Formerly known for Oranges and Kibbutzim, Israel has long morphed into a global hotspot for innovation. Given its geopolitical situation, no natural resources and a lack of water, one is left to wonder how this young and small country in the Middle East has managed to become one of the most innovative nations of the world with Tel Aviv being among the world’s most acclaimed startup clusters. Israel’s Silicon Wadi (Wadi: Arabic for Valley) – i.e. the metropolitan area around Tel Aviv ranks as the sixth largest cluster in the world (2017 Startup Genome Report). These startups are often successful. Many are acquired by big multinational companies (for example Mobileye in 2017 for 15.3 billion USD in the up to today largest acquisition of the country) or are going public. Israel with a population of only 8.5 million ranks third after the substantially more populous countries of US and China when it comes to the number of companies having IPOed on NASDAQ in the last 40 years (more than 250 Israeli companies).
In Israel innovation-startup ecosystem has been and remains to be the result of a bold and forward-looking policy. Initiated in 1968 with a political decision the country has since made the transition from a centralist agricultural society into a competitive knowledge-based innovation economy. Especially since the 1980ies, gloomy desert settlements and barely developed regions have become thriving economic centers with a vibrant startup scene and corporate offices from around the world.
The Office of the Chief Scientists (OCS) of the Ministry of Economy (& MATIMOP) was put in charge of supervising, proposing and implementing Israeli innovation policies. Renamed as the Israel Innovation Authority (IIA) it still serves today as an independent and impartial public entity for the benefit of the Israeli innovation ecosystem and Israeli economy as a whole. Its role is to nurture and develop Israeli innovation resources, while creating and strengthening the infrastructure and framework needed to support the entire knowledge industry.
Among the legion of factors that make up the Israeli ecosystem, the following stand out:
- R&D: no other country has been spending a greater part of its GDP on military and civil R&D.
- Venture Capital: only in the US it is more available.
- Technological Incubator Program: a program that was to create jobs for immigrants became one of the ecosystem’s drivers.
- Industry-Academia Cooperation: researching for the market & the entrepreneurial spirit at universities.
- Military: IDF’s special role in molding startup founders.
- Culture: Chuzpah & networking “one grade removed”.
Since its foundation in 1948, the country has invested heavily in military R&D in light of its distinct geopolitical situation and conflict related security threats. This has led the foundation for the development of the computer, security, telecommunications, electronics, and semiconductor industries, the Startup Nation is known for today. In recent decades, support for civil R&D has caught up, with Israel investing around 4.21% of its GDP in R&D in 2013. Based on the Law for the Encouragement of Industrial Research and Development funding through its central instrument, the R&D Fund, have had a multiplier effect on private sector research investment.
On top of the country’s dire situation, in the 1980ies one million new immigrants (then about 20% of the population) arrived from the former Soviet Union. These mostly well-educated immigrants pushed into the already tight labor market, that was unable to absorb them.
Since 1991 a newly established OCS led Technological Incubator Program was to mitigate the situation by helping those new immigrants to start a company on their own. What was primarily intended as a tool to create employment for immigrants, turned out to be crucial for the genesis of the ecosystem. The technology neutral Technological Incubator Program has since sought to mitigate some of the shortcomings of new ventures, such as lack of capital, inexperienced management or lack of understanding regarding markets. For those startups accepted into its 2-year program, it provides a supportive environment with free offices and resources, mentoring, assistance in finding product-market fit and determining technological and marketing feasibility, business and legal advice, investor relations, networking, as well as pre-seed and seed capital.
Technology Incubator Programs cover 100% of their Startup’s approved budget during the program period (usually 2 years): 85% (max $ 1 million) via the OCS, 15% from the (today private) incubator operator in exchange for equity. Only if the startup turns out to be successful, the public grant is to be repaid by royalties in the amount of 3-5% of the annual income. Crucially, the 15% private incubator money ensures a diligent assessment whether the startup is promising enough to be accepted into the program. The public investment, on the other hand, allows incubators to support ventures that would otherwise be too risky. Today incubators are licensed under a franchise model by the OCS/IIA for a period of 8 years. Relatively modest use of taxpayer money has catalyzed private capital investment and has indirectly benefited the whole economy through spillovers.
Israel took another innovative approach to help establish its Venture Capital (VC) industry. In 1993, the Yozma (Hebrew for “initiative”), often referred to as the most successful and original program in Israel’s history of innovation, offered to match investments by a foreign VC fund with public funds. A lever to start a VC industry was found, and as a result, in recent years only in the US and China has more VC been invested.
In order to join the program, an Israeli fund had to cooperate with a foreign investment company. If together they managed to raise USD 12 million, the state would contribute another $ 8 million. In return, the state retained 40% ownership in the newly established fund. However, the private partners had the option to buy back the state’s shares within five years for the amount of the public investment plus interests. Thus, although the state accepted a considerable part of the risk (80% of the downside risk), it allowed private investors to reap the profit. To many foreign investors, this value preposition proved irresistible, and soon demand to join the program had become so high that the necessary amount of foreign investment was raised to $ 16 million.
This cooperation was key to the program’s success: While the Israeli part was responsible for relationship management between investors and founders, the international partner contributed its network, market knowledge and experience as a VC-investor to help the startups scale. The plan worked out. Today, Israel ranks top in the availability of VC.
Reasons why Israel is so successful
Isreal ranks top in university-industry collaboration. Commercialization of academic research is expressly encouraged also through state funded programs. Inventions of academic staff are property of the university, that is commercialized by special affiliated Technology Transfer Organizations (TTOs). Led by experienced business people these for-profit companies ensure the protection of this IP (esp. via patents) and commercialize them. TTOs also link the research institution to industry, startup founders and investors. From royalties received Israeli universities can increase their research budget substantially. Flexible terms of employment for university academic staff and a proportionate participation of the researcher in any royalties resulting from his developments further breed an entrepreneurial spirit in the research departments.
R&D departments of big multinational companies are crucial components of the clusters. Big players such as Intel, Microsoft, Apple, Amazon, Dropbox, Dell, Citibank, Merck Group or SAP tap into the country’s innovative potential – and support the ecosystem at large: They hire engineers, acquire startups or cooperate with them, establish a branded co-working space or run their own accelerator.
In only 70 years, Israel’s population has increased more than six fold. This has been due to waves of immigration making Israel a multicultural country of immigrants that continues to actively encourage immigration. Public support programs and a pronounced “welcome culture” facilitate integration of new arrivals. Many immigrants are natural entrepreneurs – they are more willing to take risks than people who have not left their familiar environment in order to start anew in another country in which they are at a disadvantage on the local labor market. Thus, a nation of immigrants is also a nation of entrepreneurs.
In Israel, entrepreneurial spirit is regarded highly and founding a startup is the preferred career choice of many. The country’s multicultural set-up together with its open culture of discussion and lack of formal hierarchies breeds creativity. Living in a conflict-stricken region in the Middle East where war can basically break out every day makes people not only enjoy life in spite of this situation (World Happiness Report ranks Israel 11th), but also puts the entrepreneurial risk of founding a startup in perspective. If you cannot be sure whether there will be a war when you will wake up in the morning, founding a startup looks a lot less scary. Israeli entrepreneurs are thus known for being risk-takers and do not shy away from daring decisions. Additionally, failure is understood as part of the entrepreneurial process, and an unsuccessful startup as another stepping stone towards a breakthrough. Improvising is a valuable skill in a Middle East – and comes in handy in a startups inherently unripe processes and systems.
The military service is a crucial factor of the Israeli ecosystem, that cannot be replicated. The (for men and women) compulsory army service in the IDF (Israeli Defense Forces) helps develop character traits that are useful for aspiring entrepreneurs, such as the ability to make decisions on complex issues under pressure, self-confidence, self-assertion and the ability to work in a team. Many startups are based on technical innovations originating in the army. The Elite Intelligence and Cybersecurity Unit 8200 has been legendary for its graduates and their potential to found successful ventures.
Its small domestic market puts Israeli startups at a disadvantage – leading to the prevalent business strategy of “go global fast”. The flipside of a small country is a close-knit network, further strengthened by the shared experience of the military service. A culturally rooted dislike for authorities and hierarchies makes people approachable and ready to help with introductions and advice. The promotion of lighthouse successes – joined together with the aforementioned self-confidence – urges many Israelis into trying to become an acclaimed entrepreneur themselves. Finally, a nation branding campaign has created the label of the “Startup Nation Israel” further attracting interest and attention from investors, big companies and talent alike.
Key Learnings for Austria
Israel seems to have figured out a way or two to “startup” Innovation-Startup Ecosystems. For Austria especially interesting are the targeted decisions the Israeli government took to help push its innovation ecosystem forward. Special cultural factors and of course the distinct role of the military aside, targeted policies played a crucial role in establishing an VC-industry, integrating immigrants to become entrepreneurs, inviting MNC into the country and encouraging academic-industry cooperation. However, as in all case studies, also with the Israeli Startup experience, the role of its specific history, cultural aspects and geopolitical situation may not be underestimated when lessons shall be derived for other ecosystems.