The Israeli VC market – a change?

Calcalist published on November 1st the results of a survey performed by DeLoitte in Israel. The survey checked the attitudes of Israeli VCs towards the finance ministry intention to guaranty institutional investors investments in VCs. The finance ministry intends to assure insurance companies, and pensions funds against losses up to 200 million NIS of their investments in the Israeli VCs.
The article emphasizes the fact that while 70% of the VCs asked were for the move, 15% were against it. And that when the VC sector's plight is well known.
While this step may seem radical and even innovative, this was in fact one of the steps taken in the early 1990's in order to allow the sector, just newly formed to grow. The government than guaranteed the investments of private investors and allowed the new VCs to raise funds from the general public (so called Inbal funds). After two decades of impressive growth into a diversified and mature market the move back to such measures is an indication of the sectors difficult position.
Would that be enough to put it right?
The reasons for the sector's weakened position stem from different sources – the first is exogenous, relating to the general world financial situation, the reduction in available funds, and reduced tendency for risk. The Israeli VC market has been from inception involved in the world market and is affected in two ways. Difficulties in raising funds, and reduced return on selling the firms it invested in. Another reason is endogenous and relates to the performance of the sector compared to other investment possibilities. The VCs have not performed spectacularly. There are some successes but the sector failed to produce the vast riches it promised.
What may happen?
The sector may downsize in two main ways, it may reduce the number of VCs, while keeping their size more or less the same. This will create a mature and stable sector. However, another possibility is that the reduction in number will be small, but the size of the VCs will be smaller. Small VCs enter the trap of not being able to count on the large numbers averages. That is to say that they will need to focus on investing more funds, but in a smaller number of firms, trying to reduce risk. This will of course reduce their profitability, and may lead to further reduction in size and the creation of a downsizing spiral.
Will the measures the ministry offers suffice?
If by chance they measures coincide with an improvement in world economics, increased return of sales of firms, more funds available for VCs – it may work. But if the measures stand alone, without solving the investment issues of the VCs, we may find ourselves at the same spot in two to three years, only without the institutional investors in the wings.

Bibliography:

1) Calcalist article - Delloitte survey (November 1st 2010)
2) Calcalist article - VCs fund raising (October 13th 2010)