It’s different this time.  Why?  Because in Israel the reality of demographics is catching up with those who previously believed that wishful thinking makes for sound public policy.

It’s hard to distill into a sound bite what’s going on in Israel and the West Bank.  Knowledgeable pundits are fond of prefacing their answers to meaningful questions about the region with, “It’s complicated…”  And it’s true.  In Israel, especially in Jerusalem, everything is complicated, because politics permeate every crevice, from issues of local real estate to childhood education.

I’ve just returned from a week in Israel, including visits to Tel Aviv, Herzliya, East Jerusalem, and the fascinating work-in-progress at the ambitious construction project of Rawabi City, as well as other sites in the West Bank.

While I have been to Israel many times since my first trip in 2002, I was fortunate join an outstanding program sponsored by the Philanthropy Workshop West for this trip.  Among the highlights of our trip, we visited a wide range of community outreach programs for ethnic groups at risk (Israeli Arabs, the Ethiopian Jews, the Bedouins) sponsored by groups including the Portland Trust, the New Israel Fund, and the American Jewish Joint Distribution Committee.

What struck me most about this visit was that Israel finally appears to be acting more introspectively to address its painful social and political contradictions, acknowledging that these can no longer be left to fester from salutary neglect.

Chief among these contradictions is the discrimination of Jews against other Jews, particularly by the ultra orthodox against Jewish women who seek the right to pray at the Western Wall, and by the State of Israel against Reform and Conservative Judaism (which define Judaism in the United States) by denying these branches of Judaism official recognition and fiscal support in Israel.

I was not expecting to hear from multiple individuals what I have felt since I first visited Israel 11 years ago: that the country cannot allow the ultra orthodox to be exempt from military service and from carrying their economic share of public services.  And there is a sense of urgency that also surprised me, a sense that this must be addressed by the legislature now.  To wit, the newly formed government majority in the Knesset, for the first time in the history of the State of Israel, excludes the ultra orthodox block, effectively taking the keys to the religious car away from these intolerant and uncompromising constituencies.

The release of the Women of the Wall from arrest, without consequence, on April 11 brings this new political reality home.  The courts overruled the police and squarely placed the blame for public disturbance on the haredim at the scene.  This is a big deal! As reported by the New York Times:

“The judge said the people disturbing public order on Thursday were a group of ultra-Orthodox protesters who were demonstrating against the women. The police said an ultra-Orthodox man was also arrested after he grabbed a book from one of the women and burned it.”

Job training centers for the ultra orthodox are springing up, supported by U.S. NGO’s and the Israeli government, and there are waiting lists because of excess demand from haredim who wish to change their lives to consist of more than Torah study.  I view continued progress or renewed failure to achieve change in this area as a canary in the coal mine in terms of handicapping Israel’s prospective trajectory toward broader achievements with the Palestinians.

April 7, 2013      East Jerusalem

Local time: 4:00 AM

The wailing chant of the muezzin woke me up.  As an outsider, this unfamiliar daily call to prayer for muslims reminds me that I am not just 7,397 miles away from my home in Napa, California; I am centuries removed from the familiar frames of reference that define my daily existence.  But there is also a familiarity to all of this for me…

I started this blog in early 2005 because of a chance encounter I had with an elderly Palestinian man in East Jerusalem on November 3, 2004.  Almost nine years later, I am back…

On the surface, East Jerusalem seems cleaner and quieter to me today than it did in 2004.  I’ve been here about 14 times since my first business trip to Israel in 2002.  This Spring the weather is dry, clear, and cool.  Walking through the Old City, things feel calm, not riddled with the tension of active conflict and imbalance that I have felt on many other visits.  I’ve been asking local friends for an update on the most pressing issues in Jerusalem and, so far, I’ve been told me that one social issue of increasing concern is the degree to which gender segregation has become more pronounced, even though the public buses are no longer segregated.  At the same time, the struggle for the recognition of reform and conservative in Israel continues unabated. Some progress has been made, but it remains painfully slow due to the entrenched political power in the Knesset of the ultra-orthodox minority.  I asked one friend what the “top of mind” political issue in Israel is likely to be in the short term this year, and she said “elimination of the exemption from military service for the ultra orthodox”.  Security and Iran were not on the top three list…

This is my first time back in Israel since December 2009.   I remember vividly my first visit to East Jerusalem in 2003, when I was introduced by Rabbi David Saperstein to Anat Hoffman of the Israel Religious Action Center and founder of Women of the Wall.  We met at the Jerusalem Hotel, and this led to a random meeting with a Palestinian man who spoke fluent Spanish outside of the Interior Ministry in East Jerusalem, an encounter that started this blog.

Much has happened in my life since then- professional successes, professional failures, the death of close friends, my own divorce.  And today I look ahead with renewed vigor as I open a new book, not just a new chapter, in both my family and professional lives: remarriage, personal renewal, new business ventures, and revitalized new and old friendships.

I feel fortunate to be back in Jerusalem this week as part of a trip with the Philanthropy Workshop West.  This extraordinary group has chosen to come to Israel this year for their international workshop for a series of meetings with thought leaders and experts on the region in order to better understand the complex social fabric that defines is at the center of the conflict that defines Israel. It is a privilege for me to join them.

Firas Raouf of OpenView Venture Partners, a Boston-based venture capital firm, recently interviewed me for two podcasts on the topic of  optimizing the contributions that a board of directors can make to a startup.  Seasoned venture capitalists are well aware of the challenges that emerging companies face in the boardroom due to conflicts of interest and misalignments.  Entrepreneurs must be equally aware and enter the boardroom with their eyes open as to these critical issues because they can undermine the success of a promising venture.

While some boards of directors are effective, many boards perform well below their potential, and some boards are dysfunctional.  This is particularly the case for emerging companies, largely for two reasons: (1) startup boards omit necessary processes because they feel it is “too early”; and (2) inexperienced entrepreneurs and first-time CEO’s are often not aware of best practices in this area.

These two podcasts provide useful practical advice for early stage company boards of directors:

OpenView Leadership Lab Podcast I:  Building a High Performance Board

OpenView Leadership Lab Podcast II: How to Run an Effective Board Meeting

While every company founder makes trade-offs in building a company, few entrepreneurs appreciate the far-reaching implications of several critical decisions they will be required to make at the outset of a startup’s evolution.  Noam Wasserman, Professor of Entrepreneurship at Harvard Business School, classifies this sequence of inevitable decisions as “The Founder’s Dilemmas”, which is the title of his important new book on this topic.  A refreshing contribution to the business literature on startups, Founder’s Dilemmas is engaging without sacrificing substance and statistically sound without being turgid.  One of the core differentiating strengths of the book lies in that it weaves seven highly relevant case studies of entrepreneurs throughout its 11 chapters, providing concrete anecdotes and illustrations to back up the author’s general observations and recommendations.  “The Founder’s Dilemmas” is required reading for entrepreneurs and for the professionals who work with them, particularly venture capitalists.

Wasserman notes that venture capitalists attribute 65% of the failures in their portfolio companies to problems with the startups’ management teams.  Focusing on the critical decisions that founders have to make, he observes that entrepreneurs who are company founders are naturally inclined to be passionate, optimistic, and to prefer to avoid conflict with their co-founding team members; these tendencies lead to short-sighted decisions.  Most founders tend to make decisions with no process, based on their gut instincts. Wasserman concludes, backed up by a data set of 10,000 companies compiled over 9 years, that the entrepreneur’s most common choices are the wrong ones, particularly co-founding with friends and splitting equity equally among co-founders at the outset of the new venture.

In The Founder’s Dilemmas Wasserman revisits his most well developed dilemma, Rich vs. King. He convincingly argues that, while the passionate desire among entrepreneurs for both wealth and control seem complementary, as entrepreneurial motivations they turn out to exist in perpetual tension with one another.  Why?  Because founders are resource constrained and need to attract three key outside resources: people, information, and money.  Consequently, Wasserman concludes that “wealth and power are decoupled for entrepreneurs and, indeed, in active conflict.  As a result, few founders of high-potential startups can achieve both wealth and power; most choose between one or the other and often end up with neither.”

These sobering words are backed up with specific examples and recommendations.  Among the most useful, Wasserman points out that the most durable business teams are formed between people who have had prior working relationships and that, though these may “be less endearing”, they are “more enduring.” In determining how to split equity among co-founders, Wasserman prescribes a “dynamic allocation model”, complete with charts, as he points out that founders, from Steve Jobs and Steve Wozniak at Apple to Evan Williams at Blogger/Odeo, rarely correctly identify the future contributions that will actually be made between each other at the outset of the venture.

Turning to the critical issue of raising capital, Wasserman cogently describes the trade-offs associated with taking venture capital, focusing on critical issues such as board composition, understanding the implications of liquidation preferences, vesting of equity stakes among co-founders, and the phenomenon of creeping dilution—both of economic interests and of management control.  Many of these issues come to the foreground once entrepreneurs have raised money from VC’s.  The book makes a great contribution to practitioners on both sides of the table by shining a light on the difficult conversations that entrepreneurs need to have with their colleagues and with their investors.

The Founder’s Dilemmas is effective because of its plainspoken, common sense conclusions: “…core founders are often missing skills, connections, and financial resources to build the most valuable startup possible.  They can make up for this by attracting complementary cofounders or by hiring talented nonfounders.  A third possibility is to add investors to the team, but founders must first think carefully about the often-hidden implications for themselves, for the startup, and for the board of directors.  For a founder-CEO, losing control of the board is only the first step on the way to losing control of the major decisions in the startup…”

This book is a useful tool to facilitate important dialogue between VC’s and entrepreneurs before they decide to make an investment in each other.

My comments on the key findings from the Shareholder Representative Services 2012 M & A Deal Terms Study are in bold:

Deal sizes: although the median deal size* rose slightly to $75 million in 2012 from $70 million in 2011, deals $50 million or less grew to 42% of deals in 2012, up from 33% in 2011. An increase in the percentage of smaller deals in and of themselves doesn’t tell us much.  I’d like to know what percentage of those acquisitions are takeunders versus takeovers—a takeunder in this case means that the consideration paid is less than invested capital.  That’s the key statistic on the health of the acquisition market from the 42%-of-the-market-seller’s perspective.

Seller financial performance: acquisitions remain heavily weighted toward Sellers with revenue, and Sellers in the aggregate continue to show improved earnings since 2009. Coupled with a slight increase in Seller-favorable terms generally, data suggests that some degree of market leverage is returning to Sellers that have survived the downturn even as M&A activity remains deliberate. I don’t believe this last point reflects the reality of the market– unless your company is cash flow positive, a ‘slight increase’ in Seller-favorable terms means nothing given the place form which we are starting:  highly favorable terms for the buyer.  The trends absolutely support that buyers are looking for non-dilutive acquisitions.

Cash vs. stock deals: cash is still king in M&A as long-term interest rates decline. That’s for sure!

Earn-outs: usage of financial metrics (revenue and earnings) and multi-metric achievement tests is declining, accompanied by a shift toward longer earn-out periods. Beware the earnout, it is often used by the buyer as a subterfuge for reducing the back-end payment of the acquisition.

Indemnification trends: median R&W survival periods and escrow sizes have leveled off at 18 months and 10–12% of transaction values, respectively, since 2009. Other terms are increasingly Seller favorable, for example, an increase in available offsets against Buyer indemnification claim amounts and requiring that claims exceed a minimum threshold.  I’ve seen very bad behavior here and am glad the median statistics show Seller favorable trends because it can’t get much worse than it has been…

Alternative dispute resolution (“ADR”): mandatory ADR such as mediation and arbitration has steadily declined since 2010, down to 26% of deals in 2012 from 41% in 2010. I am a strong advocate of binding ADR.  Large corporations like to avoid this because they want to wait the little guy out and they have plenty of salaried staff on hand to go to court or posture as if they are prepared to do so.  I’d like to see this trend reverse.

Post-closing expense funds: the median size as a percentage of the indemnification escrow continues to trend upward, at 2.08% in 2012. This is consistent with ADR declining, as more resources that should be going to shareholders are being wasted on post-closing disputes.

Denis Dougherty of Intersouth Partners was recently interviewed by Brian Gormley of The Wall Street Journal on the decade-long liquidity crisis that continues to plague the venture capital industry. Responding to the question “What do you see as the biggest investment opportunity for venture capital in 2013?”, Dougherty said, “If we have a broadly rebounding economy, the big corporations would begin to buy products and programs that they want to have, not just the ones that they have to have. Venture capitalists that have an inventory of acquisition-ready companies will do well.”

I agree with Dennis. My concern, based on my direct experience negotiating half a dozen acquisitions sine 2008 (three in 2012), both inside and outside of technology, is that the negotiating environment for such ‘acquisition-ready’ companies is fraught with challenge from the seller’s perspective.

Recent reports reveal that mergers and acquisitions still account for over 90% of liquidity events for venture-backed companies in 2012, a lamentable condition that has plagued the US innovation ecosystem for close to a decade. In my view, many acquisitions of emerging growth companies often lead to the burial of promising technologies by incumbents more focused on protecting market share than on delivering the best product or service to their customers… (think Linksys, Flip…)

It is critical to know the state of the art in merger terms leading to an acquisition and in post-merger covenants, particularly with respect to the release of cash consideration held in escrow or as a holdback by the buyer.

Shareholder Representative Services (SRS) has produced another excellent report that investors and management teams should scrutinize very carefully before engaging in merger negotiations.

I have one general comment to make about the SRS report before reviewing its key findings:

In any negotiation, just because the average term is X, you should not abdicate your responsibility to improve your position and negotiate to get a better outcome for yourself.  You may consider some terms to be acceptable in the agreement because your lawyers tell you “it’s the market” in the heat of battle.  That might be OK, but it also might be a rock that will not always be floating above your head…

Because the current world of venture-backed exits remains dramatically and asymmetrically skewed to the advantage of the acquirer, the aggregate statistics in the SRS report reveal a landscape pockmarked by buyer-friendly terms. Challenge yourself to do better as a seller!  More on this topic to follow…

After a one-year hiatus, I am back.  Stay tuned for new posts on venture capital, corporate governance trends, and current public policy issues that impact investors and entrepreneurs. I have also done a lot of hiking throughout America and Europe in the last year and will share highlights from my hiking experiences as a new topic.

Over the past year I’ve made meaningful personal and professional changes. Today I am healthier, happier, and more energized than ever. I look forward to sharing my thoughts with readers and welcome all constructive comments.

Spencer Stuart recently previewed their annual public board governance analysis in the November 2011 Harvard Business Review, comparing board demographics in 1987 and 2011.  Some highlights and my thoughts on the implications:

* Directors are older:  boards whose average director age is 64 or older:  1987, 3%; 2011 37% .  This may have as much to do with director liability issues as it does with the increased oversight responsibilities associated with being a public company director.  It takes more time to be a public company director– more formal meetings, more preparation, and more informal consultation.  Older directors have more time and also have the flexibility to accept the liability risks as their other corporate responsibilities diminish.

* Director compensation is up: average board retainer plus meeting fees per director: 1987: $36,667; 2011 $95,262. The 1987 figure equates to $69,428 in 2010 inflation- adjusted dollars, or a real increase in director compensation of 38%.

*Smaller is better: public company boards with 12 or fewer members: 1987: 22%; 2011 83%. In my view, this is one of the most positive trends among public boards, as smaller groups generally work together more cohesively than larger groups and larger boards are most often dominated by smaller groups within them– sometimes formally, most times de facto.

* More independent directors: the independence rules have become more clearly defined, with Sarbanes Oxley’s passage in ’02 driving the trend.  1987:68%; 2011: 84%.  Having more independent directors, however, does not necessarily correlate to having a more effective board– let’s not forget models of director independence, such as Tyco and Enron, that were emblematic of poor board governance.

* Still dominated by white males: in 2011, 9% of boards have no female directrs, 16.2% of corporate directors are women, and 15.3% of directors at the top 200 companies are African-american, Hispanic, or Asian.

Dan Primack posted an article in Term Sheet last week titled Yelp This: IPO Market Is Killing It. Several well informed observers of the capital markets, including me, strongly disagree with the assertions in that post that lead to the following conclusion: “What we’re seeing in terms of IPO ebbs and flows is about momentum, not structure.”

In my view, it is all about structure– the U.S. equity capital markets for emerging growth companies with market capitalizations below $500 million are structurally broken and systemically dysfunctional.

Responding to these comments in a new post on Monday November 14, IPO Worries Put to the Test This Week, Dan reasserts “my belief that the death of small company IPOs has been greatly exaggerated.” Several readers, including me, again took Dan to task on this because we believe his facts are erroneous.

Dan’s second post did make it clear that there is considerable confusion over the relevant metrics to determine the health of the IPO market for small cap companies.  To wit, Dan used the following examples to make the argument that all id well in the land of underwriting IPO’s:

‘Well, this week may put that complaint to the test. Clovis Oncology is set to price a $160 million offering, despite having a whopping $0 in revenue. Also on the docket is Lashou Group, which only reports $16 million in revenue for the first nine months of 2011. And InterMolecular, with $26 million through the first nine months of 2011. And, just to be sure this isn’t a one-week trend, pre-revenue BioAmber today filed for a $160 million offering. Maybe this week’s low-rev companies don’t price. Or maybe they do so, but only with massive insider support. But, on the other hand, what if they do price with outsider support. In that case, what say you dissenters?’

While I commented again on Dan’s article on Term Sheet, below is a more extensive response with additional facts:

To be very clear, the central issues behind the systemic dysfunction in the U.S. equity capital markets for emerging growth companies are not the current revenues of companies filing to go public or their current profitability levels—the core problems for U.S. securities regulators, investors, and entrepreneurs are (1) the steadily increasing absolute size of the offerings itself; and (2) whether or not the companies raising the public market capital are U.S. companies that will create new jobs in the U.S.

The small growth company is widely recognized as creating new jobs, and, in America, over the past eleven years we’ve witnessed the capital markets death of one of the great job-creation mechanisms in the United States, the sub-$50 million IPO. Between 1991 and 200 80% of IPO’s raised $50mm or less.  Today, the threshold for liquidity demanded by institutional investors requires $100mm plus for an IPO.  And this isn’t just a venture capital problem—this is a major problem for the American entrepreneur—since 1991, 47% of all U.S. IPOs were neither VC nor PE backed.

Why should you care? Because the following list of companies, which were all venture-backed, went public raising less than $50 million at various times between 1971 and 1996: Adobe, Applied Materials, BMC Softare, Computer Associates, Dell, Electronic Arts, Fiserv, Intel, Paychex, Symantec, Intuit, NetApp, Oracle, Western Digital, Xilinx, and Yahoo! These companies raised just $367 million in the public markets, and they account for 470,000 U.S. jobs today. Adjusted for inflation and measured in 2009 dollars, the $367mm in total dollars raised by this group equals $670mm, and only 2 of these 17 companies’ IPOs (EMC $80mm and Oracle $70mm) exceed $55mm in 2009 dollars. While todaythese companies are household names, let’s not forget that they were unknown small cap growth companies when they first went public. How many companies that represent the next generation of household names will be still-born or acquired into obscurity because they cannot access the public capital markets today?

Your sample of companies is perfect in illustrating these points:

Lashou           Chinese company raising ADR’s in U.S. $70mm offering.  No U.S. jobs here.

Clovis Oncology       $130mm offering from latest news report- and note that Life Sciences companies have a completely different business model from IT companies as the public round is typically another “interim R&D” type of financing on the long road to commercialization.

InterMolecular        $120mm -$140 million, reduced from original offering size based on latest news report.

BioAmber                 $150 million offering

To summarize:  actions need to be taken by securities regulators in the U.S. to restore sufficient post-IPO market liquidity and ongoing research coverage for U.S. based companies to be able to successfully raise less than $50 million in an IPO at a market capitalization of $500mm or less.  That will not happen unless it becomes economically sensible for market makers and research analysts to be involved with such companies.

For more background and facts on this topic, please refer to :

http://www.levp.com/cat-bin/filexfer/show/032410_ICAP_Ocean_Tomo.pdf?artist_id=365&folder=news_attachments&file=032410_ICAP_Ocean_Tomo.pdf

Kelly Slone, director of the Medical Industry Group of the National Venture Capital Association (NVCA) posted an important article on October 7 on the NVCAccess blog, clearly calling out that the unintended consequences of FDA regulations have precipitated a full-blown crisis in medical innovation in the U.S. This crisis has already damaged America’s global competitiveness and slowed medical innovation in the U.S.  The report “revealed that US venture capitalists are reducing their investment in biotechnology and medical device companies and shifting focus overseas to Europe and Asia, primarily due to regulatory obstacles at the Food and Drug Administration.”

In related news, Mark Heesen, NVCA President, announced today that U.S. venture capital funds raised a total of  $1.7 billion, a 53 percent decrease in dollars from the third quarter of 2010 and the lowest amount since the third quarter of 2003.  Heesen observed in his blog post what he expects will become apparent when Q3 2011 VC investment statistics are released next week : “you can bet the total dollars invested into start-up companies will be a multiple of the amount raised.  It has been this way since 2008 when the industry began investing more than it was raising.  In fact, by the end of this quarter, the venture industry will have invested at least $20 billion more than it has raised in the last 3+ years.And just like a bubble, this imbalance is not sustainable.  Unless the industry begins to raise more money, we can expect investment levels to decline in the coming years in a significant way.”

You can download the full report: Vital Signs: The Threat to Investment in U.S. Medical Innovation and the Imperative of FDA Reform, from the NVCAccess blog.

Some key conclusions from the report follow:

U.S. venture capitalists have been and will continue to:
• Decrease their investment in biotechnology and medical device start-ups
• Reduce their concentration in critical therapeutic areas, and
• Shift focus away from the United States towards Europe and Asia
FDA regulatory challenges were identified as having the highest impact on these investment decisions.
We must act now or lose our leadership position in medical innovation, job creation and access to life-saving treatments in the United States. If the current situation is left unaddressed, the implications to U.S. patients and the economy are significant:
• Many promising medical therapies and technologies will not be funded and therefore will not reach the patients that need them.
• Those that are funded may not be brought to market in the United States first, or at all.
• An estimated funding loss of half a billion dollars over the next three years will cost America jobs at a time when we desperately need employment growth.
• The U.S. leadership position in medical innovation will be placed in further danger and economic growth with suffer.

For more factual background on the decades of neglect that have led us to where we are today, you may find the following links to presentation slides useful:

America’s Slipping Global Competitiveness– Implications for the Next Generation of American Emerging Growth Companies, keynote speech remarks delivered by Pascal Levensohn at ICAP Ocean Tomo conference, March 24, 2010, San Francisco

American Innovation in Crisis,Cybersecurity Applications and Technologies Conference for Homeland Security (CATCH) Conference, Walter E. Washington Convention Center Washington, D.C. Keynote Speech by Pascal Levensohn, March 4, 2009