The Israeli VC Industry: Emergence, Operation and Impact

1
The Israeli VC Industry Emergence, Operation and
Impact
Morris Teubal and Gil Avnimelech
2
Objectives

• To Analyze the emergence of the Israeli VC
  industry in the 90s background, triggers,
  operation and growth.
• To Analyze the emergence of the Israeli Hi-Tech
  industry.
• To Analyze the role of RD support policy with
  connection to the emergence of the Israeli
  Hi-Tech industry

3
Background The Israeli Hi-tech Industry Till
the 70s

• 50s-60s emergence of innovative agriculture
  industry.
• Early 60s Strong science academic departments
  in Israel.
• After 67 a major objective of the government
  was to generate relative independence from
  external supply of military equipment.
• 60s-70s Academic links with Europe and US are
  being strength.
• Military RD cooperation with US, Germany and
  France transfer of technology from those
  countries to the Israeli military industry.

4
Background The Israeli Hi-tech Industry Till
the Mid 80s

• 70-80s many Israeli scientists emigrated to
  the Silicon Valley.
•  70s-80s dominance of strong military
  industry.
•  70s-80s first foreign multinational companies
  establish RD centers in Israel including
  Motorola (1964), IBM (1972), Intel (1974) and
  National Semiconductors (1978).
•  In 1972, Elscint (Hi-Tech company) became the
  first Israeli company to be traded on an US stock
  exchange.

5
Background The Israeli Hi-tech Industry From
the Mid 80s

• The reconstructive of the military industries
  (sharp reduce in military expenditures) led to
  enhanced flow of engineers to civilian Hi-Tech
  industries.
• A new trend of creating new Hi-Tech companies
  (startup companies) in the late 80s, with high
  rate of failure.

6
Background Government Policy Supporting RD
Till the 70s

• 50s-60s add-hock solutions supporting
  academic and industrial RD.
• After 67 strength of the military industries.
• Military RD cooperation with US, Germany and
  France transfer of technology from those
  countries to the Israeli military industry.
• The establishment of the Office of the Chief
  Scientist (OCS) and the creation of the RD
  Industrial Fund program. This program, which is
  a direct neutral support for RD in individual
  companies, is the backbone of Israel
  RD/Innovation/Technology Strategy. The OCS budget
  grew from 2.5M in 1969 to almost 400M in 1999.

7
Background Government Policy Supporting RD
Till the 80s

• Incentives to capital investment in Israel
  (1964) convince the first foreign multinational
  companies establish RD centers in Israel and
  later on manufactories including Motorola (1964),
  IBM (1972), Intel (1974) and National
  Semiconductors (1978).

8
Background Government Policy Supporting RD
From Mid 80s

• The reconstructing of the military industries.
• Successful macroeconomic stabilization program.
• Liberalization process which generate a better
  environment for doing business in Israel.
• the new RD low of 1984 and increase in RD
  incentives in the mid 80s.

9
Triggers to the Emergence of the Israeli Silicon
Wadi Global Environment Triggers.

• The global growth of the IT industry in the 80s
  and 90s.
• The de-Regulations in the telecommunication
  market in the 90s.
• Globalization of Capital and Assets markets
  enhanced opportunities for startup companies to
  get financed.
• The rapid grow of global capital markets (Nasdaq
  effect).

10
Triggers to the Emergence of the Israeli Silicon
Wadi - Environment Triggers Related Only to
Israel(1).

• Readiness of the industry after the rapid
  changes in the 80s and deeper understanding of
  the Israeli market failures.
• The breakdown of the Soviet Union, which brought
  a very large number of immigrant Scientists and
  Engineers to Israel.
• Greater legitimacy acquired by Israel after the
  Gulf War.
• Entrance of global investment banks into Israel
  during the late 80s and 90s.

11
Triggers to the Emergence of the Israeli Silicon
Wadi - Environment Triggers Related Only to
Israel(2).

• The emergence of several Israeli communication
  technology companies including Tadiran, ECI,
  Fibronics, DSPG, NiceCom, Efrat and others during
  the 80s.
• Few successful Exits of Israeli startup
  companies in the early 90s, in which the
  entrepreneurs and investors made very high profit
  (including Scitex, Megic, NiceCom and few
  others).
• A new trend of Israelis that return to Israel
  after few years in the Silicon Valley.

12
Triggers to the Emergence of the Israeli Silicon
Wadi Policy Triggers(1)

• The reconstructing of the military industries
  Successful macroeconomic stabilization program
  Liberalization process the new RD low of 1984
  and increase in RD incentives in the mid 80s.
• US guarantees of 10B, after the Gulf war.
• Structural change which help transferring the
  environment to become more adjusted to Hi-Tech.

13
Triggers to the Emergence of the Israeli Silicon
Wadi Policy Triggers(2)

• Technology Incubator program supporting
  startup companies in very early stages..
• INBAL program gives guarantee to public VC
  companies on the down side.
• MANET program Support generic RD.
• Yozma program the creation of the Israeli VC
  industry, though establishing 11 VC funds.

14
Yozma Program Background

• Readiness of the Israeli Hi-Tech industry.
• Long history of incentives to RD.
• Shortage of finance for startups (high demand for
  VC money).
• Weak management and marketing capabilities in
  the Hi-Tech sector.
• Verity of supporting programs.
• Strong supply of experience manpower and good
  ideas.

15
Yozma Program Objectives

• Creation of stabile VC industry.
• Ensuring that their wont be a monopoly in the
  VC industry.
• Ensuring minimum government intervention in the
  management.
• Ensuring the industry will continue to survive
  after the government incentive stops.
• Fast learning of local VCs and creating added
  value to SUs.

16
Yozma Program Creation(1)

• Long preparations and Continues consulting with
  the Treasury and other government offices.
• Long consulting and negotiation with global VCs
  and with local financial institutions.
• Changing Israeli corporate low.
• Creating 10 Yozma funds 5 in 1993, 2 in 1994,
  2 in 1995 and 1 in 1996.
• Total government investment of 100M Investment
  of 8M in each fund Total capital managed by
  Yozma funds was 310M.

17
Yozma Program Pre-condition to Become a Yozma
Fund

• Investment in technology startup companies.
• raising private capital of 12M minimum.
• strong local office based on a local financial
  institution or corporate.
• strong foreign partners/investors represented in
  the management company.

18
Yozma Program Growth

• Most Yozma funds management companies has at
  least 2 additional funds.
• All but 2 of Yozma funds bought back the
  government share.
• The total sum managed by Yozma funds management
  companies is approximately 5B.
• At least 8 out of 11 Yozma funds management
  companies are among the top 20 management
  companies in Israel (out of approximately 100
  VCs).
• Yozma program was a critical element in the
  amazing growth of the Israeli VC industry.

19
Stages of Evolution of the Israeli VC Industry.
Phase1 (1993-1995/6) Creation and
Learning. Phase2 (1996-1998) Rapid growth and
fast maturation process. Phase3 (1999-2000)
mature and bobble. Phase4 (2001-) Back to
reality and first big obstacle (overcoming the
global slowdown).
20
Phase1 (1993-1996) Creation and Learning(1)

• Very dominant by Yozma funds.
• Very low valuation in private investment .
• Small funds (20M).
• Small amount invested in each startup and small
  numbers of investments.
• Many co-investment with other Israeli VCs in
  order to increase total amount invested, to
  reduce risk and Little co-investment with US VCs.
• Little seed investments and No specialization in
  areas.

21
Phase1 (1993-1996) Creation and Learning(2)

• Foreign partners had important role and
  operational role.
• Learning mostly from lowers and attorneys on VC
  operation.
• Cumulative learning in the industry.
• Very little understanding of the market and the
  VC business - Very small added value.
• Goal of VCs to make fast exit through MA (in low
  valuations - 10M-70M).
• Israeli VCs were very important for startup both
  due to shortage in access to capital and due to
  need in added value both operational and during
  Exit.

22
Phase2 (1996-1998) Rapid Growth and Fast
Maturation Process(1)

• First round of private VC funds (not related to
  Yozma) but the market is still dominate by Yozma
  funds.
• still low valuation in private investment,
  comparing US startups.
• medium funds (100M).
• Increase in the amount invested in each startup
  and Decrease the portfolio companies.
• Increase in seed investments and Beginning of
  specialization in areas.
• Foreign partners had less important role and
  non-operational role.

23
Phase2 (1996-1998) Rapid Growth and Fast
Maturation Process(2)

• Learning, mostly from investment-banks, the core
  business of VCs.
• Less co-investment with Israeli VCs- less
  collective learning and increase in co-investment
  with US VCs.
• VCs have better understanding of the market and
  Increase in VCs added value.
• Goal of VCs to make successful IPOs.
• Israeli VCs were very important for startup both
  due to shortage in access to capital and due to
  need in added value.

24
Phase3 (1999-2000) Mature and Bobble(1)

• Many VC companies, verity of VCs.
• Normal valuation in private placements,
  comparing to US startups.
• No change in number of portfolio companies amount
  of investment grows rapidly.
• Most VCs have specialization in areas and
  Increase in seed investments.
• Learning mostly from strategic partners which
  helps in understanding of future demand and the
  dynamics of the market - Increase in VCs added
  value capabilities.

25
Phase3 (1999-2000) Mature and Bobble(2)

• Minimum co-investment with Israeli VCs increase
  in competition and increase in co-investment
  with US VCs.
• Goal of VCs to create successful independent
  companies or very high valuation Exits.
• Israeli startup companies has small need in
  Israeli VCs added value both due to easy access
  to capital market and many exit opportunities and
  due to experience management. Moreover,
  successful Israeli startups has direct access to
  US VCs.

26
Phase4 (2001-) Back to Reality and Global
Slowdown(1)

• The first time many startups and fund will be
  closed down.
• Verity of funds sizes (50M-500M).
• Decrease in the amount invested in every startup
  (and in number of investments) and many
  down-rounds.
• Strong specialization in areas, abundant of areas
  and decrease in seed investments.

27
Phase4 (2001-) Back to Reality and Global
Slowdown(2)

• Co-investment with Israeli VCs and with US VCs.
• VCs have little added value.
• Main business of VCs is to decide which startups
  to close and which to keep supporting and the
  Goal is to have any kind of Exits or to find the
  next investor.
• Israeli VCs are very important for startup both
  due to shortage in access to capital and due to
  need in added value.

28
In Depth AnalysisOf A Sample Of Israeli VC
Companies
29
The Sample

• We interviewed 20 VC companies including 9 of
  Yozma Funds and 11 other VC companies.
• They represent more than 60 of total capital
  under management in Israel's VC industry - 6B.
• These fund were usually established according to
  the phases in the Israeli VC industry.
• We identified rapid growth in the funds size.
• The average size of the last fund in the VC
  management companies we have interviewed is above
  200M compared to average size of the first funds
  of 32M.

30
Table1 Descriptive Statistics
31
Table2 Direct Indicators of Vc-performance
32
Direct Indicators of VC-performance

• Average number of portfolio companies 50-60
• Average number of Exits is 9, which represent
  between 15-20 of success.
• The percentage of success is higher in the first
  phase 30.
• The percentage of IPOs is 1-2 higher then the
  percentage of MAs.
• The percentage of IPOs in the first phase is
  more then 20 while the percentage of MAs is
  less then 10 in this phase.
• These figures demonstrate the strength and the
  maturity of Israeli hi-tech and VC industries
  (IPO is considered to be more complicated and
  requires not only good technology but also
  additional capabilities).

33
Table3 Indirect Indicators of Vc-performance
34
Indirect Indicators of VC-performance

• 7 VCs had at least 1 very successful Exit
  (valuation of at least 500 million), and another
  3 VCs had at least 1 successful Exit (valuation
  of at least 200 million).
• 7 VCs has leading strategic investors and 11 VCs
  has financial institutions as investors
  (investment banks, private equity funs...).
• 6 VCs had at least one office out of Israel.

35
Founder and Initial Team Background

• We identified very strong background of the VCs
  founders and initial team. Israeli venture
  capitalist are characterized by very strong
  technology background including science degree,
  actual work in RD.
• Education - In 11 VCs, some founders/initial
  team members had a Technological Educational
  Background. 10 Had a Business/Economics
  education. 6 VCs had Technological and
  Business/Economics degrees.
• Work Experience - the founders/Initial team of 5
  VCs had Work Experience in MNEs 5 had experience
  with SUs and 2 in Israeli Global Companies.
• Investment experience - 11 had investment
  banking or VC background.
• Management Position background- All VCs in our
  sample had management Position background In 9
  cases they previously had founder background.
• RD position background - In 8 VCs, at least
  one founder/member of initial team worked in RD
  positions.
• In 5 cases at least one VC founders/Initial Team
  held MS positions in 4 cases-
  Accounting/Finance positions

36
Type of VC

• During foundation, (4) of the (15) VCs where not
  Limited Partnerships but of these (3) adopted
  such an organizational form in the course of
  time.
• (8) of the VCs were part of Yozma.
• (5) VCs are part of a Global Network of VC
  companies (All of these are also Yozma funds).
• (4) VCs are part of an Investment Bank, and (1)
  is part of a Holding/Investment Company.
• At foundation, (2) VCs had publicly traded
  funds, but in the course of time one became a
  Limited Partnership.
• Phase of Creation - (10) VC companies were
  created in Phase I (2) during Phase II and (3)
  in Phase III.

37
Trigger to VC Foundation

• (8) VCs where Yozma Funds that is they received
  Yozma incentives.
• (2) additional ones did not receive such
  incentives but still their creation directly
  resulted from Yozma.
• (5) were created in the wake of prior Israeli VC
  industry successes.
• (7) were directly the result of prior personal
  success in investing in high tech SU- entering
  the VC industry was a natural phase in their
  evolution

38
Linking Characteristics With the Model of a
Successful VC Company
success is a function of four basic
operations Deal flow- good SU who apply to the
VC Scanning Abilities- Identifying a subset for
Due Diligence efficient due diligence process
and successful selection of SU Value added
"operational' activities- ability to help
companies during startup and early growth
phase Value added during Exit- networks with
Investment Bankers or with Strategic Partners
timing of exits, preparing the company for the
exit, etc.
39
Linking VC Characteristics to Performance-some
Hypothesis

• Hypothesis I prior Management Experience is a
  necessary condition for VC entry and VC success.
  It however cannot explain success failure.
• Hypothesis 2 Important Role of Founder
  Technology/Science Education combined with RD
  Work Position --absence of founder
  Technology/Science Education background and RD
  Work Position/Function is strongly associated
  with failure.
• Hypothesis 3 Belonging to a Global Network is
  Strongly Associated with VC success.

40
Prior Management Experience Is a Necessary
Condition for VC Entry and VC Success. It However
Cannot Explain Success Failure
All VC partner has prior management experience.
Moreover, considering the VC business it seems
trivial that all VC partners must have prior
management experience in order to be successful
VCs.
41
The Absence of Founder Technology Education
Background and RD Work Position Is Strongly
Associated With Failure
Founders/ Initial General Partners of (7) out of
the (15) VC companies did not have a combination
of Technology/Science Education and an RD
Position. -(4) Our of the (7) were significantly
below average performance (among the (5) lowest)
An analysis of the other (3) shows the
following -(1) VC was founded in 1992, had
Investment Banking experience and had an US
investment bank as partner in the first
fund. -(1) VC had a partner with US VC experience
and all founders had an Investment Work
Position. -(1) VC is Yozma, qhich its General
Partner is Yigal Erlich.
42
Belonging to a Global Network Is Strongly
Associated With VC Success
In (4) out of (5) cases of belonging to a Global
Network were successful VCs. The fifth case did
have neither a founder Technological Educational
background nor a prior RD Work Position.
Belonging to a Global Network, however, is not
necessarily the cause of success rather it may
be in indicator of success and of factors leading
to success e.g. of good founder initial
capabilities.