Today, savvy investors know there are three global
hotbeds to look for tech-nology start-ups: Silicon Valley in San Francisco,
Route 128 in Boston, and the Tel Aviv – Haifa coastline in Israel. As a
result, approximately 60 venture capitalist firms in Israel raised over
$500 mil-lion in 1997 to invest in Israeli start-ups for an aggregate $2.4
billion in capital under management. It was only a few years ago, however,
that private equity investing in Israel was practically nonexistent. By
the early 1990s, things started to change as the Land of Milk and Honey
was transformed into the Land of Tech and Money.
Paving the Way for the Future
In 1977, Israel and the United States each contributed
$30 million to form the Israeli-U.S. Bi-national industrial Research and
Development (BIRD) Foundation. The objective of the BIRD Foundation was
to promote and support joint industrial research and development activities
of mutual benefit to the private sectors of the two countries. The endowment
was later raised to $110 million. The BIRD Foundation shared 50% of the
cost for a project in which a U.S. company-Israeli company team proposed
the development and commercialization of any innovative, non-defense high
technology product or process. The BIRD Foundation acquired neither equity
nor intellectual property rights. If a project failed, all parties lost
their investments. If it succeeded, the BIRD Foundation received royalties
up to a maximum of 150% of the conditional grant. Since 1979, the group
had invested $95 million in approximately 320 projects. Over 170 of the
projects led to sales approaching $3 billion. The BIRD Foundation targeted
U.S. companies that developed high technology products and were perceived
to be limited in growth only by their capacity to devise and develop new
products
In Israel, the BIRD Foundation focused on companies
that had leading-edge technological capabilities and had the willingness
and flexibility to apply their skills to the development of products that
fit the business strategy of a proven U.S. company. The BIRD Foundation
was willing to consider any size Israeli company and medium-sized U.S.
companies with $10-$500 million in annual sales. Encouraged by the success
of BIRD and other factors, the Israeli government passed a major initiative
in 1985 called the Law for the Encouragement of Industrial Research and
Development. The Law’s major objectives included: (1) the development of
science intensive industry while utilizing and expanding the technological
and scientific infrastructure and the human resources existing in the State,
(2) the improvement of the balance of payments in the State by manufacturing
and exporting science intensive products developed herein and reducing
the import of such products, and (3) the creation of places of employment
in industry and the absorption therein of scientific and technological
manpower.
The Office of the Chief Scientist, which itself
was a critical initiative by the Israeli government to encourage the development
of Israel’s high technology industry, was charged with the implementation
and administration of this Law. Hyperinflation, geopolitical risk and significant
government intervention in the economy deterred much potential foreign
investment in Israel before the early 1990s. Those investments which had
made their way to Israel were in many cases motivated primarily by religious
and Zionist sentiment, rather than pure economics. The Arab boycott directed
at firms doing business with Israel also historically deterred foreign
investment. Foreign investors began to reconsider Israel after noticing
the government’s success in containing prices and reducing foreign debt,
the emergence of successful world-class exporters and the beginnings of
improved relations with neighboring nations. Israel established agreements
like BIRD with foreign countries including Canada, France, Holland, and
Spain. By 1990, more than 150 foreign companies were involved in R&D
investments in Israel, including Applied Materials, IBM, Intel, Microsoft,
and Motorola.
HBS Study Identifies Need
Despite these government initiatives, a 1992
Harvard Business School study found Israel lacked a venture capital culture
and “a substantial capital gap exist[ed] among capital suppliers that
target[ed]
firms in the expansion stage of development.” The study showed Israeli
companies would require between $300 to $400 million of venture capital
over the next three to five years with opportunities requiring about $100
million available immediately. In particular, the study estimated Israel’s
software industry alone could productively use $60 to $75million of short-term
capital. By 1993, only $75 to $150 million of capital was potentially available,
leaving $150 to $325 million in unmet demand. Available capital, however,
included very little professionally man-aged venture capital.
There was essentially only one independent venture
capital firm in Israel, Athena Venture Partners L.P., which had approximately
$25 million. Although Athena had a virtual monopoly in the Israeli venture
capital arena, most successful Israeli companies seemed to have found alter-native
capital sources. Instead, demand was being met by corporations and high
net worth individuals. In addition, more and more Israeli companies were
finding they could access equity capital markets through the Tel Aviv Stock
Exchange (TASE). The HBS study concluded that venture capitalists entering
Israel would discover that management assistance was “even more important
to the successful continued formation of businesses in Israel than capital….
The ability of new capital providers to be ‘venture managers’ rather than
simply venture investors will greatly enhance the chances of success for
that money.”
Yozma Experiment Serves as Catalyst
The Israeli government understood this funding
gap and wanted Israel to grow a private venture capital industry to maximize
the investment in the ideas of its entrepreneurs. In June 1992, the government
created Yozma Venture Capital Ltd. (Yozma means “initiative” in Hebrew)
as a $100 million venture capital fund that was wholly owned by the government.
Yozma had three goals: (1) to promote the growth of promising high technology
firms in Israel, (2) to encourage the involvement of major international
corporations in the Israeli technology sector, and (3) to stimulate the
development of a professionally managed, private sector venture capital
industry in Israel. Underlying these goals was Israel’s desire to bring
foreign venture capitalists’ investment expertise and network of contacts
to Israel rather than merely to attract money.
Accordingly, Yozma did not want any existing Israeli
financiers to participate in its programs. Yozma hoped to serve as a catalyst
for international investment in Israel by cooperating with experienced
venture firms and major corporations in the establishment of new venture
capital funds. Yozma shared the risks associated with its venture investments,
but offered its partners an option to increase their upside by buying out
Yozma’s share of the investment within five years on very attractive terms,
usually LIBOR plus 1%. The amount of risk inherent in the fund’s investments
would normally have justified a much higher interest rate. Thus, Yozma’s
contribution effectively offered a venture capital firm an equity partner
to share the downside plus an option to turn that equity partner into a
debt partner with a very low rate of interest on the upside. Yozma hoped
that such favorable terms would cause experienced international investors
to take notice of Israel.
The Promised Land
Yozma chose to make its first investment in Gemini
Israel Funds along with Advent International Corporation, a Boston-based
international investment organization, and the Discount Investment Corporation,
an established Israeli holding company. Gemini raised a $36 million fund
in 1993 to target small to medium sized Israeli technology companies. In
the five years since, Gemini has invested in over 30 Israel and Israel-related
companies. The fund achieved an internal rate of return exceeding 40%.
Advent and the Discount Investment Corporation raised a second fund in
November 1997 for $110 million in committed capital. With dozens of venture
capital firms and hundreds of start-up companies transforming the economy
by the mid-1990s, the Israeli government declared its Yozma initiative
a success. In March 1998 as part of a broad privatization plan, the government
sold Yozma for NIS 50 million to a group of investors led by the Ofer Brothers,
who beat seven other bidding groups.
