1. 1 Changes in the Israeli VC Market: From an Emergent to a Developed Market Gil Avnimelech & Dafna Schwartz School of Management Ben Gurion University, Israel 5 th Bi-National Regional Science Workshop Tel Aviv, 29-30 April 2007

2. 2 Objectives This paper analyzes the process of development of a VC industry in a new geographical market We examine the changes that have occurred in the Israeli VC market since its emergence at the early 1990s toward its consolidation stage We identify changes in the VC market size, structure, concentration, investment patterns and performances.

3. 3 The Israeli VC Industry High VC investments as a share of GNP – 1.2% during 1997-2006, compared with 0.48% in the U.S.. High Share of VC investments in Early Stages - 44% of VC investment during 1997-2006, compared with 25% in the U.S., and 23% in EU. High Share of VC investments in ICT - 74% of VC investment during 1997-2006, compared with 55% in the U.S. Diversified Global Exit Channels – almost all exits are in Global capital markets – IPOs in NADSAQ and in other global capital market and acquisitions by MNEs.

4. Related Literature  Evolutionary Economics (Winter & Nelson 1982; Dosi 1982, 84; Freeman, 1988; Arthur 1990) (Anderson & Tushman, 1990; David, 1994; McKelvey, 1998; Perez, 2002)  Product/Industry Life Cycle (Abernathy & Utterback, 1975, 1978, Klepper, 1996, 1997, 1999, 2000, 2001) (Malerba & Orsenigo, 1996; Audretsch & Feldman, 1996, Simons, 2001)  Geographical Economics - Clusters (Marshell, 1890; Krugman, 1991; Audretsch & Feldman, 1986, 2003) (Maskell, 2001; Saxenian, 1994; Boschma & Lambooy, 1999; Fujita & Thisse, 1996)  Venture Capital & Entrepreneurship (Chan, 1983; Act & Audretsch, 1990 Timmons & Bygrave 1992; Berglof, 1994) (Himmelberg & Petersen, 1994; Hellman & Puri 2002; Wright & Robbie, 1998) (Marx, 1998; Gompers & Lerner 1999, 2001; Repullo & Suarez, 2004 )

5. 5 The Main Arguments The services provided by VCs should be analyzed as innovative services within the financial markets. When VC industry enters a new geographical market, in many aspects, it follows similar patterns to an innovative product life cycle. A new VC industry will initially include a few but extremely innovative agents. As the industry matures it becomes much more competitive and the VC agents become less innovative.

6. 6 Israel's high Tech Cluster Selected Structural Elements (1969-2006) 01-06*93-0085-9277-8468-75Period 2,260 (305)2,360 (748)297 (96)80 (8)56 (1) # SU Creation (VC-backed**) 3,931 (7,264)7,480 (9,495)85 (170)0 (0) VC (PE) Fundraising 40 (13)133 (65)19 (3)13 (0)1 (0) # Global IPOs (VC-backed) 81 (56)91 (37)2 (0)0 (0) # M&As (VC-backed) 100+50+18105 Foreign MNE R&D Centers Sources: IVC (2007), USPTO (2007), IAEI (2007) and authors processing

7. 7 VC Emergence 1993-1998 Triggered in 1993 by Yozma  created a critical mass of activity  VC Industry Emergence Few VC agents – Extremely innovative agents Rapid development of the high tech cluster  demand for VC services Rapid growth of NASDAQ, of global high tech sectors and of Global VC industry  Exit opportunities  Accelerated growth of VC activity in Israel  VC Industry Development

8. 8 VC Emergence & Development Startups’ Foundation: 1986-2005 Source : IVC 2007

9. 9 VC Emergence & Development VC Raised & Invested: 1991-2006 (M$) Source : IVC 2007

10. 10 Toward Consolidation Entry of a significant number of foreign VC agents to Israel. A solid base for acquisitions of Israeli startups – significant number of MNE active in Israel More diversified exit channels for Israeli startups. First VC companies complete a full VC cycle and raise third and forth funds. Overcoming the external high tech crisis Only successful VC raise new fund.

11. 11 Entry of Foreign VC Investments of Israeli vs. Foreign VCs (M$) Source : IVC 2007

12. 12 Not Only VCs Finance Startups VC-backed Startups 1991-2006 Source: IVC 2007

13. 13 Less High-Risk Investments Stages of VC Investments 1997-2006 Source: IVC 2007

14. 14 More Competitive Industry A Dominant Group of Leading VCs 20052003200119991997199519931991 496978503220144# VC MC 55%54% 62%72%69%89%100%Big-10 MS 1211121097448322822 Ave. VC Size (M$) 613498482234124523722 Big-10 Ave. VC Size 5.074.454.423.162.581.621.321.0Size Ratio Sources: IVC (2007) and authors processing

15. 15 Characteristics of Israeli Startups that were targets of M&As 1997-2006 2006200520042003200220012000199919981997 2616159683418157 Number of Deals 1251385790121429439200131174 Average Valuation (M$) 29.938.232.428.960.330.615.521.418.717.4 Average Investment (M$) 4.23.61.83.12.014.028.39.37.010.0 Average Multiple 4.03.53.32.73.3 1.42.11.01.7 Average # of Rounds 8.18.38.07.07.36.13.75.21.52.7 Average # of Investors Sources: IVC (2007) and authors processing

16. 16 Characteristics of Israeli Startups that had IPOs on NASDAQ 1997-2006 2006200520042003200220012000199919981997 2450121812413 Number of Deals 121178166NA6216622240316378 Average Pre- Value (M$) 40.542.441.7NA20.027.021.610.56.73.4 Average Investment (M$) 3.14.24.0NA3.16.110.338.424.322.9 Average Multiple 52.84.0NA1.02.02.61.91.81.0 Average # of Rounds 11.511.313.8NA1.07.57.35.43.01.9 Average # of Investors Sources: IVC (2007) and authors processing

17. 17 Characteristics of Consolidation Relative stability in VC investments Continued stream of startup creation with realistic closure rate (50%-70%) More diversified VC market. More conservative industry - less early stage and high risk investments. Much lower returns – larger investments and many rounds & investors in each startup

18. 18 Conclusions When VC industry enters a new geographical market, in many aspects it follows similar patterns to a product life cycle. A new VC market will initially include a few but extremely innovative agents, which gain very high returns. As the industry matures it becomes much more competitive and conservative, therefore it will be less innovative and take lower risks and consequently have significantly lower returns. This have significant policy implications.