Summary

1
Venture Capitals Contribution to the Israeli
Economy
Summary
June 15, 2005
2
Introduction

• This study, prepared for the IVA, evaluates the
  contribution of Venture Capital investments to
  the growth of Israels economy.
• While VCs have been active in Israel for over 10
  years, there is no complete study of the VCs
  contribution to the Israeli economy, which is
  therefore unclear.
• This analysis discusses only the contribution to
  Israels economy and does not discuss the
  opportunity for investors, VC funds or fund
  managers.
• We evaluate the contribution to the economy in
  terms of GDP growth and an increase in
  employment. We place a large emphasis on the long
  term drivers of these factors.
• This study relies upon data collected and
  formulated by Economic Models over many years.
• The data on VC capital raising and investment was
  obtained from the IVC Research Center and has not
  been confirmed by us.

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1. Summary and Conclusions
4
VC Capital Raising and Investment in Israel
1995-2004, Mil.
Source IVC Research Center, Economic Models
5
The Direct Contribution of VC

• Various VC investors (Israeli and foreign), have
  invested over 12 B in Israel in the past decade,
  mostly derived from foreign sources. This amount,
  in proportion to GDP, represents the highest rate
  in the world.
• Most funding (about 70) has been channeled to
  paying wages to Israeli workers. As the economy
  has a high level of unemployment, it makes a
  direct contribution to GDP (unlike investments in
  imported machinery and equipment).
• Fund raising and VC investments continue in 2005.
  We expect 1.5 B of investments and about 1 B to
  be raised by Israeli managed VC funds this year.
• We can therefore conclude that currently, VC
  investments have a direct contribution of over 1
  to Israels GDP.

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VC Contribution to Israeli Relative Advantage
Escalation

• The rare combination in Israel of a high level of
  technological ability in electronics and software
  companies, together with enormous research
  capabilities, globally-embracing export ties, and
  a rare ability of fund raising, allows the
  unparalleled growth in the electronics and
  software sectors.
• This advantage of the Israeli economy can last as
  long as the Israeli education system safeguards
  these skills. VC investments play an important
  role in this advantage.
• The amount of VC invested in Israel as a portion
  of GDP is the highest in the world and the output
  of Information and Communication Technology
  (ICT) as a portion of GDP is also the highest in
  the world.

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VC Investment in ICTRelative to GDP
Source OECD 1999-2002, IVC Research Center 2002,
CBS (Isr.)
8
The Correlation between VC and ICT
ICT share of GDP ()
VC investment in ICT as a proportion of GDP
Finland was removed from the sample (Nokia
biased). Source USA Census, OECD 1999-2002, IVC
Research Center 2002, CBS (Isr.)
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The Contribution to Human Capital

• Wage payments to Israeli workers for RD lead to
  an accumulation of experience and expertise and
  creates an intangible but important asset for the
  Israeli economy, even in cases of start-up
  closure due to unfeasible business models.
• We should view VC investment in failed
  enterprises as a contribution to the overall
  development of Israeli technology. A failed
  business is not necessarily a failure from a
  national economic point of view.
• We find the cumulative experience (of failures
  and successes) as part of the total Israeli
  relative advantage in the advanced technology
  sectors.

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The Contribution to the Start-up Sector

• 90 of VC investments are in early stage
  start-ups VC investment is the dominant source
  of capital for these companies.
• We believe that without VC funding, the Israeli
  start-up sector would not have developed to the
  current level.
• The electronics and software sectors include a
  range of companies that began as start-ups and
  matured.
• Growth of the electronics and software sectors is
  influenced by the maturation of start-ups which
  rely upon VC investment.
• Vast majority of VC investments (over 90) is in
  the electronics and software sectors (including
  medical equipment and other implementations).

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The Contribution to the Electronics and Software
Sectors

• Currently, over 40 of the electronics and
  software sectors product is in companies that
  were invested by VC (during the first decade of
  their operation), compared to about 10 in 1995.
• The electronics and software sectors have grown
  during the last decade (1995-2004) in an average
  annual rate of 11.
• We estimated that internal processes in these
  sectors allowed it to grow in a high 7 annual
  rate, however, an addition of 4 percentage points
  was created by maturity of Start-up companies.
• Therefore, we see the major VC indirect
  contribution as about 35 of the electronics and
  software sectors growth.

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Electronics and Software Sectors Estimated Product
2004 B
Companies supported by VC during the first
decade of the companys operation Source CBS
(Isr.), Economic Models
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The Growth Model for Israels Electronics and
Software Sectors,1995-2004
Contribution 4 Annual Growth
7 Internal Annual Growth
Israeli Electronics and Software Companies
Defense Industries
Academic
Incubators / Angels
Office of the Chief Scientist
Venture Capital
Israeli Start-up Companies
IPO
MA in Israel
Foreign MA operation abroad
Ceased Operation
Foreign MA operation in Israel
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VC Contribution to Growth of the Electronics and
Software Sectors Average annual growth rate,
1995-2004
We assumed that 20 of VC investments would find
alternative funding
Source CBS (Isr.), Economic Models
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Summary of the Total Contribution

• Under current economic conditions in Israel, it
  is necessary for 1.5 B to be invested in
  start-ups on an annual basis to achieve 11
  continuing growth of the electronics and software
  sectors.
• This ambitious level of growth is necessary for
  GDP growth to reach over 6 a year, allowing
  Israel to reach 15th place in the world in 20
  years time (Israel today is in 22nd place).
• Under current conditions, it is difficult to see
  an alternative route to the unique contribution
  of VC investments in supporting start-ups. This
  is an unusual situation where few succeed in
  attracting foreign investors to invest in
  technology development in Israel with all of its
  associated risks.

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Implementing the Israeli Relative Advantage

• The scale of the Israeli economy is small and it
  lacks the critic mass for local market
  merchantable products production.
• Its hard for Israeli companies to reach a major
  international status which would allow them to
  continuously produce standard products for the
  international market.
• Therefore, we see the Israeli relative advantage
  to produce unique products and to sell the
  knowledge and technology to third party.
• This situation, in witch theres a wide variety
  of knowledge and technology allows part of the
  companies to become major and successful
  companies in Israel (Ishkar, Teva, Check point
  and other)
• Additionally, an industry of advanced products
  does not have to be based on Israeli companies.
  (Intel, Motorola, Vishay)

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Knowledge and Technology Export

• As mentioned before, the relative advantage of
  the Israeli economy is development of ideas and
  technologies and production of unique products.
• Therefore, we believe that a major export sector
  in Israel for the long run would be new ideas and
  technologies (the overall production potential
  would be much greater than the local production
  potential).
• We hope that this sector would expand and
  encourage Israel to become an international
  center for ideas and technologies (the Silicon
  valley is a development center, not a production
  center).

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No Massive Knowledge and Technology Leakage

• In vast majority of VC investments, the
  development activity stays (at least at this
  point) in Israel.
• We believe that most of the developers stay in
  Israel, even though some of the projects leaders
  stop dealing with the projects development after
  the exit.
• As much as the start-up companies in Israel
  succeed, it stimulates Israelis to return to
  Israel and establishing the development centers
  in Israel.
• Most of the Israelis who are part of the
  development procedures stay in Israel even if the
  operations move abroad.

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Investors Exit
The foreign investors objective is to sell their
part in the projects with profit (Exit). Thats
the basis for their entry to the VC funds and
their investment in Israel. The Exit in case of a
success is made in one of 4 options

• IPO (mostly in the US).
• MA with Israeli based company.
• MA with foreign based company, which continue
  their operations in Israel.
• MA with foreign based company, which discontinue
  their operations in Israel.

Each one of the options described above is
legitimate and the actual action is selected by
the investors according to the best market value.
About 75 of the exits are made with options 1
and 2.
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The Fear of Transfer of Manufacturing Operations

• From our analysis, less than 10 of companies
  that have received VC investment have transferred
  activities abroad.
• In most cases, the main activities remain in
  Israel and definitely the development
  capabilities.
• Location of manufacturing in Israel is in
  accordance with the advantages of the location
  and we see the transfer of some operations abroad
  as a natural process.
• We are of the belief that operations in Israel
  can also be established by foreign companies
  (Intel, Motorola, etc.) and the opportunity to
  expand these operations are in accordance with
  the economic advantages of the location
  (government policies).

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The Technology Sales Price

• U.S. data shows a long-term average yield of
  investments in VC at 13 annually in real terms,
  with a high component of volatility (since 2000,
  yields have remained negative).
• We believe that this rate is reasonable for high
  risk investments, therefore it represents a
  reasonable price for the projects.
• Most VC investments in Israel have been made
  since 2000 and have not yet accumulated high
  yields and the complaint that foreign investors
  are acquiring Israeli IP and technology at low
  prices does not accord with reality.

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OCS Grants and VC Investments

• VC investments are in most cases made in new
  start-ups at various stages of research and
  development.
• The greater the supply of start-ups, the more
  Israel is attractive and the greater the amounts
  of VC investment in Israel.
• At the incubator stage, VCs usually do not
  invest as they are unable to evaluate the
  potential risks involved.
• At this initial and critical stage, the start-up
  is usually funded by the entrepreneur (and close
  friends) and by OCS grants.
• The more start-ups at incubator level, the more
  start-ups there will be for VCs to invest in. We
  therefore view favorably an increase in OCS
  grants to new entrepreneurs as a necessary
  condition for the increase in funding of VCs.

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Start-Up Funding
US Millions, 2004
25
160
13
600
45
705
Excluding Magnet and international cooperation
projects. Source IVC Research Center, OCS,
Economic Models