Nir Linchevski | Israel Secondary Fund

Nir Linchevski | Israel Secondary Fund

Nir, beginning in the 90’s you’ve had an insider’s view of Israel’s capital markets evolution – tell us a little about how you got started.

Actually, my career started in an operational role at a large Israeli software company, The Formula Group. As more startups began to pop up in Israel, we were looking at ways to work with or invest in these companies. In 1999 we decided to professionalize that activity and raise outside capital, and we formally launched Formula Ventures.

Year 2 of operations was the dotcom bust, but we put our heads down and kept our best companies growing. In truth, the experience was invaluable: I was learning the role of a VC at the same time that the entire tech industry in Israel was going through the same process. Namely, that growing a startup is not just developing a product or building a business, but it is understanding what it takes to have a durable financial supply chain to support the StartUp Nation, which Israel absolutely did not have at the time. We went on to raise three funds at Formula.

And you began to look around for new challenges?

Not challenges per se but ways to differentiate. In 2005 I joined a Silicon Valley-based VC, Vantage Point, as their point man in Israel to execute on their strategy targeting larger investments in capital intensive businesses. Keep in mind that back then the term “unicorn” hadn’t been coined yet. Vantage Point was the first $70mil check into Tesla. We invested in companies in Israel like BrightSource Industries in the renewable energy space.

And in 2007, when I felt the supply of attractive startups in Israel was overshadowed by the number of VCs, I shifted my focus away from tech to more mature cash-flowing businesses and formed a private equity fund, Shiraz Investments. We made some notable investments including asset manager Altshuler Shaham, where I assumed the Chairmanship and we dramatically increased the firm’s AUM.

Then I decided to really differentiate: I sold my stake in Shiraz and took my wife and 4 kids on a year-long trip around the world.

Amazing – and intrepid! Coming back to work must have seemed like a vacation.

I was excited to look for opportunities in Israel’s capital markets where capital was not a commodity – again, I was looking for a differentiated investment thesis. And for great partners to work with. I was introduced to Dror Glass and Israel Secondary Fund, and joined the firm in 2014. ISF was formed in 2008, and in 2016-17 we raised the firm’s second fund, ISF II.

Define the focus of secondary fund.

Our target is the $50bil in assets which represent the private stock and limited partner stakes invested in Israeli startups and venture capital funds. This sector brings in around $6bil annually in new capital, but a startup’s journey from founding to exit takes, on average, twelve years – a very long holding term. What we do is supply liquidity options to stakeholders along the way.

Who are these stakeholders?

That’s a good question, but it’s not the right first question. We should start by discussing the types of companies we target.

Great point. So…?

Our business is predicated upon being disciplined investors. We need to identify the right assets, at the right time, and at the right price. To do that, we gather data and maintain an extensive database on Israeli startups, almost from their founding. Of 4000 active startups at a given point in time we are looking for the 6-800 that have built a quantifiable business with repeat customers and predictable revenue. We also see our role not as joining this 12yr “startup journey” at any stage, but rather trying to nail a point 3-4yrs before an exit.

That sounds a lot like what growth equity shops do – do you compete with them?

No, because our search discipline is different. Growth equity firms are focused on opportunities to help build companies and shepherd them to their exit, and their focus will be narrower. Our expertise is in providing liquidity mechanisms to stakeholders in companies with advanced revenues. Companies are not looking to us for help building the company, though we can certainly increase the value of those companies.

How so?

That answer brings us back to the question of who these stakeholders are. Effectively, we work with two main categories: the first are the founders/entrepreneurs and employees of a company, and the second are the investors – angels, VC’s, LP’s, etc. The overarching commonality between these constituents is that only a small percentage of them are willing to bear the risk of having a single large financial asset locked up for 10-12 years. Founders and employees may want to pay off their mortgage or fund other life needs. VC’s may need to liquidate a fund. Institutional LPs may have a change in their investment strategy. The point is that for the tech market to continue to grow, the ecosystem requires a mechanism to provide secondary liquidity to stakeholders.

You’ve given us the big picture of how secondaries can boost the value of a company, give us more tangible details:

Sure – I’ll give you two specific areas: employee retention and corporate conflict resolution. Startups can become large companies with significant revenue and EBITDA but their long-term employees have seen no monetizable gain in the value of their options. This can make it difficult to retain their most talented employees. Often these companies will approach us to set up a plan for their employees to sell their options at regular intervals.

Similarly, the longer a company stays private and grows, the more complex its capitalization table becomes. There can often be conflict between the early investors who feel that plenty of value has been generated and would prefer an exit versus newer investors who favor further growth. We can step in an make an offer to the existing shareholders such that those who remain are aligned around a common goal.

With the amount of startup capital flowing into Israel, have you seen an explosion in the amount of deal flow you are seeing and the number of LP’s from whom you are seeing it?

Our deal flow has certainly increased, with the growth coming along two axes: increased funding in the primary market and companies staying private longer. With regard to LP’s: newer LP’s to the market may account for an increase in deal count, but by dollar count we are still mostly working with sophisticated, experienced LPs that have been in VC for a while and understand the role of the secondary markets. That said, we still look to put our expertise to work in less liquid markets; we’re rarely making a bid in a market where we have 10 competitors.

How would you characterize the competitiveness of the secondary markets in Israel?

The barriers to entry in Israel are pretty high. The secondary market here is very different than in the US, Europe, or Asia. The main reason being that most of the assets are in technology, where each company in unique and complex and can only be addressed by firms that are experts in the field. But once you can unlock that you are in a market that is less crowded. The proof to this is that other global secondary shops will seek us out when there are Israeli assets in a portfolio they are evaluating.