High-Tech Opportunities in Israel

Israel has been known for several years as "Silicon Valley II," and for good reason. The Israeli high-tech industry has been developing and reaching new peaks each year, both in technological achievements and in sales.

Israel celebrated the fiftieth anniversary of its independence in 1998. Today more than ever before, the country's helmsmen regard encouragement of high technology - the jewel in the crown of Israeli industry - as a national challenge of the first degree.

Wherever You Turn - High Tech

Factories, R&D centers, or software houses have opened up everywhere in Israel. Indeed, figures collected at the end of 1997 show an interesting geographical distribution of electronics and hardware firms, software houses and research centers. The central region is dominant, but there's high tech in the Galilee, the Golan Heights, and the Negev, too. And the trend of increasing distribution is only beginning.

Electronics and hardware industries
Total: 158 electronics & hardware firms

Software houses
Total: 87 software houses

Investment - The Opportunity Market

Israel is in the midst of an important and promising period in the fields of high-tech industry and information technology. Within just a few years, Israel's technological industry has penetrated world markets and has become a research and development center eyed by firms dealing in high-tech products and software for communications, medicine and engineering around the world. The 40,000 university graduates who immigrated from the former Soviet Union were among the prime catalysts that propelled this industry to today's level.

In the past three years dozens of venture-capital funds and investment firms have been founded, and they have already invested hundreds of millions of dollars in R&D projects in start-up companies. Investors worldwide, including Israelis, have discovered the local potential for high-tech products and software.

The Middle East peace process, despite difficulties and delays, presents unprecedented opportunities. Countries which previously did not maintain business relations with Israel are today seeking to collaborate in research, development, manufacturing and marketing. Many of them have already invested in projects in Israel, and some have permanent representatives and offices here.

The hundreds of R&D projects in technological incubators and the thousands of start-ups operating today in Israel have made it a world leader in start-ups as well as in public offerings in North America.

Together, these facts make Israel a powerhouse of high-tech and software. High-tech and software firms currently employ 45,000 engineers, technicians, engineering technologists, computer scientists and information-systems workers. Recent technological and business developments have created a gap between supply and demand for professionals in software, hardware and communications, both in software houses that deal with administrative processing and in high-tech firms that are developing sophisticated software-powered products.

In addition, American and European companies are now establishing research and development centers in Israel, and because they require computer professionals, they, too, are boosting demand for high-tech workers. Assistance for business development is available to Israeli entrepreneurs from diverse sources. These include government funds run by the Office of the Chief Scientist of the Ministry of Industry and Trade; MAGNET, a program designed to allocate substantial financial resources to generic projects; and international funds that operate in conjunction with various foreign countries.

The volume of Israeli high-tech sales totaled about $7 billion at the end of 1997, with more than $5 billion of it exported. Israel expects to reach $10 billion in sales in the year 2000. The high-tech industry follows Israel's successes in the fields of agriculture, water and security. It is expected, in the coming years, to lead Israel to economic independence.

Israel's High-Tech Industry - A World Player

The phenomenon of Israeli high technology has long since grown past the narrow confines of industry insiders or the newspaper financial pages. The big breakthrough by Israeli high-tech firms into international markets and U.S. stock exchanges even prompted the magazine Newsweek [April 8, 1996] to devote a long article to the topic. The authors end the article with the following punch line: "The land of milk and honey has become a land of tech and money." The article's subtitle is no less complimentary: "Silicon Valley really has only one rival outside the United States - Israel."

Today, some 100 Israeli companies are traded on the NYSE, NASDAQ and AMEX equity markets, in the wake of a large number of public stock offering in the 1990s. Other than Canada, no foreign country is so heavily represented on Wall Street. Most of the firms are high-tech companies traded on the NASDAQ, and over a dozen have market capitalizations of over $500 million.

The developments of the last few years were not born in a vacuum. Israel's work force was considered one of the most educated in the world even before the present wave of immigration. The 800,000 immigrants who arrived in the past six years, many of whom have technical professions, further improved the situation and raised Israel to the top of the educational charts, especially in the field of technology. In the 1990s approximately 135 of every 10,000 employed persons in Israel were engineers, compared to about 70 in the United States and 65 in Japan. Nevertheless, there is already a shortage of skilled high-tech professionals. It is estimated that high-tech firms will need another 15,000 engineers and scientists by the end of the decade. In terms of employee output in high tech, Israel also has no reason to be ashamed. The annual output per employee in Intel Israel's Jerusalem plant, for example, was $270,000 in 1995 - which would not put any factory in this field in the world to shame. The development of the high-tech industry in Israel and the steadily increasing output are naturally manifested in salaries, too, which are lower than those in the United States. Years ago, though, Intel CEO Dov Froman disclosed that it was not the low wages that had brought his company to Jerusalem; the main motivation of the company's management in United States for setting up a factory in Israel was the availability of high-caliber professional personnel.

Incubators for Technological Entrepreneurship

In the belief that the country's economic future is largely dependent on the success of its technological industry, the government launched a technological-incubator program seven years ago. This program enables any entrepreneur with an innovative technological idea to turn the idea into a product.

Technological-entrepreneurship incubators are supportive frameworks that enable beginning entrepreneurs - whether they are residents, returning residents, or immigrants - to take innovative technological ideas in the preliminary stages of development, turn them into commercial products for export, and establish factories for this purpose in Israel.

The preliminary stage naturally involves high economic risks, which sometimes deter entrepreneurs from taking the next step. The state assumes this risk by funding the first stage. A successful start-up will repay this loan; one that never makes it off the ground will not pay back anything. By means of the technological incubators, the entrepreneur receives the space, financial resources, tools, professional guidance and administrative assistance needed to turn a vague idea into a product that will prove itself in the global marketplace.

The period spent in the incubator provides the entrepreneur with chances to attract an investor, link up with a strategic partner and leave the incubator as an independent business that can stand on its own two feet from an economic-marketing standpoint. For starting entrepreneurs this is essentially the only real opportunity to survive the fearful preliminary stage and to extract the appropriate economic viability from their initiatives, ideas, or inventions.

The Project in the Incubator

The project remains in the incubator for about two years, during which time the entrepreneur is expected to turn his or her idea into a clear product definition with proven technological and marketing feasibility, set up a working model or prototype, and present an approved business plan.

The incubator will provide:

1. Assistance in studying the technological and marketing applicability of the idea and preparing a research and development plan.

2. Assistance in recruiting and organizing a research and development team.

3. Guidance, direction and professional and administrative monitoring.

4. Administrative, secretarial and management assistance, as well as maintenance, purchasing and bookkeeping services.

5. Legal advice.

6. Assistance in raising funds and getting organized for marketing.

By the end of the incubation period the project is expected to have contacted a commercial investor or a strategic partner; at the end of the two years entrepreneurs must continue on their own, with or without help from the regular governmental assistance tracks or outside investors. There are no dictates whatsoever as to the project's areas of activity; projects, in fact, span all areas of research and development.

Returning Israelis - Coming Back for Success

The success of many overnight millionaires drew the best Israeli high-tech minds to Silicon Valley. Over the years an absurd situation developed: despite hundreds of impressive world-class inventions and successes in high technology, Israeli industry was deserted by thousands of professionals who moved to the United States, leaving a severe shortage in Israel. But the technological success continued. The situation prevails to this day: Israeli high-tech industry continues to record great achievements, while the shortage of workers gets worse.

Nevertheless, an impressive high-tech market has developed in Israel in recent years, resembling America's Silicon Valley. Most high-tech firms are outstanding exporters and provide hundreds of millions of dollars for the state coffers each year. Moreover, the high-tech field is good for the country as a whole. According to the figures of the Association of Electronics Industries in Israel, the average output per employee in Israeli high tech in 1996 was about $155,000. (No later figures are available.) If we calculate the added value, which is about 60 percent, we arrive at a net annual output of approximately $93,000 per worker. Because the product is intended mainly for export, it is clear that this is foreign currency - and a lot of it - coming into Israel.

In the early 1990s, Prime Minister Yitzhak Rabin decided that the time had come to bring Israeli brains home. To this end, a committee was formed in 1995, headed by Zvi Alderotti, then director-general of the Prime Minister's Office. This was known as the "directors-general committee," because it was made up of the directors-general of relevant government ministries. Its job was to alter the situation and attract large numbers of Israelis back to Israel. No less than the existential need for workers, Rabin also saw the national/Jewish need.

Concentration of efforts in North America

At this point all the agencies involved began to understand that their activity should be directed mainly toward the Israelis living in North America. Israelis in the United States and Canada currently number about 300,000, and thousands of them have technological professions required by high-tech firms in Israel, which suffer, as noted earlier, from a permanent shortage of personnel. The Israelis living in America are at the global technological cutting edge, and they have extensive technological know-how, including direct familiarity with the American market, which is the dominant market in the global high-tech arena.

International Giants in Israel

Intel, IBM, Digital, Amdex, and other international giants have set up development centers in Israel; Intel has established a $1.6 billion factory in Kiryat Gat, which is expected to provide jobs for up to 2,000 workers. Our defense industries are continuing to work on joint projects with the Americans, such as the Arrow missile project, while many Israeli high-tech firms worth hundreds of millions of dollars in all are traded in New York.

But in a market that changes overnight, in which one invention follows another and innovations are outdated after a few months, professionals are urgently needed to fill the vacant positions. Therefore the work force returning from North America is vital for the continued development of the Israeli high-tech market.

Profitable Ventures

Israel has developed a venture capital infrastructure which has enjoyed average annual returns of 40%-50% by investing in the country's high-tech start-ups. Many of the investors include major companies from North America, Western Europe and the Far East looking to profit from Israel's unique capabilities in communications, computer software, medical equipment and biotechnology.

Venture capital funds differ from other investments in that they are usually made in unproved businesses and thus face higher risk. Commensurate with the risk is the possibility of very high profits. Such funds, then, invest in new or quickly expanding businesses - but only those that have revolutionary technology which provides a considerable advantage over their competitors.

Some 50 venture capital funds dedicated to high-tech, as well as some 20 diversified funds which focus major resources on start-ups, have raised nearly $2 billion since the early 1990s. According to Yigal Erlich, chairman of the Israel Venture Association, the first wave of funds set up from 1992 onwards raised about $600 million; these funds have successfully invested their capital. A second wave of funds mobilized an additional $1.4 billion for investment.

"The first wave of investment was split 50-50 between local and overseas investors," explained Mr. Erlich, "but in the second wave some 80% of funds come from overseas."

The list of foreign investors ranges from leading investment banks like Hambrecht & Quist and Goldman Sachs in the US and George Soros' Quantum and Converse Technologies as well as major worldwide business corporations like France Telecom, Germany's Siemens and Daimler Benz and Japan's Kyocera. The US aircraft manufacturer Boeing recently invested in an Israeli venture capital fund - its first such investment anywhere in the world.

One unique aspect of Israeli venture capital is that the government initiated this most capitalistic of endeavors. Mr. Erlich, a former chief scientist at the Ministry of Industry and Trade, set up the government-owned Yozma Management and Investment Fund which raised some $200 million in the first wave of venture capital investment. Yozma, still headed by Mr. Erlich, has since been privatized.

In Israel, the venture capital assumption - that only a small percentage of these start-ups will actually succeed but that the profits from these companies will be enough to make the investment worthwhile - has paid handsome dividends.

"I would estimate that the average fund has earned 40%-50% in annual returns for its investors," said Mr. Erlich. "Some have profited by more than 100% per year. But there is an element of risk. Other funds have yet to yield anything and, remember, our investors would consider anything below 20% per annum to be a loss."

The asset that venture capital seeks to profit from is Israeli high-tech. An estimated 70% of Israel's annual exports of $22.5 billion worth of goods contain high-tech components. Furthermore, it has more start-up companies in absolute terms (somewhere between 1,500 to 2,000) than any other than country in the world except the US. According to Minister of Industry and Trade Natan Sharansky, it boasts more high-tech start-ups than all the countries in Western Europe put together. In particular, Israel excels in the development of computer software, medical equipment, communications and biotechnology. In some areas like Internet policy-based management and security and inspection equipment for the manufacture of semiconductor wafers, Israel has gained a near worldwide monopoly. In many instances, military high-tech systems have been adapted for civilian use.

Moreover, Israel not only offers innovative high-tech solutions but also a pioneering entrepreneurial spirit and high quality workforce. A typical young executive would not only have graduated from one of the country's universities but also served as an officer in the Israel Defense Forces. In addition, a high percentage of the over 800,000 new immigrants who have reached Israel from the former Soviet Union are scientists and engineers, who have brought with them innovative ideas.

While venture capital seeks to put seed money into these high-tech start-ups at an early stage in exchange for equity, major worldwide corporations, institutional and individual investors have also been targeting Israeli high-tech companies that have already developed a viable product. An average of $1.2 billion annually in overseas investment has poured into Israeli high-tech either directly or through share issues by Israeli companies on overseas stock exchanges, mainly the NASDAQ market in New York.

Some 100 Israeli companies are traded in New York. Some recent acquisitions of Israeli high-tech companies include: General Electric purchased the nuclear imaging division of Elbit Medical Imaging; Picker (UK) bought Elbit Ultrasound; Johnson & Johnson acquired Biosense, a biotechnology company; Converse Technologies purchased Efrat Future Technologies which makes message management systems; Siemens acquired Ornet for its LAN-switching equipment; 3Com bought Nicecom which develops inexpensive ethernet LANS; and US Robotics acquired Scorpio which manufactures innovative ATM systems. The most celebrated recent take-over in Israel was the $407 million America On-Line paid to the "twenty-something" owners of Mirabilis, which developed a unique program (ICQ) for notifying Internet users if their friends are on-line.

The importance of overseas investment in general and venture capital in particular is that it not only provides the capital for product development but also additional services such as marketing contacts worldwide and business advice including high-tech expertise. Israel's venture capital funds have spawned an entire industry including analysts, lawyers, accountants and consultants. In fact, many venture capital funds are looking to export their expertise to Western Europe where a well-developed venture capital infrastructure does not yet exist.

Meanwhile Mr. Erlich sees the present wave of venture capital fund raising in Israel as coming to a premature end due to the global financial crisis. "But today there is already not enough venture capital in Israel," he observed, "considering the many good investments available. This will soon result in the start of a third wave of venture capital funds which will be larger than the last wave, perhaps raising as much as an additional $2 billion in the years to come."