Innovative Israel Failing To Grow High-Tech Start-Ups
more in Tech »
By SARA TOTH STUB
JerusalemIsrael's inability to turn its high-tech start-ups into mature companies that remain in the country is causing concern for both the industry and the government.
While Israel boasts the most high-tech start-ups per capita in the world, over the past decade a tendency has emerged whereby the majority of successful ones are acquired by or merged with larger foreign companies. This occurs before the Israeli companies have the chance to grow into substantial independent firms that can provide local jobs and encourage the development of management skills.
SolarEdge Technologies
One firm facing the challenge of getting later-stage funding is SolarEdge, which makes technology for photovoltaic solar panels. 'We want to build a global company,' says one of the company's founders.
------
------
"They tend to exit as soon as possible to get some sort of return. They don't have the patience or confidence to grow to the next level," says Eldad Tamir, chief executive of Tamir Fishman Group, a Tel Aviv investment house that also engages in venture capital.
Gal Trifon, CEO of digital-advertising company MediaMind Technologies Ltd., which raised $57.5 million in an initial public offering in early August, says finding enough funding and building a corporate structure was difficult and required a lot of patience. "It would have been easier to sell," he says.
Without more big companies and international investment in local high tech, Israel risks not capitalizing fully on, or even losing, its innovative edge, which is a backbone of the local industry. Israel has few natural resources, and its main asset is human capital and innovation, says Yoram Tietz, managing partner of Ernst & Young Israel.
Israel's high-tech industry, which includes the software, medical-device, electronic-device and advanced-mechanical sectors, made up about 15% of the country's $200-billion-a-year gross domestic product in 2009, and 40%, or $35 billion, of its exports, according to the Ministry of Finance.
""There are weaknesses in the model; we don't have the whole ecosystem to grow companies in Israel," says Eugene Kandel, head of the National Economic Council, a division of Prime Minister Benjamin Netanyahu's office, which is studying the issue. "We need at least a small part of our start-ups to turn into big companies and stay in Israel."
Mr. Kandel says Israel has 3,800 start-ups. But according to the Israel High Tech Industry Association, a trade association for the high-tech and venture-capital sectors, it has only four technology companies with market capitalizations of more than $1 billion. Such statistics give rise to two questions: What makes Israel so innovative? And why can't companies there grow?
Saul Singer, co-author of the 2009 U.S. best seller "Start-Up Nation," says the innovation required for start-ups is natural to Israelis who, in a small country surrounded by enemies, are used to taking risks, facing adversity and making decisions amid ambiguity.
"Israelis have always been good at turning adversity into a source of creative energy," Mr. Singer told The Wall Street Journal in an interview. "The country is a start-up. It took a lot of drive and innovation just to survive in Israel."
Entrepreneurs identify two main obstacles to companies growing bigger: a lack of later-stage financing and a paucity of managerial talent.
The roots of the financing problem lie in the sector's origins in the 1990s, analysts say, when it was backed heavily by venture capital that focused mainly on early-stage investment and put pressure on entrepreneurs to sell their companies to ensure a return on that investment.
CEOs say that while they would prefer to stay headquartered in Israel to take advantage of the local culture of innovation, not selling to a foreign company is dependent on getting later-stage funding, either through venture capital or an IPO
"Late-stage funding is barely available for this industry," Mr. Kandel says.
One company facing such a challenge is SolarEdge Technologies Inc., founded in 2006 by three veterans of an Israeli military laboratory, and which makes technology for photovoltaic solar panels. Like many of their peers, the founders say Israel is the best place for innovation and engineering talent. The company has received $34 million in funding from a combination of private venture capital and GE Energy Financial Services, and a month ago began a search for new funding to tide it over until an IPO, which is at least a year away. It expects 2010 to be its first cash-flow-positive year, with $30 million in revenue; expected revenue for 2011 is $65 million.
"We don't want a big player to buy us out," says Lior Handelsman, one of SolarEdge's founders and vice president of product strategy and business development. "We want to build a global company."
But venture capital—which has been of major importance despite its limitations—also isn't what it was. In 2009, Israeli high-tech companies raised $1.12 billion in venture capital, the lowest amount since 2003, according to the IVC Research Center, which publishes data on the industry. The industry raised $2.07 billion in 2008 and $1.76 billion in 2007, the center said.
"The VCs are almost dried out," says Inon Beracha, who founded Ceragon Networks Ltd. in 1996, and who says he doubts he would get funding today like he did back then. Ceragon began with venture funding from the founders of RAD Group, a collection of companies in the network and telecommunications fields.
Compounding this problem, local institutional investors have largely stayed away from venture-capital investment, allocating an average of 0.2% of their portfolios to it, as opposed to an average of 2.5% for U.S. institutional investors, according to the finance ministry.
Mr. Kandel, of the National Economic Council, says the government should team with the private sector to create late-stage venture-capital funds to address this problem, much as it invested $100 million in early-stage venture funds through the Yozma program in the 1990s.
In that program, the Israeli government partnered with foreign venture funds to create 10 venture-capital funds for the high-tech sector. Michael Eisenberg, a general partner in Benchmark Capital's Israel office, credits Yozma with creating Israel's venture-capital industry and has called for a similar government program dedicated to late-stage capital.
The cabinet recently approved policies to encourage the development of larger high-tech companies, including tax incentives to companies that stay in Israel and to Israeli companies that buy or invest in smaller local start-ups. The cabinet also approved the creation of a safety net to encourage local institutional investors to participate in venture capital. The safety net would allocate 200 million shekels ($52 million) annually to reimburse qualified institutional investors for part of their losses in venture investments, the finance ministry said. The proportion of reimbursement hasn't been established.
The government hopes the safety net will help raise the average amount of portfolio money that institutional investors dedicate to venture capital to 2.5%, a finance ministry official says. The plan also includes measures to encourage that innovation continues, such as bringing retired high-tech professionals to teach in high schools, establishing more cooperation between university laboratories and the corporate world, and offering financial incentives to Israeli researchers returning from abroad.
CEOs of several high-tech companies aiming to keep their headquarters in Israel say the government's plan seems to be on the right track, but that it doesn't do enough to increase significantly the availability of late-stage funding.
The government's safety-net plan for institutional investors is only a first step in creating more late-stage capital, Tamir Fishman Group's Mr. Tamir says. "The good news is that people are aware. Whether or not that will solve it or not remains to be seen," he says.
It's also in the interest of the local venture-capital sector to focus on expanding companies in Israel rather than creating early exits, says Aaron Mankovski, managing general partner of Pitango Venture Capital and chairman of the High Tech Industry Association.
"It's not just for the sake of Zionism," Mr. Mankovski says. "To get a good price in a merger or an initial public offering, you need a larger company today." Unlike in the late 1990s, acquiring companies don't want to buy just an idea or technology, but want an organization with management and a proven business record. The amount of revenue a company needs in order to go public today on the Nasdaq Stock Market is about $100 million, he says, up from $50 million 10 years ago.
Another challenge is finding qualified managers, industry and government officials say. Ori Hadomi, CEO of Mazor Surgical Technologies, says his company, which produces medical robotics for the global market, is still headquartered in Israel and trades on the Tel Aviv Stock Exchange, but runs its marketing and product management out of an office in the U.S., where Mr. Hadomi has recently relocated. The company tried to hire people for such jobs in Israel, "but we couldn't find them," Mr. Hadomi says. "We really lack a professional marketing and sales culture."
Many CEOs see Israel's problem as one of critical mass. More large companies developing there would develop local managerial talent. But the lack of such talent stops such companies from developing. Israel needs to be seen as not just a hub for innovation but as a center for business development, they say.
They also say developing a number of large high-technology companies in Israel is crucial in being able to draw more investment to the country and raise the level of corporate managerial skills.
Mr. Netanyahu said in a speech at the conference of the High Tech Industry Association in Jerusalem earlier this summer that it is a priority for the government to help develop large Israeli high-tech companies to keep the industry sustainable for the long term.
"We're not resting on our laurels," Mr. Netanyahu said in the speech. "We want to create a structure both of ideas and people and money that encourages these ideas to develop into actual companies, into products and services that stay in Israel."
Mr. Netanyahu's concern for the high-tech industry recently led to eight months of meetings between his office and finance ministry officials, to develop, with the input of high-tech industry leaders, a plan to address the sector's weaknesses, Mr. Kandel says.
One measure that could lead to more companies staying in Israel is raising foreign investors' awareness of locally listed companies, says Ester Levanon, CEO of the Tel Aviv Stock Exchange, which lists about 130 high-tech companies. This would draw more foreign investment, which in turn would allow for more local IPOs and higher valuations, giving start-ups that aren't big enough for the Nasdaq an alternative to selling out to a larger international company, she says.
To raise awareness internationally, the exchange is developing a plan to subsidize two years of coverage of Israeli high-tech companies, with four reports a year by an international investment-research company, Mrs. Levanon says. "In order for companies to survive on the stock exchange, they need analysts. That's crucial for companies," she says.
Mrs. Levanon says the exchange is considering adding another index that caters to small to medium-sized high-tech companies. A new index would encourage more of these companies to list in Tel Aviv rather than on smaller start-up oriented indexes abroad. "I don't believe it makes sense to list in London or Toronto when there is a high-tech sector in Tel Aviv," she says.
But if the problems of financing and management skills can be solved, there is still a more basic issue to address: the mindset of the Israeli high-tech sector itself. "Everyone who sells a company is a hero in Israel," says Mr. Beracha, now CEO of PrimeSense Ltd. a maker of 3D-sensing technology. This stems in part from a culture of short-term thinking that has come to pervade Israel, a young country dealing with a constantly volatile political and security situation, local analysts and CEOs say.
"Israelis act before they plan because you can never know what will happen tomorrow," says Mazor's Mr. Hadomi, speaking the day after one Israeli soldier, at least three Lebanese soldiers and a Lebanese journalist were killed in an exchange of fire on the Israeli-Lebanese border.
No one doubts that the sales of Israeli start-ups over the past 15 years have boosted Israel's economy and helped put it where it is today, with a positive foreign-investment balance. Since 1998, Israel has drawn $70 billion in foreign direct investment, according to Ernst and Young Israel. The country's economy weathered the global economic crisis well, reporting 0.7% growth in gross domestic product in 2009, according to Israel's Central Bureau of Statistics. Unemployment in May, the most recent month for which figures are available, was 6.5%, and in late July the Bank of Israel raised its key interest rate 0.25 percentage point, to 1.75%, to combat inflation and rising housing prices.
"We don't want to mess with success," Mr. Kandel says, saying innovation and the selling of start-ups will probably always play an important role in Israel's economy. "But while we were quite successful, this was not necessarily a sure win, and it's not necessarily going to stay that way unless we stay ahead of the curve."
He would just like to see 1%, or 30 to 40, of Israel's 3,800 start-ups grow into global companies based there.
But not everyone is swayed by a perceived need to build big companies. Mr. Singer, the author, calls all the talk in the sector about trying to build bigger companies "Nokia-envy," referring to the Finnish phone firm. He says Israel perhaps just isn't suited to developing big companies and that it may be better off concentrating on start-ups.
"The lack of patience, lack of respect for authority, lack of planning, chutzpah—whatever you want to call it—are things that make us good at start-ups but don't make us particularly good at big companies," he says. "We need to appreciate the importance of start-ups in the global economy, and if we can build bigger companies along the way, well, that's nice too."
