Israel turns 71 — Is the start-up nation ready to be a scale-up nation?

Israel has rightly achieved a world-wide reputation as a start-up nation, with the highest concentration of high-tech companies per capita and more than 350 local R&D centers of multinational companies. A less known secret is the growing phenomena of more mature scaled-up Israeli companies. This is a positive trend for Israel, at the national level, and could expand horizons for appropriate Israeli companies, at the corporate level.

A Start Up to a Scale Up

A start-up is usually defined as a company in its early stage, developing a unique technological idea, product or solution. Often, it does not yet have revenue or profit.

A scale-up company is less talked about. These companies customarily have wider operations, significant revenue (let’s say above US $150 million) and a more robust structure.

Are There Israeli Scale-Up Companies?

In recent years, we see a growing flow of Israeli companies that have scaled successfully and taken market share from more established global companies. These are robust companies with global operations, providing comprehensive solutions to market needs. Some remain Israeli, like Check Point, Amdocs, Nice and Teva, but others are acquired by even larger buyers. The largest Israeli exit was Mobileye (autonomous driving solutions), sold for US $15.3 billion to Intel in 2015. A more recent example is Melanox Technologies, to be bought by Nvedia for US $6.9 billion. It is expected that the Israel operations of this 20 year-old company, a leading supplier of interconnect solutions and services for servers and storage, will grow further post-acquisition.

Should Israel become a scale up nation?

There are many pros to being a scale-up nation. As more companies scale up, more manufacturing and other positions will be kept in the country, supporting the country’s economic growth. While globally, for each hi-tech position there are five lateral non-tech positions, in Israel there are only two. More positions, especially in the tech sector that pays double the average Israeli salary, will improve the employees’ situation. At the same time, the employing companies would enjoy higher revenue and the country will collect more taxes.

Additionally, Israel’s global business and tech role will increase. This could also improve Israel’s global standing from a geo-political angle. Even the most devout BDS supporters cannot in fact boycott Israeli technology. Intertwined in our daily routines, it is almost impossible for one to boycott Israeli technology while maintaining a modern life.

And yet there are no pros without cons. As companies scale-up, more of their operations are shifted out of Israel, making them less Israeli. In a way, more scale-up, less nation.

Why now?

One could argue that what makes Israelis so good at start-ups – like creativity and the ability to improvise – constitute a set-back in the context of building a leading global company.

However, in recent years, we see more and more scaled-up Israeli companies. The drivers are experienced Israeli founders who have already made an exit and experienced Israeli managers who worked and studied abroad. Israel also was placed on the radar of added-value investors like strategic and private equity funds. Another driver is the expansion of the business perception from niche-technologies looking for markets to broader business solutions targeted at pre-identified market needs. A final driver worth mentioning is the development of un-organic growth via acquisition of other companies – both Israeli and non-Israeli.

Consequently, more founders are interested in growing large companies as opposed to making a quick exit, which was the leading conventional wisdom for Israeli companies in the past.

What can be done to support scaling up?

The Israeli human capital is a major part of Israel’s success. The Israeli Innovation Authority is right in saying there is a need to increase Israel’s human tech capital, including by increasing the participation of women, ultra-Orthodox and Arabs in the tech market. The shortage of experienced and talented technology workers also limits Israel’s ability to scale-up.

The Innovation Authority also funnels funds to growth companies, targeting companies with disruptive technologies and higher risk portfolios, who find it more challenging to raise funds in the prevalent investment arena. This approach of giving greater amounts to fewer, larger companies differs from the earlier one of distributing lesser amounts to many smaller and earlier-stage companies.

Another approach could be to concentrate efforts in areas where Israel has a natural advantage, such as cyber, AI (artificial intelligence) or where sophisticated manufacturing is required.

One could also use government incentives for large companies to remain in Israel, such as a taxation reform that would match the US tax reform and incentives offered by other countries.

Is it sustainable?

A review of comparative data from recent years shows an increase of later stage and larger funding amounts and less funding of earlier stage investments, including a record five investments of over US $100 million and one hundred investments of over US $20 million in 2018, four times of that of 2013. At the same time, we see a decreasing number of exits in the range of US $100-$500 million, and not for lack of offers. The likely reason they don’t exit is that these companies are being groomed to become substantial companies, including many in the cyber and computer-related space. These companies in the growth stage could well be the pipeline for the next scaled-up Israeli companies.

Macro vs. Micro

A caveat. Although it could be advantageous for Israel to be a scale-up nation, it is not necessarily the case for every company. We could all name flag-ship international companies from the past that are no longer in existence because their product became obsolete, such as Kodak for film. Their investors could have been better off had the company exited rather than stayed put. Distance from the market and other restrictions could be significant challenges to scaling up for smaller Israeli companies. However, as scaling up is favorable at the national level, we should create the conditions that would make it advantageous for more Israeli companies to scale up and become market-leading global companies. As we turn 71, scaling up could be a win-win for Israel and Israeli companies.

About the Author
Ms. Herzog is Head of the Mergers and Acquisitions, Securities and International Transactions Department in the Israeli firm of Ron Gazit, Rotenberg & Co. Ms. Herzog handles a variety of Israeli and cross-border merger and acquisition transactions, for public and private companies, and private equity transactions. She advises many Israeli and foreign clients on corporate governance matters. Ms. Herzog was recommended by Legal 500 and IFLR for many years as one of the top lawyers in Israel in Corporate and M&A. She was chosen by "Melumadot" as the most influential and outstanding female lawyer in Israel in the field of M&A. She served as an Adjunct Professor of Law at Georgetown University Law Center, teaching a course on multi-jurisdictional corporate governance. She lectures on various legal matters to professional groups of lawyers. Ms. Herzog publishes numerous articles in Israel’s leading financial newspapers and is frequently interviewed in the media, on areas of her expertise. Ms. Herzog is admitted to practice in Israel and in New York. She was an associate in the Corporate and Banking department of Simpson Thacher & Bartlett in New York.
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