funding are more diversified today. When we started to build Pitango 20 years ago, we were targeting financial institutions, endowment funds — people who were supposed to have stability in their investment. But as we saw the subprime crisis and then the global financial crisis, we understood that nobody is immune. We, therefore, decided to address the funding of our funds the same way that we address our investments.
Early in the process, Pitango decided to be diversified by sectors and by stages of investing in portfolio companies. We adopt the same approach today when we raise money. So we diversify ourselves by geography. We have for the first time investors from Korea, India, China, Russia and, hopefully, from Brazil. At the same time, we decided to also diversify the type of investors, because we no longer want to be completely dependent on financial institutions; they may suffer from lots of problems. We raise money from high net-worth individuals, from family offices, from endowments, and also from corporate sources — whoever is interested in being part of the technology game.
One of the other challenges I have mentioned: Israel will never be a strategic place to grow revenues on a global scale. You’ll go first to India or China. So how do we attract investors? We manage to attract them by deep innovation.
The second challenge is the fact that we are a local market that is very small and barely a regional market. What we’re trying to do today is break through and create a regional market. If you start a company in Israel, you have to bridge immediately to global markets. If you start a company in Silicon Valley, you are in a local, regional and global market without moving. We want to get to that point. When we do that, we’ll be very, very competitive on a global basis.
Knowledge@Wharton: How do you get to that?
Peres: One of the things we did is look at the region and look at our society. What we discovered is that in order to grow our economy, to strengthen our local market and the regional market, we need to do two different things. To strengthen our local market, we need to make sure that the entire society is participating in the start-up nation game. The population in Israel is very small — 7.8 million altogether and 1.2 million [Israeli citizens that] live outside Israel. Non-Jewish minorities account for 1.6 million. And there are a significant number of ultra-religious people who do not participate in the workforce.
We decided to address that issue by opening the strategy of Pitango saying that we’re not only investing in Israel, we are investing in Israelis. So we address the 1.2 million people that live outside Israel, in Silicon Valley and New York, and we say, “If you want to do something in innovation, we would be a partner.”
The second thing we started almost three years ago was to address the non-Jewish community in Israel. We created a new fund completely focused on investing in the Israel-Arab minority. We’re talking about 1.6 million people. When we looked at that market, we saw there were no funds, activities and limited entrepreneurial activity. There are no exits in this market, no M&As, no IPOs, no nothing. Then we looked at how our industry needs to grow, because in the technology sector you can create jobs, but you don’t have enough people to fill those jobs. In the early 1990s, we managed to do that by absorbing one million newcomers, mainly from Russia — highly-skilled, highly-trained people who were absorbed in the high-tech society and contributed to growing the GDP to $30,000 per capita. But if you want to go to $40,000, where do you bring the people from?
We said we have 1.6 million people, and many of them are highly educated; they are highly motivated. A lot of them are young. So we decided to set up a fund that would focus on the young generation within the Arab community in Israel. Al Bawader is the first fund that is operating in this area. We did it together with the Israeli government. They matched our funding. We managed to raise $50 million. We have already concluded seven investments within the Israeli-Arab community. We want to be the first to bring a company for an IPO and the first to be acquired by a strategic partner. We believe that by doing this we will be able to stimulate that community.
This community, which is about 23% of the population, generates between 7% and 8% of our GDP. We [need to] grow that GDP, raise the standard of living and create jobs. We’ve seen the Arab Spring; if you neglect it for a second, you will have problems.
The Middle East is the youngest region in the world. The average age is below 26. It has one big advantage: 350 million Arab speakers. There are an additional 60 million living in different places. If you think about the Arab Spring, there is a major opportunity we can leverage economically in Israel. I’m talking about the Arab Internet or Arabic-speaking Internet market, which we believe is coming up and will be a great opportunity. This is where the world needs to invest today.
There is a completely aligned interest — global interest — to start growing the Middle East. I think the Internet is the way to do it. It will help the young generation to create jobs. It will bring knowledge. It will bring education. It will bring communication. It will bring efficiency into the market. I think that, if the Arab world, with the support of global companies, creates an Arab-speaking Internet market, it will contribute to the growth of the region.
At the end of the day, one of the challenges for Israel economically is to integrate into the region. Here you have a local play, which is also a regional play and potentially a global play. I think Israel has a great advantage because it is a start-up nation that has lots of connections in the world and lots of entrepreneurs who have started successful companies. If we take the Arab community in Israel and have Arab and Jewish entrepreneurs working together, we can contribute to the growth of the Arab-speaking Internet market and the growth of the economy in the region.
I think this is a unique opportunity. The challenge is to draw the attention of the business community to a market opportunity that has not been in existence. That’s part of what we are trying to do at Pitango. We see lots of entrepreneurs, lots of businesses. We are starting to see our first Arabic companies emerging on the Internet. We’re now building an accelerator for early-stage companies to get the young entrepreneurs in the Arab community in Israel connected to young Jewish entrepreneurs. Together, they can build the best Internet companies in this region.
Knowledge@Wharton: Can you give me any examples of the investments you’ve made?
Peres: I won’t mention names because it’s always sensitive. Today, there are 250,000 Arabic websites. Let’s say that about 85 million people are connected to the Internet in the Arab community. So the ratio between the number of websites and the number of users is actually one website for every 310 people. If you look at the U.S., the average is one website for every two or three people. If you look at the global ratio, it’s one website for every 10 users. That means that the content gap in the Arab world is about seven million Arabic websites.
We know that they are eager to have Arabic websites as opposed to English websites. So there’s a big opportunity. And we see that everything that works in the Western world is starting to happen in the Arabic world, whether it’s e-commerce, shopping, travel…. In Al Bawader, we invested in a company that is bringing health care services. We have a company that is starting to sell electronic books in Arabic. And we have companies that are working in media space. We have a company that is doing travel. These are companies that have great Arabic entrepreneurs, mentored and supported by Israeli entrepreneurs, working shoulder to shoulder. We think the opportunity is just amazing.
The Arabic language is the fastest-growing language today on the Internet. The potential of this market is bigger than the Russian market and the Spanish-speaking market. It’s unbelievable. There’s a huge opportunity. What we need to do is get the coalition of the multinationals, as well as the business community in Israel and in the region, to focus on this market.
Knowledge@Wharton: You referred to the challenges Israel faces within the region. What are some of the barriers that you have faced in trying to implement this strategy? How are you overcoming those obstacles?
Peres: The first barrier was the perceived risk of investing in Israel, a troubled society that does not have peace in the neighborhood. To address that, we said: “Look, it’s not Israel’s economy; it’s a global economy. We are selling our products around the world. When our companies are raising money, they’re raising money around the world. When they go public, they go public around the world. When they are being acquired, they are acquired by global strategic players. All we have in Israel is the innovation.” That’s one thing.
The second thing we are saying is that there’s no safe place around the world. My best example is that we were once contemplating holding one of our meetings in New York. It was scheduled for October 2001. We cancelled it because of September 11. It was the first time we cancelled a limited partners meeting.
We had one of our companies headquartered in the World Trade Center. The reason the company was saved is that they did not obey any of the advice that was given at the time of the attack — stay where you are and do not move. The Israelis there decided to evacuate immediately. The company was up and running the following day. So we say that there is no safe place today from terrorism. The world has moved from wars to threats and risks. And threats and risks are everywhere.
Third, we say, look at what’s happening in Israel. We have 300 R&D centers run by major global players. Israel has been, interestingly enough, the first destination for many people who decided to go global. When Warren Buffett did his first transaction outside the U.S., it was the purchase of 80% of a company called Iscar, close to [Israel’s] border with Lebanon. He did the transaction at a time we had a dispute on the border. He paid $4 billion. Buffett said that if you are looking for oil and gas in Israel (at the time, he didn’t know that we would find gas in the sea), you just go to the Middle East but don’t stop in Israel. However, if you are looking for innovation and you reach Israel, you don’t need to go any further.
The second example is the VC community. If you look at the VC community in Silicon Valley, they have never invested in companies beyond a 30-minute drive to a board meeting. They actually thought that the most exciting global sources of innovation were Sunnyvale, San Mateo, Palo Alto and Menlo Park [all in California]. But today, if you look just from this window to the next building, you will see Sequoia, Benchmark and Greylock. All of them set up shop in Israel before they went to India and China. They thought there is something here that’s worth exploring.
The third example is one of our portfolio companies that was acquired by Apple. It was the first time Apple acquired a non-U.S. company and the first time they set up an R&D center outside Mountain View, Calif. A lot of people are doing their first globalization through Israel. I think that people understand that this is a vibrant democracy. This is a start-up nation. It’s not just a nation of start-ups; it’s a nation that by itself is a start-up. It started and succeeded against all odds. We had wars before we had a country. So I think that is the way to mitigate the risk: When people come and visit Israel, they go back and tell the story of how it is here, how it feels here. Others understand that there are a lot of risks perceived, but they’re not real.
I think another thing that helps us is the move from television to the Internet. In television, you switch on CNN or one of the channels and here is a terrorist attack which took place at some place. Maybe a few people were killed. It is broadcasted to every home. But if you have the Internet, you can choose where you go and what kind of content you consume. Then you shift from the broadcasting to learning and understanding. Television was very bad for Israel, because every attack was multiplied and augmented dramatically. But Israel is quite safe. We’re a powerful country. We’re a powerful democracy. Israel is here to stay. Once people visit here, and they start doing business with the Israelis, they understand we are a technology economy, a global play. The economy in Israel has grown over years, based on its high-tech engine. And that high-tech engine is continuing to grow more vibrantly than ever.
Knowledge@Wharton: You’ve referred a couple of times to the game-changing nature of the discovery of natural gas.
Knowledge@Wharton: What kind of investment opportunity and risks for global investors do you think that creates?
Peres: This does not create a risk; it creates an opportunity for Israel. First, lots of countries around the world are looking for energy. They are looking for international strategic collaborations with Israel. So, that’s an opportunity for Israel. I’m saying that every dollar that is invested in Israel, every office that is opened by a multinational, and every deal that is closed with a multinational or with a state strengthens the Israeli position. It makes the country more secure and safe.
Secondly, I think that what we do today in Israel on resources — energy supply and water supply — can support our neighboring region. The Middle East suffers from water and energy problems. Israel can provide some of these resources. If the government plays it right, we’ll increase our security by having more international players buying an interest in this natural resource. We will also be able to distribute it in the region and help our neighbors. We can build the kind of economic relationship that enhances security. If the high-tech sector plays the regional game with the Israeli-Arab community, we can build a much stronger economy in the Middle East. That will reduce the tension and help the Arab Spring really shift to the right direction. Today, with the age of the Internet, everything has opened up and people are highly aware of what’s going on. Leaders cannot play the same role they played before. They cannot hide from the public. Everyone is scrutinized. You can see every bit of what he or she does. If there is no message for the young generation and for the future, they will be thrown out.
I think we’re getting into a very promising time with regards to where the Middle East can head. We have all the ingredients. The only thing we need to do is be proactive and start investing. I think that the economy is the bridge — the tool to change the region. I think leaders are led; they do not lead. Reality forces itself on countries. People understand that the world is starting to move so fast that, if you stay behind, you put your country at risk. So you have to play the game and you have to be part of the global trends.
Knowledge@Wharton: Following the Arab Spring, do you think that there will be more cross-border capital flows within the region?
Peres: We think that Israeli technology in different areas — agriculture, water, energy, Internet, whatever — can be a significant addition to the Middle East. There are already investors from different countries. There is a lot being done under the radar screen, major projects between Israelis and Arabs. But much more can be done. We can contribute to health care, food security, energy….
Take, as an example, the Nile River. The Nile crosses 11 countries. Among them is Egypt, which is the largest Arab state in the region. Since they signed the Nile Basin Agreement in the early 1990s, the populations have grown dramatically and the allocations of the Nile have changed dramatically. Egypt is at the end of the Nile. Now, the Nile loses a lot of water because of different problems and the fact that it flows a long distance. There is technology today that can bring more water to everyone. Instead of having all the countries fight over the water allocation, let’s use technology and share more water in the region.
Israel can play a major role in these kinds of things, because we have lots of technologies in water that can actually provide more supply and mitigate scarcity. If there is a risk in the Middle East, it’s definitely around the Nile, because Egypt is unwilling to change the agreement and Ethiopia is trying to get more water. They have grown from two million to 20 million [people]. The game is changing. And technology is the way to deal with it. Israel has a lot to offer, in agriculture, in water, in all those areas.
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