This OHK blog post is the first of three parts. It was first presented in an executive roundtable discussions in the Wharton School in the University of Pennsylvania. OHK’s Ahmed Hassan provides perspectives and lessons learnt from VC expert exchanges, interviews with industry veterans and OHK’s own insight from advisory on success in innovation and entrepreneurship.
Visits with Israeli startups in the Bay Area offered valuable exchanges and case studies on the VC landscape in Israel’s strong emerging market. They offer perspectives and lessons for peers, especially in the wider Middle East. Photo © OHK Consultants
Part 1: Background and Theses 1 to 3
Both popular and academic literature about the Israeli startup scene abounds with heady language. Israel is referred to as the “Startup Nation”; its entrepreneurial-minded citizenry lauded as an economic miracle and its landscape given the playful sobriquet “Silicon Wadi”. Authors and theorists have gone to great pains to compare Israel to Silicon Valley, seeing the former as something of a younger brother to the latter or two sides of the same entrepreneurial, late-capitalist coin. Much of the literature revolves around either a) the convergence of the two, measuring both the Israeli and American startup ecosystems against a universal, model-type, end-stage entrepreneurial ecosystem, or b) the applicability of the “Israeli model” to developing countries. Less is said about the differences between the Israeli and American models, and the extent to which those differences may be more structural than incidental (and thus problematic as templates for other countries).
In the spirit of Hall and Soskice’s pioneering work on global “flavors” of capitalism (see: Varieties of Capitalism: The Institutional Foundations of Competitive Advantage. Oxford University Press, 2001), this discussion sets out a series of hypothetical theses that aim to provide insight into the differences between the Israeli and American startup environments and to set a research agenda going forward. We proceed from the assumption that differences between the two startup landscapes are not epiphenomenal accidents of history, but rather reflect more fundamental structural differences between the two. In using the term “structural,” we are referring to unique institutional and cultural forces that are fundamental to national identities and that, while not immutable or uncontested, have come to characterize local economic landscapes. The economic phenomena we seek to highlight in these theses are slow-moving and often unwritten; to understand startup cultures, it behooves us to look not at individual companies, actors, or events, but rather institutions and regulatory regimes.
Some of the nine theses we identify have strong quantitative bases, while others are more qualitative and have emerged from various guided discussions with subjects from both Israeli and American startup ecosystems. In each case, however, we provide a lens through which to better understand the particularities of the Israeli startup landscape and predict its evolution. This is particularly useful in the context of emerging markets and the wider Middle East, and in countries like Egypt, Jordan, Morocco, and Tunisia where there is a significant potential to develop a far more developed VC ecosystem.
Thesis 1: Aspects of Israel's High-Tech Ecosystem Are Not Easily Replicable
Throughout the literature, there are ample references to Israel’s unique high-tech ecosystem. We believe that three aspects of this ecosystem and, in particular, the interplay of these factors is unique and difficult to replicate.
The GrEEK Campus is an Egyptian attempt at setting up a “San Francisco” or a “Tel Aviv” – a technology innovation hub in the heart of Downtown Cairo. Photo shows campus walls of the American University in Cairo which today houses this growing hub. Photo © OHK Consultants
Much of Israel’s startup dynamism can be traced to a three-part institutional framework, which in turn is highly specific to a history of bilateral cooperation between Israel and the United States. Firstly, Israel’s "Law for the Encouragement of Industrial Research and Development—1984" encourages “raw” R&D on a national level. We believe this particular legislation departs from the more common paradigm of economic promotion through FDI, tax breaks, clustering, and attraction of mature “anchor” enterprises, focusing rather on raw research and tech development. Secondly, Israel has created an Office of the Chief Scientist populated by startup and private sector veterans that coordinates support for and resources to tech entrepreneurs in Israel. Thirdly, funds like the BIRD Foundation, a product of US-Israeli bilateral ties, directs funding to tech companies to support R&D and has had a hand in many of Israel’s largest startups. It is essential for the student of the Israeli startup ecosystem to understand the extent to which these regulatory and institutional bodies are unique to Israel and would be unfeasible in other countries, whether because they are at odds with broader cultural attitudes toward legislation (as in the regulation-averse United States) or because prerequisite institutions or bilateral relationships are absent (as in any number of developing countries). As a result of this interplay and supportive environment, expenditure on R&D in Israel as a percentage of GDP is the highest in the world, as noted by Orna Berry, Former Chief Scientist, to OHK’s Managing Partner, Ahmed Hassan.
In interviewing various Israeli startup founders in Palo Alto, we noted that the Israeli military is a unique onramp for talent, while Israel’s compulsory military service ensures that virtually all Israeli startup founders have military experience, it does not explain why a preponderance of successful entrepreneurs come from elite units like Unit 8200 of Israel’s Intelligence Corps. Not only are founders commonly alumni of such units, but many of Israel’s leading startups are in industries that parallel the unit’s specialization, including security, telecommunications, and encryption. Over the course of a week spent engaging with Israeli startup veterans, our estimate for the number of startups with founders coming from Unit 8200 ranged from 25% to 90%. This highlights the need to better understand the role of entities like Unit 8200 in Israel’s entrepreneurial ecosystem and how they supports entrepreneurship in tangible terms. Exactly how much of Israel’s startup talent comes from such an alumni pool? And how precisely do such units create and maintain this startup elite? Do they function as an MBA providing leadership skills and holistic critical thinking, as a technical undergraduate degree providing foundational and top-notch technical training (i.e., an MIT), or as an incubator attracting existing talent and providing hard and soft resources for improvement? Further research is needed.
Israel’s universities were founded as early as 1912 with the Technion. Today there are eight, three of which are ranked in the world’s top 200 universities, per QS World University Rankings. In 1959, the Weizmann Institute established the Israeli Technology Transfer Office (TTO) marking academia’s ingress to research transfer. Since then, every leading university in Israel has created technology transfer companies. Presently, Israeli TTOs generate around NIS 1 Billion in royalties, license 150 new technologies, and support 15 new research-based companies every year. “Yissum” of the Hebrew University and “Yeda” of the Weizmann Institute rank among the top ten in terms of revenue of global TTOs, notes Yaacov Michlin in “Where Science Means Business–Technology Transfer: The Secret Engine Behind Israel’s Success.”
Although this aspect is not dissimilar from elite universities in the United States, again the focus of the government shines through in the founding and support of these institutions and how intricately they fit into the high-tech ecosystem, factors more unique to Israel.
Thesis 2: Lower Pre-Money Valuations are Indicative of Brand Challenges
Despite the breathless praise of Israel’s startup culture as an economic miracle rivaling that of Silicon Valley, and despite anecdotal evidence that Israeli technical talent often exceeds that in the United States, pre-money valuations of Israeli startups are persistently below those of comparable startups in Silicon Valley. We believe that any student of the Israeli startup ecosystem must understand the extent to which this devaluation is a function of Israel’s brand; that is, its perception among the various players within global finance. Do Israeli startups suffer from a geographical discount much in the same way that startups based in peripheral American markets are valued less than those in Silicon Valley? Or do lackluster pre-money valuations reflect perceptions of Israeli startups’ market viability?
Upwest Labs is a Silicon Valley seed fund targeting Israeli tech entrepreneurs. Photo courtesy of Upwest Labs.
On the latter, there is growing evidence; data suggests that Israeli startups are 46% more likely to take on smaller markets relative to startups in Silicon Valley, and that Israeli startups are 5% and 33% less likely to take on USD 1 to 10 Billion and over $10 Billion markets, respectively, as noted in “The Startup Genome, Startup Ecosystem Report 2012”. This corresponds well to remarks made by Gil Ben-Artzy who suggested that US venture capital funding of Israeli startups should “redefine success,” move away from traditionally smaller exits, and expect bigger returns and shorter times to market (reflection from meeting with Gil Ben-Artzy, Founder, UpWest Labs Headquarters, Palo Alto).
Thesis 3: Israelis Frame the "Founder's Dilemma" Differently than Americans and Other Leading VC Markets
When asked about the challenges they face, American entrepreneurs frequently focus on difficulties related to career decisions and transitions – the difficulty of leaving a high-paying job for an uncertain venture, the challenge of balancing their family’s needs with the founder’s business imperatives, and choices around managing risk. In addition, US startup founders amplify the importance of “getting the team right,” while their Israeli counterparts hardly mention it. To wit, Israeli founder challenges appear 67% less likely to be team related and 39% more likely to be product centric. In a meeting with Gil Ben-Artzy, he noted that age may well play a factor given that on average founders in Israel are in the mid 30s.
“The Founder’s Dilemma” by Harvard’s Noam Wasserman discussed startup pitfalls and how daunting they may be for founders of startups in the US innovation landscape, however we do not see Israeli peers necessarily seeing it the same way. Photo © OHK Consultants
Our experience with Israeli founders is that the question of personal risk is far less salient. Indeed, some are downright dismissive of the “founder’s dilemmas” that preoccupy American founders. We propose that it is necessary to frame these discussions with further insights into the perceived and real opportunity costs and demographics of Israeli founders. Are Israeli founders less saddled with debt? Are their families more receptive to riskier career choices? Is there some nebulous “survivor mentality” among Israelis that reframes the founder’s dilemma in a way unintelligible to American founders? We suggest that the answers to these questions are as much ethnographic as statistical.
OHK’s Ahmed Hassan would like to thank colleagues from the Wharton School, namely Vijeta Johri, Bruno Samuel, Richard Tsai and Jian Zheng, and special thanks to insights by Professor Rafi Amit, Founder and Director of the Wharton Global Family Alliance at the Wharton School.
For more information about OHK's work in venture capital and entrepreneurial management, contact us.