Chapter Four: 28

Chapter Five: 35

Chapter Six. 45

Chapter Seven. 57

EPILOG.. 79

PREFACE

I wrote this study so that another voice could be heard on the discussion about what is best for Israel’s high technology industries. Today one only hears the views of the venture capitalists and the foreign investment banks about what the Israeli government should, or should not, do to promote Israel’s technology-based industries. I felt that another perspective that had as its first priority the interests of the Israeli public, should be presented.

This study is an expression of that commitment to have an additional voice heard. It is entitled, Broken Promises: The Rise and Fall of Israel’s Technology-Based Industries because the potential existed for high tech to make a meaningful contribution to the development of the Israeli economy. This potential was sidetracked when Wall St. “discovered” Israeli high tech after l995. What then took place is what this survey documents.

The hypothesis is that Israel’s high tech industries fundamentally changed directions after 1995. Before then, the companies operating in the sector were serving the needs of the Israeli economy by providing jobs, stimulating the economy, and building Israel’s marketing and managerial capabilities. Companies such as Gilat Satellite Networks, Scitex, Mercury Interactive and Comverse were founded in the l980s and over the years have blossomed into multi-national operations- run by Israelis- with sales and marketing efforts worldwide. These firms are the pride and joy of Israeli business and proof positive as to what Israel can achieve in the high tech sector. The goal of the Israeli government should be how to create another 20-50 companies in Israel as large, successful, and beneficial to the economy as Gilat Satellite Networks and Comverse Technology have been.

Unfortunately, the situation changed profoundly in the mid-l990s and a new factor entered the equation: venture capital funds. Backed by major investment banks and financial institutions in the US, the phenomenal rise in the number of venture capital funds and the amount of money these funds manage shot-up from $20 million in l992 to more than $7 billion by mid-2001, radically altering the playing field. As a result of the influence the venture capitalists have exerted on Israel’s high tech industries, companies created after l994 were of a different ilk to their predecessors. Israeli high tech firms were no longer established to become the next Scitex or Gilat or Comverse but to be sold out to foreign multinationals as quickly as possible. Instead of waiting until the company was ready to be a public company, start ups were urged by the venture capitalists to go public too early and thus were unprepared for this challenge. The very essence of Israeli high tech companies took a 180 degree turn. It is this danger against which I am warning the Israeli public. Seven years ago the high tech industry was oriented towards the advancement of good, solid, long term thinking Israeli companies. That is no longer the case.

In short, Israeli high tech went from serving the needs of the Israeli economy and hence the Israeli public, to the short term needs of the foreign investors and VC fund managers. In the process, few great companies were created from l994-2000- certainly none that could match those created in the previous decade. Instead of building companies that would survive over the long haul providing employment opportunities and economic stimulation for the state’s economy, the goal of nearly all the companies created by the venture capitalists after l995 was first and foremost to make the greatest amount of money for their investors in the shortest period of time. While such goals are legitimate in their view, the best interests of the Israeli public were neglected.

I wrote this report to inject important issues into the public debate over how best to serve Israel’s technology-based industries. This “debate” about what is beneficial for a country’s technology industries could apply to any country which is trying to further the development of its own technology-based industries. While much of what I have written and proscribed refers to Israeli industry, many other countries which are trying to develop their own technology-based industries can learn a lot from the mistakes Israeli policymakers have made.

I feel uniquely qualified for this role of watchdog for Israeli high tech. I believe that I was one of the pioneers of the high tech industries in Israel- though I am neither an entrepreneur, investor, nor a scientist. My contribution came by way of the pen. I spent 15 years as a business journalist describing Israel’s transformation into a technological powerhouse and the ramifications of that process. This survey collates my knowledge and understanding of Israel’s technology industries and how best to promote them.

I have tried to make the final draft as readable and interesting as possible. As I am not an economist, I have avoided using graphs, charts, and statistics, which few people can relate to. Also as I also have no formal training in journalism, my writing style was formulated and driven by my desire to report the facts as I saw them and to bring the information I have gathered on the subject of Israeli high tech over the past 15 years to the attention of the Israeli public. I truly believe that the role of the journalist is to inform the public and to provide the public with the facts and knowledge so they can better understand what policies are being carried out in their name. 

If some of my conclusions don’t correspond with your preconceived notions in regards to Israeli high tech, I’m sorry. My job is not to fawn anyone. Rather it is to point out the flaws and mistakes of current government policy so they can be corrected.  Above all, please, don’t shoot the messenger. I didn’t create the current situation. I am just reporting it as I see it.

Please believe me when I say that my only goal is to have the Israeli public become better acquainted with the various issues that are part of their nation’s technology-based industries. With a better understanding of the subject matter, it is hoped that all Israelis (not just venture capital fund managers and CEOs of foreign high tech companies) will be able to participate in the debate of how best to further Israel’s technology industries.

The majority of this study was written in the summer of 2000 before the Palestinian violence of September 2000 began, and before the massive fall of high tech stocks which occurred around that same time. Since then Israeli start ups have discovered what it is like to exist in an environment, which is less than optimum. Since the fall of 2000 many start ups have gone bankrupt and Israeli venture capital funds have had a difficult time raising new funds. The Epilog was added in April 2001 in order to bring the rest of the report up to date.

As the focus of the study is to review government policy in relation to how it is developing Israel’s technology-based industries. The current conditions of start ups proves my basic argument that Israeli high tech companies should be focused on building for the long-term, and not structuring the companies for the short term via a quick exit or IPO so as to satisfy the Wall St. investment bankers and the local VC funds and their investors. Had Israeli high tech followed the path of building for the future instead of letting the VCs and Wall St. investment bankers shape the future destiny of the industry Israel’s high tech companies would be in a much stronger position today to weather the current storm.  While this country has produced some major high tech companies in the past, due to the change that took place seven years ago it doesn’t aspire to do that anymore. This is the tragedy that I hope to avoid with the writing of this report. Consider it a plea for someone other than myself to take a look at who is benefiting the most from the expansion of high tech in Israel in the past seven years and who is footing the bill for these profits.

Joel Bainerman

June, 2001

Zichron Yaacov, Israel

Chapter One:

Where Did Israeli High Tech Begin- Where Is it Going?

It is important that the Israeli public understand all the issues surrounding their technology-based industries so that they can be better informed on how best to promote them in the future. To fully understand the origins of Israeli high tech and the problems the sector faces today, some background facts are required.

While most Israelis only know of the recent advances in Israeli high tech due to the tremendous media exposure the sector has received in recent years- Israeli high tech really started to take off around l983 when the Likud-led government of former Prime Minister Menachem Begin decided to put Israel on the world’s technology map. The Israeli leadership at that time did this by enticing US microchip manufacturers such DEC, Intel, National Semiconductor, and Motorola, to established R&D centers courtesy of cash grants by the Israeli taxpayer. IBM, Microsoft, Cisco, 3Com, Rockwell, Sun, Oracle, Analog Devices, Applied Materials and a host of other US high tech firms followed suit in the early l990s.

Although automobile companies and other multinational firms submitted to the Arab boycott, due to a lack of markets in most Arab nations, the U.S. semiconductor industry had little to lose by setting up plants in Israel. Nor were they affected by the volatile political situation in the region as in Israel, unlike most of her neighbors, they saw a stable democracy.

So the government waved large cash grants in front of these companies and convinced them there was a highly educated and dedicated workforce in Israel in electronics that could help them design their microchips. This decision (by the Israeli government of the time) was the right one and it established Israel’s reputation (at least in some circles) as a center of technology in the electronics industry. It also brought to Israel American management techniques and exposed Israelis to the way large, multinational corporations are run.

There were other factors which attracted these multinationals to Israel, for example,  the unique personality of the Israeli researcher. Many Silicon Valley companies adopt a laid-back approach as part of their management strategy and Israeli society is in general very informal as well. It isn’t unusual to see the general manager of a company come to work in T-shirt and jeans. This informal environment helps in getting researchers to concentrate on ideas, rather than such things as “company politics” or personality clashes.

Israelis are also considered dedicated workers. In contrast to the US which high paying job offers break up R&D teams,  it is commonplace in Israel for R&D teams to stay together to complete the project. In addition, as it is a land of immigrants, there is no problem in finding a R&D team or a marketing manager who is fluent in English, but also Russian, Spanish, French or other major languages

In those days (as well as today) Israel was competing to attract US chip manufacturers with countries such as Ireland and Scotland, which offered similar cash grants but whose workforce wasn’t quite as good as Israel’s. Israel won its fair share of these “off-shore facilities” and during the early and mid-l980’s these R&D and manufacturing entities were instrumental in putting Israel on the high tech map worldwide.

What differentiated Israel from Scotland or Ireland were the military experience Israel faced. Israel has an army made up of the majority of its citizens- not just its professional soldiers. This “people’s army” is by far the most potent source of Israel’s technological expertise and it could be said that without the Israeli army, there would be no Israeli high tech.

How Does The Israeli Army Influence High Tech Developments?

More than any other single factor, it is the Israel Defense Forces (IDF) creation of talented researchers that has made Israel such an attractive off-shore R&D location for U.S. firms.

“The Israel high-tech industry is fifty years old, as is the State of Israel,” says Nisso Cohen, founder of International Data Corporation Israel, a subsidiary of the large US research company and one of the leading opinion-makers on Israeli high tech. (He will be quoted extensively throughout this study because he is one of the very few high tech professionals in Israel who, like myself, is interested in serving the needs of the Israeli public and not any self-interest) Its origins extend to the years prior to Israel’s independence, when the newly created Israel Defense Forces established what was euphemistically called “The Science Force. “One may be a bit doubtful about an army fighting for its country’s very existence while spending valuable time, people and money on “science.” However, the facts are that in 1948 the Science Force played a very important role in the establishment of Israel’s independence.”

Cohen relates how this group’s soldiers and officers were busy developing and providing the IDF with new arms, explosives, booby  traps and a variety of electric and electronic appliances which were necessary for a variety of special operations. In the long run, the Science Force had an enormous influence on the development of  Israel’s defense industries.

After Israel established its independence, the Israel Military Industry (IMI) developed at a rapid pace, meeting the country’s needs for armaments and technologies that it could not obtain for a variety of reasons from its allies.

Says Cohen: “During the same period, Israel was busy developing what was to become the best education and science research system in the Middle East. These world-renowned institutions include the Technion in Haifa, Weizmann Institute in Rehovot, and the Hebrew University in Jerusalem, and universities in Haifa, Beer Sheba and Tel Aviv. In the early Sixties, Israel entered the nuclear era with the establishment of two nuclear plants, entering the global arena in the areas of physics and related science research.”

It was at the Weizman Institute that the first Israeli computer was developed and assembled, in the early Fifties. “Golem” (dummy) was an all tube computer, similar to the first computers developed in the U.S.A. in the forties. In the late fifties and early sixties, there were already several mainframe computers in Israel, that were purchased from International Business Machines (IBM) and Philco. Primarily government authorities, universities and a number of banks used those computers. In the late sixties and early seventies, mainframe and mini computers penetrated the financial and business sectors. In the eighties, Israelis hurried to adopt personal computers.

Probably no one person was more responsible for the development of Israeli high tech and the commercialization of defence technologies for civilian products, than Uzia Galil, chairman and CEO of the holding company Elron Electronic Industries. Known as “the founding father of Israeli hi-tech” Elron is a stable of some 20 hi-tech companies with a market cap of $500 million.

In the mid-l950’s Galil spent a number of years learning at US universities and saw there how American companies were turning military technologies and scientific know-how into sellable products. Returning to Israel in the early l960s he created Elron Electronics Industries from his small apartment in Haifa and turned it into a multinational holding company which spun off companies such as Elbit (military computers), Elscint (medical imaging), and Optrotech (automatic inspection of PCBs)- many based on military technologies adapted to civilian markets.

Says Galil: “When I started out people were against me. Even scientists were horrified at the idea of making money from science. “ (August 22, 1999 The Jerusalem Post)

It was people like Galil who led the export drive in military products and the strengthening of the defence industries, along with private companies such as ECI Telecom, Tadiran and El-Op.

“It was in these firms that advanced technologies turned into electronics-defense products which were intended to be used by the Israel Defense Forces (IDF) alone,” Cohen points out. “Demand for the “proven in battle” products from Israel led to an  export industry of defense-related products which to this day comprises a large percentage of Israeli high-tech exports.”

What Is It About The Israel Defence Forces That Creates Such Talented Engineers?

In Israel, the IDF serves as a magnet for the Israeli economy and high tech environment drawing together the best people from industry, academia and the R&D institutions.

“The military itself comprises an ideal advanced R&D center for many technologies as it often serves as a beta site for new products and systems,” opines Daniel Halpern, a financial consultant with many years of experience working with Israeli high tech firms. “It is precisely the close interplay between industry, academia and the military that accounts in large measure for Israel’s distinct competitive advantage in the rapid and cost-effective application of R&D funding.”

In the IDF engineers are given the necessary building blocks, sophisticated tools and the freedom to experiment. Added-value  is always on the engineers’ mind. Also, by thinking in terms of “systems” in civilian products, Israeli engineers are superb at blending together different technological disciplines, such as hardware, software, and optics. The multidisciplinary nature of Israeli engineers comes from their experience in the army where every recruit is encouraged to learn as much as possible about many areas of technology.

Another aspect of the army that influenced Israeli entrepreneurs is the emphasis on improvisation, which proved very useful to Israel’s early high tech pioneers.

In those years, the early l980s, when companies such as Scitex (computerized printing), Elscint and Optrotech first tapped the US capital markets and began building their international marketing structures, the selling point was always the “state-of-the-art” engineering of the products. Efi Arazi, the founder of Scitex, once told me in an interview, “That’s all we had to go on as no Israeli industrial company had ever really tried to penetrate foreign markets with sophisticated products before. We had no game plan and had to make up the rules as we went along.”

In addition, the training methods employed by the IDF emphasize flexibility and the ability to adapt to changing circumstances is encouraged. Risk taking in encouraged. IDF officers are trained to analyze and comprehend a situation in the broad context and to identify solutions to solve specific problems and challenges. Israeli engineers are highly goal directed, and because of their military training, extremely project focused. All of these advantages, when taken into the civilian R&D arena, contributes to the par-excellence nature of Israeli R&D.

BIRD (U.S.-Israeli Bi-national R&D) Fund

No institution is more responsible for the development of Israel’s high tech industries than BIRD.

Someone in the Israeli government (although the someone is never identified in any of the literature) came up with a brilliant idea back in the late 70’s. If the Israeli government would contribute $30M and the US government the same, to an endowment, the interest income generated from the endowment could fund annual grants to Israeli companies that partner with a US company to help them bring their product to the US market. As a budget didn’t have to be passed every year but was guaranteed, this arrangement worked like a charm and on a totally professional basis. Since its founding, BIRD has distributed approximately $130 million to over 400 projects.

The purpose was to get the Israeli and US high tech industries “better acquainted”. It was assumed the Israeli company would do the R&D and the American company the marketing. Eventually, many Israeli companies could create their own ties to US firms on their own and could fund their own R&D programs. By the late l990s Israeli start ups were developing their technologies strictly and solely so they could be sold to some large US firm. There was no pretence of even talking about “how the product would be marketed” thus no need to look for a marketing partner. Up until the last few years the biggest issue with an Israeli company was how it would market its product. With the start up craze and VC encouragement in the past few years to develop and sell out quick, the need for a BIRD grant was diminished.

The organization is still very active and doing its job bringing Israeli and US companies together for joint ventures. The only problem is that with the new kids on the block, the VCs, the priorities switched somewhat and how to crack the US market no longer was the issue as it was up until the mid-90s. Prior to l995 it was hard for companies to raise money. A BIRD grant was a valuable part of the budget of most companies. With the flood of VC money post l995, it meant that companies didn’t worry about turning to BIRD for operating budget capital.

The important thing to remember about BIRD is that it was a successful government-to-government initiative- and that is being experimented with in other countries. The person most associated with the founding of the institution in Israel, Ed Malavsky, should take a few bows for the contribution he made to the Israeli high tech community at a time when nobody cared about or understood the great potential here. His successors such as current BIRD executive director, Dov Hershberg, continue the job.

Thus the rest of the story begins. Israeli high tech was moving along quite nicely by the end of the l980s. About twenty companies had gone public on Nasdaq based on their pioneering technologies. The name of the game then was how Israeli high tech was going to provide a strong economy and better future for Israel. This theme was a powerful one and it enabled the pioneering group of Israeli entrepreneurs to carry on their battle knowing that winning meant not only a reward for them- but also for the country. This type of “high tech Zionism” disappeared by l994 when the foreign investors and their local partners, the Israeli VCs, took over. It didn’t matter anymore to the new crop of Israeli entrepreneurs whether the country benefited from high tech- what mattered was that they and their investors profited handsomely from Israel’s expertise in developing products for world markets.  By l995, this had become the name of the game in Israeli high tech.

This alone is enough for the Israeli public not to be happy over the change in direction in Israeli high tech that has taken place over the past seven years. Surely entrepreneurs and private investors aren’t supposed to worry about “helping the country” but merely with turning a profit. As one of the group of Israel’s first proponents of the need for a deregulated economy in the Jewish state, I would not be true to my ideological beliefs if I thought otherwise. However the issue isn’t whether every Israeli citizen has a right to make as much money as possible for himself, or if foreign investors deserve to make lots of money from Israel’s technological expertise, but rather, how can Israel’s technological-based industries strengthen the Israeli economy by providing economic stimulation for as many sectors of the economy as possible, and to provide as many employment opportunities for the most number of Israelis.

If I were the Minister of Industry and Trade that would be my only goal. While it may be nice if individual Israelis become millionaires in the process, and foreign investors reap huge profits in Israel,  the goal of economic development must take precedence in this equation. Currently, it is not and as a result the Israeli economy is not the big winner in the high tech game. That is because the rules were changed and new priorities took over.

Chapter Two:

How Much Should It Cost To Finance Israel’s Technological Infrastructure?

The very issue of how much it costs to provide the Israeli people with a world-class technological infrastructure to exploit its technological assets and potential- is an issue very dear to my heart. As Israel’s leading critic on the development of Israel’s technology-based industries I make it my business to know what is good and what is not good in the way of promoting future generations of technology industries in this country.

For more than 20 years, it has been assumed by every incoming Israeli government that it is permissible to ask the Israeli public to turn over a portion of their tax revenues so that Israel may enjoy a solid technological infrastructure. For the most part, governments from across the political landscape believe that the allocation of cash grants to encourage Israelis to perform R&D on new products and processes,  is justified.

This study intends to provide a forum so that the average Israeli citizen is better informed about how their tax revenues are allocated and what purpose these tax revenues serve when they are earmarked for the “development of Israel’s high tech industries.”  While it could be said that the total budget the Israeli public spends on technological education covers much of the cost of training and education in the Israel Defence Forces, and the entire higher academic budget to operate Israel’s seven major universities, for the purpose of this study I will address solely those government policies that come into contact with the private sector. The question of whether Israel could save taxpayers’ resources in the area of technological education is beyond the scope of this study and of the expertise of this writer. My concern is strictly and solely with the budget that allocates public funds to private companies- ostensibly to further Israel’s technological expertise. For the most part, these programs involves the Office of the Chief Scientist (OCS) and its program of offering subsidies for companies that perform R&D, and industrial subsidies to local and foreign companies that establish R&D facilities or manufacturing concerns in Israel.

The Office of the Chief Scientist: The Holy Cow of Israeli High Tech

Without a doubt, the most visible program to further technological development in Israel is the Office of the Chief Scientist (OCS), or “HaMadan” as it is referred to in Hebrew (madan is Hebrew for scientist). Private high tech companies are eligible to receive financial incentives for research and development from the OCS which comes under the responsibility of the Ministry of Industry and Trade. Ostensibly, high tech companies are able to leverage their investments and improve chances for success for their portfolio companies. These incentives take the form of cash grants for R&D. The budget of the OCS is about $500 million, which includes the cost of administering the program.

The OCS is part of the Law for Encouragement of Industrial Research and Development that serves as the cornerstone of the government’s R&D support policy and has been since l980. From the government’s perspective, the Law is aimed at developing science intensive industry and expanding the technological and scientific infrastructure of the State. It hopes to improve the balance of payments by encouraging the local manufacture of technology-based products to be exported throughout the world. For the recipients of the grants, funds are provided that might not otherwise be available. These funds have permitted projects to be developed that ostensibly had little chance of getting off the ground without the OCS participation.

That’s the official line. The unofficial one is that while there may have been a need for such a program twenty years ago, it is doubtful there is still justification for the Israeli public fork out nearly $500 million every year so that private high tech companies will get free cash grants.

As I am ideologically committed to free-market principles, I hate government interference in a market. All the more so when it “subsidies” private entities to “encourage” them to do something the government believes is in the public’s interest.  Supporting research and development (R&D) in private high tech companies is an example of how a government interferes in a market which could run just fine on its own and serve the same goals the government claims it is serving- without spending public funds to do so. If an entrepreneur has a great idea for a new type of computer or software program, but if he can’t find an investor to back him, perhaps the idea is not really that good.

As Israel now has a venture capital industry (venture capitalists typically fund early-stage companies to develop new high tech products) that has more than $7 billion under management, if an Israeli entrepreneur can’t raise the required funds from this source of private funding, why should the government back this private entity with public funds? Today, when Israel has so many billions in high risk capital on its shores seeking new and innovative ideas to fund- there is simply no reason why the people of Israel should continue to fund this endeavor.

However Israel has a tradition of government subsidies for industry, high tech, water, milk, municipalities, political parties, labor movements, health funds, mortgages, you name it. If it moves, it is likely that the Israeli government has subsidized it at one time or another. But high tech? Today? Does high tech development in Israel need to be subsidized? Today, when the whole world seems to be lauding the virtues of the technological powerhouse Israel has become, the government of Israel still feels the need to take tax revenues from the public and disperse these monies to lucky individuals who go by the name of “high tech entrepreneurs.”

Another big problem I have with governments awarding cash grants to selected individuals in selected industries, such as those given out by the OCS, is that it creates two classes of citizens:  “high tech people” who due to the fact that they studied computers or electronics, are eligible to receive the public’s money to develop their own private companies. And the rest of us poor schnooks who run businesses to serve society’s needs, but aren’t “flashy and sexy” like high tech is? What’s in it for us?  Those that aren’t employed in high tech, the other 95% of the workforce, are told that “high tech is Israel’s future and thus the government needs to subsidize R&D and the establishment of industrial plants for the good of the economy.” But if I own a restaurant or a dry cleaning store, and believe that eating and clean clothes are important, why then shouldn’t I be eligible to receive a grant from the OCS?

The OCS will argue that the grants they disperse are to “foster technological innovation in Israel” which they will contend, is “good for the economy and Israel’s balance of payments account.”

Could be, but isn’t food also important? Won’t tourists eat at my restaurant and have their shirts pressed at my dry cleaning store  thus “contributing to Israel’s balance of payments account?”  What if I am the proud owner of a chic diner in downtown Tel Aviv and don’t  care about high tech, nor if high tech “is Israel’s future”. My eatery brings in money to my family, brings money into the tax authorities, earns foreign currency from tourists and foreign businessmen and stimulates the economy by ordering local food and produce. Why then should I have to subsidize some computer or electronics engineer with a good idea who will be able to sell his company to Intel or Cisco? When that company gets sold to an Intel or Microsoft or goes public on Wall St, what do I as an Israeli taxpayer get out of that? It appears that I get to share the risk of his R&D but receive nothing of the upside.

Perhaps It Is Time To Close Down The Office of The Chief Scientist?

Back in l986, I decided it was high time the issue of public support for start up companies was put onto the public agenda, and initiated a cover story in The Israel Economist (a local business magazine which I worked for from l983-l988) on the subject . The first place to start was the OCS, an institution I knew about from my work as a writer. I had heard on more that one occasion of the bureaucracy, waste, and other unsavory things that went on there. To get the whole story, I called on Dr. Steve Plaut from the University of Haifa. 

Plaut was the first person I ever heard criticize the notion that the Israeli government should hand out cash grants to companies to shoulder their R&D expenses. He was then a senior lecturer at The Technion in Haifa, Israel’s version of MIT. Back in the mid-1980’s Plaut was the only Israeli economist who regularly criticized the government for being too large, intrusive, and monopolistic. Back then the notion in Israeli economic circles was that the government had to direct the economy because “Israel’s economy was different than other western countries” due to “immigration and security expenses”.

In l986 Plaut wrote a study for The Technion stating that the OCS and the government’s program of “directing grants to deserving companies” was “nothing more than blatant interference by the government in a private market and a waste of public funds.” Needless to say nobody then took heed of what he was saying. He wrote that a full eight or ten years before the flood of venture capital hit Israel.

Today, as someone who learned much from Dr. Plaut (particularly from his book, The Joys of Capitalism) on how markets get distorted by government interference, I can close the 15 year gap. I’ll go on record as being the second person ever to argue for the closing down of the OCS and saving the Israeli taxpayer a half a billion dollars a year.

Steve Plaut and I are not alone in our assessment. In mid-l999 the OCS came under attack in a report written by Adam Ruskin of the Institute for Advanced Strategic and Political Studies in Jerusalem. The report pointed out that since the program began 30 years ago it has cost nearly $4 billion and returned only $559 million in royalties a loss of $3.3 billion. Each year the program hands out nearly $500 million worth of R&D subsidies, including the salaries and expenses of the administrator of the grants. 

The report concluded:

“The OCS liberally dispenses the taxpayer funds entrusted to it without proper screening of the companies that apply for grants. Contrary to the thinking of high-tech and start-up enthusiasts, not every idea is worthy of being funded. In fact, there is a great opportunity-cost loss associated with funding mediocre or poor ideas, as it leaves fewer resources available for good ideas. When too many ideas receive funding, including weak ideas, financing and human resources are siphoned away from businesses with stronger chance of succeeding. The private sector, on the other hand, is able to painstakingly screen ideas and elaborately fund those, which are good. Most damaging and disheartening is the wasteful and unnecessary expenditure of the taxpayer’s money. A ministry budget allocation should not be a license to give away money to industrial fat-cats or to highly-sought after and highly-paid high-tech specialists. In short, there is no sound economic reason for the Israeli government to provide R&D subsidies to Israeli high tech companies. Israel is fortunate in the fact that it can be handled by the private sector. The venture capital industry in Israel is mature and fully capable of financing promising start ups”

Ruskin’s report was the first time that the OCS had ever been raked over the coals in such a convincing manner. “HaMadan” (as the Chief Scientist is referred to in Hebrew) has never been treated with such distain. The response from Dr. Orna Beri, then the Chief Scientist, was not surprising. Replying in a review of the report by Maariv’s Gad Peretz on August 22^nd 1999,  Dr. Beri said that the Institute was a “right wing, fanatical group”, and she wouldn’t dignify them with a response. She admitted that she hadn’t yet read the report which had come out earlier that week.

Beri was also angry with the Ministry of Finance which was set on cutting R&D subsidies in the coming year.   Of them, she told a press conference, “the people at the Ministry of Finance know nothing about what is good for the future of Israeli high tech”.

Yet while Dr. Beri was lashing out at anyone who dared question the future need of her fiefdom, some Israeli high tech personalities were telling it like it was.  Nisso Cohen of IDC Israel (the subsidiary of the US high tech research company), one of Israel’s leading analyst of its high tech industries,  says: ”there’s simply no real reason why the OCS needs to exist if Israel is awash in venture capital.” Adds Cobia Alexander, Chairman of Converse Technology; "There is no country in the world that is capable of raising venture capital like Israel. The big money for high tech comes is coming via the venture capitalists and not by way of the OCS. In comparison, the extent of the financial support for start up companies from the OCS is a joke.” (Globes, July 12^the, 2000)

On May 16, 1999, Globes, Israel’s daily business newspaper, published a report on how private companies in Israel view the issue of R&D grants, and of one of their motivations for applying for a grant:

 “Berry’s diligence is not appreciated by major industrialists. They have no time to wait until a long-range plan is worked out; they need the money here and now. Why the haste? Is R&D being disrupted? Not necessarily. These companies are simply in the habit of publishing balance sheets whose income item includes an R&D grant. Any delay in receipt of the grant will force public companies to publish profit warnings, and investors do not like profit warnings. Nor do managers like to annoy their investors, or their bosses.”

Three months later when the debate over the need for the OCS hit its peak, Globes went back on the offensive.

“ It is the task of this fund to find the most appropriate way of encouraging net research and development. Listening to high-tech insiders talk, even in large companies, one obtains a hair-raising picture of R&D funds being “commercialized” in a general free-for-all. For example, an application is made to the Chief Scientist for support for a certain project. The money, when it arrives, is redirected, by a bookkeeping system no less sophisticated than the R&D itself, to other projects. This generates a new mix of researchers, so that any follow-up of where the money went is difficult. Looking for royalties, later on, is a hopeless task. Moreover, injured parties and those in the know dare not complain, in case their requests for R&D assistance are not met in future. To what extent the Chief Scientists themselves are aware of these illicit games, in which large companies not infrequently star, is not clear.” (Globes, Aug 22, 1999)

The current Chief Scientist, Carmel Varian confirms the irrelevance of government support for start up companies in the current environment. Varian revealed in July 2000 that in the previous 12 months, only about 200 companies had approached the OCS for funding- down from 600-800 start-ups in previous years. (Yediot Achranot, July 10^th, 2000) The reasons, according to Varnia, is the restrictions the OCS puts on companies receiving government grants- such as not being allowed to transfer manufacturing outside of Israel.

One of Israel’s most revered high tech player (at least until the fall of the dot.coms) Yossi Vardi, one of the founders of Mirabilis which was sold in June l998 to AOL for $400 million, contends that certain start up companies manage without government assistance: “There’s a lot of money, smart venture capital that loves start-up companies and makes a purely economic choice,” he said. “We know what sophisticated investors think of the economy’s growth and development prospects. If the government offers support, it will be able to accelerate the development of the sector. Yet the question is whether, when all’s said and done, the money will indeed reach the start-up companies, or whether, given all the influences that exist in the sector, the funds will be channeled elsewhere.” (Globes, June 21st, 1999)

Dr. Ehud Geller, one of the driving forces behind the creation of InterPharm, one of Israel’s most successful biotech companies, takes a different view. He is part of the group of Israeli industrialists who propose not only continuing the program of government subsidies, but favors increasing the level of funding. In an op-ed written for Globes, Dr. Geller stated:

“Some of the arguments advanced for eliminating the Scientist’s budget are based on the development of Israel’s venture capital industry. These arguments reflect a fundamental misconception. Venture capital funds are not meant to replace the Chief Scientist’s budget, nor do they do so. The funds invest primarily in business development financing, but are not prepared to shoulder the risk on their own. They invest in young ventures, on the assumption that the risk is somewhat diluted by sources such as the Chief Scientist’s budget.” (Globes, August 31^st, l999)

Yet in the US, there is no such animal as the OCS. US high tech companies receive no R&D grants from the Department of Commerce or Treasury. Yet American venture capitalists don’t complain. Unlike Israeli venture capitalists, US high risk investors are prepared to “shoulder the risk on their own.” Unlike Israeli investors, they don’t assume that the risk will be diluted by government sources of financing. 

When Giora Bitan of the Giza Group (one of Israel’s blue chip investment banks) was asked whether government should continue funding R&D, he replied:

“Foreign investors intending to put money into venture capital funds like to see a supportive environment created by the government. It’s important to realize that, by putting up relatively tiny sums, the government creates a favorable, nurturing environment for the high tech industry.” ( Globes, August 22^nd, l999)

But at what cost? And if these foreign investors put money into US venture capital funds without the same “supportive environment” (i.e., government grants) why would they not do the same in Israel even if the government didn’t offer cash grants to start ups? 

At the height of the debate, Israeli high tech leaders also went on the offensive and threatened the government. Hanan Achsaf, president of Motorola Israel, declared: “If the terms of assistance to research and development are worsened as the Ministry of Finance intends, Motorola will relocate the development of new products from Israel to other countries, followed by the relocation of manufacturing and export activities from Israel to other countries”.

The Chief Financial Officer for Teva (Israel’s largest pharmaceutical company),  Dan Suesskind, said that  “If the terms of assistance to research and development are downgraded compared to what they are at present, Teva will be forced to reduce its R&D investment, including either discontinuing or selling some of the ten R&D projects currently at various stages of development”.

Suesskind stated that outside financing must be found for these projects, as Teva could continue to finance them out of its own fiscal resources. Suesskind warned, “If R&D conditions worsen, it will not be feasible for us to bring these projects back to Israel”.

The question then needs to be asked is: Do well established companies like Motorola Israel and Teva (Teva is an Israeli company, Motorola a subsidiary of the US company) really need to rely on government grants to maintain their competitive edge? What do other multinational companies do who don’t have access to OCS grants?

The Manufacturers Association (Israel’s business lobby) Oded Tira has threatened that if the conditions the Israeli government offers for its R&D grants does not improve (i.e., the government lowers the rate of royalties companies must pay back when the grants lead to successful products) it would encourage Israeli high tech companies to transfer their R&D activity abroad. (Globes, February 15^th, 2000)

Where could an Israeli tech company go to get the quality of R&D it gets in Israel? What other country would subsidize its R&D activities?

Shuki Abramovitz, the Manufacturers Association chief economist claimed that an internal survey carried out by his organization of its members, showed that in the next three years, 77% of the companies will cut their R&D, 33% will transfer R&D abroad, and 31% of the companies will transfer manufacturing overseas, and 49% will bring in a strategic partner.” This, Abramovitz claims, is due to the reduction of R&D support the government is planning.

One wonders how pure these numbers are as Abramovitz’s members are the recipients of the freebies the government hands out. (Other questions that might be asked of Abramovitz’s statement are: where they will contract their R&D abroad if they leave Israel;  and,  why it is that bringing in a strategic partner is somehow considered a negative event in the eyes of the Manufacturers Association?)

Large Israeli companies should not receive government hand-outs. Their competitors don’t get government R&D grants yet manage to survive. Any high tech company knows it has to develop new products if it is to stay on top and protect or expand its market share. R&D in the high tech world is a critical part of the game. Don’t the huge gross margins on high tech products enable these enterprises to pour a significant amount of their revenues back into their R&D departments? How likely is it that a large Israeli company will stop engaging in the research and development of new products if OCS funding stops?

So How Much Do Grants From The OCS Help The Israeli Economy?

In October l998, Deborah Claymon of The Red Herring, the leading high tech magazine in the US, interviewed Natan Sharansky, Israel’s Minister of Industry and Trade in Benjamin Netanyahu’s government. When asked about criticism that the Israeli government gives “too much money” to foreign entities to invest in Israel, Sharansky responded:

“Investors are attracted to our high-tech startups when they know that the government endorses them.”

Which begs the question: if Israel has attracted nearly $7 billion worth of venture capital in the last seven years, and raised nearly $5 billion on foreign stock exchanges, hasn’t the time come when Israel’s high tech policy need no longer be oriented toward convincing foreigners to invest in Israel? Also, do investors in high tech companies in other countries require “government endorsement” before investing?

The time has come for the Israeli government, and its high tech leaders, to start looking at Israel’s high tech industries as all grown up, and no longer in need of the government’s helping hand. Israeli companies are good enough to compete on an equal basis- even without OCS grants.

For a perfect ending to this section of my study,  on June 8^th, 2001 it was reported in the Israeli press that CommTouch, the Israeli company that managed to accumulate $73 million losses with the stock down to under $1 and a total marketcap of $8 million, has managed to convince the Office of the Chief Scientist to award it a $1M R&D grant. That is a lot of money for the government to invest in company that has clearly not shown any promise and could be facing bankruptcy.

Free Money Breeds Lousy Companies

Another problem with the OCS is its mere existence creates start ups that have no business existing and wouldn’t exist if there were no government hand-outs to support them.

The hidden problem with R&D subsidies is too many, if not the majority of companies, living off grants to survive. Back in the mid-l980s one could have argued that the money the government allocated for OCS grants was a legitimate expenditure of public funds as it increased the number of start ups and gave the entire high tech industry a needed boost. As no other entity existed in the market at that time to back early-stage companies, the government was right to supply the funds.

Another major drawback of having so many weak start-ups is that it spreads the pool of trained engineers too thinly. Companies such as Elbit, Gilat, Comverse, and ECI-Tadiran are major exporters which stimulate the economy. Yet many of the engineers they need to compete internationally are to be found in the hundreds of start-ups, many of which aren’t going anywhere in the marketplace and will eventually provide no “added-value” to the economy. Start-ups also siphon-off seasoned management and marketing personnel from the larger companies. In Israel’s case, where management and marketing are weak links in the high tech chain, this is a major hindrance to the future growth of its high tech industries.

In an article in Forbes Global Business & Finance on January 25^th, l999, Zohar Zisappel of the Rad Group, claimed: “The high number of start ups aggravates the shortage of skilled manpower.”

Yes, the Israeli government should consider getting rid of the OCS?

“What! Abolish the OCS. What, are you crazy? “Gone mad” Israel’s high tech leaders must be saying to themselves as they read these words. The conventional view has always been that the OCS is the best thing that ever happened to Israeli high tech.

Well, it was then. Things changed. One reason why Israel has so many start-ups is because the government gives out nearly $500M in subsidies to companies so the end result is many start-ups are created. The question is how many of them are any good. The issue is quality, not quantity. If funding ended, the weaker companies would disappear, and the stronger ones, the ones most attractive to the VCs, would survive. By definition, as the number gets smaller, the quality of the average start up goes up.

The weak companies should simply not exist. Their founders and employees should find work in other companies to strengthen the country’s national capabilities in high tech. If I was in charge of shutting down the OCS, I would tell these weaker companies to wake up and smell the roses: if a start-up isn’t able to convince a venture capitalist of the potential of his idea or product, there is no justification for its continued existence.

If the huge subsidy program was shut down very little would change as there would still be hundreds and hundreds of start up companies however, they would depend on private sources of financing, not public funds. The market, not government officials, would decide which are the good companies and which are not. In addition, since there would be no more grants to give out, there would be no reason to employ these government officials. Result: a further saving of public funds.

What To Do With The Hundreds of Millions Of Dollars That Would Be Saved By Not Funding Start Ups?

If Nisso Cohen of IDC Israel had his way, he would allocate the money for marketing. He recommends ceasing all new funding for R&D projects, and instead, support the 500 or so projects that the OCS has invested in the past three years with marketing grants in return for shares in the companies. He says this way, there would be some chance of recouping some of the losses as well as providing an important funding vehicle for many companies to market the products and technologies that have already been developed.

My first choice as a professed libertarian (free-marketer) would be to leave it in the pockets of the Israeli taxpayers.  Let them decide what they want to do with their hard-earned money. Unfortunately, in Israel, a “tax and spend” policy is the order of the day. As this is the case, then invest it in the educational network to create more engineers and better managers, or give it to the universities for basic research. No venture capitalist will fund educational networks or basic research. Basic research can be regarded as a “national asset.”

On a strictly economic basis, a sound argument could be made for bolstering Israel’s academic research community with an additional half a billion dollars in public funds as no source of private funds will support applied, industrial research in universities. The additional $500 million allocated to Israel’s network of technical institutes will create a depth of knowledge that future generations of companies will be able to exploit.

The reason that private industry will never finance basic scientific research as there is no immediate financial reward to be derived from it. Another reason, which has been advocated by Professor Paul Romer, an economist at the University of California at Berkley, is that while companies develop new products, they don’t develop new processes to manufacture those and existing products. New manufacturing techniques must be carried out by non-profit institutions as private companies won’t be able to justify these costs.

A country loses its ability to manufacture efficiently if sufficient research funds are not directed at scientific institutions. The end result is that Israel’s brainpower resources will help the Intels and Motorolas of this world design innovative new products while companies in other countries will be given the right to manufacture them because Israel’s manufacturing capabilities are not efficient enough. In essence, Israeli high tech becomes nothing but a “sub-contractor” to multi-national firms with little added-value for the Israeli economy.

Some will say that while the arguments presented for closing down the OCS are sound, it is unlikely to happen since in Israel’s highly regulated economy, the government rarely contracts. Yet there is a precedent in Israel for closing down a government subsidy program.

In the early l990s, in an effort to lure US venture capital funds to Israel, the Israeli government contributed 40% of the new funds if these VC funds put up the remaining 60%. The policy was a resounding success as Israel is now swamped in venture capital. The program, known as the Yozma initiative, was shut down last year and the government’s holdings in these funds were sold to the VC funds that participated in the program. Mission accomplished.

The same policy should be applied to the OCS. Close down the operation. Mission accomplished. It is time Israeli start up companies began to live off their own means and not handouts from public coffers.

Government-Sponsored Technology Incubators: Who Needs Them?

Another public institution the Israeli government should consider closing down to save taxpayers’ money, is the national incubator system. It too is administered by the OCS out of the Ministry of Industry and Trade. Israel’s experience with technological incubators has been a disaster. The reason is because of the origins of the idea and how the program was established.

It began back in 1990 when the Israeli government was in a panic. The massive immigration of Russian Jewish immigration had started, amid talk of more than one million newcomers arriving over a period of two years. The Ministry of Industry and Trade started considering programs, government-initiated work projects, and professional retraining to employ the newcomers.

Yigal Erlich, now the general manager of the Yozma venture capital fund, was at that time the Chief Scientist at the Ministry of Industry and Trade (OCS), and it was under his auspices that the technological incubator idea was born. The Minister of Industry and Trade at the time, Moshe Nissim, quickly received a budget of $1 billion to initiate the program in l991. In the local context, that was a huge sum of public funds.

Looking for quick solutions, a brand new government subsidy program was born.

In an interview in July l998 in Globes, Erlich said:

“The problem was how to give them management capability. They were extremely fearful of anyone taking away their ideas. They were suspicious, they found it difficult to work in groups, they argued between themselves. They did not get along among themselves, nor with the Israelis or the incubator administration.

“When we planned the incubators, we weren’t aware how large this chasm was. There was a need to combine the managerial ability of a private enterprise with what the government could offer. The solution was to link the incubators with centers supported by local authorities, and assign a board with a business background to each center. We already knew then that this was not an ideal solution, but the politicians brought pressure to bear to get something done.”

In other words, they knew from the very beginning that it was not the best of solutions.

Erlich continued: “It would be an understatement to say that venture capital does not enter companies of the sort found in incubators. Venture capital funds don’t like taking risks, and don’t like entering projects where they don’t know the people involved, and where there is no managerial experience. If they have other alternatives, they will prefer them.

When asked whether the program, which Erlich admitted was not the best idea from the beginning, is now, five years later, completely unsuitable, He replied: “It is not economical for venture capital funds to invest seed money in general, and in high risk co-efficient projects in particular. I wouldn’t invest such money.”

So if private venture capital funds aren’t investing in companies which come from the technological incubators why is the government keeping these companies alive by providing them with public funds?

A better idea would have been to offer existing Israeli companies a compelling financial incentive to employ a Russian immigrant. In this way the newcomer would learn a little more about what a for-profit entity is and how companies are run before being expected to establish and run his own company. Israeli companies would have found that the Russians are highly educated and dedicated workers and can contribute much to their firm- and thus would have kept them on the payroll well past the end of the government subsidy. The probable result: many Russian scientists would have brought their unique technologies to the attention of their bosses to convince them to allocate a budget to develop the new product or technology. At least in this way the entrepreneur would have had a professional team of managers to help him commercialize the technology and aid in enlisting financial investors.

It is time to close down the program of technological incubators in Israel. The initiative was created for a different era not for today’s new immigrants. New Russian immigrant programmers find their way to suitable employment in Israeli high-tech companies. There is very little unemployment amongst qualified people. They never should have been expected to be entrepreneurs and managers of high tech enterprises.

Is it any surprise that so many companies run by Russian immigrants fail?

The idea was inane from the very start. It made no sense to expect people in the country for a very short time to become the manager of a start up and then is required to secure a financial investment. When the entrepreneur couldn’t find an external investor, what usually happened was after the two-year incubating period, the government told him he had to leave the incubator and would not receive any more public funds to continue to operate the company. The end result: lots of small companies were created, given public funds to perform some R&D, and then were forced to stop for lack of funding. In the process billions of millions of shekels of public funds were wasted.

Just so my readers don’t think that the network of technological incubators has been a failure is just my opinion, here is what Globes had to say on the subject on June 23rd, l998:

“Our investigation reveals a rather dismal reality of companies on government-supplied life support waiting for “Prince Technology” to awaken them with a kiss and an investment. The investigation’s findings indicate that 70% of incubator companies don’t even succeed in repaying to the State financing they have received.”

Regardless of how the Ministry of Industry and Trade classifies companies that are “still active in an independent manner” the fact is there are but a handful of companies that made any splash on the Israeli high tech investment scene, and even fewer that have a sales record. It doesn’t matter whom you talk to in Israel, once the subject of the incubators are brought up, a chuckle usually enters into the conversation. They are considered a joke by serious investors and that is why Erlich stated that venture funds are not interested in companies coming from the incubators.

Why not?

Because while Israeli start ups in general lack seasoned management, this is a particular problem with a company in the incubator. Unlike their counterparts in the private sector, an entrepreneur from an incubator didn’t have to convince an angel investor or venture fund to back his idea. Only the bureaucrats at the incubator and at the OCS.

It doesn’t really matter whether the policy to establish the incubators was right in l991 or not. The fact is that today, there is no need for it. If a Russian immigrant has a good idea he can approach the same sources of funding as Israeli entrepreneurs: the $7 billion worth of venture financing found in the more than 100 venture capital funds which operate in Israel.

If this subsidy program ended an additional $50 million would be either returned to the pockets of the Israeli taxpayer, or be allocated to Israel’s network of university and research institutes.  An additional $50 million worth of research money given to Israel’s extensive research environment would also employ immigrant scientists, and further Israel’s science-based industries.

As a footnote to the experience of technological incubators in Israel, in September 2000, the Hebrew University in Jerusalem announced it would invest $50 million in two venture capital funds that will enable students and faculty members to launch start ups. The move is part of the university’s effort to retain its top students and faculty members.

Heaven help us if this becomes the new trend. Israeli universities are constantly in the red and have not been very successful in licensing much of the technologies developed by their institutions.  It says much about the current high tech landscape in Israel that universities feel they can be skilled investors. The last thing Israel needs now is more start ups established by public institutions. One can only pray that these “university VC funds” don’t grow and one day ask the government for the capital to fund the newest version of the “technology incubator.”

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“The State Comptroller’s Office conducted an examination of enterprises receiving aid between l988 and l995. they found that 32% were not longer active, 14% no longer existed, 15% had not implemented a single investment plan approved by them, although at least one year had passed since the date for completion of the plan, and 17% of the supported enterprises still active were at great risk, 5% of which were in the process of liquidation.” (Globes, November 13^th, 2000)

Chapter Three:

Freebies and Crybabies

The other major arm of the government of Israel’s  policy to further its high tech industries is the granting of cash subsidies to foreign companies if they carry out R&D activities in Israel, or if local or foreign companies establish a manufacturing concern in Israel.

Hence this news item, which is fairly typical of Globes or Haaretz on any given day:

“Japanese concern TASK has placed an order for a $20 million project for real time image processing systems from its Israeli development center, TASK Israel. The technology integrates dozens of processors with real time high-speed calculation capability at over 600 MB per second. The project is expected to provide the parent company with sales of at least $60 million. TASK International is listed on the Tokyo stock exchange at a value of $4 billion. At the beginning of the year, the company announced its intention to invest $100 million in R&D and in high tech companies. Of this investment, at least $15 million will be invested in its Israeli development center. TASK International intends to make TASK Israel its world software development center.”

Notice the tone of the report. The writer is thrilled (as is the Ministry of Industry and Trade) that this large Japanese company has decided to exploit Israel’s technological infrastructure and develop products in the Jewish state.

Why, you may ask, is a Japanese company which is worth $4 billion, investing in a software center in Israel? Because for them, it makes good sense.

But, the better question is why is the government of Israel allowing- even subsidizing- TASK to develop software in Israel? How do the Israeli people benefit from this deal? Why is it good for Israel that a multinational Japanese company can now solve its software problems by employing Israeli engineers in its wholly-owned software center? Is this indeed a good policy for the government of Israel to promote? Why should the Israeli taxpayer care if a large Japanese company has difficulty developing creative software and pays this company to do its development work in Israel?

The answer to these types of questions has always been the same. The government claims that by offering cash grants to foreign companies, and by having these companies use Israeli manpower to develop their products, Israel gains by taxing the employees’ wages, and by the ties that the R&D center brings to the rest of Israel’s high tech industry.

Back in the early l980s when there were not enough local employment opportunities for all of the graduates coming out of Israel’s institutions of higher learning- this policy may have made sense. Today, however, when Israel faces a shortage of skilled labor, such a policy merely makes it harder and more expensive for local companies to fulfill their manpower requirements. (although the downturn in high tech worldwide in late 2000 and in the first half of 2001 eased the labor shortage in Israeli high tech, when the cycle returns and  high tech is the “flavor of the month” again amongst investors, these arguments will be relevant)

Whether Israel benefits from having this Japanese company base its R&D operations in Israel is impossible to know.  It could be that because an Israeli worked at this R&D facility, and came into contact with a member of the Japanese management team something other than an employee-employer relationship developed which later on turned into a major gain for the Israeli economy. While such an outcome isn’t impossible, to be honest, I haven’t heard of many instances like it in nearly two decades of being around Israeli high tech circles. The government’s claim that having large, multinational companies base their R&D operations in Israel furthers Israel’s technology industries, or strengthens Israeli industry,  has not been backed up by any hard data. 

When Did This Policy Begin?

The origins of this government policy of funding foreign high tech companies so they will establish an R&D center in Israel goes back to the early l980s. By offering substantial government subsidies (38% of the cost of any new investment) Israel persuaded many foreign companies to establish design centers in its country. The objectives of the grants were to give a shot in the arm for fledgling high-tech industry, to develop a dependable backbone and to achieve international credibility.

The policy began in the early l980s when Intel, IBM, Motorola, National Semiconductor and DEC took the Israeli government up on its offer and established R&D centers in Israel to design their newest generation of microchips. Today, Israel is home to more offshore R&D and design centers in the microelectronics industry than any other country.

For the first decade, nobody complained. The policy brought Israel onto the radar screen of large US high tech firms, and, their US-style management techniques  helped many Israeli high tech professionals “learn the ways of the world.”

Following the earlier crop of companies, in the mid-l990s entities such as 3Com, Cisco Systems, Computer Associates, Hewlett-Packard, Rockwell International, Analog Devices, and LSI Logic, established R&D and design centers in Israel’s own version of Silicon Valley—a 60-mile-long strip of land stretching from Tel Aviv  through Herzliya Pituach to Netanya and winding up in the port city of Haifa. With nearly 40% of the cost of these centers borne by the Israeli taxpayer, the US company was given access to leading-edge development capabilities at a very favorable price, it is easy to see what motivated the large US firms to establish a presence in Israel.

By the first half of the l990s, the policy had produced better-than-expected results: foreign investment grew from $366 million in 1991 to top the $2 billion mark in 1995. According to the World Markets Research Center, that figure represented a fivefold increase over the last 15 years.

However, things have changed since the mid-l990s as Israel is awash in foreign venture capital, and not a week goes by without some international high tech company coming to Israel to scout around or to buy an Israeli firm. By l997, Israeli high tech had arrived on the world scene.  At that point government policy should have changed and recognized that there was no longer any good reason to continue taking tax payers wealth and handing it over to foreign multinational in the form of R&D subsidies.

The policy was certainly successful in stimulating the development of a technology industry, which is now strong enough to grow on its own. Says Efi Arazi, the founder of Scitex, one of Israel’s high tech pioneers: “The policy of subsidizing foreign companies is crippling the continued growth of the Israeli market. Foreign R&D centers offer no added value or economic benefit to the country and only make the shortage of engineers worse.” (The Red Herring, October l997).

Yehoshua Gleitman, a former chief scientist at the Industry and Trade Ministry, agrees, repeating that foreign companies should not receive investment subsidies from the Israeli government.

The debate over how much the Israeli taxpayer should fork over in order to satisfy the needs of the US multinationals heated up in l996 when it came apparent to policy makers and economists just how much a commitment by the then Israeli government led by the late Yitzhak Rabin, was going to cost the national accounts. The government agreed to hand over about $450 million to Intel to build a semiconductor fab. Intel’s Israeli plant was to be the first outside the United States capable of making microprocessors with lines as small as 0.25 micron.

When an outcry erupted, The Minister of Industry and Trade at the time, Micha Harish, countered that the huge grant to Intel would benefit the country’s technological infrastructure by creating spin-offs and bringing Israel new microelectronics technology, which he claimed was “desperately needed.” (It seems Mr. Harsh was ignorant of how many start ups designing microchips were already in existence even back in l996)

In  May 1997, Israel’s state comptroller, Miriam Ben-Porat,   released a report lambasting the government’s decision to allocate funds to Intel. “The plant is due to cost Israel between $202 million and $231 million to build, according to conservative estimates,” Ms. Ben-Porat wrote. “Intel stands to gain at least $1.12 billion to $1.32 billion from the plant. It is not clear what Israel will gain other than additional jobs.”

Despite the criticism, the Israeli government still wishes Intel would ask for more public money to build more plants in Israel. In late June 2000, Israel lost the bid for a new Intel computer-chip plant to Ireland, due to a recent change in Israeli government policy which reduced the percentage of subsidies from 38% to 24% of the new factory.

“The opening of the new installation in Ireland shows that the Irish government is more responsive to changes taking place in the development market than other governments,” a senior Intel source told the Hebrew daily newspaper, Haaretz. At the time of this writing, the Israeli government is still figuring out how to entice Intel to build another plant in Israel- while at the same time how to avoid the outcry by the Israeli public if another huge grant like the one which allowed the creation of the first plant, is awarded.

Can there be instances where government support for private enterprises is acceptable- even warranted?

Allow me to take my “free market cap” off for a moment. Take the case of Tower Semiconductors, Israel’s sole chip factory. Founded in l993 and whose shares are traded on NASDAQ, the company wants to do what Taiwan Semiconductor did in Taiwan: become a leading center for the manufacturer of computer chips. By having a foundry plant in Israel the company claims many customers from Europe, who now have to go to Taiwan to get their chips manufactured, could become their customers as no foundry currently exists in Europe. The government is being asked to chip in (excuse the pun) $360 million in grants, and to guarantee a $450 million loan out of a total budget of $1.5 billion over four years. It will take a decade for the total investment to be recouped.

Supporters of the project claim that as the expertise will remain in Israel (unlike Intel, Tower is an Israeli company) and contribute to Israel’s national infrastructure by enabling the country to become a manufacturer of sophisticated chips. At least in Tower’s case, the money is being transferred from the pocket of the Israeli taxpayer to a manufacturing facility owned and operated by an Israeli-owned corporation. There is a difference.

Says Dani Goldstein, CEO of Formula Systems and probably one of Israel’s most respected high tech leaders: “If I had to chose between granting public funds to Intel or Tower, I would chose Tower. Why shouldn’t I, as an Israeli tax payer, not want to subsidize an Israeli company over a foreign company?” (Maariv, July 7^th, 2000)

Where Is The Payback For The Israeli Taxpayer?

Another critic of the policy of handing over Israeli tax revenues to foreign multinationals is Dr. Yossi Rein, a well known Israeli high tech business consultant. He claims: “I was at a meeting with the Taiwanese prime minister a number of years ago and he couldn’t understand why we give Intel money so that the value-added services become theirs and not ours. Taiwan doesn’t give financial subsidies to Intel to erect a plant. They do it themselves.” (Globes, July 18^th, 01)

While it was advantageous for Israel back in the early l980s to give cash grants to foreign high tech companies to establish R&D facilities here to put Israel on the “high tech map” internationally, 20 years later the policy is in need of at least serious review if not total elimination.  The problem is that many foreign companies do not go on to set up manufacturing plants in Israel after the R&D facilities are in operation because other countries offer lower labor costs.

“Israel should reconsider the benefits it gives to foreign companies, since international firms that establish local R&D centers do not create a significant number of jobs or generate sizable proceeds for the local economy,” says Giora Yaron, former managing director of National Semiconductor’s Israeli R&D center.  “For every dollar a U.S. high-tech company invests in a local R&D center, it generates $10 elsewhere. These companies end up removing their assets as well as the intellectual property created by Israeli engineers.”

One of the major problems of foreign firms being subsidized by the Israeli government to establish design centers and manufacturing plants in Israel, is that Israel is facing a dire shortage of high tech personnel. In the past few years, the booming local high-tech industry and the stampede of foreign firms hiring Israeli computer experts have caused a huge inflation of salaries. Experienced software and hardware engineers are earning $50,000 to $60,000 a year, compared with the $35,000 that a top-level project head was paid in 1992. Israel Manufacturers Association predict a shortfall of 10,000 engineers by the year 2002. While the downturn in high tech in 2000-2001 may alleviate some of the shortages, the steady flow of new engineers entering the sector in the decades ahead is by no means assured.

Dani Falk, executive Vice President of one of Israel’s pioneering high tech companies, Optrotech, believes that foreign high tech firms that set up development centers in Israel are not good for Israel’s long term technology future.

“While flattering to Israel, the issue is nonetheless problematic. Foreign companies set up development centers here. Paying very high salaries, they skim off the very cream of personnel in the technological world. But no sooner is the product developed, than production is assigned to some other country. In my view, a way should be found of linking investment in development centers in Israel with the establishment of manufacturing activity in Israel, or of extracting added value from such development, for example, in the form of royalties ultimately due to Israel.” (Globes, January 21^st, l998)

The issue of whether the government of Israel should provide investment subsidies and R&D grants to foreign companies is a complicated one for people like Hanan Achsaf, Chairman of the Board of Motorola Israel. As an Israeli, he wants to do what is best for his country. As a representative of a foreign multinational, his company’s interests must take top priority. Emphasizing that unlike many other US high tech companies, Motorola has many manufacturing plants in Israel, he claims: “Most companies are coming to Israel to set up R&D centers, but few are putting up a manufacturing base and even fewer are using Israel as a base for their exports.” (Globes, July 4^th, 2000)

Still, Achsaf fully justifies the spending of public funds to entice large multinationals to set up plants in Israel, saying:  “For every country it is very important that the foreign investors come, invest and produce more jobs for its citizens and so increase their standard of living. They need the help that foreign companies bring when they come in. There is competition between the various countries. You are competing against not just with Ireland, but Hong Kong, Singapore, Malaysia, Alabama, Georgia, and North Carolina. So if Israel wants to be part of the global competition for foreign investment it must provide the necessary incentives and economic conditions.”

Outmoded thinking is also part of Israel’s problem. For instance, when asked by Maariv on July 7^th, 2000, “What benefits does Israel derive from the cash grants it offers to foreign companies?”  Ran Cohen, the then Minister of Industry and Trade in Prime Minister Barak’s government, replied: “If these multinational companies come and set up plants here, it will signal great faith in the Israeli economy to other companies.”

With all of the excitement Israeli high tech has received in the past five years, with all of the US giants either operating a base here or busy looking for Israeli companies to acquire, does Cohen really believe that when it comes to high tech, Israel has a problem of credibility or faith? Our problem is how to keep these large multinationals from completely smothering us, not how to make them feel more at home here.

Why Does Israel Have To Subsidize Foreign Multinational Companies?

It is important to remember that these grants and industrial subsidies given to foreign companies (so that they will come here and we can hug them and they can tell us how much they love us and love our  “highly skilled, high tech workforce”) are funded with hundreds of millions of dollars of tax revenues which could be put to much better use either by leaving this money in the hands of the Israeli taxpayer or invest in education.

It is time the Israeli taxpayer woke up and took at long, hard look at how the government of Israel has been planning Israel’s “industrial policy” and how these directives are carried out.  For instance, in an interview she gave to Globes on November 12^th, 2000, Haviva Cohen, the director of the Investment Promotion Center at the Ministry of Finance (the cash register for all the grants the government gives out to establish new factories):

“We need to create in the Ministry of Industry and Trade a clear support plan for young companies, starting with the Chief Scientist and continuing with the Investments Center and other aid plans in the Ministry, such as training of human capital and marketing encouragement.”

Why she feels these activities should be supported with public funds, she never says. Such assumptions by our civil servants about how the Israeli taxpayers’ money is spent, should be challenged.

Cohen went on to say: “We used to think that Israeli companies were always our captives and would establish plants in Israel, but today we know that’s not completely true. More and more Israeli companies are investing overseas and acquiring overseas companies. The government grant is unquestionably a way of keeping them here.”

Apparently it has not occurred to the person who sits at the highest level of the “disbursement machine” that these companies are not in need of government hand outs to survive, According to Cohen, they are buying companies abroad and setting up facilities everywhere, meaning they are succeeding abroad and becoming multinational Israeli companies whose heart and soul will always be Israel, even if not all of their manufacturing plants are in Israel.

As a sideline to all this, in the last days of writing this survey a small press release appeared in all the business papers announcing that the Investment Promotion Center had just “approved a subsidy of $7.5 million to ICQ so they could continue software development in Israel.” Understand that ICQ was purchased in June l998 by American On-Line for $400 million. Yet four years later the government of Israel decided it was worthwhile for the Israeli taxpayer to give (i.e., offer, present for free as in a gift) AOL, whose market cap at the time was $12 billion, a present of $7 million worth of tax revenues so that the American company can go on having its subsidiary company in Israel, to continue to develop new software for the Internet.

What justification can our government have to provide these large sums of money (as a gift, not a loan) to one of the most successful high tech companies in the world? What would happen to Israel’s technology-based industries if this grant weren’t given, the money was returned to the Israeli taxpayer, and AOL had to pay full price for the R&D center it has established in Israel? How does the Israeli public benefit by handing over $7.5M of tax revenues to AOL?

Let’s remember, it is not just foreign companies that love to take Israel’s taxpayers’ money to set up a plant in Israel. Large Israeli companies are also encouraged to partake. In the second half of 2000, Amdocs, one of Israel’s largest companies traded on NASDAQ (even though it is not officially registered in Israel but is a US company), received a $30.7 million gift from the Israeli taxpayer because the company agreed to set up a plant in Ramat Gan to manufacture software. With 3700 workers worldwide, annual sales of  $629 million, net profits of $98 million, and a market cap of a whopping $16 billion, one wonders what would have happened if the generous Israeli taxpayer hadn’t come up with that gift. I think that as a corporation that sells products, Amdocs would have figured out that they need a plant to manufacture the software products they sell. But just in case they forgot, the Israeli government gave them 30 million reminder notes.

The Israel Export Institute’s “High Tech Program”

The requests for additional government subsidies just keep on coming- from Israelis as well. In late June 2000, at a business seminar in Tel Aviv, the Israel Export Institute (a government-funded organization to encourage Israeli exports abroad) deputy director-general Yair Ofek said that the chief problem facing start-ups is management and marketing overseas. He claimed: “For every dollar given to the Chief Scientist for technology development, $5 should be given for marketing, but at present, the ratio is the other way around: the Chief Scientist’s budget amounts to NIS 1.3 billion ($350 million) , while the Marketing Fund budget is NIS 180 million ($45 million).”

Did I hear this man correctly? He wants to give 6.5 billion shekels, about $1.6 billion, as freebies to high tech companies so they don’t have to spend so much of their investors’ or their own money on marketing? For the 1.5 million households in Israel, that’s $1000 for every family. Talk about generosity with someone elses’ money! The Marketing Fund, financed by the Ministry of Industry and Trade, assists exporting companies with their marketing programs. Ofek said new instructions should shortly be promulgated by the director-general, giving technological start-ups preferential treatment over other companies benefiting from the Fund’s assistance.

“The Ministry of Industry and Trade realizes that start-up companies should be given more assistance from The Marketing Fund than other companies. We requested that start-ups should immediately receive 75% of the $100,000 marketing budget. We argued about it, and they reduced the amount to 60%, half of which will be in the form of an advance payment.”

Ofek’s boss, Israel Export Institute director general Amir Hayek, says that the government should offer start-up companies assistance in two major areas: (1) Infrastructure, including investment in training and in penetrating new markets; (2) Risk sharing with the companies, including participation in insurance, such as foreign trade risks insurance. ”These are the only two aid types capable of ensuring growth,” Hayek said. “Everybody’s talking about R&D, which is important in its own right. However, research has shown that 85% of entrepreneurs have been trained in technology, rather than in marketing or business management. That’s why start-up people need a lot of assistance in marketing.” (Globes, July 19^th, 2000)

Hayek doesn’t believe that these costs should come out of the millions that these start ups are raising from venture capitalists, but rather the pockets of the Israeli tax payer. As for risk sharing with the company, one has to ask whether the companies are prepared to share their profits or the proceeds from the sale of the company with the Israeli tax payer that “shared the risk” for marketing and training?

One can only wonder what the response would be in Congress if the Commerce Department proposed that the US taxpayer give “marketing funds” to new start ups so they can “risk share” with these companies who typically raise $10-20 million in rounds of investment from venture capitalists?

Who Should Get The Dough?

But of course it isn’t only government officials who want to redirect Israel’s wealth into the pockets of industrial entities. Israel’s leading capitalists are also at the forefront of that effort.

In May 1999, a controversy arose in Israeli business circles over whether large companies in the Israeli economy should continue to receive funding from the OCS to carry out R&D. Despite the fact that R&D is the lifeline of any high tech company (without R&D a high tech enterprise will not develop the next generation of products and lose its marketing lead to companies developing new technologies), the captains of Israel’s high tech industries still want to award public funds to private companies for doing what they should be doing anyway: conducting R&D.

During May 1999 it was announced that the OCS was working on a new policy which would favor smaller enterprises over larger ones for the allocation of government grants for R&D. The larger companies claimed they weren’t getting their fair share of the pie, and that R&D grants to them go further as the companies are more stable than start ups.

The same month, one of Israel’s leading spokespeople for its start up sector, Mirabilis founder Yossi Vardi, came to the aid of his fellow start ups. He told Globes’ Ora Cohen :  “Allegations that big high-tech companies such as Motorola, are not receiving a large enough slice of the R&D pie, should be put to the public test. It would be good if there were transparency as to the size of the cumulative amounts that such companies have received over the past twenty years……“encouragement extended to start-up companies should continue, since they are, today “the glory of the State of Israel”.

(I will remind my readers that this is the same Yossi Vardi who a month later on June 21^st, l999 told the same newspaper: “certain start up companies manage even without government assistance.”)

Another supporter of increased government support to the “glory of the State of Israel” is Zohar Zisappel, one of Israel’s most successful high tech industrialists and together with his brother Yehuda, owner of Rad Industries, a high tech holding company. Through his statements, one can better understand how Israeli industrialists think.

Zisappel, who is also chairman of the Electronics Industries Association, blames the Ministry of Finance for blocking an increase to the OCS’s budget based on the claim that Israel’s high tech industry was succeeding and attracting vast amounts of private capital from venture capitalist funds. Says he: “Since industry is growing, in order to preserve the process, the Scientist’s budget, too, must increase by the rate of industrial growth”. (Globes, May 11^th, l999)

Such reasoning means that the stronger the industry the more the government is obliged to support it.  The Globes reporter asked Zisappel an intriguing question, one which I would have also asked:, “Why help industry succeed? “ Zisappel answered: “”Because national thinking on this matter is not necessarily identical with the thinking of the individual scientist. He can do as he pleases, and he will do what is best for him and his shareholders. But from a national point of view, it is worth the State’s while for him to invest in R&D more than he would invest if it were left to his discretion. It is estimated that the national return on R&D is two to four times greater than the yield to the individual enterprise”.

Estimated! By whom? Not once in my 18 years of listening to Israeli policymakers and industrialists pontificate of what the country needs to do to become richer, have I ever heard of a study to back up claims that the state benefits more from R&D than the individual enterprise Any calculation must include the public funds that are spent on R&D projects that are unsuccessful. Is enough return made on the ones that are a success to pay for the losers? Venture capitalists look for one big winner out of seven so that the losses on the six other companies can be repaid.

Another point to make is that Zisappel assumes, as does the OCS, that if a firm is offered subsidies from the government, it will embark on more R&D projects than if no subsidies are offered. Such reasoning would lead one to believe that there are no R&D projects carried out where there are no government grants to support them. The US, probably the world leader in R&D-based companies and in the creation of new start ups, has no such government subsidy to encourage private companies to perform R&D.

And it isn’t as if Israel is suffering from any lack of funds its government allocates to industrial R&D.  According to Israel’s Central Bureau of Statistics, Israel spends proportionally more on R&D than all other industrialized countries except Sweden and Japan with 2.8% of GNP invested in civilian R&D. So what is Zisappel complaining about?  

Shuki Abramowitz, the chief economist at The Manufacturer’s Association, also believes R&D subsidies are great because they help all companies. (Keep in mind that Abramowitz is representing the companies that are the chief beneficiaries of the state aid)

“State subsidies for R&D benefit the economy as a whole rather than just individual companies, as successful R&D also improves productivity and profitability in other companies in the field.” (Haaretz, June 15^th, 2000)

I, for one, would like to know how in this world this happens?  Do Israeli companies share the secrets they obtained from their R&D with other companies in the field? What does productivity have to do with R&D on new products?

For an encore, in mid-July, 2000, the Ministry of Industry and Trade announced that the new criteria for determining the allocation of R&D funding will be the project’s level of risk, not the size of the company requesting aid or its “proximity to the centers of power and influence.” The State will aid projects with high risk level,” said outgoing Minister of Industry and Trade Ran Cohen.  Cohen added that it is not the job of the State to finance safe projects and that the Chief Scientist, which allocates the R&D grants, was now more interested in high risk in order to encourage new and rarer development fields.

So now, instead of just backing out of the R&D game altogether and letting Israeli VCs finance start up companies’ development expenditures and larger companies’ their own R&D costs, this government agency will now be “risk takers” (of course with public funds) in order to “encourage new fields of development.” This means that the government feels it is in a better position to know what level of risk a project should be ascribed, and that it will now decide which areas of development will be important in the future.

So the government of Israel will now be the most risk-taking venture capitalist in the country and back R&D projects that nobody else will go near.

It would be nice if every once in a while the government asked the Israeli public what they wanted to do with their money and just how much risk they were prepared to take with their own funds.

So How Much Is Enough?

Nothing could be a more fitting conclusion to this chapter than the words of Comverse Technology chairman and president, Kobi Alexander. Before you read his words, remember that Comverse Technology is Israel’s second most valuable company with a market cap of more than $10 billion. The Chairman of this multinational firm has decided that the government of Israel owes it something, and if it doesn’t get it, it’s out of here. On July 12^th, 2000, Alexander held a press conference to announce publicly that: “Comverse Technology would not stay in Israel if it does not receive support from the State- either in the form of reduced corporate taxes or additional funds for R&D.”

“Israel should support a company such as Comverse, or Comverse won’t be here,” Alexander said in response to a question about why Comverse needed support from the State.

He added, “The State of Israel need not help us. We don’t deserve it. But if it wants us to stay here, it had better offer us adequate support - be it in the taxation process or through the OCS. If the State of Israel wants to attract genuine industries that generate employment, it should tempt them to stay on.”

Alexander also criticized the view that the State should support start-up companies rather than large companies: “Why support small companies? The amount of money on the Israeli capital market is unparalleled. If a company fails to raise funds, it probably doesn’t deserve to.”

There is only one word that accurately describes this type of industrialist: crybaby.

Keep in mind that Alexander said quite clearly that his company doesn’t even deserve the support, but wants it just so that his company will be “tempted to stay on.” He states that small start ups have no right to demand that the government subsidize their R&D expenditures because there is plenty of private funding in the capital markets, but somehow, in the case of his company, which purchases other companies for hundreds of millions of dollars in Comverse’s stock, has sales of $872 million a year with net profits of $172 million and nearly $800 million in cash reserves,  the Israeli taxpayer should cough-up its tax dollars to share Comverse’s R&D expenses and potential risks. Hutzpah!

One can only imagine the reaction of the business press in Sweden to a claim that Ericsson is going to leave Sweden if the government doesn’t give it more support? I’m sure that Nokia has never blackmailed its government into giving it more tax revenues, or it will leave? Where would it go? It seems only Israeli companies have somewhere else to go.

To be fair, not all Israeli high tech managers feel the way Alexander does and threaten to move their company unless more support is forthcoming. RAD general manager Efi Wachtel says that as his company sells its communications equipment in tens of different countries around the world, there is no place in the world where they are closer to their target markets than in Israel. “On the contrary, Israel is an excellent place from which to run a multinational company.  (Globes October 31^st, l999) )

The fact is if Comverse believed it would get a better deal by leaving Israel, either in subsidized R&D or lower taxation, it would have been gone long ago. It sticks around because it needs Israeli engineers to keep the company supplied with a steady stream of new products. Should it pay the Israeli people a dividend in the form of corporate taxes for this? You bet it should. That’s called payback. Or in the language Alexander’s language: return on equity.

What Alexander and many other Israel’s high tech leaders seem to have forgotten is that for the last five decades the poor Israeli taxpayer (and Diaspora Jews as well) has underwritten the cost of Israel’s technological infrastructure- the same technological infrastructure that created the brilliant engineers which made Comverse what it is today and which keeps it ahead of its competitors. We’ve seen how much money companies like Comverse have made due to their ability to exploit Israel’s sophisticated human resources. My only question is when does the Israeli people get repaid back for what they’ve invested into this and other Israeli high tech companies? When does their dividend come due?

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“About the only “added-value” with an Israeli venture capitalist is the 17% value added tax”      

‘An Israeli Entrepreneur’

Chapter Four:

Israeli Venture Capitalists and Their “Sense of Smell and Luck”

Any survey of Israel’s technology industries would be incomplete if it did not include a chapter on Israeli venture capitalists (VCs) and their impact on the local technology industry. While most media reports in Israel and abroad about the role played by Israel’s VCs are uniformly upbeat, this is so because no alternative view has ever been presented to the Israeli business press or government bureaucrats. While the Ministry of Industry and Trade lauds the sums of money the country’s VCs have brought into the country, as does the local business press, the real nature of what stands behind these investors- and their true goals- is rarely discussed. As the purpose of this study is to give the Israeli public the facts they need to better understand the current and future development of Israel’s technology-based industries, this chapter will discuss the harm the VCs have caused Israel’s technology industries over the past seven years.

While the Ministry of Industry and Trade is busy subsidizing the bottom line of multinationals with R&D grants, Israel’s VCs are taking these same multinationals by the hand and encouraging them to purchase Israel’s technological assets- sometimes on the cheap. While the VCs have much to gain when an Israeli company sells its technology to a high tech multinational, the big loser is the Israeli public. Unfortunately, until now, nobody has been worried about what is good for the Israeli taxpayer so that he receives a decent return on the huge investment it has made and continues to make in Israel’s technological infrastructure.

While currently there are about 100 venture capitalists operating in Israel with about $7 billion under management, before l993, there were only two groups of venture capital in Israel: The Elron Group and Verities. The Elron Group was led by Uzia Galil, and Veritas Venture Partners. For much of the first ten years of the life of Israeli high tech, this was all there was in the way of venture capital.

Then, in l992, the Israeli government adopted a measure by Yigal Erlich, then the Chief Scientist at the Ministry of Industry and Trade, to create a mechanism for bringing foreign venture capital to Israel. Called the “Yozma” program, (Hebrew for initiative) the government said to private venture funds abroad, “set up a venture capital fund in Israel and we’ll contribute 40% of the capital of the fund. If the fund is successful you can buy us out at cost. If it is not, we’ll take the loss.” Ten funds were created with a government outlay of more than $70 million.

The program was phenomenally successful and brought major names in the world’s venture capital industry to (invest in) Israel, including Walden, Advent, Vertex and Apax. The “Yozma funds” as they were called, were all capitalized at around $20 million and as investments in each company were quite small, most of the funds the government helped create did fairly well. Unlike most government programs, the bureaucrats at the Ministry of Finance decided to take their winnings and run: the program was closed down and the holdings in the ten funds were sold back to the funds. Mission accomplished.

Due to the huge number of acquisitions of Israeli start ups by US high tech companies in the past few years, the return on investment by Israeli VCs has been very good. (Take the acquisitions out of the pie and the numbers fall way down). According to Zev Holtzman of Giza (an Israeli VC fund), Israeli venture capital funds currently yield an average annual return of over 30%. (At least their investors are happy. My question is what has all this “new wealth” done for the Israeli public and Israeli economy?)

Israeli entrepreneurs are less content with the situation they must currently contend with. The abundance of local VC money hasn’t stopped Israeli start ups from seeking investment capital abroad as the prevailing attitude here is that if an American VC invests in an Israeli company, there will be more “added value” to the money “Smart money”, as it is referred to in venture capital parlance. The Israeli VC is often viewed by start ups as having less to offer the start up in the way of strategic contacts and lack the ability to help the start up “grow and mature.”

Matty Karp, senior partner at the Concord venture fund and one of Israel’s most straight-forward fund managers, reveals: “One of the main problems between funds and entrepreneurs is the eagerness of the funds to force decisions on the entrepreneur. The biggest problem is that these decisions don’t always come from people with a relevant background. A fund has to recognize the border between assistance and harmful interference. I recognize that investors have the duty to intervene when they think that things aren’t right, including application of pressure on the company.”

Enter into our story Chemi Peres, you-know-who’s son (Shimon Peres) and managing director of the $500 million Polaris Venture fund. Along with Shlomo Kalish of Jerusalem Global, he seems to have been appointed by the Israeli business press as the Israeli VC who wears the “think cap” when it comes to figuring out what is happening in Israel’s venture capital industry.

Peres is sometimes tricky to follow and one gets the feeling after listening to him that his concerns aren’t solely with the best interests of the Israeli public at large- as he would like us all to believe. For instance, at one investment conference in l998, he stated:

“Israeli high tech companies are persistently chasing investors in the US. The managers of these companies don’t understand that in order to build a serious industry, there must be a slower process of cultivating companies before going public with them on Wall Street or selling them to foreign investors.”

Peres believes that managers of Israeli high tech companies present short term thinking. According to him, they are guided all the time by thoughts of selling the company to American investors or taking their company public as quickly as possible, and “they don’t think one meter ahead of the exit strategy.”

Long term thinking, which he says should always be at the forefront for Israeli managers, is virtually nonexistent. Peres explains that in the years l995-l997, VC funds like his Polaris fund were interested in investing in high tech companies when they were at their later stage, when they already had an existing product and sales turnover of somewhere between a few million dollars and $10 million. However, the later stage market in Israel is very small, since almost all Israeli companies hasten to Wall Street when their annual sales volume is much lower than $10 million.  He says this puts pressure on the venture capital funds interested in investing in good companies. Since these companies don’t wait for the later stage, the funds are forced to invest in them at the seed stage, the start-up stage where the company does not yet have a finished product.

What Peres is saying is that the VCs would rather not invest in early stages where not only is the risk high, but the VC is needed to help the company grow. As Israeli VCs never could contribute this type of expertise, they avoided early stage investments until there weren’t many later-stage opportunities left and thus the valuations of the start ups became so high for second and third stage financing that it was no longer feasible to invest in them. While the VCs are themselves responsible for such a situation, as up until just recently Israeli companies only raised their money locally via Israeli VCs, nonetheless Peres would rather blame the companies and their search “for a quick exit.” (Peres has a habit of never blaming himself or any of his colleagues for any problems in the development of Israeli high tech, but rather, it always the entrepreneurs’ fault)

In this sort of investment climate, Peres notes, “sense of smell and luck” plays a more significant role, than it does in later stage investment. Peres referred to the problem at a national level and said a situation in which every company only wants to be sold or go public prevents the creation of a real technology industry.

“Instead of companies focusing on developing their business for the long term, which would create here an advanced industry that would contribute to gross national product and economic growth, the good companies are acquired by foreign giants,” he opines. “Afterwards, the manufacturing centers are changed into development centers, while the developed products are marketed by the acquiring companies’ marketing channels. Israeli companies should be aspiring to a situation in which they are dominant in the industry, and a scenario in which they are the ones acquiring foreign companies.”

Nice scenario. Trouble is Peres forgets to mention that it is the VCs themselves that have been encouraging the companies to take that quick exit. While he was manager of the Mofet fund before joining Polaris, Peres had some early success stories by selling Scorpio Communications to US Robotics, and at Polaris, cashed out nicely from its late stage investment in Medinol. But for the most part, its return on investment was made in pre-IPO investments and nothing at the earlier stage. I guess he is the most qualified to criticize Israeli companies for “selling out too early” as his game is pre-IPO investments- not building companies for the long term. “Smell and luck” may be part of the game, but the tremendous ability of Israeli engineers to develop cutting-edge technology (and then typically sell it to a large US high tech giant) is the real reason for his success as a venture capitalist and the phenomenal rates of return that Polaris has brought its investors.

One last quote from Mr. Peres. On February 2^nd, 2001. On that day he wrote an opinion piece for the online newsletter The Marker.Com, claiming:

“Going global means making the most of the Israel based hi-tech industry. Yet, this carries a great risk. Every country must bear in mind and by moving to the global market for lack of a substantial regional or local one, we risk losing our greatest assets. These include our technological developments. We should create a situation in which Israeli entrepreneurs will find it worthwhile to establish local companies, fit to compete in the global marketplace.”

For a investment manager who has made a fortune selling Israeli start ups to foreign companies, it is interesting to hear Peres express public concerns that Israel is at risk of “losing its technological assets”?

What Peres forgets to mention is that nearly every single VC fund today will not invest in an Israeli start up unless it is registered in Delaware so they will not pay 50% capital gains tax if and when the company is sold. About the last thing Israeli VCs care about is building companies for the long-term. Rather they are to be sold or taken public as quickly as possible to bolster their return on investment.

Says former Chief Scientist, Yehoshua Gleitman:  The funds should not set the government's agenda. It was a mistake in recent years to think that the high-tech industry should be viewed through the venture capital funds' prism. (Globes, November 11^th, 2001)

Successful Yes: But For Whom?

One of Israel’s most successful VCs is Erel Margalit of Jerusalem Venture Partners (JVP). Founded by Margalit in l992, JVP only invests in communications companies. The overall size of this market is what attracts Margalit in addition to the proven expertise Israelis have shown in everything from design of chips to IP over the internet and telecom software. The list of winners include: FundTech, Paradigm Geophysical, Summit Design, all IPOs; and Scorpio, sold to US Robotics for $75 million. Netro, a data communications company founded by Israelis living in the US. Chromatis Networks, which developed a unique data switch that can multiply capacity on fiber optic networks, was sold in June 2000 to Lucent for a whopping $4.5 billion (which eventually was reduced to $1.1 billion due to the downfall in Lucent’s stock), the largest transaction in the 53 year history of the Jewish state.

Margalit says that if you wish to become a genuine business center, not merely a development center, the entire Israel market should be directed towards this, including income tax authorities and all the factors involved. He adds: “They have to decide whether they want Israel to become a business center, engendering market leaders, or remain a development center.”

The problem is that for many Israeli start ups, the moment they begin their marketing efforts the “business centers” are moved off-shore to the US and Israel remains with the development center.

These are the facts of life as long as Israeli high tech is US oriented as opposed to Europe or Asian focused. As most of the money for the funds come from the US, Israeli VC fund managers tend to direct their portfolio companies in this direction. Until very recently there was only one stock market in the world that would issue shares of start up companies, NASDAQ. Today, that’s not the case. However for Israeli fund managers, the most important aspect of their business is to gain a presence for their companies in the US because that is most likely where the future acquirer of the company will be located. (Unfortunately, out of all those “business centers” in the US that the VCs and their companies were creating were not generating any sales. If you were an Israeli high tech start up and you were were created after l994 your goal was to sell out to a larger US company, or go public. Of the ones that go public few have done very well since l994 when the VCs arrived on the scene.)

While there are some very professional venture capitalists in Israel, and those would definitely include Erel Margalit  and Marty Karp of Nitzanim/Concord, (professional in the sense that they are more interested in objective criticism of them and their colleagues than boasting about their achievements) most Israeli VCs see themselves as being chiefly responsible for ushering in this great gold rush called “Israeli high tech”. With the profits they have made, they have crowned themselves the ones who should benefit most from it. Anyone who dares challenges their position or right to profit from Israel’s technological expertise, becomes relegated to “lower class investors.”

By late summer 2000, the new buzz-word in the venture industry was that there were too many venture funds, most would not make it, and in a few years’ time just five or ten mega-funds would remain. Of course this view of future events serves the largest funds like Polaris as the fewer funds there are, the more opportunities for the larger funds to choose from. In 2000 Polaris and Eucalyptus Ventures merged to create Israel’s first mega fund with more than $800 million under management.

Instead of appreciating that Israeli VCs need to specialize in certain fields, and that it is their added-value, not their size, that counts, the approach of two of Israel’s leading VCs is basically to de-legitimize the competition so all the best deals will go first to “the real VCs, not to the “smaller funds”. By doing so, the leading funds can continue to showcase their phenomenal rates of return-on-investment based on their strategy of investing in pre-IPO rounds of financing and then quickly cashing out.

Just so the public doesn’t see it that way, the managers of the new “mega-fund” had this to say to Haaretz on July 24^th, 2000 on the future of Israel’s venture industry: “Stupid money there will always be.”

The implication, of course, is that money from the mega-funds will be “smart money” that actually helps the company develop and grow.

By late 2000, another new “buzzphrase” for Israeli VCs was to establish an office in the Silicon Valley so that, as one of them says (Globes, July 25^th, 2000), “they can be closer to US VCs.” Such a strategy evolved from the Israeli companies’ need to find strategic investors to help them penetrate markets” viewpoint which the VCs injected into the high tech lexicon in the mid-l990s. Unable actually to help their portfolio companies build their enterprises, this buzzphrase was conjured up so that foreign multinational high tech companies would invest in Israeli start ups thus upping their valuations. Now, the “trick” is to interest American VCs in Israeli start ups so that they will invest in them and do the dirty work of helping them build up their US operations or prepare them for a US-style IPO on Nasdaq.

Building the enterprises they invest in never seems to be on the agenda of Israeli VCs.

So Have Israeli Venture Capital Funds Helped Israeli High Tech Develop?

The bottom line is this: In Israel, private investors can do just as much for a high tech company as an Israeli venture fund can do: not much. The only difference is that the private investor admits this from the start and the entrepreneur only finds out how little the VC can help much later in the game.

As a result, as the statistics demonstrate, the Israeli VCs may be losing their hold on the high tech investment market in Israel. According to statistics released in July 2000 by the Israel Venture Capital Association, in the first six months of the year the VCs invested $477 million in companies while non-VC investments (private investors, investment companies, foreign VC funds) totaled $809 million. In l999, out of a total of about $1 billion invested in Israeli high tech companies, the VCs comprised less than 50%. In the first half of 2000, that figure is down to about one third. The writing is clearly on the wall: Israeli high tech companies are searching for other venues of financing other than via Israeli VCs.

The most positive observation one could make about Israel’s VC community is that some of the fund managers have a keen eye and are good at spotting the winners, and thus have a sense which horse to back. However attributing the success of these companies to an Israeli VC may be going to far. In the US, VCs don’t just provide money; they help companies devise strategy, open marketing doors and find good people to fill key posts, etc.  Israeli VCs typically help in none of these areas. When it comes to fulfilling the role of a VC as the profession is practiced in the US, Israeli VCs don’t even come close.

What Israeli VCs have been good at is making money for their investors- in large part due to the large number of acquisitions that have taken place in their portfolio companies. While this undoubtedly makes them very smart investors, it does very little to bolster Israel’s technology-based industries. While the Ministry of Finance may be happy when a few more millions come their way via the capital gains that are derived from the owners and investors in these companies- the long-term viability of Israeli industry and the Israeli economy is the big loser. If the name of the game is not to build commercial enterprises, for the long term then the objectives are not serving national interests and should not be supported nor be held in favor by the general public.

However just so that everyone understands clearly which side of the table Israelis VCs are sitting at, I present this news item from Haaretz on February 25^th, 2001. In a letter to then Finance Minister Avraham Sochat, Yigal Erlich, chairman of the Association of Israeli Venture Capital Funds, warned that “as long as foreign investors in Israeli venture capital funds are subject to Israelis taxes, it will be difficult to continue to raise capital from abroad since foreign investors will prefer more tax friendly countries.”

In other words, foreigners should be exempt from paying taxes in Israel on the profits they earn on their investments. Or put another way, the Israeli public should pay for all the expenses of training its workforce and make the huge investment in technological infrastructure- so that the foreign investors can come here, hire a few fund managers to make investments and then initiate quick exits, without paying for the privilege of exploiting our technological environment.

I embarked on this study so that the Israeli public can determine whether Israeli VCs should be deciding what is good for the long-term benefit of Israel’s technology-based industries, or not. By now it should be painfully obvious which side Israel’s VCs are on. Don’t let them fool you with their lofty declarations that Israel will “lose foreign investment” unless the government gives into their demands. Foreign investors who exploit Israel’s technological infrastructure and profit from it should pay taxes, just as Israeli citizens are required to. Period.

As these words are written the current Finance Minister, Sivan Shalom, is being pressured by high tech leaders to propose legislation, which will establish an entirely new code of tax laws just for high tech industries. Considering how little high tech start ups contribute to the long term interests of Israel’s technology-based industries, you can guess who has the most to gain from a change in the current laws. The way the game of high tech is currently played out, only the VCs and their backers are allowed to profit.

How Israeli Is Chromatis Networks? Very Israeli

Unfortunately, Israeli VCs don’t feel the way I do about “sharing the gain” of Israel’s great resources of brainpower. They feel they should be entirely exempt from paying taxes on the gains they make exploiting Israeli brainpower.

In February 2001, it was widely reported in the Israeli press that Jerusalem Venture Partner’s senior partner, Erel Margalit, had made the colossal mistake of waiting rather than realizing the stock that it had in its possession due to the sale nine months previously of Chromatis Networks to Lucent. Meanwhile Margalit tried to convince the Israeli tax authorities that Chromatis was a US company and not liable for capital gains tax in Israel, and then Lucent’s stock tanked and the value of the deal sunk to $1B.

What is interesting about this whole affair is not the event itself, but an article that appeared in Globes on February 26^th in an extremely critical tone about Israeli VCs.

The writer, Eli Tzippori, took offence to Margalit’s claim that: “Chromatis is a US company that wanted to set up a large R&D center in Israel, but the entrepreneurs and funds are persecuted by the Income Tax Authority because one of its executives speaks Hebrew.”

For the first time ever, an Israeli VC was about to be raked over the goals in a Hebrew business publication. Tzippori reminded us that:

“Chromatis is an Israeli company that disguised itself as an American solely in order to blur its Israeli identify and increase its chances of finding a shiksa like Lucent (to acquire it).”

To hear an Israeli journalist speak in such harsh terms of an Israeli VC was simply not the norm in Israeli business journalism. Tzippori broke new ground, but forgot to mention that all of Chromatis’ “value” was created in Israel by Israeli engineers who were received their high level of educated courtesy of the Israeli taxpayer. No matter. He wasn’t finished pointing out to his readership just exactly what Israeli VCs are all about:

“One of the notable side effects of the market boom was the flowing of the venture capital industry. In recent years, venture capital companies marketed themselves as more than mere sources of capital but as financial deal makers, “added value” in their terminology. When the crash came, the venture capital companies were the first to take to their heels and flee. Their new economy is now saturated with tales of entrepreneurs abandoned by their backers.”

Well well. At least someone other than me has begun to expose Israeli VCs for what they really are about. However Tzippori wasn’t close to being finished:

“To some extent, the venture capital industry organized a cheerleading squad for itself and its demi-gods such as Margalit. The cheerleaders erroneously turned them into uber-managers of the Israeli economy. Under their adulation, Margalit and his colleagues began to pass out grades on the management of the Israeli economy. These new economy Ph.D.s had excellent ideas especially where their pockets were concerned. The idolatry of the venture capital managers created an illusion that the industry’s money was created by marvelous talents: Creativity, imagination, assertiveness and all the other mantras. A totally different impression now prevails: venture capital money was mostly created by luck.”

Or, their “sense of smell and luck.”

Eli Tzippori isn’t alone in his desire to expose the fraud behind the great profit-making capability of the Israeli VC. We can’t forget Guy Rolnik when he too tries to expose the bluff behind the phenomenon of the “Israeli VC”, when he wrote this column for Haaretz ( July 5^th, 2001):

 “Last week eMation merged into Nasdaq shell corporation Ravisent (Nasdaq:RVST), which had foundered after its own Wall Street issue. eMation's company value for the merger was a lowly $17 million, a quarter of the value at which it issued equity to the venture capital funds.

Why should a company ostensibly flush with cash, with 13 years of operations under its belt, sell itself to a defunct American firm so cheaply? Because it had to. In its transmogrification from PC Soft to eMation, it had turned into a cash crematorium. Within a year, it had lost $25 million. The hapless software house had lots of company. Plenty of hi-tech and computer companies got drunk on the easy money flowing like champagne, only to find themselves lying ruined the next morning in the gutter, dizzily mumbling computer code.

The venture capital managers blame the entrepreneurs. The companies should have cut costs and evolved with the changing market conditions, say the financiers. But they forget that they are the ones chiefly responsible for the turn of events in the hi-tech industry. The fund managers forget that they advised the entrepreneurs to secure as much capital as possible, and that they shouldn't bother their little heads about money.

They forget that they told the entrepreneurs to focus on time to market, to stop thinking small-time, to behave like the big boys in Silicon Valley and think big, outside the box, break the boundaries, and suchlike slogans. They forget they insisted they didn't want to see the company value double – no, that wasn't why they got in. They want to see it explode 10 or 20 times its original value into a billion-dollar company at the least. They forgot the role they played in inflating valuations and entrepreneurial egos, and in creating hordes of companies with megalomaniac plans and strategies.

At least they remember why they did all this. They wanted to raise big money for one fund after another. They wanted to show the investors and industry that they were wheeling and dealing in the big leagues, that they were movers and shakers.

The process of sobering up from the megalomania and easy-money culture looks to be fast and furious. Wall Street slammed the door, venture capital funds had to crash into lower gear and become far more selective when choosing investments. Companies had to change from visionaries to lean, mean producing machines.”

The importance of Rolnik’s criticism is that it can be applied to all venture capitalists not just Israeli ones. He of course was only describing Israeli VCs but the disease is universal. American VCs are not the “great company builders” the legends tell it as. All Rolnik has done is shrink the Israeli VC down to size with the truth. However the analyses could just as easily be made about VCs in the US.

Where do you think Israeli VCs learned the rules of game?

"The business of creating and selling start-ups is effectively dead. In terms of the national-industrial interest, the damage done to the economic and social fabric in recent years was devastating. It's unreasonable that the circle of beneficiaries was so restricted. An economy cannot be built on that. It causes greater harm than good." (Carmel Varnia, the current Chief Scientist,  Globes November 26^th, 2001)

Chapter Five:

The Great Sell Off

This chapter is placed after the section on Israeli VCs as it is the Israeli VCs that have been the chief proponents of the notion that it is good for Israeli industry for young companies to sell themselves to larger, predominantly US companies, rather than try to develop the business as an independent entity.

So while Israeli VCs are busy finding US high tech firms to buy their start-ups, the question the Israeli public should be asking is whether such a policy benefits the Israeli taxpayer and economy as much as it does the VCs and their investors.

During the past few years there raged a controversy in Israel’s high tech community about whether it is inherently better for start-ups to sell themselves out at a relatively early stage to large, US high tech enterprises, or, to build up the enterprise for the long-term.   While in the US buyouts of start ups regularly occur and are considered a successful exit for the investors,  whether selling start ups “hurt the US technology sector” has never been an issue. It is in Israel, where the government and some high tech analysts (such as yours truly) discourage companies from selling out too early. The argument is based on the notion that it is better for Israeli high tech companies to stay independent, increase their sales network and market penetration, and thus become  true multinational companies which will bring substantial wealth to the country in return.

For the purpose of this study, what is of interest is what will be the most beneficial to the Israeli economy: To sell off companies to larger firms, or to avoid selling them and instead, build them up so they become thriving independent enterprises whose headquarters are based in Israel. Ultimately, what good for Israel’s high tech industries is also good for the Israeli taxpayer.

However there are many sides to this issue. Consider that while Checkpoint may be deemed Israel’s most successful high tech company of the l990’s, its relative economic benefit and impact on the Israeli economy is much overstated. Now,  consider the sale of the Internet company Mirabilis to American-On-Line (AOL) in June l998.  The $140 million the treasury received by taxing the owners of the company on their capital gains was a much bigger contributor to the welfare of the Israeli people than the income tax levied on Checkpoint’s engineers who are domiciled in Israel.

Mirabilis is (was) a reality. It happened. It’s over. The state, along with the founders cashed in its chips and banked the profits. The people of Israel have $140 million more to spend on technological education.  (Unfortunately, the money went directly into the general tax revenues and is not earmarked for this purpose)  Most Israelis don’t enjoy the fruits of success of the Checkpoints. At least by receiving tax revenues when start ups are sold, all of Israeli society benefits from these companies’ technological achievements and these monies can be used to repay the Israeli taxpayers for the money they collectively invest in the country’s technological and educational infrastructure.

Thus it may very well be argued that from the public’s perspective, the best thing is too sell off start ups and register a gain by taxing the capital gains made on the sale by the investors and founders of the company.

That’s one side of the issue: instant tax revenues. The other side is the long-term viability of Israel’s technology-based sector.

The question is: do acquisitions of technology-based companies harm a country’s ability to build multinational corporations and provide different types of employment opportunities (not just for engineers but for management and production)? Without a core group of these multinational companies headquartered in Israel, how will Israel’s managerial and marketing expertise improve? And, how will the Israeli economy as a whole benefit from the success of its high technology enterprises if all the good ones are sold off at an early stage to foreign companies?

These issues are rarely incorporated into the public debate about whether selling off  start ups to foreign high tech multinationals is good or bad for Israel. The essence of the debate usually revolves around whether Israel is losing precious technology resources, rather than the social and economic benefits that could be lost when few companies feel the need to become multi-national enterprises. For the VCs the huge windfall is a given when the company is acquired. They are hardly a disinterested party. Yet it is their opinion and contentions that are presented in the Israeli business press. 

Are Acquisitions Of Israeli Start Ups Good For The Israeli Economy?

For those familiar with Israeli high tech there is no need to go through the list of acquisitions of Israeli start ups by predominantly US companies since l995. For those less familiar with the local industry, multinational companies such as Cisco, Intel, 3Comm, Boston Scientific, Lucent, Computer Associates, Johnson & Johnson, General Electric, AOL, Kodak, Nortel and Texas Instruments, have found nice pickings in Israel.

Instead of establishing strategic alliances- the typical route Israeli-American high tech cooperation took until the mid-l990s- the US companies found it easier to buy the company outright to avoid dealing with different business cultures. The Israeli companies and their entrepreneurs had been told by the venture capital fund managers and the foreign investment bankers that the country’s high tech experts that they could only survive in global markets with a major “strategic partner” with the marketing/distribution capabilities multinationals can offer. Thus they simply took the equation to its logical conclusion and sold out as soon as the offer hit the table.

For many Israeli managers, it isn’t just the money an acquisition brings that matters, but the “stamp of approval” of having made it. Israel is a fiercely competitive society where money alone is not reward enough. Accolades from friends, the press, and the government, are just as important. While in the early l990s it would have been considered “unpatriotic” to be acquired by a foreign firm, today it is viewed as a mark of success. The Israeli public can thank the country’s VCs for hammering this idea into the heads of the country’s entrepreneurs.

However sometimes it is legitimate to sell-out

In the fast-paced world of high tech, sometimes it is better to sell out. Take for instance RADNet, which developed a multiplexer in ATM technology (fast communication protocol). In September l997 it was sold to the German communications concern Siemens and Canadian company Newbridge, for $75 million. The company’s manager, Avi Domoshevizki, said one of the reasons the company decided to sell out early was that “an IPO would not take place before at least two years of sales.”

Other companies sold out for different reasons. When Ornet was sold to Siemens for $30M in l995 its owners believed that the company didn’t stand a chance of survival alone.  The computer communications market then was undergoing a structural change and control of the market was moving to a small number of large companies. Algorithmic Research, which was sold to the US firm Cylink in l997 for $82M, also believed it had no other option. The company was on its way to going public when it became clear that its encryption products were considered weapons in Israel and therefore are restricted for export. It was clear to everyone that without unhindered export, the IPO was destined to fail.  The entrepreneurs made an about-face, and decided to sell. (As a footnote to this deal, in 2001, Cylink decided to put Algorithimic Research up for sale for a quarter to one third of what it paid, citing the fact that the Israeli subsidiary never lived up to its sales projections).

For the US companies, the attraction to the Israeli market is that they can get their hands on innovative technology at a very reasonable price as many of the deals are paid for mostly with stock. For some, like Lucent Technologies, which in August of l998 acquired all the shares of data communications manufacturer Lannet Communications for $117 million, the upside is not just innovative technology, but complete product lines: “This acquisition helps fill an important space in our growing data networking portfolio,’’ says Bill O’Shea, president of Lucent’s Data Networking Systems group. “This move will help us offer a comprehensive LAN switching solution.”

Good For Whom?

That’s great for US companies like Lucent. However, the question some Israeli high tech analysts are asking is: beyond some instant cash, how are all these acquisitions benefiting the Israeli high tech sector and the Israeli economy?

In the Silicon Valley, such questions would elicit a chuckle: “It isn’t the role of entrepreneurs to worry about “national economic goals”. However Israel is not the US. Without a long tradition of individual first, national goals, second, Israelis carry with them five decades of patriotic/nationalistic thinking which sometimes makes it difficult to put the desires of the individual ahead of the state.

When the merger and acquisition (M&A) phenomenon began in Israel it was met with mixed feelings. The companies were elated, as were their investors. The government, (via the Ministry of Industry and Trade which deals with the promotion of Israeli high tech in the US) however, felt that “selling off the national technological jewels” was not in the national interest. Yet it knew that it couldn’t step in and tell companies like 3Com and US Robotics that they shouldn’t purchase Israeli start ups as the government’s overriding goal was to make Israel an attractive destination for investment by US high tech companies. So the government simply sat on the side lines and kept silent. Much of the opposition from the bureaucrats was effectively quashed when the government realized after the sale of ICQ-Mirabilis in June l998. The tax coffers would see a windfall of nearly $150 million- nearly the entire budget (for R&D) that the Ministry of Industry provides young start ups. Selling off “Israel’s national jewels” was no longer an issue.

At least not any longer in government circles. Privately, concerns began surfacing. Shortly after the Mirabilis deal in mid-l998, Nisso Cohen, the local representative of the US consulting firm IDC, wrote a think piece for the prestigious daily, Haaretz. In it, he lamented “the death of the Israeli high tech industry.”  By selling off high tech companies too early “the state of Israel rejected its golden opportunity to develop a genuine, mature, productive high tech industry.”

“We have stopped developing for the sake of exporting,” Cohen says. “We have stopped trying to build marketing and sales systems, because what’s the point in them anyway? What is the point in investing a decade in struggling to succeed in world markets if one can make tens of millions of dollars in the space of a couple of years without actually earning one red cent from sales?”

Cohen’s criticisms, the first hardcore comments to appear on the subject, were widely reported throughout the Israeli business press. Cohen also singled out Israel’s venture capital community, claiming that “the “welcome” phenomenon of hundreds of millions of dollars made available to start-up investments has become the scourge of the industry.”

Cohen blames the venture capital fund managers as much as the entrepreneurs: “The venture capital funds active in Israel today see only the short term of two or three years ahead. A start up company that fails to show the fund managers how to make a rapid return on their money might as well give up in advance.”

Another critic of the sale of Israeli start ups to foreign multinationals is Mike Eilan, former high tech analyst for Globes. He wrote:

“The companies that are acquired are usually one-trick ponies — good bearers of good technology that somebody else needs by yesterday, making it more worthwhile to buy than build. The more interesting companies have something far stronger going for them: Depth. Depth of technology which creates that only working formula that has ever made Israeli companies into world leaders in their particular industry. It is depth that creates barriers that competitors find difficult to overcome. It is depth that gives them time to develop the management, marketing and strategic alliances that are needed. It is also depth that creates a valuation high enough to provide enough time and money to do the very difficult job of building a real company.”

In his weekly column of April 5^th, l999 he commented:

“Israeli VCs bought into an industry characterized by incredibly bold people, from Efi Arazi onwards, who dared to challenge the world on its own home ground. They are reducing it to something that is good at pretending that it challenges the world, but backs off and sells out before the real confrontation. This means that they are not making use of one of the country’s main assets - Israeli entrepreneurs - whose gut and vision are the real engine of growth………But the collective and individual lack of vision that is making this an M&A shopping mall will have its results. In the late eighties and early nineties we used to sell Israeli high-tech with stories about major foreign players who had R&D centers here. That doesn’t wash any more because there are major R&D centers all over the world. Then we used to brag about the number of Israeli companies traded on NASDAQ, and point to the wonderful multiples investors got from them. There haven’t been enough of these of late.”

The Israeli VCs see things differently. In l998, Dr. Shlomo Kalish, then a general partner in the Concord venture capital fund, claimed: “the future of Israeli high tech is through acquisitions and there is nothing wrong with that because both the wealth and the jobs stay in the country.”

Not true. First, much of the wealth in these types of deals is made by the venture funds whose owners are predominantly US-based residents, not Israeli citizens. The founders do earn huge profits which are taxed in Israel. As for jobs staying in the company, this is debatable.

Take Cisco’s acquisition of HyNex, for example. In May 2001, just a year after buying it for $135 million, Cisco pulled the plug on HyNex, a developer of computer-access equipment. The Israeli company no longer exists and fifty people were fired. While HyNex’s investors did well out of the deal, as did the company founders, the Israeli economy lost 50 jobs that might not have been lost had the company remained independent. The same situation happened after Lucent acquired the wireless company Waveaccess, and then a few years later closed the company down when it no longer fit into Lucent’s overall strategy. Nortel’s purchase of Arnon Networks saw the same fate. As did when Lucent acquired Chromatis Networks. (Don’t get me wrong, I would rather they are not here at all, but as they are here buying up our best start ups. So closing down their R&D operations is not a bad thing for the Israeli high tech economy).

When Jerusalem-based Tradeum Technologies was sold to in March 2000 to the US company VerticalNet its lead investor Israel Seed Partners led a massive PR campaign in the Israeli business press telling everyone how  “Zionist” this deal was as the deal wasn’t a sell off, but a “merger into a larger enterprise” (an Israeli venture capital fund manager’s euphemism for ‘no longer existing’). The PR releases told of how VerticalNet will provide jobs by doing R&D in Israel.  Fourteen months later VerticalNet cut 35 positions in its Israeli facility- half of its workforce. I guess the “Zionists” in VerticalNet’s senior management in the Silicon Valley figured that of the company’s 1100 workers, the 35 researchers they employed in Israel weren’t that valuable to the company.

The Israeli public shouldn’t be naïve to think that acquisition of Israeli high tech start ups by foreign multinationals does not come at a price. There are plenty of downsides for the Israeli economy to encourage the sale of the best and brightest. Anyone who tells you differently has a special interest to protect.

Some Venture Capital Fund Managers Tell It Like It Is

Not all Israeli venture fund managers need to send out press releases to justify acquisitions of its portfolio companies.

Consider the views of Yaacov Koren of the Comsor VC fund which is partly owned by George Soros’ Quantum fund. Koren says outright:

“Very few Israeli entrepreneurs have what it takes to build real world beating companies. There are however many good opportunities for venture capitalists among other companies that will ultimately be sold to larger players abroad. Hence, it is wise to invest in these companies with the clear knowledge that they will be sold.”

The reality is that most Israeli start-ups will be sold to larger global players and they should be built with this in mind from the start- even if my colleagues in other funds would rather talk to the public about the absolute need of building great world beating Israeli companies.”

Adds Hanan Achsaf, Chairman of the Board of Motorola Israel: “There are some companies that would have disappeared if they would not have sold themselves.” (Globes July 4th, 2000)

Someone who has seen the entire development of Israel’s high tech sector from its earliest days in the late l970s, is Zohar Zisappel, founder of the Rad Group of companies, a conglomerate of high tech start ups with over $250 million in sales. He believes:

“For the nation, Zisappel claims “the sale of companies is not good as it amounts to selling one’s birthright for a mess of pottage. From a national point of view, an existing company provides employment for many other people who supply it with various services.”

Despite such sentiments, three of Zisappel’s companies have been sold; Armon Networks to Bay Networks for $36 million; Radnet to Siemens and Newbridge for $75 million; and Radwiz to the US company Terayon for approximately $50M)

He continues: “In Israel, in contrast to other countries that are rich in minerals, people’s heads are the national asset. From a national point of view, if you sell these ‘heads’, you are selling your birthright for a handful of silver. Selling a company is a partial failure, as it means you have not managed to conquer the market, and you have actually given up the struggle.”

Zisappel believes that the one thing that Israelis have a lot of is pride, which of course comes from the military service Israelis do. In the end, conquering the market and “winning” will be more important than the quick cash out. (Let’s hope for the sake of the Israeli economy, that he is proven right)

Another high tech manager, Dan Vilenski, who is chairman of Applied Materials (Israel) which acquired the Israeli companies Orbotech and Opal, contends “selling companies is good”. When he managed the BIRD Foundation (a bi-national institute for R&D between the US and Israel)  Vilenski says he encountered many Israelis who had the courage to develop a new product, but failed. He contends that foreign companies purchasing Israeli companies is positive as the multinationals better understand the market and as part of their organization, the Israeli start up stands an infinitely better chance of success. He says they also provide the start-up they acquire with a global marketing and sales infrastructure, which, as everybody knows, is a weak point with Israeli companies.

The problem with Vilenski’s arguments is that while Orbotech and Opal have remained as separate entities this is so because they were not acquired by Applied Materials when they were start ups, but rather, mature companies. Most Israeli start ups purchased by US companies are absorbed into the larger companies’ corporate structure- and disappear from the face of the earth. As Orbotech and Opal’s situation were different because they were public companies that had significant sales infrastructure and expertise, they were not dismantled. Applied Materials would have been foolish to eradicate an existing sales and manufacturing network that the two companies had built. However with most acquisitions of start ups by US firms, it is the technology which is of interest to the purchaser, not an existing sales network or track record.

The claim that by selling out, the Israeli company will “gain access to a large marketing infrastructure”, is nothing but a buzzphrase which is often used to justify the sale. The implication is that the Israeli company will earn greater profits by having access to this large marketing structure. However, the owners of the products will be the US company, not an Israeli entity or individual. The problem is, Israelis are no longer the owners of the company and thus will not share in any of the future profits.

Another downside to selling out is that the US company takes over the marketing of the product thus stripping the Israeli company of the opportunity to learn how to sell its own product. In this way, acquisitions stunt the ability of Israeli managers to learn how to market- and to be given the opportunity actually to do it. In this respect, selling out is a cop-out that robs a company of its future. If companies are created and develop their products strictly and solely on the basis that a large US company will acquire them, how many great companies will this country produce?

Another buzzword that is used to justify the sale of companies, is “merger” as opposed to “acquisition.” Somehow, we are supposed to believe that when Cisco with its $300 billion market cap buys Class Data Systems for $50 million in Cisco stock that a “merger” of the two companies takes place.

A claim that is heard in defence of acquisitions of Israeli start ups by American companies is: “This brings US-style management techniques to Israel.”

Hardly. The last thing the American company is thinking about when it acquires an Israeli start up for its hot technology, is spending time and resources training its new Israeli management.

I wonder how many Israeli entrepreneurs, who after being bought out by a US company, then set out to “learn about US management skills.” What most want is to fulfill the contracts they signed with the US company after the acquisition to ensure a proper transfer of the technology, and then leave as fast as they can to get on with a new project. Probably the last thing on their minds is to become “managers in an international high tech company” and have to answer to someone 20,000 kilometers away.

Can Acquisitions Benefit The Israeli Economy?

   In some instances, the acquisition of the Israeli start up turned out well for the company- but not necessarily for the Israeli economy. Witness NiceCom which was sold to 3Com in l994 for $53 million. Didi Arzi, former general manager of NiceCom’s parent Nice, says 3Com purchased NiceCom in order to do away with the competition.

“3Com’s products compete with the products NiceCom developed”, Arzi points out. “3Com reached the conclusion that the most economic way of achieving market control without having to battle NiceCom over market share, would be to buy out NiceCom.” Over the objections of some of NiceCom’s senior executives, we reached the conclusion that, strategically, it was better to sell the company and concentrate on Nice’s core activities.”  (Globes, July 29^th, l998)

Six years later, 3Com’s sales of NiceCom products alone amount to $200 million. The Israeli branch of 3Com could have managed output in the range of $100 million, providing jobs hubs. But now the US concern prefers to do its manufacturing at the Selectron and Gabil Tel plants in Ireland and France.

Some foreign companies do buy public Israeli companies to extend their market reach and not necessarily for access to the company’s technology. As was the case with the acquisition of Opal and Optrotech which left the two companies intact, as was the case with the acquisitions by US companies of  DSP Group, New Dimension, Oshap, Elscint, Teledata Telecom, and Memco, didn’t cause the reduction of local jobs or the transfer of manufacturing abroad. From a national perspective, these types of acquisitions aren’t as detrimental to the Israeli economy as the type involving the multinationals’ purchase of the Israeli company for its technology, effectively turning it into a division of the multinational with no independent life of its own. This type of transaction, in general, is bad for the Israeli economy as it sucks Israel dry from a managerial perspective, as it doesn’t allow Israeli managers the opportunity to build and manage larger high tech enterprises.

Some US companies have contributed to the Israeli economy in other ways. The software giant BMC purchased New Dimension in March l999 for $650 million. As New Dimension had more than $100 million in sales at the time, this acquisition was clearly different than most whereby the US company purchases the Israeli company for it state-of-the-art technology and either closes the company down, or transfers the key human assets to the US. BMC did neither. Instead it increased the number of employees at its Israeli development center by 50% to 470 workers, and then moved the Tel Aviv-based New Dimension to Tel Hai in the Galilee where employment opportunities in high tech are scarce.

Who Is The Biggest Promoter Of The Acquisition Of Israeli Start Ups Besides Israeli VCs?

The rapid pace of acquisitions in l998 and l999 put the Israeli government on the defensive. It loved the fact that so many international high tech concerns were finding good reasons to spend big money acquiring Israeli technology firms, however they were jolted by what the future could hold for Israel if the trend continued.

In mid-l999, former Chief Scientist, Dr. Orna Berry, announced: “The Israeli market is very small, and subject to wild fluctuations. At the moment, we are overshooting when it comes to selling companies to overseas entities. The proceeds is becoming an important element in Israel’s balance of trade, and 20% of Israel’s export is currently sales of technology companies.”

Adds Hanan Achsaf, general manager of Motorola Israel: “Overall, it isn’t positive for the economy to have so many foreign entities purchase Israeli start ups because the country will find it difficult to maintain its long-term relative advantage in technological development.” (People and Computers, April 19^th, l999)

Addressing the point, the Rad Group’s Zohar Zisappel says: “For entrepreneurs it’s not bad, for the venture capital funds it’s excellent, but it’s not good for the economy. You must remember that if there’s a depression, and the foreign company that acquired an Israeli company has to cut back - it will do so first of all at the periphery. The hardest blow will fall on the sites furthest away from it.”

This is exactly what happened when Nortel acquired Bay Networks which in l996 had purchased the Israeli start up Armon Networks for $36 million. When Nortel initiated cutbacks after a few poor performing quarters, the Israeli R&D center was the first place they looked. LSI Logic also shut down their Israeli R&D center when the cutbacks began. US Robotics didn’t even incorporate Scorpio Communications products when it was acquired by 3Comm, and Scorpio’s modems were left by the wayside (even though US Robotics paid $72 million for the Israeli technology). The same was true when Intel purchased Shany Computers in l994. Shany’s local area networking product didn’t even work and thus Intel just closed the unit down and admitted their mistake.

So while it is good that some companies are acquired as they would be unlikely to make it on their own, the opposite is true as well. There are many instances of companies that could have been great- but that instead fell victim to the temptation of the quick exit.

For instance, in mid-July 2000 US components manufacturer Conexant Systems ($2 billion in sales) acquired Novanet Semiconductor for $123 million in stock. Novanet specializes in developing high-speed components for Internet infrastructures and telephony networks.

This acquisition was particularly painful to me. First of all, there was no Israeli VC to blame for encouraging the acquisition, as Novanet was one of the few Israeli start ups that shunned Israeli VCs in favor of a strategic investor such as Ericsson, which owned 40% of its shares. What was so painful was that that Novanet was a company with superb management (I had met the CEO many years back when he was building up the enterprise and was very impressed with him) that seemed as if it was in it for the long haul. I guess the company fell for the temptation of such a large sum of money, and sold out. Pity, because it could have been worth billions one day. Instead, its fortunes will now be tied to a US company- and its stock price.

So Who Else Are Acquisitions of Israeli Start Ups Benefit?

How satisfying can that be for an Israeli entrepreneur?

One reason why start ups with a great future are selling out quickly is because the venture capitalist and investment banking community in Israel is encouraging it.

When asked by the Globes reporter on March 9^th, l999: “Are Israeli companies not being sold at unduly low prices?” Ron Lubash, the general manager of Lehman Brothers Israel, replied:

“A wonderful thing has happened to Israel: the development of a high tech economy. In the past five years, the Israeli high tech economy has become integrated into the global high tech economy. The current wave of sales and acquisitions is the final stage of full integration. The problem with integration is that there’s no going back. Either you’re in or you’re out. If you let entrepreneurs run ahead and develop, you can’t deny them the ability to take advantage of all the tools afforded by the international capital market: financial and strategic deals.”

In his view, the Israeli citizen should be tickled pink that its technology-based industries have now been incorporated into the “global high tech economy” even if that means the end of their existence as independent companies. As for his concern for “affording Israeli entrepreneurs the advantage of “strategic deals”, who is this guy trying to kid? The strategic deals he is referring to mean acquisition of an Israeli start up by a US giant. The giants have no interest in going into a joint venture with a tiny Israeli start up to sell the start up’s products or technology: it is much easier for them to buy the company and control the entire technology.

Lubash reflects current thinking in Israeli high tech investment banking circles and the message is clear: “Israeli high tech companies have no long term future so the only way to go is to sell out to US giants the Israelis will never be able to compete against the Americans so might as well sell out now rather than lose out later.”

Many in Israeli investment banking circles seem to have identified the problem accurately but have come to the wrong conclusion. Selling out isn’t the answer: building better enterprises is.

For the Israeli VCs, it is clear why selling their portfolio companies to foreign firms is desired. The fund managers are interested in one objective and one objective only, and that is to maximize returns for their investors. As Eddy Shalev of Genesis Partners so clearly states:

“M&As are the best exits because there aren’t any barriers on when we can sell the stock (as there is an IPO. The moment there is a sale of a company you receive cash and stock, and for us, this is excellent because at the end of it, our loyalty is to our investors and to bring them the most profits.” (Globes, August 2^nd, 2000)

True, and totally justified from where he is sitting. The problem is what about the other players in this game, the Israeli people, the technological infrastructure of the country, long-term economic growth? I don’t expect people like Eddy Shalev to worry about those issues, but certainly the government of Israel should. I do. They should. You should.

Somebody needs to or else Israel’s technology-based industries will come under the complete domination of American high tech companies. How is this so good for the Israeli public?

Instead, the Ministry of Industry and Trade is busy organizing trips for the US giants to come to Israel to “scout out the territory for acquisitions.” Who ever heard of such a policy whereby we tell everyone how much we need them because alone, we can’t survive in their markets and how we need to large US high tech companies purchase our start up companies?

The lesson to be learned here is not just for those concerned about the development of Israel’s technology industries, but observers and analysts in Asia and Europe. Don’t let the VCs take over like they did in Israel. Don’t allow US high tech companies to have free reign and take over whatever start ups look promising. Such activities are not beneficial to the population as a whole and ultimately, that is who should control a country’s technological resources. Encouraging start ups to “sell out early” will stunt the development and growth of local companies and the local industry so that it can’t compete internationally. This isn’t good. Big companies are good for a national economy and Israel needs big companies like any other country needs big companies. Period.

How The Israeli Public Can Fight Back

There is a way out of this dilemma Israel’s high tech industries find itself in. It is called “encouraging mergers internally and between Israeli and European start ups.”

Not all types of acquisitions are necessarily detrimental to Israel’s future technological direction. While there is no doubt the Israeli public is being shortchanged by the Ministry of Industry and Trade actively promoting the sale of Israeli start ups to American high tech giants, the policy can be counteracted by that same Ministry encouraging Israeli start ups to merge with each other, and for Israeli start ups to merge with European companies. Merging means you don’t sell out, but create something much larger. In Israel’s case, it means acquiring “a local market”, Europe.

Merging Israeli companies was always a difficult task due to conflicting egos and unfriendly tax regulations. However, a simple change in the tax code could give Israelis a compelling reason to merge their small companies and create larger enterprises. This is the answer to the threat posed to Israeli high tech from the US multinational.

The encouraging sign is that recently there have been some mergers between Israeli firms- usually when the management of the two companies realized that their major competitor was each other. This was the case with Optrotech and Orbit Instruments which controlled much of the market for automatic inspection systems for printed circuit boards. They eventually merged, and the combined company was later acquired by Applied Materials. Laser Industries and ESC, manufacturers of medical laser systems, decided to merge rather than compete. So did the telecom divisions of Tadiran and ECI Telecom.

In the past few years there has been a burst of Israeli acquisitions of Israeli start ups by established Israeli high tech companies. It began with Scitex acquiring Idanit, followed by Orcit (telecom) acquiring Silicon Value and EDSL, Geo Interactive buying Zapex and Orca, and the largest acquisition of an Israeli company yet by another Israeli company, Comverse’s $550 million purchase of Exalink in July 2000.

Is it better for an Israeli company to be acquired by another Israeli company?

You bet. The technology and management remains in the country. Would it have been better if Lucent bought Exalink (sold for $500M to Israeli company Comverse) rather than Comverse? More important, the acquiring company is by definition an Israeli one and thus becomes larger and can better compete in the international arena. Mergers or acquisitions by Israeli firms are the best way to protect Israel’s technology industries from being procured by US firms. If the policymakers and tax legislators really wanted to help Israeli high tech, they would create the proper incentives for more of these mergers and acquisitions between and by Israeli companies to take place. Suitable financial incentives such as a reduction in capital gains tax, or tax holidays, should be enough to do the trick.

Merging With The Europeans

Without a doubt, Israeli high tech has been “colonized” (albeit willingly) by American high tech giants and by the US investment bankers. Not many people out there would put it exactly that way, but that is precisely what is happening. Remember in the Preface to this study when I asked you to be kind to me and not to shoot the messenger. I didn’t create the current situation in Israeli high tech; I am just analyzing what is there. These are my conclusions. You can argue with them, or reject them, but you have to consider they could very well be correct. If so, the current trends needs to be reversed so the Israeli public starts gaining from Israel’s vast technological resources.

Don’t let those with vested interests hoodwink the Israeli public into believing that it is good for Israeli start ups to be acquired by US high tech giants, or that we have no choice but to accept this fate. The Israeli public owes nothing to the “globalization” trend that certain individuals are pushing. When the world becomes more “globalist” the bigger get bigger and the weak become even weaker. The same is true for Israeli high tech companies. As an Israeli citizen, I want to see lots of large Israeli companies, not Israeli-developed technologies in the hands of US multinationals. Call me old-fashioned, call me “anti-globalization”, but I simply like the idea of having an economy full of strong companies that sell their own products and employ Israeli citizens rather than worrying about how best to enrich foreign investors, multinationals, and Wall St. bankers.

Encouraging the M&A of Israeli companies by other Israeli firms and European entities would better serve Israel’s long term interests and create viable Israeli companies that would return much to the society which bred them. Better to have more Israeli companies that are independent, headquartered in Israel (or co-headquartered, in Israel and in Europe) and belong to the Israeli economy rather than as a division of a US high tech giant or in the portfolio of some venture capitalist in Palo Alto.

This is the Zionist in me talking: someone who believes that Israelis can (and indeed has) create great companies that are based in the country where the entrepreneurs are domiciled, and the country they so much want to serve. Selling out to foreign firms can be the best strategy as the company may very well never go anywhere on its own. However the goal should be to strive to build large, Israeli-based enterprises that are Israeli owned and operated.

In my view the Israeli public needs to take a close look at this issue as the future of the country’s technology industries is at stake. What should the government policy be on this issue to best safeguard the future direction of Israel’s technology industries? By no means should the current government policy continue whereby the Israeli government actively encourages US high tech companies to acquire Israeli start ups. Nor should the government subsidize US high tech companies (sometimes the same ones that are acquiring certain Israeli start ups) to persuade these foreign entities to transfer some of their R&D projects to Israel which will be manned by Israeli engineers which have been educated courtesy of the Israeli taxpayer.

The Ministry of Industry and Trade to stop “promoting and hyping” Israeli high tech companies- particularly the unproven start ups. Israeli high tech is not a secret and doesn’t need to be promoted- by anyone. What we have we have because we, the Israeli taxpayers, have financed it throughout the years by investing in technological education in public institutions and in the Israel Defense Forces. 

Chapter Six

Where Did All The Great Israeli High Tech Companies Go?

Okay, so now that I have finished criticizing Israeli VCs and exposed their preference for selling their portfolio companies to foreign multinationals rather than creating independent companies, here is my proof for this contention. This section of the survey will show how few great companies have been created since the big boom in start ups and venture capital began post-l995, and why this is so.

Every time an Israeli company approaches Wall St. for its IPO, there is euphoria in the Israeli business press. These start ups, which invariably haven’t much more than a few millions in sales and many more million in losses, are still just leaving the gate. Yet they are widely applauded by the press as having “made it” because they were able to issue their shares on Wall St.

The only problem is that what is good for those that promote Wall St. IPOs is not necessarily what is good for the Israeli public. These start ups are expected to perform like mature companies- right off the bat.

Most of these companies never amount to any great shakes. While a small number of US companies do okay after they go public, and reach sales of $30M in three or four years, Israeli start ups always have trouble jumping from a few million in sales to tens of millions in sales. Thus most Israeli companies perform poorly after their IPO, and their sales really never takes off. Only a handful ever break the $25 million in sales barrier- even fewer reach $50M, let alone $100M. As Israeli high tech business consultant Dr. Yossi Rein of the SBD Consulting Group, says: “Whatever we engaged in science, industry, technology- we need to reinvest the wheel. That the positive side. But when tit comes to managing the start ups or turning them into business successes, we’re big failures.” (Globes, July 18, 2001).

How Do Israeli IPOs Differ from American IPOs?

Some say the problem is that the VCs usually push them to go public as soon as possible so an “exit” can be shown and gigantic returns to the investors in the VC funds can be registered. While this is great for the VCs and their backers, it is terrible for the companies as they are not ready to face the responsibilities and burdens of being a public company. While this is true for American start ups which go public, it is even more true for Israeli companies which typically don’t experience rapid growth rates in sales as many of their US competitors do. Thus the Israeli firms don’t become the “darlings” of Wall St. Instead they quickly get relegated to the backburner as far as the financial analysts go. The result is a company with a so-so market cap, usually between $100-150M, which never approaches the level of sales their US competitors nor can they boast the marketcap that the American companies can.

Take Vocaltec, for instance, more than any other Israeli company, is typical of Israel’s experience on Wall St. in the l990s and of Israeli high tech start-ups in general. VocalTec pioneered the technology to enable phone calls to be placed over the Internet. Single-handedly, Dr. Ehud Ganor created the Voice Over Internet Protocol (VOIP) market. Fair enough- even if hardly anyone used the product his company developed for the first few years. The point is that because of pressure from the VCs, the company went public in early 96. It never fully exploited its early technology lead and today, five years after going public, the company lost $28 million on $26 million in sales and has just a $35 million market cap while its two major rivals boast billion dollar market caps. This is typical of Israeli companies: pioneer a technology but lose the window of opportunity to commercialize it and winding up third or fourth down the list after the US company takes over the sector.

Another good example is Orckit which also went public in 1996. Analyzing Orckit’s failure, Globes wrote on August 1^st, 2000 of the company: “The ADSL field was inherently difficult, even for companies with a technological advantage like Orckit had at the beginning. While Orckit didn’t try to market by itself, but through companies like Lucent and Fujitsu, the prices dictated by the large companies fixed low profit margins. At the same time, Orckit’s technological advantage evaporated.” On Orckit’s future, Globes wrote: “It could be that where Orckit is concerned, the train has already left the station. Orckit is not in an optimal position to be acquired. The company’s maximum price has long gone, due to the rapidly closing the technology gap and the current depressed share price.

In March 2001 the company’s market cap was just $28 million. Hardly a “high tech success story” yet according to the published record it is one of the feathers in the cap of the Israeli venture capital community.

So Just How Good Are Israelis At The High Tech Game?

Fact is, since the VCs took over the mantle of leading Israel’s high tech industries after l994, Israel’s experience on Wall St. has been very mediocre. Leaving aside the companies that were created in the l980s out of the picture, such as Comverse, Gilat, Mercury, etc., the group of companies that went public on Nasdaq after l994 consists of: Optibase, Radcom, RIT, Radview, Radware, Nova, Accord, Metalink, Paradigm, Viryanet, VYYO, Delta Three, Click Software, ESC, Fundtech, Floware, Breezecom, Jacada, E-Sim, Cimatron, Back Web, Orckit, and VocalTek. A few potential winners, such as Paradigm, ESC, AudioCodes, Breezecom and Jacada are promising, however there is not a Comverse, Mercury, Gilat or CheckPoint among them. The number of very good companies created in the past seven years is very small.

If you want to know the story behind many Israeli high tech IPOs ask Eli Zippori a writer for Globes. I mention Zippori because as a reader of at least five Israeli business sections a day for the past 15 years I have never heard anyone rake the so-called financial success of businessmen like the Zisappel brothers, Yehuda and his brother Zohar, as Zippori did on May 25^th, 00 in his newspaper.

The article, entitled, “Financial Charlatanism” was something of an indictment of most Israeli companies that went public on NASDAQ in the l990s: Zippori went through the list of Rad companies (Rad is the holding company the Zisappel brothers control to incubate their companies) that have been issued in the US: Silicom, RIT, Radvision, RadCom, RadWare. “Together, the five companies are worth less than $1 billion in market cap (they were worth $470 million on April 15^th, 2001), 8% of the market value of Check Point,” Zippori wrote. “This marvelous bunch had aggregate sales in the past four quarters of only $100 million, 40% of CheckPoint’s sales. Their combined net profit…excuse me, net loss, came to $5.4 million compared to a profit of $110 million for Check Point.” (My Footnote: In July 2000, Radwiz, yet another Zisappel company, filed for an IPO at a market cap of $200 million with $5M in annual sales)

Singling out the revered Zisappel brothers for churning out companies that can’t produce decent financial results after their IPO, is something one doesn’t see in the Israeli press too often. In the context of the larger picture, it shows how so-so the financial performance of Israeli high tech companies after they go public

Their Track Record: What Have The VCs Created In The Way Of Great Companies?

When discussing the success stories of Israeli high tech in the past decade, the name CheckPoint Software dominates. This is because there are no other examples to point to of a truly successful Israeli company. Apart from Gilat’s IPO in February l993, the only Israeli company to go public on Nasdaq and achieve a marketcap of $1 billion or more is CheckPoint.

Check Point has done so well because it was one of the few Israeli companies to come along since the early l990s to be perceived as being a clear market leader- not merely a company that pioneered a technology but failed to cash in on the marketing end- but that carried the ball the whole nine years. In its market, it is number one. This is recognized by all, and it is why their market cap on May 15^th, 2001 was nearly $15 billion.

One could argue that Israeli companies in general go public in the US, and never do succeed as their competitors in the US do- either from the perspective of leading their market or reaching hundreds of millions (rather than tens of millions) in sales. One could take that point further and argue that on top of this, Israeli companies backed by Israeli venture capitalists do worse than Israeli companies not backed by Israeli venture capitalists.

Other than Check Point, how many great Israeli companies were created in the l990s? Companies like Gilat and Comverse are not included as they were created in the l980s.

This question is important because in order to determine the overall success of Israeli high tech companies backed by Israeli VCs, the major success stories of the IPOs that were invested in by the VCs must be examined. Where are they?

So let’s do that. Let’s look at the list of Israeli companies that went public on Nasdaq after l993 and were backed by at least one Israeli venture capital fund.

**Amdocs: A phenomenal winner with yearly sales of $1 billion and a market cap of $15 billion. It was not even known to have any ties to Israel until just before its IPO. It is essentially a US company run by Israelis from the US. No Israeli venture fund invested in the company.

**AudioCodes A success story at a $382 million market cap. It only had venture money invested in it at the last round before IPO by Polaris. For its first five years of existence it was financed by DSP and then ECI Telecom. The only Israeli VC invested in the company is Polaris, which participated in the pre-IPO round when the company was fairly mature. It is highly doubtful whether Polaris influenced anything in this company or contributed anything to its success. It could be argued that the success of the company is due to the luxury of not having to raise money from the VC funds and could concentrate on growing the company.

**BATM: Surprise hit of the Israeli companies going public in London. It started on the AIM exchange and then graduated to the London Stock Exchange. In 2000 the company posted revenues of $91.9 million, with an operating profit of $8.4 million. Truly one of the great Israeli companies to be created in the l990s if profits and losses matter. You guessed it; no Israeli VC invested in the company.

**BackWeb: With a current market cap of nearly $86 million the company had a small amount invested in them in a pre-IPO round by the Evergreen and Polaris funds. However, nobody could argue that anything but the talents and perseverance of CEO Eli Barkat is responsible for the successful IPO of this company. Despite it initial success as a public company, and with all due respect to Mr. Barkat, company losses just keep growing with no pot of gold over the rainbow. Like CheckPoint, this company’s ultimate contribution to the stimulation of the Israeli economy is minimal. It may be considered a huge success in magazines such as The Red Herring and Globes, but if a company can not achieve significant profits three years after going public, when will it? My view is that if the company can’t show any real net profits, then even its $86 million market cap is highly inflated.

BreezeCom: Solid company that waited until it was ready before going public with $40M in sales. The market rewarded it with a $664 million market cap, and a secondary offering in August 2000 brought in another $200 million in capital. Its market cap was $213 million when it decided to merge with Floware which has a current market cap of $140 million. Like Zoran and NogaTech merging, the merger of BreezeCom and Floware is one of the most positive trends to develop in Israeli high tech.

**Checkpoint: Even if its $15B valuation is still somewhat exaggerated for a company that sold $425 million worth of software last year, nobody can deny that this is Israel’s greatest success story since Gilat and Comverse. It is worth noting Check Point was backed by BRM (then not operating as a venture capitalist but as a software house) and in a pre-IPO round of investment by US VC funds. Ultimately however, its benefit to the Israeli economy is limited as it employees 900 workers- with a portion of these being engineers based in Israel, but the majority employed in sales and marketing functions abroad.  How much benefit do they bring the Israeli economy?

**Comtouch: Huge winner for the five funds that participated in the pre-IPO round. The only Internet company other than Mirabilis that can be called a winner (at least for the VCs; certainly not for the IPO buyers or the Israeli public). The company was going nowhere after it was created in l991 to develop email systems for companies before the internet came along. It repackaged itself and wound up going public with low sales and huge losses in the “dot.com froth” in l999. In two years the company managed to accumulate $73 million losses, its stock is down to $1 and its marketcap is $8 million. In fact, like most high tech companies that go public on Nasdaq and then falter, the company can be considered a big winner for the venture capitalists, as they will typically have sold their shares within four months of the IPO.

**ESC: A big winner when it went public but taken a nosedive since then. It lost $67 million in l999 on $149 million in sales. Currently ESC has an $852 million market cap and recently acquired a major US competitor. Despite recent problems the company is a major player in its market, sees itself as an Israeli company, and employs hundreds of Israelis- in Israel and abroad. Without a doubt ESC is the type of successful Israeli high tech company that brings real value to the Israeli economy. Go to Yokneam just outside of Haifa and look at the factories with ESC’s name on the building. In July 01 after the merger with Coherent the company is called Lumenis.  The newly-named company with the Israeli company as the lead player in the merger, signs an exclusive distribution agreement with Boston Scientific to distribute its urological technologies in the US. A true winner and yet hasn’t received its due recognition as being a “Comverse” or a “Gilat”.

Most important for me and my fellow Israeli taxpayers is ESC’s great contribution to the local economy. Compare this company’s achievements in stimulating the Israeli economy with that of ComTouch or Backweb. ESC is the type of high tech enterprise that brings untold benefit to the Israeli economy. If you’re the average Israeli citizen you want lots of ESCs and less ComTouchs and BackWebs.  How much of this success is due to the sweat and know-how of the four Israeli venture capital funds that invested in the company is known only to ESC’s founders and senior managers.

Shimon Eckhouse is known to be a tough guy to deal with, but you got to hand it to this person. He has created sources of livelihood for hundreds of Israeli families which didn’t exist six or seven years ago.   Brilliant achievement that should be recognized by the Israeli public. These are the high quality Israeli managers this country is capable of creating and have created many times in the past. ESC also represents the various notions that Israeli companies must be headquartered and operated out of Israel if there is to be any benefit to the local economy. This notion that “for tax reasons we are forced to register in Delaware” is VC propaganda. Israel. ESC proves we can be number one and still be based in Israel. Why should the Israeli public settle for “quick sell-outs” when they can create world-renowned companies like ESC?

**Formula: Holding company of high tech companies managed by high tech pioneer Dani Goldstein. Market cap: $253M. No Israeli venture fund invested. Crystal and Forsoft, two other Formula-backed companies, have market caps of under $50M.

**Fundtech: Another minor-league winner with $33 million in revenues and a market cap of just under $116 million five years after going public. Like most Israeli high tech companies, Fundtech had a lot of technology and a mountain of potential, but remains number three or four in the market.

**Galileo:  Develops chips for communications systems. Had a $700M market cap when it merged in October 2000 with large US company. A genuine winner. One fund, Nitzanim, invested fairly early on. It has been so successful because from day one the company was always based in the Silicon Valley as well as Israel, and management of the company was always from the US, not Israel, which just dealt with R&D. It is certainly not an example of an Israeli high tech start up created after l993 that with the help and money from the Israeli VC, went public on Nasdaq. It was US-based and like Mercury and EFI knew how to exploit Israeli knowhow. If the Israeli funds made money on Galileo it is only because of the talents of the founders (one Israeli and one American) and their efforts to build a thriving company.

**Matav: Cable TV operator. Market cap of $290M. No VC money invested in it.

**Mercury: The company has a $5.3 billion market cap and is a US company started by Arie Feingold whose headquarters were never in Israel but whose R&D facilities are. Huge success after the rise and fall of Feingold’s previous company, Daisy Systems. Only one Israeli VC invested in the company, Veritas, and that was in l992 before the current wave of venture capital reached Israel’s shores.

**Metalink: Developer of chips for telecom applications with a $179 million market cap. Not a huge winner, nevertheless a winner for its pre-IPO investors from  the Evergreen and Vertex venture funds. Another company that made it to Wall St. without much help in its first five years of existence by any Israeli VC fund but instead, the Zispeal brothers personally. 

**Partner: cellular telephone service provider with a $735 million market cap. Like Matav, it is not a high tech company nor was it backed by an Israeli VC.

      ** Paradigm Geophysical: With more than $50 million in sales in the very unsexy field of software for oil exploration, this company has all the makings of being a big winner one day. Although, with just $81 million in market cap the stock has greatly disappointed investors, it is one of the more serious Israeli companies to come along in the post l994 era and has recently acquired other companies abroad to improve its marketing position. While essentially a software company that can’t contribute too much in terms of economic stimulation to the local economy via manufacturing jobs, it is creating many white-collar employment opportunities with its operations base in Israel.  In fact, this is more of a service company than a product company, and in services in general, Israel has done superbly and are very competitive since not all nations have the ability to design and build factories in Bulgaria and Poland like Israelis do. The service sector of high tech could be a huge return for the Israeli economy if the government supported these sectors rather than the VCs and their “phony baloney start ups” that are worth hundreds of millions but can’t earn a yearly profit. That is not what Israeli high tech was about in l985 and it shouldn’t be today. Service companies have to earn a profit or they couldn’t survive because no VC will invest in them. As far as new jobs are concerned, they are creating top quality jobs for Israelis at home and abroad. Compare what service companies like Paradigm are contributing to the Israeli economy, and then consider that it doesn’t cost the Israeli taxpayer one cent as in the case when the government on a yearly basis hands over Israeli tax payers wealth in return for the benefit of having Intel or Microsoft using Israeli brainpower to develop their products which are assembled/manufactured and sold by non-Israelis. For some lousy income tax proceeds from the workers in the R&D facility (who would probably be employed elsewhere anyway) the Israeli government hands over hundreds of millions of dollars to foreign multinationals so they will be convinced to come to Israel to establish a development center to exploit skilled Israeli manpower. Can someone tell me what does the Israeli public get in return for this? Hello, am I the only person who sees this or just the first? Is there any logic in such a policy that is based on “bribes” in a situation where the “bribes” are not even needed because Israeli technology is so good and everyone knows that.  Twenty years ago they had to bribe the companies to come. Today, two decades later, that policy remains in place. If anything is to change in Israeli high tech and revert to the direction the industry was taking in the early 90s, this insane policy the Ministry of Industry and Trade carries out year after year must end.  Nobody has to “bribe” multinational high tech companies that Israelis are good when it comes to “high tech”.

 If were so good in high tech like we think we are, why would we need to offer cash subsidies for these giants to come to our country and exploit our skilled labor pool? Does anyone have an answer to this question?

**Radvision: A Rad Group company which trades at a $150 million market cap. Besides Rad’s money, four other funds invested in the company at mezzanine rounds. It lost $2 million last year on $28 million in sales.

**Zoran- A designer of DSP chips, Zoran was backed by the Elron group not a local venture capitalist. Went public in l995. Market cap-$365 million. In summer 2000 it merged with the Israeli company NogaTech.

***

So, other than Check Point, and after Gilat’s IPO in early l993, Israeli companies have not been stellar successes on Wall Street. How much more true this is of the companies that were backed by Israeli VCs and that went public after l995.

Despite their lack of success-stories, Israeli VCs love to make nice sounding, sound-bite statements in  support of their profession, which they present as “building great companies.” In a round table discussion organized by Globes and published in its August 2^nd, 2000 edition, Yigal Lavana, the senior partner at the Neurone venture capital fund, declared: “The name of the game is to build successful companies that grow and are profitable.”

Could be, but Israeli VCs haven’t built many “successful companies” in the past five years. Out of the 18 companies that have gone public since l995 that had Israeli VC money invested in them, only two of them, AudioCodes and Galileo, ever actually made any money. AudioCodes had no VC money invested in it until its pre-IPO round.

As the ever astute Eli Tzippori of Globes wrote on February 26^{th, 2001:}

“The lawsuits now winding their way through the courts are gradually revealing the ugly side of the venture capital industry and arousing astonishment at the managers’ behavior and their contribution to the high-tech bubble and hullabaloo. The biggest wonder of all has not yet penetrated the public’s awareness: Who needs them at all?  No-one has noticed, but the two greatest success stories of Israeli high-tech in recent years didn’t bother with the “added value” of the venture capital funds, managing quite well without them. This may be one of the factors in the success of Check Point and Medinol, which have built thriving businesses in Israel, earning tens of millions of dollars annually. Although Gil Shwed brought BRM into the picture, this happened when BRM was considered a small company. It was thanks to the Check Point investment that it became a large and not particularly successful venture capital fund. Similarly, although Kobi Richter brought Polaris Venture Capital into Medinol, he threw it out again. Shwed and Richter were apparently sufficiently intelligent and dominant entrepreneurs not to become enslaved to the caprices of the Israeli venture capital industry’s easy money. “

Even In Selling Out The VCs Aren’t Much Help

Even when acquisition is the name of the game, being backed by an Israeli VC doesn’t necessarily mean a higher price.

To make this calculation, let’s remove Chromatis Networks from the equation. The reason we need to leave Chromatis out of the picture is not just because it was the largest acquisition of an Israeli start up- it was ten times the largest. Since the sales of the company the value of Lucent’s stock has tanked and the value of the deal is now around $1 billion. Prior to Lucent purchasing Chromatis, Exalink was acquired by Comverse Technologies in June 2000 for $550M and before that Vertical Net purchased of Tradeum Technologies (also without any sales) for $420M

Leaving Chromatis aside, between l996 and mid-2000, there were 22 acquisitions that involved start ups which VCs had invested. Another 14 companies were acquired in which no VC invested. Of the 22 companies in which VCs had invested the total price paid for all these companies (excluding Chromatis Networks) was $2.7B, about $120M per company. For the 14 companies sold in which no VC money was invested, the total amount paid was $1.6B or $114 per company.  By June 2000, of the total of twelve start ups acquired in the first six months of the year, only five had VC money invested in them.

What does that tell you? It tells me VCs sell companies for about the same price as non-VCs. Putting aside the issue of whether a $100M exit for a venture-backed company is considered respectable by the industry, the fact is that Israeli VCs are not better at their jobs than private investors and investment companies operating in Israel.

But aren’t VCs supposed to “add value” to their investments? Don’t young entrepreneurs come to them so they can help them build their enterprise and increase the value upon exit?  Perhaps, but not in Israel.

Are We Being Sold On The Cheap?

Worse than selling off the nation’s technological crown jewels, is the fact that we may be selling them too cheaply. At least two leading high tech figures, one from the US and one from Israel, think so.

Says Nir Barkat, founder of BackWeb: “American companies come to purchase Israeli companies because people here are prepared to sell companies that it would be very difficult to purchase in the US. If you have a company with an opportunity for a billion-dollar market, the Israeli mentality says that if you are offered a few hundred million in cash or stock, then take the money and run.” (Globes April 12^th, 2000)

Says David Helfreitz, general partner of the US venture capital fund Comventures which invested in the Israeli company Chromatis before it was sold to Lucent for nearly $5 billion: “It pains me to see Israeli companies sell themselves to US firms for $100-150 million. I don’t understand. Why do Israeli companies think they are worth less than their American competitors?”

While Helfreitz is saying Israelis are selling out too cheap, he is indirectly saying what Barkat claims: that US companies come to Israel looking for acquisitions because they know they can get the technology for less than they would pay in the US. The Israelis, and their VCs, oblige them by selling out cheap.

While the acquisition route has been chosen rather than the long-term approach of building up of a company to take it public with American-style IPO numbers, most of the acquisitions that have taken place in Israel had nothing to do with the active involvement of local VC fund managers. Typically the Israeli company comes knocking on the door of the large US firm with a request for a joint venture. When the US company realizes just how hot the Israeli company’s technology is, it figures, “why bother trying to be partners with a tiny little start up half way around the world. Let’s just buy the company.”

The founders of the company see a few millions in front of their eyes. They turn to their investors, the VCs, who tell them without the blink of an eye, “take the money and run” and the deal goes down.

In some cases, the eventual “sell off” is predetermined and incorporated into the investment contract the VCs sign with start ups before they are willing to invest. As former Globes high tech analyst, Mike Eilan, points out:

“Anybody who’s ever seen a term sheet knows that a venture capitalist effectively controls the company when it comes to major moves like a sale or IPO. Israeli VCs also prefer to invest in companies whose entrepreneurs are amenable to M&As. Entrepreneurs who want to go for the gold (i.e. building up the company for the long term rather than to sell out quickly) are often regarded as “difficult,” and nobody wants to be “difficult” with so many millions hanging in the balance.” (Globes, April 5^th, l999)

We Can’t Say Not To Cisco, Can We?

So one needs to wonder if it is the Israeli entrepreneurs, the US giants, or their venture capitalist investors that are encouraging them to “take the money and run” My view is that in the past it was the VCs urging the companies, and in the future, it will be the US company doing the persuading. This is partly due to the enormous respect any high level American high tech manager receives in Israel. The Israeli VCs, the government, the companies, and especially the business press are all flattered by US companies’ interest in Israeli high tech. So much so that when a company like Cisco offers to buy Class Data for a measly $50 million, the deal is done more because Israelis are enamored at the thought of being acquired by the leading companies in the information technology industry, rather than on the price offered.

Make no mistake about this. The US giants come here looking for technology bargains. Any sound-bites they may feed the Israeli press, venture capital funds and entrepreneurs are for show. Dirt cheap acquisitions are their goal.

Let’s hear what managers at Cisco think about what they see in Israel. Senior Vice President Dan Scheinman is deeply involved in Cisco’s “Israel strategy.” He says that, “Israel is a wonderful and exciting place to be and it’s a wonderful place for Cisco to look for technologies.” (Haaretz, February, 21^st, 2000)

So far, so good. Cisco believes it can access state-of-the-art technologies in Israel. The only question is, on what basis? He continues to describe his company’s “Israel strategy”: “Israelis are not good at establishing long-term companies.”

Wrong. There is a group of more than 30 Israeli high tech companies that are large, and successful, and are so because they didn’t sell out to a Cisco or a Lucent early on. Besides, how can they build a long-term company if companies like Cisco move in early on and acquire them? What the Cisco employee is really saying is, ”hey, you Israeli entrepreneurs, you don’t have a chance to make it anyway and become a big player. You might as well take the money now and run.”

He saves the best statement for last: “Israelis have an additional problem in that they are far away from their markets. This forces them to set up good sales facilities outside of the country. Cisco has a wonderful marketing operation and you (Israelis) have the technologies. It is a situation which everyone comes out a winner, in which 1+1=3.”

The way Scheinman puts it, you would think that Cisco is interested in mutual relationships in which it would market the products Israeli companies develop. Not true. Cisco is not a distributor of small start ups products. It doesn’t enter into “mutually beneficial, joint ventures” where it sells the product that the Israeli company develops. It buys the company and sells its products under its own name, reaping the great profits from the manufacturing and sale of the products.  When the US high tech giants come to Israel and start talking about  “strategic joint ventures with Israeli start ups”, they don’t mean the Israeli company will sell them products which they will resell. They mean they buy the technology and do all the selling.

Israelis fall for whatever the US giants say because, for the most part, Israelis have been impregnated with the notion that if foreign companies come to Israel to talk with them, “the foreigners must love Israel, Israeli high tech, their company and its technology.” You have to recognize the many years of craving for world recognition that is built right into the heart and soul of every Israeli and deeply ingrained in Israeli society fully to comprehend this unique mentality. As soon as the latest acquisition is announced the press spokesperson in Israeli embassies and consulates around the world is busy preparing the press releases to happily announcing that another US high tech giant has found something to its liking in Israel’s technology sector.

The government of Israel treats this type of transaction as a huge gain for Israel and a sign that it is “accepted” into the world’s economy. Whether it serves the best long term interests of the Israeli public is never part of the equation.

There Is Another Way

As sad as the current situation sounds to those of us who aren’t prepared to admit that Israeli companies can’t compete in world markets, there are still plenty of managers in Israel who think like Efi Arazi (Scitex) and Shlomo Burak (Optrotech) did; that Israelis can create multinational companies that sell their products to all four corners of the world.

While there is no doubt that it is the Israeli VCs which are cheering companies like Cisco on in their search for sophisticated technologies to acquire in Israel, for a core group of sophisticated managers of Israeli start ups, they will resist the suggestion of being acquired and instead go for the home run.

Here’s one example. On July 18^th, 2000, Globes reporter Zvika Paz asked Coby Rozengarten, the general manager of Saifan, which had developed a technology enabling normal manufacturing processes to increase Flash memory by up to five times without any substantial increase in cost, whether his company was “going to do a public offering just to satisfy his investors?” The fact that the reporter even asked such a question suggests the centrality of the issue of Israeli VCs urging their companies to go for quick exits- via acquisition or an IPO before the company is ready.

To the credit of Rozengarten, he answered, “The Israeli VC funds invested in our company don’t interfere directly with our activities. Pressure exists to exploit business opportunities (i.e. go public as soon as possible) and we feel the investors need an offering, but the floatation process will be aimed only at expanding strategic cooperation. We’re building a long-term company with value, not looking for quick profit-taking.”

Music to this writers’ ears.

People like Rozengarten are voting for doing it a different way and against accepting inferior status at the hands of the American giants. Israel has a core group of world-class companies (most of them from the pre-VC era before 1994) to show off: while most don’t sell in the hundreds of millions, or billions, many have done relatively well. Their record far exceeds what most European countries have done since the early l980s in high tech. We can do it. We can compete. We don’t have to give in and become colonized by American high tech companies.

Another example of an Israeli company that does not have an Israeli VC as one of its investors, and thus can think long-term rather than go for a quick sell-out, is Itamar Medical. The company has developed a non-invasive, finger-mounted probe capable of identifying and locating vascular malfunctioning. When CEO Israel Schreiber was asked by Globes writer Aviva Mishmari (May 10^th, 2001) if the company was positioning itself to be acquired by Medtronic (a large US biomedical firm which was one of the investors in Itamar Medical), he replied: “No, we want to be an independent company. We thought about it, and we want to build a proud Israeli company.”

People like Rozengarten and Schreiber prove there are still many Israeli managers who see the goal as building world-class companies, not selling out quickly at the first offer. Unfortunately, not many Israeli VCs feel the same way. 

Then Came The Internet

Nothing better demonstrates the Israeli VC’s overall approach than its investment in Internet companies beginning in l997.

It must be remembered that most high tech is bluff and hot air. Most sectors are touted as having multi-billion future markets that never materialize. From l998-2000 we all heard all about how the “internet is going to change our lives”. Today the buzz phrases are “optical networking”, “ASP”, “WAP” and “Mobile Commerce”. Before the Internet it was “voice recognition”, “pen computing”, “computer games”, “virtual private networks” and “CD-ROM/multimedia”. Every 18 months or so the investment bankers and research companies find a new area of high tech to hype the living daylights out of. The Internet was no different.

Internet hype, Israeli style, however, had its own set of rules and it began with Mirabilis. After Mirabilis was sold to AOL in Jun 1998 Yossi Vardi became a hero to a whole new generation of Israeli entrepreneurs who thought that all you need to make hundreds of millions is the belief that you know more about the future of the Internet than anyone else. Israelis have a history of this sort of arrogant thinking so it wasn’t too difficult for them to go to their local VC and tell them, “don’t worry about business models and how we will earn revenue, the Internet isn’t about that. Did Mirabilis have any sales when AOL bought it? It is a new economy now. Eyeballs are what AOL bought. All you need is to build eyeball numbers and I know how to do that”

With nothing more than this, Israel’s “new economy entrepreneurs” found it very easy to raise capital from Israeli VCs since nobody knew less about where the Internet was going then the VCs did. The VCs big mistake was to believe these arrogant pony-tails knew what they were talking about. If I was sitting in a VCs chair and someone told me how sales no longer mattered, I would have first twitched his earring and then showed him the door.

The end result of the tens of millions of dollars Israeli VC spent on start ups developing new Internet technologies was Mirabilis- and for this reason, Mirabilis was unique. It was Israel’s only big Internet success story (no Israeli VC invested in the company). This, despite the fact that Israel has probably developed the most advanced Internet technologies in the world, and continues to do so. Yet this was the only acquisition. The one major IPO of an Internet company was Commtouch which as I explained previously in this section, made back phenomenal profits for their investors, unfortunately the American public that bought their stock didn’t fare so well. Nor did the company which is awash in red ink and without much of a future on the horizon once its last $13 million in its bank account runs out at the end of 2001.

Why Weren’t There More Israeli Internet Winners?

One could argue that Israeli VCs were simply not up to the task. Either they didn’t have what it takes, or had no interest in trying.

When a Globes reporter asked venture capitalist Giora Bitan of the Giza Group on August 22^th, l999: “Don’t you have a feeling that Israeli venture capital funds have missed out on the Internet revolution?” Bitan answered:

“I don’t think so. I haven’t seen a single Israeli eBAY yet. In fact, with the exception of Mirabilis, I don’t know of any serious Internet company that’s not American, so it’s impossible to say that the venture capital funds have missed out on anything if no such companies have emerged. In the past year, to be sure, massive investments were made in the Internet sector, but their results will be visible only in a year or two. Even Kleiner-Perkins took two-three years to get eBAY off the ground.”

Bitan admits US venture capitalists get companies “off the ground” yet would never dream of doing the same thing with Israeli Internet companies. He’s absolutely right when he says that besides Mirabilis, there are no major Israeli internet winners. For a country that has developed some of the most innovative technologies and tools relating to the Internet, it has done a terrible job commercializing them. The reason, at least according to this writer, is because the US dominated the Internet and Israeli Internet start up’s had no help in penetrating the US market (or, in other words, in bluffing the public with hyped-up valuations that had no basis in reality, either way you want to say it.) Israelis VCs couldn’t fulfill this role for them like the typical US VC could for its portfolio companies.

In the last week of August 2000, Maariv wrote a weekend magazine article on the current state of valuations of Israeli high tech companies in light of the difficulties of dot.com companies to raise capital after the crash the previous spring.

Good old Chemi Peres and Shlomo Kalish. What would an article on the current state of Israeli high tech be without a quote from the crowned gurus of Israeli high tech? The Prime Minister and Foreign Minister of Israel’s high tech industries. Here were the two experts of the story in which the views of Kalish and Peres are predominately featured:

Peres: “There are Israeli companies that still have not understood that the market they are in is dead. In a few months companies will close down, a portion will be diluted, and a portion will have to totally change their business model.”

Kalish remarked: “We are seeing more and more that a big part of the failures of technology companies is a failure of the funds that invested in them.”

Interesting. Two entirely different views. Kalish is trying to tell the truth and remain discreet. He knows the real problem with Israel’s Internet companies is not the companies themselves but the VCs that invested in them. Peres on the other hand, is still blaming the companies and telling them, “you better ship up or shape up because you won’t get any more money from us until you can prove you deserve it”.

A few weeks before in Globes (August 3^rd, 2000) Ofer Segev, one of Israel’s leading high tech players in the accounting world, said of Israeli internet start ups: “Every Israeli dot.com company outside of Mirabilis, CommTouch and DealTime, is dead. Not a week goes by that five companies doing the same thing come through our offices- none of them have a workable business model, and there is more hype than there is a viable business.”

I assume that Mr. Segev’s firm had no trouble representing these firms to investors before Internet stocks took a beating. Like the VCs, there are lots of armchair high tech players who have all the answers- after the fact.

If Israel has lousy Internet companies that don’t have a prayer of ever turning a profit, then the company’s investors should at least share in the blame for the failure. Somehow we are led to believe Peres when he claims that it is the companies’ fault they got it all wrong and didn’t have a solid business model at the start. Yet the VCs invested in these shaky companies. So who shall we point the finger at?

I rest my case against Israeli VCs. Their spokesperson’s own words proves my basic contention that when it comes to being a “value-added investor”, Israeli VCs have never performed and have no intention of ever performing this function. What they have done, those with “stupid money” could do (the term the VCs use to disparage non-VC funding sources that ostensibly doesn’t offer any of the “value-added” that VCs provide).

There is a reason why so few great Israeli high tech companies have been created since the venture capitalists took over the ballgame after l994. Building enterprises for the long-term is not on the agenda of the venture capitalists because their game is short-term profits for their investors. Companies that seek their financing from sources other than the VCs have the luxury of building for the long term and usually end up creating business enterprises that are based in Israel, manufacture products in Israel, acquire foreign companies for access to the market, and create viable companies.

Chapter Seven

Israeli’s Technology-Based Business Is Every Israelis’ Business

High tech is an extremely important element of the Israeli economy and will be for years to come. Total sales have reached $11.5 billion including exports of $9 billion- 25% of the country’s total exports. In a report conducted for the Israel Democracy Institute, economists Yaacov Sheinin and Yossi Hollander predicted that in ten years Israel’s high tech exports will reach $37 billion and comprise nearly 45% of the country’s total exports of goods and services.

Yes, the high tech sector is important to the Israeli economy. It is so important that the Israeli public needs to be made more aware of the various issues facing this sector of the economy. This section of the study will look at some of these major issues facing Israel’s high tech industries.

How Many Start Ups Does One Small Country Need?

Over the past five years Israeli venture capitalists, government officials, and anyone else that had an interest in hyping Israeli high tech, would boast about the huge number of start ups in Israel, “more than any other place other than the Silicon Valley” the press releases would claim. While few people knew exactly how many start ups were operating in Israel, the more, the better.  Government sources would throw out figures such as 3000 and 4000 new companies, so as to justify their positive management of the economy as new company creation is always viewed by economists as a positive trend.

However, the exact number of start ups in Israel is an open question. Gilay Dolev, a former Tel Aviv stock market trader who now makes his living archiving Israeli startups as a partner in the high tech research firm, D&A, has Israel’s most comprehensive database of start ups- much better that of even the Office of the Chief Scientist in the Ministry of Trade. He puts the number at about 1,500, and adds: “There is no doubt, the government exaggerates this figure to encourage foreign investment.”

It isn’t only Israeli government bodies that talk about “3000 and 4000 start ups”. MATI, a non-profit organization that helps Israeli start ups get off the ground, often gives erroneous information to the press regarding the number of Israeli start ups. MATI claims there are 4500 start ups in Israel, of which only 1500 are registered and known to the public. It says another 1500 are operating in houses and garages across the Holy Land without anyone knowing about them but the five-member staff at MATI. Another 1500 or so are what MATI calls “secret start ups”; start ups that are not yet registered and are run by people who still work at their day job in anticipation of raising money and then they will register their start up officially. (Tassia, May 9^th, l999) (One has to wonder whether MATI’s staff has done a house-to-house search of Israel’s 1.7 million households to see in which garages the founders of these pseudo-start ups are hiding out.)

Unfortunately, bad statistics such as these with no basis in the facts regularly make their way into the Israeli and foreign business press.

However there is a downside for the Israeli high tech sector in having too many start ups.

Zohar Zisappel, chairman of the RAD Group and head of the Electronic Industries Association, says the high number of start ups “Aggravates the shortage of skilled manpower, as does the decision of the Ministry of Finance to encourage investment in startups at the expense of established companies. “ (Forbes, January 29^th, l999)

Dani Falk, executive VP of Orbotech, one of Israel’s leading high tech exporters, comments on the downside of the huge number of start ups:

“Israel may be nurturing a golem (monster) that could yet turn on its maker, to the point where the very survival of Israel’s high-tech industry is threatened. Start-ups are, without doubt, a tremendous source of pride, but we do not have the capacity to accommodate so many. The number of start-ups this country generates and the technological training it provides are very badly out of synch. This tremendous bottleneck is giving rise to cutthroat competition over manpower in Israel. The start-ups offer a dream, triggering a brain-drain from the big companies that draw the electronic export wagon.” (Globes, January 21^st, l998)

Intel Israel’s general manager, Dov Forman, charges that “Israeli start up companies are exhausting Israel’s high tech industry. I blame Israeli companies for expecting the state to educate its workforce instead of training in-house.” (Haaretz, July 18^th, 2000)

Says Gil Alon, Israeli representative of the executive search firm, Heidrick & Struggles: “It’s not just a waste of financial resources because there is no doubt that, in Israel, there are far too many start-ups. Every two individuals founding a start-up actually get resources that are given to companies, which, in the final analysis, will be medium size. This holds true for money, it holds true for other resources, and it holds true for people”. (Globes, July 19^th,2000)

Also convinced that the huge inflation in the number of start ups in Israel is not a positive trend, is CheckPoint’s CEO, Gil Shwed. This is what Israel’s most successful entrepreneur of the past decade has to say about the subject:

“There is a large inflation of start-up companies that have no raison d’etre and will not succeed. The reason is, of course, that they do not possess an idea for a sound business model. Added to that are all those instances of companies that have neither the talent nor the resources needed to get a company going.  I think that, at some point, the question of ‘why set up a high-tech company’ has become a bit shaky. It may have been once that people had a will to create, to innovate and to build, but today, in many places, I am seeing a gold rush, and in the long run, I have no doubt that it is not going to succeed”.

He continues: “Part of it is undoubtedly opportunism. The point is, however, that it is ridiculous for entrepreneurs to set up a company because maybe, by chance, some US company will get enthusiastic and ‘happen’ to buy it out. A company must create value for its customers and translate this added value into sales and profits, thus becoming a successful company.”

Many VCs put forth the notion that the large numbers of start ups pay for themselves as the government taxes its employees. The argument is flawed. The increase in start ups meant the government is required to invest in more infrastructure, clear more development for high tech buildings, build more advanced communications networks, etc. And besides, it isn’t as if the government doesn’t have to provide schools and roads for these workers as part of everyone’s “obligations” when they pay taxes for public services. Also, if these people weren’t working for a start up they would most likely be employed by another company and be paying income tax from that job. All that has happened is that a big chunk of the high tech work force left established companies to work for start ups. The size of the income tax pool that the government collects on their employment has not necessarily increased. Very few new jobs have been created that are involved in exports, manufacturing, or other clear benefits to an economy.

Lots of Cash; Not Enough Engineers

No doubt the most pressing issue facing the continued development of Israel’s technology-based industries is the future supply of skilled workers. You see Israeli VCs forgot to consider that the more start ups that are created, the more engineers are needed. As it isn’t the responsibility of private investment funds to spend money training workers, as a government cannot overnight just churn out more engineers from its publicly funded education and technological institutes, this didn’t materialize. Add in the government’s policy of encouraging US companies to set up R&D centers in Israel (because of the great qualities of the Israeli engineer) and presto. There is a shortage of software and hardware engineers in Israel.

The fact that the issue has taken so long to make it to the business press and the public eye is astounding. While the VCs thought they could go on creating companies indefinitely, they woke up one day and realized there is a finite number of engineers in Israel and the number of graduates is not growing at the same pace the number of start ups are. When prices of engineers rose it was okay because by l998 Israeli start ups were flush with cash. When it reached a point in mid-2000 when it was not longer a question of how much it would cost to hire engineers, but rather, if any engineers were available to hire, only then did the you-know-what hit the fan.

It isn’t as if Israel’s educational infrastructure can’t churn out a decent number of engineers each year. According to the Office of the Chief Scientist, in l995, there were 1,395 electronics or software engineering graduates. By l999, that number had risen to 2,510, and 3,480 are estimated to graduate in 2001. However, due to the huge increase in start ups, it is believed that more than 5000 will be needed by 2003 to keep pace.

For a look at this problem, we follow Globes’ Dan Yachin. He starts out his investigation on a negative tone- rare amongst the business press in Israel.

“To the observer, Israel’s high-tech industry undeniably meets the definition “thriving”, and unlike so many instances, the book can be judged by its cover. However, among the flood of headlines about offerings and capital, a few voices casting doubt over the industry’s future can be heard……..Last week, he (Koby Alexander, CEO of Comverse Technology) even threatened to move Comverse overseas, and this was not the first time he has spoken like this. When Alexander threatens - even when the threat sometimes seems like the regular chiming of the cuckoo clock - it definitely ought to concern anyone who considers Israel’s high-tech industry to be a national resource.” (Globes, July 20^th, 2000)

Even to suggest that a high tech leader like Alexander  “regularly cries wolf” is revolutionary in Israeli business circles. My hat goes off to Yachin already. He continues: ”What exactly are Comverse and the other members of Israel’s large high-tech club complaining about? What is the basis of the claim by a group, whose annual income is hundreds of millions of dollars, that the government is hurting their businesses? Is it possible that Alexander and friends exaggerate, and they simply want to get as much as they can? After all, although the government makes certain to put bureaucratic spokes in their wheels, the high-tech industry still manages to succeed.”

Alexander’s threats to move Israeli R&D offshore to India or Eastern Europe is an empty one. Those engineers simply aren’t creative enough to satisfy companies like Comverse. The problem isn’t the shortage of technicians or people to work on manufacturing lines in high tech companies- it is a shortage of people to deal with the compression algorithms and systems design- the software and hardware engineers.

Gil Shwed, CEO of Check Point Software, says that, “In a global economy, if the state doesn’t support its companies there is no reason why they won’t establish R&D centers abroad.”

That’s high tech mumble-jumbo and Shwed should know better. Who is he kidding? What country does he have in mind, the US? Does a manpower shortage not exist there as well? Will computer professionals in New Delhi or Warsaw solve the critical technological problems that companies like Check Point face? And what other country is stupid enough to subsidize R&D for foreign companies? Face it, when it comes to R&D, shortage or no shortage, this is still the best place for Israeli firms to be and the threats of “moving R&D abroad” are as empty as the Sea of Galilee will soon be if Israel doesn’t find a solution to its water problem.

Instead of threatening, the general manager of Mercury Interactive, Amnon Landen,  told Yachin:

“I can prove - and prove to the Americans too - that it is good to develop in Israel. We have more company loyalty than in the US, and there are salary differentials as well. The US is still too expensive.”

In other words, shut up and do the job with fewer engineers if need be. In Israel it is as good as it is going to get, and that is still better than in most other places.

It’s interesting to note that it is the huge influx of venture capital into Israel that created the shortage of engineers in the first place via the creation of more, and more, and more start ups. But it is the leaders of the established companies who are doing the most complaining because they have the most to lose as they actually sell products and need engineers to design and develop news ones to fill their distribution channels. Start ups have no such concerns as they produce very little in the way of finished products.

National Defence Versus The Needs Of Start Ups

The acute shortage of manpower sent representatives of personal agencies prowling around army barracks. They were armed with attractive offers to entice soldiers that had enrolled in engineering courses after their basic tour of duty to break their contract they had signed with the army so that they could join a well-financed start up.

This is a good example of how the goals of the VCs and their investors and that of the Israeli public, are in direct conflict with each other. While a few articles have appeared in the business press calling attention to the problem of the IDF’s best and brightest being poached by the private sector, the horrifying trend continues unabated. It has some senior officers very worried. Says General Aharon Zeevi of the IDF’s Logistics and Technology division:

“If the raiding of IDF personnel by the country’s start up companies continues, Israeli industry will be the ultimate loser because it will harm one of the building blocks of Israeli industry for the past 20 years: the supply of talented engineers with hands-on experience in certain strategic areas of technology related to national defence. The Israeli public needs to be made aware of what is happening and how if this continues, it could rob the country of its “relative advantage” in developing weapons systems that are required for the defence of the country.  The civilian industry stands to lose as well if it continues to “overpick” the fruits of the tree that has supplied the companies with their own relative advantage.”   (Maariv, November 7^th, 2000)

Unlike Israel’s VCs, or foreign investors in Israel’s high tech industry, the Israel Defence Forces is more concerned with Zionism than making money. When asked by a Globes reporter on November 8^th, 2000 how the Israeli army was dealing with the fact that so many of the people serving in senior positions in the famed, MAMRAM unit of the IDF,  Colonel Zev Gleichman responded:

“First, I admit the problem is difficult on several fronts. One, unashamedly, is Zionism. I’ll tell what a lieutenant said to a delegation when he was asked him why he is staying in the Army. He said that if he were to work for a company and it went bankrupt, he could move to another one. But if the Israeli Army collapses, he does not have another country. People understand that we are dealing with matters that directly contribute to the security of the State. This affects some more than others.”

Listen Carefully To What Israeli High Tech Leaders Say, But Don’t Always Do What They Want

Let’s listen to what some other captains of Israeli high tech have to say about what the future should hold for Israel’s high tech companies.

Let’s turn to Nir Barkat, who along with his brother Eli founded BRM in the late l980s to develop a family of virus protection software products. In the early l990s the brothers gave early backing to Gil Shwed and his two partners so they could create Check Point Software. With about $200 million they made from their investment in Check Point, the Barkats created BackWeb, which develops push technologies that uses the time when an internet surfer is not receiving information to send other data to the individual PC. The company went public on Nasdaq in June l999 and soared in value to $2b before settling back to its current $87M marketcap.

Barkat claims the government of Israel is forcing entrepreneurs to set up their companies in the US due to Israel’s draconian tax and corporate laws. He has the right idea when he says:

“The government has to do some reassessing: there is a brain drain of the best Israelis who are fleeing to the US; registering successful companies there and paying taxes which in the end help build educational and health institutions in the US. Wouldn’t it be more worthwhile if they were paying all that money to the Israeli come tax authorities?” (Haaretz, April 9^th, 2000)

Many of the complaints Israeli high tech leaders like Barkat have are over recent changes in the corporate legal structure which they claim will hurt Israeli high tech companies. Under the new Companies Law, every company, depending on its market value, has to have one or two directors who receive neither salary nor options so they do not have any “interest”. But they are exposed to class action suits by angry shareholders.

“Do you know anyone who might want a job like that?” Barkat rhetorically asks. (Globes, April 12^th, 2000)

Dani Goldstein is the founder of Formula Systems, a high tech holding company which has spun-off Forsoft and Crystal which are public in the US as is Formula Systems. Goldstein is one of the most serious professionals there are in Israeli high tech and his company has been around since the late l970s when it was one of the founders of the software industry in Israel. When he speaks, you better listen because this is a man who knows what he is talking about if the subject is Israeli high tech.

He says: “A major problem is the issue of options to employees. Under the current law, a company wishing to issue options to employees, whether public or private, is required to prepare a prospectus. The law insists on treating the offer of options to employees like a public offering, even though no money is being raised. In addition, when shares are received via a merger or acquisition with a US company, the taxes must be paid at time of the event, not when the shares are realized or sold.” (Globes, March 23rd, 2000).

Like Israel’s high taxation, these laws need to be reformed. The Israeli public should listen attentively to high tech leaders like Barkat and Goldstein, and accept their view of the government’s need to be more attentive to their unique situation in which they have to compete against US companies who are governed by a different corporate legal structure. What worries me is the “high tech is special” argument that they like to tout to ensure that the laws that are changed and taxes lowered are only for their sector of the economy and not for everyone.

What Really Drives Those Start Ups Away?

Accounts and lawyers who represent Israeli high tech companies are another group who pontificate about what is good for Israeli high tech. They too, have their own vested interests as they have experienced tremendous growth when the goldrush of start ups began after l993

Let’s listen to what Avi Berger, a senior partner and owner of the Kesselman & Kesselman accounting firm, the Israeli representative of Price Waterhouse Coopers, had to say in a lecture he gave to the annual convention of the Accountants’ Association in l999. He claimed: “In Israel there is enormous growth in the establishment of high-tech companies, but due to the restrictions [placed upon them] they are fleeing abroad.”

Not entirely true. They are not just fleeing abroad to escape the long-arm of the Israeli taxman, but rather to the country where Israeli venture capitalists want them to be located so as to attract US venture funds to invest in these companies at higher valuations than the Israelis VCs paid. Very few start ups ever do pay taxes- to any government, so high taxes alone can’t be the reason. Granted income tax in Israel is higher than the US but the direct labor cost of an engineer in Israel is lower than in the US so the actual cost of the engineer to the employer is still lower in Israel than the US.

According to Income Tax Commissioner, Yoni Kaplan, “the real reason that high tech companies are leaving is that the market for the product and investors in the company is overseas. The tax environment in Israel is only the third factor after these two.” (Globes May 3^rd, 2000)

Liana Ezra, a CPA in the accounting firm of Somekh-Chaikin, says that Israeli high tech companies are fleeing because “an Israeli company becoming a US company can issue their shares on Nasdaq at higher multiples than those of an Israeli company. The second reason, is taxation problems.”

As a final comment on this subject, let’s listen to the words of Chemi Peres of the Polaris fund (Haaretz, November 24^th, 2000)

“Israeli high tech industry is no longer “Israeli” and is in the process of becoming foreign-based, calling this, “a catastrophe”. “There isn’t any local high tech industry in Israel as Israeli high tech companies should no longer be considered “Israeli” as they are no longer interested in being based in Israel.”

As I have stated previous in this study, Mr. Peres never seems to have any blame put aside for him and his colleagues. If companies are “no longer interested in being based in Israel” it is because the VCs that invest in them warn them that unless they register in Delaware, they won’t invest.

Peres claims that only the government of Israel can change this situation by changing tax laws to enable companies to freely give their workers options so they won’t feel compelled to register their companies abroad. Peres says only by this will Israel be able to create a “genuine high tech industry”.

Peres conveniently forgets to include under the banner of “Israeli high tech industry” ECI, Tadiran, Scitex, Indigo, Gilat, Comverse, and the rest of the Israeli high tech companies which are based in Israel, operate from Israel, aren’t fleeing Israel because of “options” and are some of the pillars of the industrial landscape in Israel. When Peres refers to “Israeli high tech” he means the start ups, his business.

Israeli VCs should not be presented in the local business press as “representatives of Israeli high tech” when in fact, they represent the interests of their investors and no one else. What is good for Chemi Peres and his investors isn’t necessarily good for the people of Israel and the long-term interests of Israel’s technology-based industries. Peres can wrap himself around the Israeli flag all he wants to present his views to the Israeli public, but the public shouldn’t be so naïve as to accept them as “objective”.

Can Israeli High Tech Companies Still Manufacture Products Competitively?

The VCs have no interest in a company that intends to manufacture its products because that would mean that the company isn’t preparing itself to be sold off, but instead intends to be in the game for the long haul and to build-up the enterprise.  One VC of a major Israeli VC fund told me quite frankly: “We don’t consider investments in companies that intend to manufacture. It is too messy. Too much of a risk having all that raw material sitting around in storerooms.”

Since the Internet came into fashion, the notion that Israel can’ compete in manufacturing has been enshrined in the minds of the new generation of Israeli entrepreneurs (guess by whom?). The prevailing attitude now is that “Israeli start ups can’t compete in manufacturing, so it must concentrate in industries where only “intellectual property” matters; thus Internet, software, communications, etc.

One can’t help but get the feeling that the Israeli public is once again losing out by these short-term perspectives. The fact is, many Israeli high and mid-tech companies manufacture their products in Israel. The higher the price of the product, the less reason there is to manufacture it elsewhere. While in some instances the choice is either to manufacture it off-shore or simply not be competitive, in as many instances the issue isn’t a few cents here or there, but the quality control and having management be as close to its manufacturing lines as possible to incorporate changes rapidly.

When he was asked at a press conference why the company still manufactures its products in Israel, Friendly Machines general manager (the company developed a lawn mower that mows the lawn by itself and is one of the few Israeli companies that is marketing a consumer-oriented high tech product) Udi Peles replied: “Because we need to be on top of our manufacturing to be able to adapt to any slight changes in the marketplace. Besides, the relatively high price of our products and mark ups doesn’t put us into a category where we have to worry about a penny here or a penny there in production costs.”

Peles is somewhat of an exception to the rule in Israeli high tech circles today, a manager who believes not only in its ability to build his company’s marketing infrastructure abroad and become a multinational company, but in his expertise in manufacturing sophisticated products that exist in Israel. A real “captain of industry” of the sort that is has been in such short supply since the VCs started leading the way for Israel’s technology-based industries.

To get a fresh perspective on what Israel’s future technological playing field might look like, let’s turn to former Globes’ high tech analyst, Mike Eilan. 

“There is a big gaping hole in Israel’s industrial landscape. With the major exception of the defense industries, there are just not enough medium-size industries with high enough added value. There are just not enough factories producing goods with a high technology component that doesn’t change every six months. These are the kind of jobs a socialist minister should seek to create. Such jobs would then form part of the technologically oriented manufacturing backbone that high-flying start-ups currently lack. Start-ups would behave differently if they had a manufacturing backbone behind them. One of the biggest fallacies in Israel’s technology industry is that we have lost the capacity for “any kind of competitive edge in manufacturing”. It arose because our manufacturing industry, or most of it, is still in a time warp. There are plenty of tech factories in Germany, Japan, the United States, indeed throughout the Western World, that have not lost their competitive advantage. They succeeded by staying ahead of their time and finding niches where their high labor costs are justified.” (Globes, August 16, 1999)

In short, Eilan is saying that Israel can compete in the manufacturing end of high tech products- if the VCs would just believe in them enough not to put them on the auction bloc when they the start ups are still in their infancy.

How To Solve The Marketing Problem Of Israeli High Tech Companies

Marketing had always been an Israeli weakness as until the mid-l980s no Israeli company had gone out into the world and “branded a product”, set up multinational points of distribution, and run the entire operation from its Israeli headquarters. Talk to anyone who knows the problems of Israeli high tech and he will always give you the same schpiel: “Israelis are great at developing products and R&D, but lousy at marketing.”

That interpretation was certainly correct until the mid-l980s. Then Scitex, Elscint, Optrotech, Elbit and others came on the scene. The founders of these companies “wrote the game plan” (as Scitex’s founder Efi Arazi once said to me back in l985) as they went along, as nobody had done before what they were attempting to do: establish a multinational Israeli company and build a branded image for their products. Outside of a handful of companies today, that goal is just not on the agenda of many companies today nor do the VC funds encourage such aspirations. It is simply much easier to sell the company at an early stage than to build a thriving enterprise. (To be fair,  it is a problem for a small country with no local market to succeed abroad. However there are many successful companies from small countries. It is just as hard for a company from Denmark, Singapore or Finland to market its high tech wares in the US and worldwide than an Israeli company. Yet many companies from these countries are successful.)

In any case, the “find me a strategic partner” belief was created. In the mid-l980s, Scitex, Elscint, Optrotech and Elbit didn’t run around all day asking people to find them “a strategic partner” to market their products. They did it themselves. When the Israeli VCs took over the game in the mid-l990s, they told their portfolio companies “find a strategic partner to market your products”.

Why did they recommend this?

Because Israeli VCs neither had the background, experience or inclination to build world-class companies that would own their own distribution links. It was simply easier for them to suggest to their invested companies to “go find a strategic partner” (not only for marketing but also to invest in the company which would, in their eyes, increase the company’s value) than work with the entrepreneur to build a multinational enterprise. From this mentality, the “buzzwords” and “buzz phrases” about how “Israeli companies need strategic partners and strategic investors in order to be winners” was born.

For some reason I have trouble picturing Efi Arazi at Scitex and Optrotech’s founder, Dr. Shlomo Burak, claiming that it what was needed to move Israeli high tech industries further along. For the record, Israeli high tech companies can and have created world-class enterprises that market their products around the world via their own, independent distribution channels. It takes time and money, and patience and expertise, but it demons ratably can be done.

However the chief adviser  and investor to an Israeli start ups- the venture capitalist-doesn’t actually expect them to “build a company” and makes every effort to convince their portfolio companies that there is no chance of them ever building an independent marketing structure to compete with the big boys, so why bother trying. Instead, they say, “Just continue developing the technology.” What they really mean is, ‘don’t worry, the IPO route is too far off. An acquisition by a large US company is a better option”. This suits the VC as it is interested in short term returns, not building quality business enterprises.

It is interesting to note that it is very difficult to find even one example of a “strategic investor” who has actually led the Israeli company to Wall St with a king-size valuation. Of all the Israeli companies that went public on Nasdaq in the l990’s and which have a valuation exceeding $500m, there isn’t one that had “a strategic investor” or “strategic marketing partner”. They are all companies who own their own distribution links to the market.

One casualty of the “strategic partner” route was VideoNet. The start up had developed the world’s first application enabling video to be sent through the Internet. It made the foolish mistake of allowing Microsoft to invest in it at an astronomical valuation. Unbeknownst to the Israeli start up, Microsoft had invested in a few other companies with similar technologies and decided in the end to back only one of them. Eventually, the Israeli company’s technological assets were sold off for a few measly millions.

It is ironic that while the concept that Israeli companies are shortchanging themselves by not going for the home run and building-up a major enterprise is rarely uttered in Israeli high tech circles (certainly not by the VCs) a foreign academic figured out what is best for Israeli high tech companies, and the Israeli economy.

During his visit to Israel in early l999, I had the good fortune to hear a lecture by Professor Anido de Bar, an expert in technological entrepreneurialism and innovation at Boston University in the US. His analyses says it all:

“Israeli high tech start up companies concentrate all their efforts on R&D and have abandoned marketing efforts. To reach sales of hundreds of millions of dollars, or a billion dollars, Israeli management must change its orientation. The problem is that most Israeli companies see themselves as nothing more than R&D centers for large US firms rather than global companies, or the potential to be a global company. It is a matter of perspective.”

Professor de Bar continues: “There are very few Israeli companies who have “branded their products” and attained a brand or labeled image for them in the international market place. Instead, Israeli companies prefer to sell out early and thus their brilliant technological advances become absorbed into the US company architecture.”

The statement by the good professor should become the rallying call of this new decade for Israel’s high tech enterprises: “We can compete with the Americans, and become world-class companies and sell our products worldwide.”

Selling out to US giants also sells Israel short. The country is capable of producing 100 companies of the size of Scitex and Gilat which not only will provide quality employment opportunities, local manufacturing jobs, and tax revenues to meet our socio-economic obligations, but will, by definition, build up Israel’s cadre of qualified and experienced managers to create the next 100 multinational-companies.

We were on that road in the early l990s but got sidetracked due to the tremendous influence the VCs were able to exert on the future of Israel’s technology-based industries. If each time an Israeli company develops a winning product the company is sold to a US giant, how will Israel ever create enough competent and experienced management for this and future generations? If the acquisition route continues to be the preferred exit for Israeli start ups, the Israeli VC community and their backers will register huge profits as a result, but the big losers will be the Israeli economy and the Israeli public.

What Difference Should It Make If Israeli Companies Get Sold Too Early?

What’s the difference? Why should Israelis care if their high tech enterprises are headquartered in Israel and become major companies in their respective fields, or get bought out quickly by US high tech firms?

The “1980s” group of Israeli high tech companies never had that option. The only thing they knew was to build up their enterprises and manage them from Israel while selling the products worldwide. These enterprises comprise a group of only 30 or 35 companies yet back in the mid-l980s “Israel Inc.” was right on track and had gathered experience in building world-class companies. How come so few of them were created in the decade that the VCs carried Israel’s “high tech baton” becoming the spokespersons and captains of the industry?  Where are their achievements and contributions to Israel’s long-term technology industries?

Baruch Gindin, the general manager of the Israel office of the US high tech research company, The Gartner Group, had this to say about the importance of Israeli companies being “Israeli-based”:

“Seven or eight years ago the entrepreneurs still had a vision which included the establishment of a real high tech industry in Israel. The IPO was to finance the company’s growth, not an end in and of itself. Today, the typical Israeli entrepreneur either builds to sell the company, or plans to leave after the IPO. The ideology of “building Israel’s science-based industries” changed dramatically. The pioneers, Uzia Galil, Efi Arazi, and others, wanted to build an industry first and foremost. The common perception is that eventually, the company has to become an “American company”. “ (Globes August 8^th, 2000)

Gindin warns that the result of this sharp change in perspective among Israeli high tech executives is that Israel will be left with none of the management or profits for their efforts, nor will there be any major benefit for the Israeli economy in the long run.

“There is a big difference between simply doing the development in Israel, and having the management sit in the US, than having the management sitting in Israel and managing the company’s operation via wholly-owned subsidiaries,” he points out. “The ladder is what Comverse, Check Point, ECI Telecom, Scitex, and Gilat do. Unless this is the model, the best Israeli companies will simply disappear. What benefit will the Israeli economy have after this happens?”

Gindin claims that in most markets, the US comprises half of the world market and thus the other half can be attacked from offices in Israel. The moment the target of the Israeli company is not just the US, there is no good reason to have the company move its headquarters there.

Arie Weisberg, executive VP for Global Resources at Orbotech, agrees:

“The main problem for a company like ours is that it still wants to be a Zionist Israel enterprise. We, unlike many other companies listed in other places, are listed in Israel. Everything we bought in Germany, Japan or the US we moved to Israel. With all due respect to companies like Chromatis- and I admire their genius- in the end, they are merely R&D divisions of American companies.” (Globes, November 2^nd, 2000)

The legacy the Israeli VC community and their US investors will leave behind will be found in the balance sheets and assembly lines of Cisco, Lucent and Texas Instruments, and in the ROI (Return On Investment) of the Israeli funds that invested in the companies.

*****************

“I see a situation where individual Israelis have been successful in high tech, but Israel as a country has not been successful in high tech.” Nir Barkat, co-founder of BRM

(Globes, August 24^th, 2000)

Conclusion

The title of this study, “Broken Promises: The Rise and Fall of Israel’s Technology-Based Industries” refers to the great promise that Israeli high tech had to offer the Israeli people. By the early l990s Israel had created some fine high tech enterprises, which were based in Israel, but operated internationally. Some were better than others, but the important thing is that Israeli high tech was on the map.

The “Promise” refers to the great potential Israeli high tech showed in the late l980s not only as an engine of economic growth, but as an important part of the economy which would be able to create thousands of high paying, creative employment opportunities that could keep educated Israelis in the country and attract new immigrants from the west. Before l993 the goal was not only to build a thriving company, but to fulfill national goals by expanding and stimulating the local economic. 

The heroes of the previous era of Israeli high tech were named Dani Goldstein, Kobi Alexander, Dedi Arazi, Efi Arazi, Uzia Galil, Shlomo Burak, David Gilo and Arie Feingold.  One of the goals in writing this study is to return Israel’s “high tech mantle” to their hands and take it out of the clutches of the Israeli VCs and their allies, the US investment bankers, who are concerned solely with their quick exits and not with the once noble concept of building enterprises for the long term and for the benefit of the entire country.

How The VCs Changed All That

Thus what had taken place by the end of the decade isn’t too difficult to understand. Cisco, AOL, Lucent, Nortel, Intel all came here to see what bargains in technology they could pick up- all the time applauded by the Israeli government and the press, not to mention the Israeli VCs as the best thing that could ever happen to Israel. In fact, what has happened is that these companies’ sudden interest in Israel has transformed Israeli high tech from an industry that was based on building for the future, to one which emphasizes quick profit-taking. Good for the investors and some lucky entrepreneurs. Terrible for the rest of the country.

The game plan changed when the Israeli VCs took over.

According to the rules set by them,  for an Israeli start up to be successful means to “become a US company”, meaning, to transfer all of the marketing and sales operations of the Israeli start up to the US, so that it can appear as if the entity is an American company. In this way, American venture capitalists will consider investing in the company and thus an IPO will be possible, or, the company will appear on the radar screen of a large company which will acquire the Israeli start up. This strategy is based on selling ideas, not filling up containers for exporters. In the context of these new rules, the goal of the investors is to exit from the company as quickly as possible- not build world-class enterprises for the long-term.

What is good for Israel as a whole? To produce goods and services. Period. The larger the private sector is and the smaller (as a percentage of the economy) the public sector is, the better it will be for the Israeli economy. This in a nutshell is what is good for an economy and Israel’s is no different than any national economy. For Israel to have such rich technological resources means that her economy can exploit these great minds in many different sectors- not just in start ups for the “new economy”.

For instance, all the brainpower currently employed by start ups may be better exploited by many companies in other sectors, such as energy development, innovative, non-high tech products, technological consulting, and a variety of other economic sectors which would contribute more to the long term interests of the Israeli economy.

That hasn’t happened because the direction of Israel’s technology-based industries has been directed towards the goal that best suit the Israeli VCs and their American backers. By leaving the fate of Israel’s technology-based industries in the hands of a small group of players and their array of vested interests, the Israeli public is paying and will continue to pay a heavy price in the future. While Israel has extensive technological and entrepreneurial capabilities to profit in a wide array of industries and economic sectors, nearly all private capital is being channeled into investments which don’t provide much substantial benefit to the national economy.

One doesn’t have to be a developmental economist or have a Ph.D in economics to understand this and to realize how wrong our current “industrial policies” are as carried out by the Ministry of Industry and Trade.

What Can We Do?

Here are some suggestions to rectify the current situation so that Israel’s technological infrastructure benefiting the Israeli public rather than foreign investors and multinational corporations:

1) Stop thinking that “foreign investment” or the acquisition of Israeli companies by foreign multinationals “improves the long-term abilities of Israeli industry to compete in world market”. It doesn’t.

According to a recent study by the College of Management and Academic Studies, foreign-owned Israeli companies have not fared better than locally owned enterprises. Export sales for “global” Israeli companies- i.e., those domestically owned, grew by 844 percent from l989 to l999. Those owned by foreign concerns, saw export sales grow by only 242% in the same period.

Israel needs to have more readily available local sources of investment so that companies don’t have to “sell out” to the foreigners because they don’t believe they can make it on their own. They can. Many, many Israeli companies develop and manufacture products in Israel and sell them in world markets- in high tech and in other sectors.

2)  End the encouragement of more start ups and end financing of R&D expenditure for small and large companies alike. We need to listen to the words of people like Shimon Alon, General Manager of the software company Precise that went public on Nasdaq in 2000. “With $80 million in the company coffers, we don’t have to take government subsidies- nor should we even if we are entitled to these R&D grants.” (Haaretz, August 24^th, 2000)  (Unfortunately, the Israeli government is still under the impression that public funds should be allocated to finance a business sector that has little problem attracting private financing.  In late June 2001 it approved a plan for the Ministry of Industry and Trade to spend $50 million to “support early-stage companies”. )

We need to cease once and for all the inane policy of subsidizing multinational companies to set up factories or design centers in Israel so they can use Israel as a Trojan horse with which to further exploit the country’s technological resources. I am not blaming these companies for doing so. I am blaming the Israeli government for inviting them to rape Israel of its technological resources.

3)  Change the tax code and offer a tax incentive for Israeli high tech start ups  to merge with each other, and with European companies. A tax incentive could also be given to an Israeli company that is acquired by another Israeli company in the form of lower capital gains tax. In this way, the “technological jewels” would stay in the family and not pass over to foreign concerns.

It costs the Israeli taxpayer very little to give an incentive such as offering any Israeli company merging  is combining its forces with another firm, from anywhere, an instant 10 year tax holiday. If the merger with another Israeli company this benefit can be given for 15 years.  This type of tax incentive is much better than the existing ones as no distorting subsidies are employed, and the incentive helps Israeli companies grow, not promote the profit margins of  foreign companies.

The way to promote such activities is to support the idea of clusters, the notion that one or more Israeli companies in the same fields should be given a very good reason by the government in the form of a long-term tax holiday to merge, or cluster.

In late 2000, Zoran Corp. (US-based but Israeli managed) and Nogatech merged. Nogatech and Zoran coming together made real sense and here is why: Management believed there were synergies between the two companies as Zoran was focused on DVD chips and Nogatech on PCs and both companies feel that cross-leveraging the technologies could provide more      complete product solutions and quicker time to market.

The statement by Nathan Hod, Chairman of Nogatech, after the announcement of the merger, showed that Israelis still care very much about what happens to Israeli high tech and Israel’s technological jewels: “This merger is good for our shareholders, our employees, and the State of Israel.” By that, Hod meant that it was good for Israeli high tech companies to merge, and that it is better for Israeli companies to think in terms of “critical mass.”

It makes perfect sense as a stronger entity has been created. Both companies win, as does the State of Israel.  The same could be said of the merger in April 2001 between BreezeCom and Floware, two Israeli companies traded on Nasdaq which operates in the wireless communications spectrum. Each company had its own product line. More important they shared many of the same customers. A major Israeli company could evolve out of the merger as the new entity will boast sales of more than $200 million.

How much better off the Israeli economy will be because two companies like Floware and BreezeCom merged? How much worse off would the Israeli economy have been had both companies been sold off in their early stages to US multinationals?

According to Gilay Dolev, head analyst of the research outfit, D&A, “it is the largest merger of two Israeli companies listed on Nasdaq. It is probably the best thing that could happen today in Israeli high tech to get together and pool their resources and penetrate foreign markets together. The joint management team can cooperate on the technical level as well as in administration and marketing. These types of mergers creating much larger entities that have to compete abroad are the only way to go if Israel is to be successful in marketing its technologies abroad.”

Of the choice of merger partners, Guy Rolnik of The Marker.com, opines: “Surprisingly enough, the best candidate for a merger turns out not to be an American company. Or a European one or a Japanese one. No, the No. 1 nominee is often right here at home, in Israel.” (April 11^th, 2001)

The logic behind “critical mass” is the key to understanding how to improve Israel’s high tech industries. There are too many Israeli high tech companies that haven’t any “critical mass”. The only way to think is in terms of merging them so they come out as larger entities. The example of Ness Technologies should be followed. In mid-l998 the New York-based Wolfson family started buying up Israeli software companies which carry out software services. Within 18 months it had bought a group of the leading companies in the market and merged them, creating one big entity that is now being financed and will be ready to compete abroad for projects. The Wolfson family understood the concept of “critical mass” and of “clustering” and is in the process of creating a major world player in the software projects industry- an industry where Israel has no presence yet oodles of skilled manpower. The new company which is being built will eventually employ 5,000 workers. This is the type of company Israel needs more of- not more start ups.

4) Offer tax incentives for Israeli companies to invest in start ups which come from within their own company, or in Israel, rather than having the entrepreneur go to the venture capitalist for funding. This will help Israeli companies grow, entrepreneurs will enjoy the benefit of a large company in which to develop and “grow up”, and the end result will be likely be that the larger company buys out the “newborn” at a price which is relative to the risk. Tax incentives should also be given to Israeli companies that acquire, or invest in, other Israeli-based companies. Not cash subsidies; only tax incentives.

Tax incentives should also be given to large Israeli enterprises to acquire start ups in order to increase their pool of employees. This would reduce the number of start ups, keep the technology and know-how in the country, and help the larger companies (the companies that are the most important to the economy) compete for manpower against the well-financed start ups.

Tax incentives could also be given to employees in a company that want to purchase the company from management. For example, in May 2001, the employees from the data security company Algorithmic Research began negotiations to purchase their company from the current owners, the US firm, Cylink. Cylink had bought the Israeli company in September l997 for $83 million but couldn’t quite figure out how to manage their Israeli subsidiary.  Current selling price: a mere $15 million.

5) The government of Israel needs to give an incentive for capital to become available for investment in companies that are not start ups or not in high tech, but nevertheless provide significant benefit to the economy. There are various tax incentives that could be implemented to do this. The need for additional capital to enter the private market is critical if Israel’s industrial and technological sectors (not just high tech, or areas which are the “flavor of the months of the VCs) are to be able to develop and provide employment opportunities for all of the Israeli population. Not every Israeli is an engineer and thus not more than a small portion of the work force will ever be able to participate in high tech industries.  All other sectors of industry- specifically technology-based industries that are being neglected by the VCs- must have the capital required to grow and develop.  

6)  The Israeli government should subsidize (finance, but not operate) seminars, efficiency experts, manufacturing consultants, an other services to companies, in order to improve the quality and efficiency of Israeli enterprises and manufacturing techniques. This is a legitimate expenditure of tax revenues and an expense which not many small to medium-sized companies can afford. The government provides some of these services via the Israeli Export Institute, but that requires managers to leave their premises and travel to Tel Aviv to listen to experts talk generically about the problems managers face. That isn’t good enough. Efficiency experts and consultants need to be sent to each and every Israeli company to provide on-site consultations on how to improve the company’s efficiency, profitability, etc. Payment can be subsidized according to a company’s sales, and the work can be carried out by private sector entities that are licensed or qualified by a government body. In this way there are no cash grants, no distortions in the natural mechanisms of the market, and the expertise provided will enable Israeli enterprises  better to compete and hire more workers. Thus the expense of the consultants will eventually be repaid by the additional income tax revenues the government will receive from the additional workers the company has hired.

The government could also provide the financing for consultants to help companies devise ways to better motivate and train workers, to design profit-sharing plans and bonus structures so that seasoned managers have a good reason to stick with the Company.  The government can help in this regard by bringing experts in these fields to the company’s headquarters, partially subsidizing the cost, thus forcing the company to put the issue on the agenda and giving managers the tools to retain and motivate their workforce.

7) Another policy the government could implement to help Israel’s technology-based industries develop would be to refocus Israeli companies away from the US towards the European market.  After seven years of being dominated by US investment bankers and high tech multinationals, Israel needs a solid dose of “Europeanization”.

One of the casualties of so many venture capital funds in Israel is that Israel’s high tech industries have been “too” American oriented. The reason is because Israeli VCs’s business model is to encourage their portfolio companies to go public on Nasdaq as quick as possible, to sell themselves off to large, American high tech companies. The result is that very few strong companies are created which provide a significant stimulation to the economy in the form of jobs and manufacturing output. While the VCs and their investors, as well as the founders of the companies that are sold off do very well financially, there is little benefit for the country as a whole.

One way to change this would be to orientate Israeli high tech enterprises away from the US towards Europe. In the US market, Israeli high tech companies have a much smaller chance of surviving as Israeli-based companies. Israeli companies can sell and build-up their enterprises in Europe and still remain based in Israel. They can’t do that in the US as in the US market, Israeli companies wind up either becoming a very minor player in a market, or being acquired by a larger firm. 

In Europe Israelis are perceived to be, and are treated as respected winners and Israeli technology is considered to be “leading edge”. In the US Israelis are fish out of water.  If Israeli companies focus on penetrating the European market they wouldn’t have to “move the company to the US” which they must do if they hope to sell in the US market. It is possible for an Israeli company to manage operations in Europe from Israel- something they can’t do in the US from Israel. 

While not as large as the US market, if viewed as a whole, the European market is large enough for most Israeli companies. Although high tech markets are typically smaller in Europe than the US, the fact is Israeli companies rarely are able to secure more than a miniscule portion of that large market. In Europe, despite the overall market being smaller, the share the Israeli company would attain would be higher in volume terms.

The official policy of the government of Israel should be to bring Israeli technological development capabilities and European marketing expertise together through the merger of Israeli and European high tech companies. Unlike the situation when a large US company purchases an Israeli start up, a merger between a European high tech company and an Israeli start up is a positive event for the Israeli economy.

Israeli companies would benefit,  as they would suddenly find themselves with a relatively large, local market. Being part of a European company which has Europe as its market, is a lot better than owning 100% of an Israeli company that is completely domiciled in Israel.

Another reason why European and Israeli start ups should merge is so that they will create bigger entities which will be better able to compete with US firms. Merged, an Israeli and European company would also be able to raise investment capital from two sources of investment capital- in Europe and Israel. Raising larger sums of capital will enable managers to concentrate on building their company rather than on the next round of financing.

What Should Officials Of The Ministry of Industry And Trade Do?

What the government of Israel should not do is “hype” Israeli high tech. For instance, this sort of thing is really not needed anymore:

“The Israeli start-up Mysticom will be awarded the title of “Most Promising Start-Up” at a conference the Israel Export Institute is organizing in Santa Clara, California later this month. The goal was to choose the start up company at the conference which has the best potential to become a flourishing company. The 35 companies taking part in the conference are the top Israeli start-ups, according to the Israel Export Institute.” (Globes, March 11^th, 2001)

For what reason is the Export Institute spending taxpayers’ money to “congratulate” an Israeli start up- even one as solid as Mysticom? And while Mysticom founder Dr. David Almagor is a very serious high tech player who acquired valuable experience when he worked in the US before returning to Israel, he doesn’t need the Export Institute to “blow his horn”. There is simply no need for this kind of “gushing” over how wonderful Israeli high tech companies are. If the companies are that good, they will succeed. If not, they won’t. Either way the Export Institute has no valid reason to spend tax revenues to arrange such events as they serve no useful purpose for anyone but to promote The Export Institute. The fact that it is being held in the Silicon Valley tells the whole story about where the Export Institute thinks Israeli high tech should be promoted. By doing so, the Export Institute is not serving the long term needs of the Israeli public by carrying out such senseless and wasteful PR exercises in order to “promote” the notion that Israeli high tech is good. Besides, is there anyone in the Silicon Valley today who hasn’t heard of Israel’s technological powers and Israel as a world center of technology?

What the government should do is worry about aiding all of Israeli industry- not just what is considered “hot and sexy” by the Wall St. crowd. The veteran Israeli company Amcor recently signed its first $3M order for air purifiers and dehumidifiers from China. Another oldtime Israeli electronics manufacturer Electra creates more than $100 million worth of air conditioners a year. This is serious business and these companies should be commended for the fact that they are Israeli-based, are competitive internationally, and provide white and blue collar employment opportunities. What start up can match this in terms of what it gives back to the Israeli economy if its technological developments are ever successful?

Or how about MultiLock which manufactures a sophisticated locking device. In March 2001 it opened its new plant in Yavne which giving 80 families livelihoods- of which only 15% are from engineering. The company exported $30 million worth of products in 2000- a 50% increase over the previous year  to more than 70 countries worldwide. In contrast to conventional wisdom about how Israeli manufacturing capabilities are not competitive in world markets,   MultiLock is flourishing as an Israeli-based company with its manufacturing and management departments based in Israel .

Or, take Jacada, for instance. This is the type of Israeli high tech enterprise that the Israeli government should promote. Very early on in its life the software firm decided it was going to build for the long haul and thus turned down several tempting offers to be acquired. It eventually went public on Nasdaq. Its founder, Ofer Timor, was the driving force behind the policy and is one of the most talented high tech professionals in the country. In its April 1^st, 2001 issue, the trade publication Interactive Week rated Jacada ninth in the list of the top companies to work for in the US. In March 2001 the company announced that it plans to recruit almost 90 new employees this year in Israel, Europe and the US. The recruitment drive is being launched to help the company penetrate new sectors and the European market. The company currently employs 240 people and has offices in Herzliya, Washington, Atlanta and London and Frankfurt. How refreshing it is to see an Israeli company behaving as a multinational rather than worrying about how to “be an American company” by hiding their Israeli origins and roots.

Why is it important that Israel produces more Jacadas in the future? Because companies like this view themselves as “Israeli-based” that  sell their products worldwide. There are many Israeli companies like Jacada or AudioCodes which are independent, excel in their markets and maintain control over their own destiny. In the process they contribute to the development of Israel’s high technology industries and the Israeli economy.

What Type Of Companies Should The Israeli Government Promote?

While it is good that Israel has high tech companies, what better type of company to have than a Pitkit Printing Enterprises.  The company has a technological advantage, is financially stable and earns real profits on its turnover. It has an aggressive stance to search for investment opportunities in its own market in young start ups developing new technologies the Israeli company understands as they are for markets they sell it.

Founded back in l967 the company went public on the TASE in l993 and currently sells about $10 million with net profits of $1.5 million (how many Israeli companies, private or public, earn 15% net on their sales? How many even have any profits?) It employs 100 people.

What does the company do? It makes labels, low-tech labels which it sells in Israel and abroad. It realized the problem of counterfeiting clothes and thus, labels, and went out and looked for technology that the market was asking for. It then invested in a Swiss company that made the special inks to write on the labels so they couldn’t be counterfeited. With significant stakes in four other start ups that are all developing anti-counterfeiting technologies of some type, the stability the young start ups can receive from such an established company is extremely beneficial.

Or how about Tadbik. It was established in l983 and with a staff of 400 is much larger than Pitkit with revenues of $55 million and net profits of $13 million. How a company can earn 22% net profit on turnover is not a feat even the great Cisco or Microsoft can match.

A few years ago the company changed directions from being a sticker manufacturer to a “provider of comprehensive packaging solutions”. Meaning they were climbing up the food chain and gravitating towards technology as a competitive edge.  It too has made external investments, in PowerPaper (batteries built into paper) and Latent Image Technologies (anti-counterfeiting label)

Companies like Tadbik,  Pitkit, MultiLock, Electra and Amcor produce competitive products and sell them abroad. (even if part of the product, or even the majority of it, is manufactured outside of Israel)  These types of companies are creating interesting and rewarding employment opportunities for Israelis, and bringing foreign currency into the Israeli economy.

Contrast these contributions to the Israeli economy with those of the “hot and sexy start ups” that the Ministry of Industry and Trade is promoting. Instead of promoting Israeli companies like Electra and Amcor which are great contributors to the national economy and employment, the civil servants in the Israeli government are busy giving public tax revenues to foreign companies and inviting multinational high tech companies to Israel so they can buy Israeli start ups and rob Israel of its technological resources.

The problem about talking about what is best for Israel’s high tech industries, is the reaction you typically get from the VCs and the US high tech giants: “But we live in a global village where companies can register anywhere they want,” and,  “What do you want to do, make it illegal for Israeli companies to sell themselves to foreigners?”

It is interesting to note that the only ones serving up the virtues of this so-called “global village” are the large multinationals- not the small companies. These pages are not the place to argue the pros and cons of the “globalization”, but the fact is, the large and strong have much more to gain by globalism than the small and weak. This is true of nations and economies as much as it is for high tech enterprises operating in the international arena.

So just for the record, the fact is, some companies should be sold because they are in a market where they have no opportunity to grow. Even in these situations it would be better to have the Israeli company merge with another company that has a complementary product line so that the two Israeli companies can better compete. While this does not help the VC make any more money because no exit is involved, it creates larger, more sustainable companies in Israel.

No, selling a company to foreigners shouldn’t be made illegal, nor should anyone require permission from a government body to sell private property. I can rant and rave all I want about what a pity it is that the Israeli taxpayer is financing technological development in Israel and the VCs and US high tech giants are the ones making the bucks from it, but I still believe that if that is what a company wants to do, and knows it is being done just to bank the millions, as investors and founders, it has the right. If the Israeli government wants to tax these capital gains and the shareholders in these companies are willing to pay the capital gains, then hey, the Israeli people will have a great source of new tax revenues and a way to share the tax burden with taxpayers. This isn’t a bad thing. The issue arises only when the only reason for establishing a high tech company is to sell it to foreigners as quick as possible and thus Israelis don’t even try to build worldclass companies.

The point is if we give up and all sell our companies quickly, in another ten years we will not have a next generation of managers who know how to build and manage multinational firms. The lack of world class managers was always a shortcoming of Israeli high tech industry. To its credit, much of Israel’s non-high tech sector has done well abroad and created some very fine companies like the two leading plastics companies in Israel, Ketar and  Plasson.

I am stating how this is an issue that greatly impacts on the Israeli economy and Israeli society. We need “Israeli-owned” companies because without them, Israel’s high tech industries will come under the total domination of foreign companies, and we will be reduced to nothing more than an off-shore R&D center with the limited economic stimulation such enterprises have for an economy.

Registering an Israeli start up in Delaware, then performing all its R&D in Israel using Israeli engineers, and then, when the company is sold, claiming it is a US company and thus not liable to pay taxes in Israel- is a fraud.  If this is what the future holds then the Israeli people will not derive any benefit from its “high tech treasure.” Israel will become merely an offshore center for R&D- for multinational giants (with the Israeli taxpayer picking up the tab)  as well as Israeli entrepreneurs who are told by their VCs (Israeli and US) that the head office must be in the US “close to the market” and not in Israel.

Another reason why Israel needs to have its own large, Israeli-owned companies is to provide quality employment opportunities to more than just engineers and computer programmers. If Israel winds up being nothing but an off-shore R&D center for foreign companies, the “dream” of high tech and the higher-than-average salaries that accompany the potential will never be within the reach of more than a miniscule portion of the Israeli population. Local R&D centers for foreign companies don’t need many Chief Financial Officers, production managers, or an in-house legal council. Israeli companies which manufacture their products in Israel and sell their worldwide, do.

If this is what the future holds, then expect the schism between the haves and have-not to widen as the have-nots, those that aren’t part of the high tech boom, increasingly resent the haves (the 5% of the workforce employed by high tech companies). If Israeli companies don’t stay in Israel, there is no real added-value for the economy and for the Israeli people. While this issue will never be put on the agenda of Israeli VCs, it is the responsibility of the Israeli government to inform the Israeli people of this outcome. The Israeli public deserves to know that it will not reap much benefit from the enormous investment it has made in its technological infrastructure, but rather, the main beneficiaries will be US multinational companies, and Israeli VCs and their investors abroad.

In the words of Hanan Achsaf, head of Motorola Israel, Israeli technology is a “national resource” or a “national property.” Referring to the great investment the Israeli public has made in its technological infrastructure and education, he says:

“Education, to a large extent, is subsidized by the government. Experience, during service in the army, is subsidized by the state. You can ask, who owns it? Obviously, the country has got a big portion of it. The interest of the country is that whatever invention that will have will be developed into a product line that we can export and so preserve it in the country.” (Globes, July 4^th, 2000)

 The founders of the company were educated and domiciled in Israel, the company’s R&D was all done in Israel with engineers trained in Israel at the taxpayers’ expense. Then when the company was sold for billions it claimed that “since we are a US-registered company, we are not liable for pay corporate capital gains tax in Israel.”  If so, that means the Israeli taxpayer will be subsidizing the country’s academic and technological institutions for the sole benefit of foreign companies who will derive the most benefit from Israel’s engineering capabilities.

So you decide. Did the Israeli people benefit from the sale of Chromatis Networks to Lucent? 

Israeli Self-Perceptions Must Change

Probably the most important point we need to remember when we consider how to best help “Israeli Inc.” is that we are no less capable than our competitors. There is a line of thinking in Israel that says we need the foreigners and their capital in order to succeed abroad. That may have been true 20 years ago. It isn’t anymore. Israel could come up with the billions it needs to finance its industry without turning to the VCs in the US and in Israel. The money exists within its own capital markets, insurance companies and pension funds. If there were proper legislation passed to free these billions up for investment in industry- all sectors of industry not just high tech- would have more than enough available investment capital to finance their companies. Let nobody tell you anything else than the Israeli people are extremely good at developing products, produce them efficiently, and  some have managed to sell these products on a global basis (not just in America). The commonly accepted line about “Israelis are crappy at marketing” is not true as many Israelis learned how to market their wares very well outside of Israel. This is true of all areas- high tech and non-high tech. We have created success enterprises and don’t need to sell out early on .

So why must we hear our Minister of Industry and Trade tell us how important it is for foreign companies to have a base of operations here “as a show of faith in our economy”? (Maariv, July 7^th, 2000)

This type of thinking is from the Israeli of old who thought that everything Chutz La-aretz (outside of Israel, abroad) is better than Kachol Lavan (Blue and White, Israeli-made). In high tech, that is not the case. Our products and solutions are as good. It is “them”, the Israeli of old who says we need to have the foreigners like Charles Wang (Computer Associates), Craig Barret (Intel) and Steve Balmer  (Microsoft) come here and tell us what we should be doing in order to help our high tech industries grow- i.e., selling them in the name of “globalization”. It is the Israel of old who says we need the American VCs to set up shop here so they can “show us” how to take high tech companies public on Nasdaq.

Staying independent and not rushing to sell our technological achievements is the flag we all need to rally around. Yes, it is better if there are more rather than fewer Israeli companies that sell products internationally. No, it isn’t better to stop that process from coming to its natural fruition by selling these technological achievements to large multinational players in the same industries Israeli companies can operate in.

While the level of acquisitions thus far may not point to any real loss of technological resources, the question is- what will Israeli high tech look like ten years from now? Unless the trend changes, increasing numbers of start ups will be acquired and fewer and fewer companies will wait it out and build multinational companies. The writing is on the wall: there were only two acquisitions of venture-backed companies in l994, three in l995, three in l996, three in l997, four in l998, ten in l999, and twenty-one in 2000. (One positive trend is that of the twenty-one companies that were acquired in 2000, five of these were purchased by other Israeli companies)

There are those who will say after reading this study that I am being “hysterical” and I write what I write because of “sour grapes” and that the “acquisition of Israeli start up companies isn’t really all that bad”. They might add that my words reek of “jingoism” “isolationalism” “anti-globalism” and “chauvinism. They tell me how wonderful it is that Israel’s technological resources and future potential are of interest to the US high tech giants.

I  understand these criticisms and claims and also realize that they come from those in this industry who are protecting their vested interests: VCs, lawyers and accountants who represent start ups, US high tech companies and investment bankers, etc. Their concerns are not to build and encourage Israel’s industrial enterprise. This is my goal and I believe the desire of every Israeli citizen (if someone would take the trouble to ask them). My constituency is strictly and solely the Israeli people and their best interests- which I don’t believe many other voices out there in the landscape of Israel’s technology-based industries are concerned about. They didn’t pay me nor ask me to write this book and most probably won’t read it. However some might, and some policymakers will, and it is for them that I wrote these words so they are better equipped to take on the other side when the issue of what is best for the future of Israel’s technology-based industries is the subject of debate.

For policymakers from other countries- particularly many Asian and European nations- there is much to learn from these conclusions. As Israel is far ahead in developing its technology-based industries, you can learn from the experiences Israel has had and from the mistakes Israeli bureaucrats have made in the past and not repeat them.

Above all, remember that your country’s number one enemy will be New York investment bankers and their phony-baloney valuations. They make speak to you nicely like Jeremy Isaacs, Lehman Brothers managing director for Europe, Asia and The Middle East and Africa, told Globes in August 00: “The moment we take a company and give it a Lehman Brothers seal of approval, we quite often find that later we are arranging strategic partners for it, rather than selling it. Israeli companies need such partners.”

Don’t let the “investment banker-double-talk” fool you. When Israel’s technological destiny is defined by what Wall Street believes is “hot and sexy”, rather than through companies “building for the future” the people of Israel lose out.

This is the crux of what this study is about and why it was written. If nothing more, the reader should always remember this basic point: after l993 Israeli high tech took a turn for the worse, not better- despite what the Israeli VCs, US investment bankers, and the local and international business press says. The industry was progressing very well until the early 90’s. It took a turn for the worse and it is no big mystery as to who are responsible for the change. End of story.

Don’t Let The Slogans About “The Wonders of High Tech” Fool You

Until the recent downturn, “high tech” was a very fashionable phrase in the Israeli economy. However one must never lose sight of the fact that the heart and soul of high tech is industry and commercial enterprises. High tech can’t and shouldn’t operate in a vacuum, on a separate footing from other enterprises. The worst thing a government can do is to do exactly what Israel has done: put its technology-based industries on a pedestal and announce to everyone else in the economy that only it is special and worthy of public funding,.

The second worst thing it can do is do exactly what Israel has done: handed over the baton of the policy-making body in the Ministry of Industry and Trade as to what is good overall for Israel’s high tech industries to a vested interested party like the Israeli VCs. 

In the very final days of preparing this study Yediot Achranot wrote an article about what will happen next for Israel’s high tech industry (June 1^st, 2001). Of course, there was just one person interviewed, Chemi Peres of the Polaris fund. As to the importance of high tech to the Israeli economy,  Peres pontificated:

“The truth is that Israel doesn’t have a choice as we have no natural resources or raw materials so we don’t have an alternative other than to develop our high tech industries. High tech will continue to be the engine of growth for the Israeli economy and society. This I am convinced and anyone that doesn’t participate in high tech will be a loser.”

These type of statements are totally self-serving aiding those who are profiting the most from the way Israel’s high tech industries are currently structured.  Peres has simply ignored the economic benefit of 90% of the Israeli economy that is not based on high tech and has basically told his fellow Israelis that put all our eggs in high tech because that is all we got. Not true.  Israelis have many talents, with just one of them being developers of technology. The huge benefit of high tech is greatly exaggerated by the press.

The fact is only 5% of the Israeli workforce is employed in high tech, and only 15% of the national economy is derived from high tech activities (most of which comes from the major electronics firms that manufacture products not “internet start ups”). Yes high tech is important, but not more so than all of the other productive economic sectors such as non-high tech manufacturing, added-value services, tourism, construction, etc.  To claim that only high tech is beneficial to the economy, or only high tech can contribute to economic development, is to completely disqualify the contributions made to the Israeli economy from companies such as Electra and Amcor

What is important to understand is that venture capital fund managers have vested interested in promoting the “only high tech policy” and those interests are not the same as the general public. Putting aside all the neat platitudes about “inventing the new world”, and “the new economy”, the fact is the strength of any national economy is still based on how many new jobs it produces, how much industrial output increases, sales, profitability, and expansion of the commercial and industrial base.

Nobody should forget that high tech is merely another sector of the economy. If it doesn’t create jobs, move workers from the public to the private sector, improve a country’s balance of payments, and perform the function of providing general stimulation to an economy, it isn’t economically beneficial to an economy. High tech is nice, but it isn’t necessarily better or more worthy than other sectors of the economy.

One of Israel’s leading high tech analysts, Guy Rolink, founder of TheMarker.com, contends:

“In the last year, Israeli venture capital funds invested $1 billion in start up companies. Add to this the approximately $2 billion received from Israeli stock offerings on Wall Street and another $2 billion received by Israelis investors for the sale of start up companies and you get $5 billion in cash that has flowed into Israeli from abroad. The money has been powering the commercial real estate industry, it is behind the boom in car imports, and is financing the increasingly high salaries of thousands of engineers.” (Haaretz, August 23^rd, 00)

One could question the figure of $5 billion. Most of the investment in new companies is merely switching the work force from existing companies to new companies. The $2 billion in IPOs does not fuel the Israeli economy as much as it does foreign ones as most of the investors live outside of Israel and much of the money is spent on marketing and sales infrastructure abroad. As for the $2 billion received from the sale of companies, a lot of that wealth belongs to the investors in the Israeli VC funds, most of those who don’t reside in Israel.

Is it worth it?

Rolnik’s conclusion:

“This money gave the economy optimism after years of recession- but this money is also the most sensitive to the mood in Silicon Valley. Because with all due respect to Israel’s “new economy,” it is no more than a derivative of what is happening in the US.”

Still think it is worth it?

In its special September 2000 issue on Israeli high tech, the US high tech magazine, Red Herring, concluded:

“Israeli high-tech industry will thrive everywhere but in Israel.”

While such a result may make Israeli VCs, their US investors, and American underwriters and investment bankers happy, if that happens the Israeli public will be the big loser. Contrasted with the phenomenal achievements of Israel’s high tech pioneers from l985-l993, if Red Herring’s conclusions are correct, the Promise will have been broken and it will surely contribute to the “fall of Israel’s technology-based industries.”

EPILOG

The Third Phase Of Israeli High Tech

The first phase for Israeli high tech occurred between the years 1982-l993 when the majority of Israel’s most successful high tech companies were founded. The second phase lasted from l993-2000 when the venture capitalist community stepped into the picture and in the process,  changed the face and direction of Israel’s technology-based industries. The third phase in the development of Israeli tech came in the fall of 2000

At the end of September with the tumbling of shares on Nasdaq continuing through March 2001, the third phase of Israeli high tech began. The balloon burst and all of a sudden, foreign investment dropped off to a trickle. According to the research firm Zinook, in the last quarter of 2000 foreign investment in Israeli start ups plummeted by nearly 40%. “If the conflict with the Palestinians continue indefinitely, then it is unlikely that the foreign investors will return,” the report declared.

With their world crumbling in front of their eyes, and no longer a very attractive bet in the eyes of the foreign investors, the Israeli VC community retreated to the sidelines. When the Israeli accounting firm of Kesselman & Kesselman (PricewaterhouseCoopers’ local representative) held a conference in early 2001 on the future of Israel’s venture capital community, most of the local VCs present agreed with Eddie Shalev of Genesis Partners when he stated: “the local VC industry is facing serious regression. It could regress five years in time”.

One wonders what Mr. Shalev means by such a comment . If he means that the situation in Israel will revert back to the pre-l994 boom in venture capital in Israel, I for one, would be the happiest person alive as we would be going back to a time when companies were created to build for the future, not to enrich foreign investors. While that is obviously not what Shalev meant, one thing is for sure. The only concern on his and his colleagues’ minds is their interests- certainly not what is best for the Israeli public.   Building stable commercial enterprises; advancing Israeli industry; exports; jobs; none of these are the VC’s concern. What is?  In Shalev’s own words: “Nasdaq is everything.”

Many, if not most, of Israeli internet/new economy start ups really had no reason to exist as they had no viable business model. Many were nothing but a house of cards, similar to some of Israel’s new “high tech gurus” like Shlomo Kalish and Yossi Vardi.  By early 2001, Kalish’s baby, “Yazam.com,” an investment fund which probably spent more each month on public relations than it did on professional salaries, had collapsed after it made a number of questionable investments, such as purchasing the network conferencing company First Tuesday in a deal which was reported in the media as being worth $50M. Nobody in the Israeli press took the time to ask Mr. Kalish if indeed $50M was put on the table for the deal, or was it “Yazam stock” which as a private company, could not have been in much demand by the owners of First Tuesday. Eventually, after things turned sour for Kalish, he sold First Tuesday back to the people he bought it for- for a steep loss. 

Instead of blowing the entire wad, eventually Kalish was able to return a fair chunk of the $60M he raised from investors and essentially admitted he was not nearly the Israeli poster boy of “The New Economy” that his PR companies made him out to be. In a revealing article in Haaretz after his demise, believe it or not Kalish thought he had been harshly dealt with by the press for the failure of Yazam. The wind up was “Mr. Israeli New Economy” had fallen off the wall and was broken into a 1000 pieces.

With his major triumph in June l998 of showing the Israelis how to sell a piece of Israeli technology for $100M to a multinational company such as Kodak, to the spring of 2001, in just 36 months, the hero and guru of  “the New Economy” in Israel,  came and went.

The other “poster boy” for the “New Israeli high tech”, Yossi Vardi, couldn’t perform the same magic that he did with Miriblis ICQ a second time. His investments in other start ups had all closed down in early 2001. If it weren’t for the larger walls crumbling in the world of high tech, we would have heard more about the fall of the wonderboy, Yossi Vardi. Like Kalish,  Vardi’s reputation as the visionary for “Israel’s New Economy” was also built on a mountain of hot air. The difference is that Vardi didn’t pay for the hot air by enlisting PR companies to write about him. The press crowned him “the guru” and he just went along for the ride. Like Kalish, Vardi’s contributions to the development of Israeli high tech will be remembered as being one of the first Israelis to show other Israelis that it was possible to sell a piece of Israeli developed technology to a multinational for hundreds of millions of dollars.

Thus you have the entire Israeli experience of Israel in the “new economy” of the late l990s.

The new rules of the game also exposed how weak some Israeli companies traded on Nasdaq were.  When the tough times came it became clear that many Israeli companies that had tapped Wall St. weren’t  winners after all but had ridden the wave of rising valuations on Nasdaq. It became clear that companies such as Commtouch, Radcom, Click Software, Orkit, Delta-3, and Radview went public far too early and merely exploited the froth in a bull market.

By New Years Day a dark cloud had formed over the future of Israel’s beloved “high tech start ups” and the “magic” of the Israeli VC community. The second phase was over. The “New Israeli high tech” era and its leaders were shoved aside laying the last seven years of development of Israel’s technology-based industries naked for all to see just how much fluff and hype had been conjured up but which had very little substance to ride out the storm of a bear market. 

In a sense, these series of events that took place in the last quarter of 2000 proved my main thesis that Israel’s technology-based industries should be operating according to the needs of the Israeli economy, and to strengthen the private sector in Israel, rather than serving the foreign investment banks and the local VCs. From October 2000 through March 2001 the Israeli VC community invested $120 million outside of Israel. When it got much less attractive to invest in Israeli start us, the Israeli VCs simply took their pile of money and went where the “political risk” wasn’t as high. Their commitment to the development of Israel’s technology-based industries may be a mile wide, but it is only an inch deep.

The Next Phase- No More Dot-Coms, Please

The best place to begin putting the pieces back together for Israeli high tech, is to look at the failed policies of the Israeli government, learn from them, and change them. Let the officials in the Ministry of Industry and Trade conduct a full review of how best to promote Israel’s technology-based industries. Let them look back and realize what a tragedy it was for the advancement of Israel’s high tech economy for companies such as 4D, Teledata, Oshap, Optrotech-Orbot, and Elscint to be sold off- even if some people did make a lot of money on the deals. What if Telrad, Tadiran and ECI Telecom had been sold to foreign investors in the early l980s instead of remaining independent entities? Would that have served Israel’s long term industrial interests. When the sell-off of public companies took place in the late l990s it was cheered by our own bureaucrats in the Ministry of Industry and Trade and the Israeli economic attaches abroad as being “foreign investment in the Israeli high tech industry”.  This policy must change if Israel’s technology-based industries are to be put back on the right track of contributing to the development of Israel’s economy.

While nobody like to hear about “the government’s role” in anything, in the development of industry, it has a legitimate role to play to create the necessary conditions conducive to economic growth and stability. Cheering from the sidelines as foreign companies purchase Israeli firms is the last thing government officials should be doing.

If the goal is to build a strong national economy and industrial base, and develop Israel’s technology-based industries, the focus for the bureaucrats must change from the “new Israeli high tech model” to the “old Israeli high tech model”. What Israeli industry needs are companies which operate in markets that are more stable than typical high tech/new economy markets and which don’t change face every six months or so. “Mid-tech” markets, which incorporate a large technology component and require manufactured products, is what is best suited to Israel’s needs. Companies such as Amcor, Electra and MultiLock sell in these markets and do it very well. 

These type of  stable, mid-tech companies find it very difficult to raise the capital required to expand their production and marketing bases.  Israeli policymakers have to find a way to alter that situation so that these companies are able to grow and prosper, and along with them, the Israeli economy. If Israel has a future in technology-based industries, it is in all of the industries which incorporate technology- not just those that are the “hot and sexy/flavor of the month” that the VCs and investment bankers will invest in.

It is indeed a pity that columnists like Guy Rolanik are not managing industrial policy in the Ministry of Industry and Trade. If people with his insights were setting priorities for Israeli high tech I would have had no reason to write this study:

“Over the last three years, the Israeli hi-tech sector has made billions from selling start ups. Maybe. But if the entire high tech industry plans to build itself on founding and selling or floating start ups, it will prove very fragile. Many of the start up success stories of the last three years weren’t about real creation of technological innovation, but about the Wall Street bubble.” (The Marker.com, May 20^th, 2001)

Shoot The Culprits- Not The Messenger

Some readers of the survey may believe that my criticisms of Israel’s VC community are unfair. However the current reality requires someone to be blamed. The VCs have been leading Israel head-first into the “new economy” and encouraging the sale of Israeli start ups to foreign multinationals without considering how the change in the direction of Israel’s technology-based industries will impact on the Israeli economy and Israeli industry. I blame the government for handing this group the baton and allowing the VCs to frame the debate over what is best for Israeli high tech. It is the government bureaucrats that have the power to take back control over the future destiny of Israel’s technology-based industries from the stranglehold of the VCs.

As for me, I have fulfilled my job. My role is to expose current reality- not serve any group’s vested interests. My concern is the same today, 15 years later, as it was in l985 when I wrote my first article for The Israel Economist: to inform the Israeli public and Israel’s supporters abroad of what is best for Israel’s economy. As they say, “you can’t make an omelet without breaking a few eggs”; you can’t change government policy without stirring up the pot. The purpose of this study is to do just that: to stimulate public debate in Israel on how best to support and develop Israel’s technology-based industries.

I can only hope that the Israeli public will heed my warnings and agree with my basic hypothesis that the change that has taken place in Israel’s technology-based industries in the past seven years has not served the best interests of Israel’s technology-based industries or economic development in the State of Israel. The great promise that Israel’s high tech industries high tech held out for the Israeli economy in the late l980s and early l990s was broken.