Venture Capital in the “Holy Land” – An overview of VC in Israel
Updated: Dec 9, 2020
By Cole Graham (Author) and Florian Kramer (Editor), Bocconi Students Private Equity Club
Israel is home to one of the largest tech start-up ecosystems outside of Silicon Valley, making it an attractive region for VCs eager to find the next unicorn. After seeing the success of the VC ecosystem spinning up in the United States in the 90s, the government of Israel wanted to replicate that success within their borders. But at that time, the young nation did not have a robust financial system, Israeli VC and private equity firms were almost non-existent, and opportunities for national investment were scarce.
To change this, the government decided to create the Yozma Programme (translated as “the initiative” in Hebrew) where they would create public-private funds with foreign investors to invest specifically in Israeli tech and healthcare start-ups. The idea was that the government would take a hands-off approach and allow their foreign partners to make investment decisions. The partners would also be able to buy the government out of any investment the fund made within seven years at the value of the investment plus interest. By 1996, the government had invested $100m into the programme and created 10 of these such funds.
At the same time, the government created tax incentives to move foreign money into Israel.
Most notably in 1996, they announced that any foreign VC firms that set up funds within the nation would have an indefinite exemption from capital gains taxes, given that the size of the fund was larger than $10m and 30% of total funds would be invested in companies incorporated nationally. To further facilitate the investment opportunities within the country, the Israeli government invested in technical education to encourage the development of tech start-ups, which yielded an extremely talented and dedicated national workforce. Altogether, this strategy proved to be a winning combination for the government, Israeli entrepreneurs, and foreign investors alike.
In 1998, the government decided that the funds had become self-sustaining and sold their shares – by 2000, there was almost no public money in Israeli venture capital. However, this programme was undoubtedly the catalyst for VC to take off in the middle eastern nation as since then, many start-ups and national VCs alike have begun to spring up in the country. A trend which has only accelerated in the past 10 years.
Since the days of the Yozma programme, Israel’s VC ecosystem has been growing rapidly, but only recently has it been able to compete with other VC hubs in the Americas in terms of both deal count and invested capital. In the 2000s, funds were mostly small and national – a trend that continued into the early 2010s as well. VC deal activity barely cracked $1bn in both 2010 and 2011.
That changed dramatically in 2012 with Waze, the quirky mapping and direction app that allows users to warn each other about roadblocks present on their routes. The company, based in the Tel-Aviv suburb of Yafo, was acquired by Google for a massive $1.1bn. This would become a landmark transaction in the development of Israeli VC as it was the first major exit for a fund (in this case Magma Venture Partners) based in the country and is still one of the largest single-value exits in the Israel VC ecosystem.
Additionally, the Waze acquisition legitimised Israel as a tech hub, which then led to an increase in foreign investment. Starting in 2014, deal activity started to grow exponentially in the small nation as count topped 300 for the first time. Then, big money (mostly international over national) started to take notice – deal value more than doubled from $2bn in 2016 to $4.1bn in 2019. At the same time, investments shifted from mostly seed stage to growth stage, as over 40% of VC investments in 2019 topped $25m. In 2020, deal value exceeded $2.2bn on June 30th, a strong showing despite the COVID-19 pandemic’s impact on global investment.
Within any VC ecosystem, finding a well-timed exit can be tricky and Israel is no exception with exit activity varying from year to year. Large exits such as Waze, Movit (transportation app), and Habana Labs (neural networks) take most of the hype, but the number of exits has gradually grown over the years from a low of 18 in 2011 to a high of 40 in 2019 with a value of $4.1bn. And while there have been fewer exits this year, 2020 is still expected to have 30-35 exits in the end – a number on par with the 33 that took place in 2017.
For the past 10 years, the most common type of company to invest in were tech firms operating in security, productivity, and transportation. During this 10-year period, tech start-ups in Israel received 54% of all VC funding, with healthcare coming in second with 21% of all funding, and transportation coming in third with 7.8%. Further within that tech bracket, SaaS led VC investment encompassing 28% of all deals, with IT hardware a distant second at 13%.
In addition to tax cuts and the Yozma programme, Israel was able to leverage its close cultural and economic ties with the United States to create a strong VC ecosystem. For the US, investing in Israel represents a strategic regional investment in a pro-America nation and a cultural connection through the prevalence of Jewish people in both nations finance industries. This has attracted many US VCs to open branches in Israel with Sequoia Capital creating an Israel-specific fund, along with Canaan Partners and Greylock Partners, to name a few.
In the recent years, US investors have been participating more eagerly in deals with Israel-based start-ups and VCs. In 2010, there were 48 deals that included investments from US-based VCs, and that has risen steadily over the years to 182 deals in 2019 with a combined valuation of $3.2bn. Another reason contributing to this metric is the strategic value of Israeli companies to both national and international funds. Compared to companies in Silicon Valley, Israeli start-ups at both the seed and the growth stage achieve lower valuations while concurrently maintaining lucrative exit opportunities.
Top Israeli VCs
While there is currently a lot of international money interested in the Israeli VC scene, the government is trying to encourage growth through its existing domestic investment pool to balance out the foreign influence of international VCs on the ecosystem. However, the most difficult obstacle to growth for many national Israeli VCs is that they are not applicable for the same exemption from capital gains tax that international funds are privy too. Therefore, it would be wise for the government to levy tax incentives for national funds as well if they are serious about growing national VC funds at the same rate as international funds.
To understand the major players in the space, in the table above are the largest Israeli VC firms in terms of the number of deals (from 2014-2020), portfolio companies, and exits.
Given the international nature of Israeli VCs, successful exits of Israel-based companies funded by Israel-based funds further affirm the strength of the VC ecosystem in the country.
For instance, PrimeSense which was founded in 2005 by Aviad Maizles and Alexander Shpunt as a 3D sensor developer. Their company was able to develop a proprietary array of a camera, an infrared camera, a flood illuminator, and a dot projector as a simple yet effective solution to capture movement and gestures. In 2006, they raised a $9m Series A jointly led by Genesis Partners and Gemini Israel Ventures followed quickly by a $20.4m Series B led by Canaan Partners Israel in 2008. Because of these rounds, they were able to scale the product down and expand the sensor’s field of view, vaulting them past their competition.
This gained the attention of Microsoft who approached PrimeSense to licence their technology for use in the Xbox Kinect sensor. However, in 2011, right after the Kinect launched, Microsoft decided to not renew the licencing deal and instead buy a competitor. It was a brutal blow to the company, and they had to lay off 15% of their workforce. To combat this, the company decided to raise a $10m Series C, jointly led by Rainfall Ventures and Jerusalem Global Ventures. This round provided the company with sufficient resources to develop their next product, a sensor array small enough to fit into a phone or TV. This caught the attention of Apple who was having difficulty developing a gesture array on their own for their FaceID phone unlocking system. In 2013, PrimeSense announced that they had been acquired by Apple for $350m—a successful exit for the VC funds involved, and one of Apple’s biggest acquisitions in the early 2010s.
The future of VC in Israel remains bright, notwithstanding the current state of the world and the impact of the COVID-19 pandemic. Throughout the pandemic, VC investing in tech has remained strong as many investors recognize that many of the big unicorns of the 2010s (e.g. Uber, Facebook, Impossible Foods) were founded during the last economic crisis and so they are looking to replicate that success during the current one. This year’s investment activity also confirms that Israeli VCs recognize the existence of such opportunities.
However, in the long term, the outlook is not necessarily as rosy. Recessions are difficult for start-ups in both the seed and growth stages, so there is a risk that if the pandemic continues for a longer period of time, companies could close before they get to investment stages, drying up the pool for funds to choose from. This could be compounded in Israel also because of the 30% investment threshold that needs to be met in order for funds to be exempt from capital gains tax. Theoretically, this could also cause funds to pump more money into start-ups and cause valuations to get astronomically high, disrupting one of Israel’s competitive advantages compared to VC ecosystems in the US. Therefore, to maintain the growth of the VC market in Israel, funds should look more discerningly about any upcoming investments and maintain a strong portfolio of companies for the medium term.
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This article was first published on Bocconi Students Private Equity Club website on 23rd of November 2020.
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