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STARTUP

3 Dramatic Changes Propelling Startup Nation To Challenge Silicon Valley

Israel keeps adapting to the changing global startup scene. Here are the three most significant initiatives driving Israel to the top of the Pillar Company Staircase.

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BY Peter Cohan - 26 Mar 2018

PHOTO CREDIT: Getty Images

A country founded about 70 years ago keeps changing. After spending a week there from March 17 to 23 - my last visit was in 2014 - I observed three big changes in Israel.

 

Before getting into the changes, let's discuss a book published in Sept. 2009, Start-up Nation, that made the world aware of Israel's startup success. Start-up Nation pointed out that Israel - which now hosts about 8.5 million people - led the world in NASDAQ-listed companies per capita mostly in cybersecurity, medical devices, and pharmaceuticals.

 

There were many reasons for that accomplishment. Among these were the massive supply of technology talent groomed for entrepreneurship through their participation in elite NSA-like military units such as the 8200 and 8100; a culture of risk-taking and problem solving; the absence of local markets for many products - which forced companies overseas to achieve growth; and the Israeli government's success at jump-starting venture investing in Israel.

 

The government's role strikes me as interesting. Israel created a program called Yozma - which, according to a March 19 interview with Aharon Aharon, CEO of the Israeli Innovation Authority, "made $100 million available for the use of venture capitalists to come to Israel. VCs invested 60 percent in an Israeli startup; Yozma put in the other 40 percent. 10 VCs applied for the program, eight were very successful and bought out the 40 percent interest at cost. Since then the government has not funded startups and in 2017, Israeli startups attracted $5.3 billion worth of VC investment."

 

This program was effective because the outside VCs made many investments in entrepreneurs who achieved rapid growth and thus enriched the VCs. What's more the Yozma program was set up to reimburse the Israeli government for as much of the $100 million as possible. If the VC invested in a company that turned out to be successful, Yozma required the VC to buy back at cost the amount that the government had invested. If the company failed, the VC was not required to buy back the government's interest.

 

For several years, I created and taught a very popular Babson College course, "Israel Startup Strategy Offshore Elective." The course consisted of three parts. The first was two days of classroom discussion on topics using my books Capital Rising and Hungry Start-Up Strategy such as

 

  • Why do some countries attract more private capital than others?
  • Why do a few cities attract most of the startups?
  • What makes the difference between the small number of successful startups and the rest?

The second part of the course was to visit Israel for a week to interact with startups, VCs, government officials, and startup accelerators. The final part of the course was for student teams to conduct six-week consulting projects for five Israeli startups.

 

In 2014, when the course last ran, I remember thinking that Israel's biggest challenge was that so many of the startups its entrepreneurs started grew quickly by locating in the U.S. - to tap the talent to market to corporate customers -- and being acquired by big companies like Google and Microsoft.

 

This was not a problem for the founders who were happy to make a relatively quick killing and not to be saddled with the responsibility of running a public company. But Americans, rather than Israelis, were taking many of the jobs. In 2014, I thought that if only more Israeli CEOs could locate most of their employees in Israel, it would be better for the local economy.

 

Last week, I returned to Israel with two Babson colleagues, Srini Rangan and Sam Hariharan, to meet with about 45 entrepreneurs, investors, large company executives, and government officials as part of our research on the globalization of Israeli firms. This visit made me aware of three significant changes since 2014.

 

1. Adapting to labor shortage

 

Many of the entrepreneurs and government officials I spoke with commented on a shortage of technology talent in Israel. Their complaints sounded like those I have heard from Silicon Valley were graduating computer scientists command starting salaries of $200,000 a year thanks to competition from Facebook and Google.

 

Israeli startups are facing the same problem - not to mention massive traffic jams and high housing prices in Tel Aviv. Local entrepreneurs are getting around this problem by outsourcing some engineering work to lower cost locations like the Ukraine and Eastern Europe. When I visited in 2014, I did not hear about labor shortages - in fact it appeared that more local jobs would be welcome.

 

2. Focus on new industries

 

Israel is also focusing on new industries. For example, Aharon said that for financing biotechnology and pharmaceuticals, there is "market failure" - meaning that local VCs do not want to invest in exploratory research in those industries because it is so risky and takes so long to pay off. Israel is making loans to local companies seeking to commercialize life sciences research from the Weizmann Institute.

 

Israel has also expanded in the automotive and fintech industries. According to Aharon, in 2008, Israel had nothing in the automotive industry. 10 years later General Motors operates an R&D center in Israel with 300 employees and Israel hosts 500 startups in the automotive industry. What's more, on March 21 we visited with a venture capital firm, Viola, an investor in fintech companies like Manhattan-based Payoneer -- that helps companies transfer funds globally - which raised a whopping $270 million in October 2016.

 

3. Building companies to last

 

We met with Israeli business leaders who are trying to create what I call Pillar Companies in my recently published book Startup Cities. In a March 20 meeting, Gil Shwed (cofounder and CEO of $16.2 billion stock market capitalization Israel-based cybersecurity company) Check Point Software talked about how to hire executives and operate a company that gets half its revenue in the U.S. and half outside.

 

In a March 19 meeting, Shlomo Kramer, His cofounder, and now CEO of Cato Networks, said he is mentoring first-time Israeli entrepreneurs, so they can build companies to last.

 

In Startup Cities, I introduced the concept of the Pillar Company staircase. The top step is occupied by Silicon Valley which hosts world-leading pillar companies targeting huge markets. Boston and Tel Aviv are on the fourth step -- hosting pillar companies targeting niche markets.

 

But these three changes convince me that Israel is surpassing Boston - which is overly-focused on enterprise technology -- to challenge Silicon Valley at the top step of the Pillar Company staircase.

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