The Israeli VC Industry: Emergence, Operation and Impact

Emergence…. Clearly, Yozma played a significant role in the development of the Israeli VC Industry. Yozma acted as main catalyst in creating the VC industry in Israel – the supply side However…The success of Yozma was much depended on the existence of other enabling factors - mainly the demand size.

Main Objectives Identifying the background conditions for Yozma success Learning some lessons on policy design processes. Implications for Italy יש לנתח את הופעת ה VC כחלק ממכלול התגבשות אשכול ההי טק בישראל. דבר אחד זה הניתוח הכללי של ה VC בישראל ודבר שני זה לבחון את ההשפעה של יוזמה על ההתפתחות של הסקטור ולבחון את השלכות המדיניות על איטליה

Contents Of Presentation Part A: Background- Phases in the Israeli high tech industry and Innovation Technology Policy Part B: Phases in the Emergence and growth of the Israeli VC industry Part C: Policy Implications for Italy Part D – The Israeli case of Biotechnology

R&D penetration period: 60-89 Silicon Valley period: 90-00 Part A: Phases in the Israeli High Tech Industry and Innovation Technology Policy: R&D penetration period: 60-89 Silicon Valley period: 90-00

R&D Penetration Period 1960-1970 50’s-60’s: emergence of an innovative agriculture sector. After 67’: create a domestic capability for supplying advanced military equipment (this required also high level Military R&D). Military R&D cooperation with US, Germany and France - transfer of technology from those countries to Israel’s military industry. חשוב Penetration Period

R&D Penetration Period 1970-1980 70’s-80’s: dominance of strong military industry 70’s-80’s: first foreign multinational companies establish R&D centers in Israel: Motorola (1964), IBM (1972), Intel (1974) and National Semiconductors (1978).  In 1972, Elscint (Hi-Tech company) became the first Israeli company to be traded on an US stock exchange. חשוב Penetration Period

R&D Penetration Period 1980-1990 Mid 80s: re-structuring of the military industries Share of high-tech industries in total manufacturing output (and exports) increased between 1968 and 1983 from 6 % (5%) to 24% (28%). The scope of Military R&D created a broad technological infrastructure which benefited subsequent civilian R&D

R&D Penetration Period 1980-1990 – Cont. High Growth Rate of industrial Civilian R&D -from 26 M$ real to 347 M$ between 1970 and Numbers of Skilled employees in Manufacturing grew from 3400 in 1968 to over 20000 in 1987; Skill intensity increased from 1.3 % to 5.8%

Silicon Valley Period 1990-2000 The breakdown of the Soviet Union, which brought a very large number of immigrant Scientists and Engineers to Israel. Liberalization process which generate a better environment for doing business in Israel. Beginnings of Globalization of US capital markets with respect to SU (due to sharp reduce in military expenditures) מה שהיה חשוב בחוק של 84 זה שהתקציב היה גמיש ולכל מפעל היה זכות לקבל תקציב בתנאי שעמד בסף לא היתה ממש תקרת תקציב למשרד. זה לא היה competitive fund אלא העניק לכל מפעל שעמד בדרישות מימון. בליברליזציה בעיקר הכוונה ליכולת להעביר כספים לחו"ל וזה משך משקיעים זרים להסתכל על הספר של ברונו – led to enhanced flow of engineers to civilian Hi-Tech industries.

Intermediate Conclusions (1): The creation of the high-tech industry (the “demand side”) was a result of: Changes in national priorities Institutional changes Global Economical changes Availability of skilled labor (decreasing military expenses) ( Liberalization) US Financial markets Both from the defense industry and the F.S.U

Part B: Innovation & Technology Policy

Innovation & Technology Policy 1950-1970 50’s-60’s: Promotion of capital investments in Industry. This stimulated the establishment of R&D performing MNE in Israel during the 70s & 80s No policy supporting Industrial R&D till 1969. Investments in agriculture oriented research

Innovation & Technology Policy 1970-1980 1969-70: Establishment of the Office of the Chief Scientist (OCS) R&D incentives since 1970 induced a high rate of growth of business sector R&D and a strong process of learning about innovation הופעת מדען ראשי עדיין ב R&D penetration period עדיין אופקי ונייטרלי and creation of the “R&D Industrial Fund” program. The program was Horizontal (open the the business sector as a whole) and its incentives were Neutral(at a 50 % rate) This program directly supported R&D projects of individual companies, is the backbone of Israel RD/Innovation/Technology Strategy. The OCS budget grew from $2.5M in 1969 to almost $400M in 1999. (e.g. the importance of market knowledge for design; of marketing; the link between production and marketing, the shift to more complex R&D projects, etc)

Innovation & Technology Policy 1980-1990 1977 Implementation of BIRDF Till the 90s, more than 90 % of R&D subsidies to companies still came through the regular “R&D Industrial fund”(‘backbone’ program) which promoted joint R&D projects between Israeli and US companies Small Amounts & Large Impact: BIRDF helped create an Israeli hi tech reputation in the US; links and networks, etc. It is widely believed to have indirectly contributed to the high tech cluster of the 90s

New ITP Programs Other OCS support programs– Marketing, Innovation in SMEs, Export research, etc. Technology Incubator program – supporting startup companies in very early stages.. INBAL program – gives guarantee to public VC companies on the down side. MAGNET program – Support generic R&D. …… Yozma program (1993-97)

Influences of the R&D Policies Significant growth in R&D expenditures Rapid growth in employment of Engineers & Scientists in the Industry Strong ‘Learning to Innovate’ process Creation of a identifiable civilian oriented High Tech industry High growth rate in high tech output and exports Rapid increase in the share of High Tech in Manufacturing output and exports

Table 1: OCS R&D Grants (Nominal M$) Total Regular R&D Technology Year MAGNET Miscellaneous Royalties Grants support Incubators 1990 136 NA NA NA 1991 179 NA 1 . 8 NA NA 1992 199 NA 5 10 NA NA 1993 231 NA 10 18 NA NA 1994 316 NA 10 23 NA NA 1995 346 286 15 31 13 64 1996 348 276 36 30 5 91 1997 397 303 53 30 11 121

Table 2: IT High Tech Manufacturing Industry Total Sales Sale per Year Exports ( 000 $) Employees ( 000 $) Employee ( 000 $) 1991 3 , 618 2 , 283 33 , 000 109 1992 3 , 996 2 , 660 34 , 000 117 1993 4 , 610 3 , 200 36 , 500 126 1994 5 , 200 3 , 750 38 , 000 137 1995 5 , 890 4 , 300 40 , 000 147 1996 6 , 500 4 , 880 42 , 000 155 1997 7 , 200 5 , 700 43 , 000 166 1998 8 , 030 6 , 550 44 , 700 180 1999 8 , 580 7 , 130 45 , 800 187 2000 12 , 500 11 , 000 53 , 800 232

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Intermediate Conclusion (2): The different support schemes of the OCS and the Incubator programs have created the conditions for civilian R&D oriented industries and for entrepreneurship. These conditions enabled the emergence of the VC industry

Phases in the Emergence and Growth of the Israeli VC Industry

Phase1 (1993-1996) Creation-Emergence and Learning (1) Dominated by Yozma funds. Very low SU company valuations. Small funds (~$20M). Small amount invested in each startup and small numbers of investments. Large share of co-investment with other Israeli VCs Little seed investments and no specialization in areas. Before 93 only 2 small funds were active in the market with only small macro-economic impact in order to increase total amount invested, to reduce risk and Little co-investment with US VCs.

Phase1 (1993-1996) Creation-Emergence and Learning (2) Foreign partners had important role and operational role. Cumulative learning Very little understanding of the market and the VC business - Very small added value. Goal of VCs to make fast exit through M&A (in low valuations - $10M-$70M). Israeli VCs were very important for startup due to shortage of capital

Phase2 (1996-1998)- Growth (1) First round of private VC funds not related to Yozma still low valuation in private investment, compared to US startups. medium sized funds (~$100M). Increase in the amount invested in each startup and fewer portfolio companies. Increase in seed investments and beginning of specialization in areas. Foreign partners had less important, non-operational roles. ; but the market is still dominate by Yozma funds.

Phase3 (1999-2000) - Maturity (1) Many VC companies and large variety of VC company types. Normal valuation in private placements, compared to US startups. Most VCs specialized in certain areas increase in seed investments. Increase in VCs added value capabilities.

Phase3 (1999-2000) – Maturity (2) Increase in co-investment with US VCs. Goal of VCs to create successful independent companies or very high valuation Exits. Israeli startup companies becoming less dependent on Israeli VC’s added value due to :easy (direct) access to capital market; existence of many exit opportunities; and more experienced management. Moreover, successful Israeli startups has direct access to US VCs.

The Israeli VC “Case-Study” suggests That: Success of targeted policies is much depend on: Clearly analyzing the failures Identifying the required enabling elements Create the condition for these elements to exist Timing is Crucial Carrying on-going learning process is important

This may require: Coordination with existing policies The implementation of new policies/schemes Institutional changes Political/Economical changes Cultural changes Etc.

The Emergence of VC industry was the Result of: High demand backed with strong R&D capabilities High entrepreneurial activity backed with public support schemes Many good investments opportunities Proper economical and political conditions …Targeted incentives for VCs (YOZMA) Liberalization and Peace process

Part C: The Israeli Biotechnology Study

The Israeli Biotechnology Market 160 companies (30% in therapeutics) 10 Public companies 4000 employees Market valuation: $3.5 billion Market capitalization: $2.7 billion Av. Growth in no. of companies: 14% Sales: $800 million (incl. the Copaxon) 75% of the companies employs less then 20 Sales of copaxos are abot 300 millions (of which 92% is generated by less then 10% of the companies)

First IPOs in early 80th The experience gained in IT is partly be relevant in Biotech Therefore, only 8 Israeli VCs are focused on Biotechnology Other financial tools have been developed during the 90th.

Other Financing Tools include: Public Incubators Private Incubators Corporation Biotech Funds TTOs’ funds Angels New Incubator scheme (experienced and not experienced)

Israel Biotechnology Sector

Israeli Biotechnology Companies by Location Other Beer - Sheva Jerusalem 8 % 3 % Tel - Aviv 22 % 19 % Haifa Rehovot 21 % 27 % This industry tend to cluster around main academic research institutes. This is typical to most countries

Israeli Biotechnology Companies By Field of Technology

Typical Limitations of Bio-Pharmaceutical companies Complex regulation Research is complex, lengthy and costly Costly infrastructure is required carry out the research Marketing of new drugs is an extremely difficult task In practice, necessitate working with specialized and experienced companies and contract research organizations to carry out the research, mainly in the advanced phases II and III. to produce substances and drugs

Typical Business Model Strong Team of entrepreneurs Significant Innovative Idea Pre - Clinical Tests Phase I + II Strategic Partner Licensing / Selling of IPR Phase III NDA Marketing After 2-3 successful drugs Royalties IPO

Conclusion from the Israeli Biotech Study (1): Bio-Pharmaceutical function as R&D companies for long period of time without reaching an economical independency IPO is commonly not an “Exit” but rather part of R&D financing Complex networks are necessary for the firm development (IPR, Regulation issues, Financing, Infrastructure, CROs, Strategic Partners, etc.)

Conclusion from the Israeli Biotech Study (2): Proximity to academic institutes is important in order to ease the flow of knowledge VCs find difficulties in entering biotechnology. Thus relatively small no. of VCs are active. Policies directed towards Biotech can hardly be mixed with other regional development policies Therefore biotech can not serve as a tool for developing the periphery As a result of different business model and the need to specialyze

Part C: Policy Implication For Italy

Implication for Italy The policy for promoting SU should focus on: Creating higher demand (increasing entrepreneurial activity) Extending and simplifying the support for R&D oriented firms Closing the information gap between potential entrepreneurs and VCs Strengthening of relations between universities and SU Institutional changes (especially in regards to technology transfer)

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