Innovative regions: Israel

Chutzpah: effrontery, impudence, gall, audacity, nerve (Hebrew and Yiddish) – Urban Dictionary

When Saul Singer, co-author of Start-Up Nation – The Story of Israel’s Economic Miracle, says "Israel has the opportunity to be the Silicon Valley outside the US" he is perhaps demonstrating some of the chutzpah he credits as one of the many factors contributing to Israel being the world’s leading country in terms of start-ups per capita.

Other numbers seem to back up his claim – China is the only country outside the US that has more companies listed on Nasdaq, and Israel is ranked in the top six for innovation, scientific research institutions, utility patents per million population and technology readiness in the World Economic Forum’s Global Competitiveness Report. (See charts here and here.)

Because of this strength in innovation Israel is a popular destination for foreign corporate research and development (R&D) centres, despite the country’s conflictswith neighbours.

Earlier this year Apple announced it was opening a new R&D centre there, following in the footsteps of Intel, Cisco, HP, Citibank, Barclays and others. IBM has its largest research lab outside the US in Haifa and Intel employs more than 7,000 people.

In 2011, 546 Israeli high-tech companies attracted $2.14bn in venture investment, the highest amount in 11 years, according to the IVC Research Centre.

About 75% of the investment came from abroad. However, seed money was hard to come by and last year’s start-ups amounted to the fewest in a decade. Venture capital (VC) funds raised and capital invested have fallen to levels last seen after the tech bubble burst at the turn of the millennium.

Eight Israeli corporates have been identified by Global Corporate Venturing as having corporate venturing operations – Amdocs, Bank Hapoalim, IDB Group, Ceva, Checkpoint, Converse, PTT-Bezeq, and last year Teva Pharmaceuticals launched Teva Innovative Ventures to invest in Israeli drug development companies.

This comparative lack of local corporate venturers is simple to explain – as a young nation, Israel has relatively few large companies.  Despite Israel being an entrepreneurial hotbed popular with some of the world’s largest multi-national companies, and with VCs – $170 of investment capital is invested per head of population according to the Economist, more than twice that of the US – local corporate venturers seem less inclined to take minority stakes there than might be expected.

Of the 1,050 deals Global Corporate Venturing tracked last year involving corporate venturers, only 15 were in Israel and just two investment rounds topped $15m.

The corporate investors participating in those rounds were Intel Capital, Mitsui Global Investment, Citrix, Belgacom, GM Ventures, Energy Technology Ventures, GE, Ceva and Johnson & Johnson.

Doubtless there were additional undisclosed deals, and some Israeli firms may end up in the statistics for the US because they have relocated there. Nevertheless the fiures seem low.

There are several possible reasons for this relative lack of corporate venturing. First, according to Zeev Klein, a partner at advisory boutique Landmark Ventures, Israelis are much better suited to creating small, start-up companies than scaling them into larger ones, which he believes is partly due to the military background of many entrepreneurs who gained experience managing small teams of soldiers.

He added: "Where Israel has a dedicated core competency is on small-batch, sophisticated engineering entrepreneurship, and this is exportable. I do not think Israel is great at producing chief executives capable of managing 50,000 global employees – it just does not exist here."

Carlos Dominguez, senior vice-president at Cisco, likens Israel’s strength to a flock of birds – companies individually are small but together make up a powerful force, especially when they collaborate for the good of their nation.

This might explain why Israel fails to produce many Facebooks or Nokias and this scaling issue perhaps limits the attractiveness of Israeli start-ups to corporate venturers with long time horizons, leading them more down an acquisition route, folding fledgling companies into the R&D family.

Intel, IBM, Microsoft and Broadcom alone have spent over $2.5bn acquiring 31 Israeli companies in the past 10 years. In addition, many of Israel’s tech start-ups have not needed large capital injections, which potentially makes them more attractive to VCs than corporate venturers with greater resources.

Israel’s fiercely competitive VC landscape, created about 20 years ago by a government funding initiative called Yozma, which still exists, and an active angel community, may also deter corporate investors.

In an effort to find ways to encourage more corporate venturing Gary Dushnitsky, associate professor of strategy and entrepreneurship at London Business School was recently taken on by the Israeli government in an advisory capacity to look at ways to encourage more corporate venturing.

One notable exception to these rules has been clean-tech company Better Place, which has an ambitious plan to convert all Israel’s road traffic to battery power and has attracted corporate venturing.

Consumers will own the cars while Better Place owns the batteries, which can be replaced in 60 seconds at one of the many charging stations being built across the country.

The company, founded by Shai Aggassi, formerly of SAP, has raised $750m since 2007, including investment from GE and the Renault-Nissan Alliance. The first cars have been delivered to employees to test the system before roll-out.

Apart from chutzpah, what other reasons could there be for Israel’s success at innovation? Saul Singer and Start-Up Nation co-author Dan Senor identified several other factors, including national service leading to expertise in surveillance and communications technologies, high immigration of skilled workers, particularly from Russia, and immigrants almost by necessity have to be entrepreneurial as they start with very little, a limited domestic market leading to global technologies designed for export and international markets, and top-quality universities.

Four of Israel’s eight universities are in the world’s top 150. Hebrew University’s tech transfer office, Yissum, has registered more than 7,000 patents covering 2,023 inventions, licensed out 530 technologies and spun off 72 companies.

Products commercialised by Yissum generate over $2bn in annual sales. The government is committed to further investment in education. At Landmark Venture’s Israel Dealmakers Summit in February, Minister of Finance Yuval Steinitz pointed to an 8bn shekel ($2.1bn) investment over the next few years in dramatic reforms of higher education to "produce even more engineers, scientists and entrepreneurs".

Steinitz also cited two other initiatives intended to foster innovation and improve Israel’s competitiveness. Israel now has a 12% (6% in poorer areas) corporation tax for exports from Israel, the lowest in the western world.

He also touched on a 10 to 20-year plan to support the tech sector, including investments in start-ups, resolving problems for investors and supporting R&D centres.

Doron Birger, managing director of Landmark Ventures said that, according to "foreign sources", Israel suffers more cyber attacks than any nation – a staggering 1,000 per minute.

There is no doubt that Israel is a leader in cyber-security technology, born from the natural need in the military and commercial sector for defensive technology.

But entrepreneurship in Israel extends far beyond the tech sector – the country’s need to make the desert bloom has made it a leader in water technologies, while 41% of VC investments last year were in life sciences and the internet.

Incubator programmes, many supported by government money, particularly the Officeof the Chief Scientist, are also an important part of the innovation ecosystem especially in life sciences.

Rad Group’s Rad Biomed is perhaps the best-known of the Israeli success- accelerator programmes in the medical device, biopharmaceutical and diagnostic sectors, but there are many others.

Biotech company Merck Serono has created one of the newest, committing €10m ($13m) to its new incubator, and plans to invest in about eight companies over the next seven years.

Simone Botti, head of the company’s Bioincubator Fund, said: "We decided Israel is the best place to create a structure that could enjoy competitive advantage gains over almost any other multinational company. We work closely with universities here – the Weizmann Institute, Technion, Tel Aviv University and others – and take companies from very early stage to the point where they are investable by others."

Other corporates are also looking to put a toe into the water in Israel. Brook Wessel, senior investment manager of T-Venture of America, was one of several corporate venturers attending the Dealmakers Summit and is doing due diligence on two potential corporate venturing deals.

He said: "It takes years to build solid relationships with entrepreneurs and investors … so we are on our way and likely to invest for the long term, both in real terms with target companies and on the intangible side of frequent travel and events so that we enable exportation of innovation to the European market that Deutsche Telekom serves."

Israel’s ties to the US are strong and two recent initiatives provide good examples. Israel’s Technion University and the Israel Institute of Technology recently won a contract with Cornell University to create a $2bn university in New York to help incubate high-tech start-ups.

Upwest Labs was recently created in Silicon Valley to incubate Israeli start-ups and to provide seed money. While these initiatives might risk contributing to a brain drain from Israel, history suggests that Israelis who move abroad very often return, bringing back vital skills and experience.

If Israel can continue to reassure corporates that it will be business as usual even in times of tension in the Middle East, then it is likely to continue to see increased investment to feed this innovating flock