Following a fallow two years in which it failed to raise the $100 million it wanted for a new fund, Veritas Venture Partners, one of the oldest funds in Israel, has decided to reduce its equity target to $50 million to $60 million.

It will close its third fund, VVP Fund II, in July 2002. The fund, first launched in 2000 when the market was at flood stage, has raised $40 million so far.

Industry sources are wondering how it is that the veteran management company, which has internal rates of return (IRR) that are among the highest in Israel's VC industry, has been unable to raise the equity for the new fund. Gideon Tolkowsky, a founder of the firm and the son of Dan Tolkowsky - a former commander of the Israel Air Force and a pioneer venture capital investor here - admits that the fund may have acted too slowly.

"There is something to the criticism being leveled at us," he says, "but we closed the first stage of the equity round in December 2001, and there are very few funds that managed to close any equity round in 2001."

Tolkowsky now believes that large funds are no longer needed. In his opinion, seed funds do not need more than $50-60 million, due to the lower scope of investment, which is a function of the current condition of the market. In addition, he said that it is easier to return a fund of several tens of millions of dollars to investors than a fund of $200 million, such as certain funds that have been closed in Israel in recent years.

"There is a need for less money now, and for every dollar spent in the first stage, about three dollars are saved for follow-on investments," he said. "We now invest hundreds of thousands of dollars in a round, not the millions we used to have to invest, and we can already offer other investors a chance to come in with us at the initial stage."

Even in 2001 during the crisis Veritas continued to make investments, and intends to complete a new investment in another company soon. All told, the original plan - according to which the new fund would invest in 15 startups - has not been changed.

Veritas is still distinguished by an almost zealous focus on companies at the seed stage. "As in the early 90's, now, too, we are almost alone in our preference for the seed stage, at a time when almost no other fund in Israel is carrying out seed investments," says Tolkowsky. "In recent years, the industry has tended to relate to seed investments as risky, although in my opinion, investment in companies at the later stages is a recipe for losses."

Tolkowsky believes that it is this strategy that has contributed to the high internal rate of return on capital (85%) that the fund has notched in the past few years. For example, it took part in the initial capitalization of Gilat Satellite Networks, when the company value was assessed at only $2.9 million before the money. Now, despite the crisis, Gilat Satellite is being traded on Nasdaq at a company value of $40 million.

Similarly, Veritas invested in Lumenis at its earliest stages, when the company was assessed at only $500,000 - it is currently traded on Nasdaq at a worth of $220 million. "We used to speak of multipliers of 30 times the size of the investment. They now speak in the industry of multipliers of 15. That is still high," says Tolkowsky.

Veritas' current VVP Fund II, will be the first fund that the firm will manage in the customary format, in which there are multiple investors, and multiple partners managing the fund.

The first fund was established through an investment of Anglo American, which is owned by the De Beers diamond conglomerate, and the second fund was also based on a single investor, Japan's Mitsubishi group.

The new fund is being managed like other funds in the industry. Equity has been raised from several investors, and the fund is being managed by a partnership of five partners, headed by Tolkowsky and Yadin Kaufmann. "Essentially, this is the first time we have raised equity for a fund in the customary fashion, from several partners, of which Anglo American is one," says Tolkowsky. "We have investors from Atlanta, and we brought in a partner who is there. Even though we did not raise the equity we had planned, we intend to invest about one-quarter of the equity that we raised in companies in Atlanta."

Tolkowsky, who has been backing away from his involvement in sector-wide forums such as the Israel Venture Association, is critical of the government's involvement in the local industry. "The government should place greater emphasis on small businesses that include startups, not only through the seed fund established by the Ministry of Trade and Industry, but through additional bodies, as in the United States."

He also criticizes the local venture capital community for failing to invest in seed. "This is a ten-year old industry, and I would have expected the development of higher professional criteria. At a time such as this, I would have expected a certain level of players on an international scale to have developed, but this hasn't happened. Conversely, the entrepreneurs of Israeli startups are experienced entrepreneurs who are every bit as good as foreign entrepreneurs."

In conclusion, Tolkowsky said that although the security situation makes it difficult to raise equity, past experience shows that it encourages the building of good companies. "An economic slump is the best time to invest. The best investments in the 1990's were made during the Gulf War," he said.