Thursday, June 3, 2010

Israel Deserves a Real High Tech Policy

A new High-Tech Committee headed by Ministry of Finance Director General, Haim Shani, presented several recommendations yesterday to revive and buttress the local high tech industry. Here they are with my commentary and star rating:

1) Safety Net for Institutional Investors (**) – The idea is to encourage local pension funds to invest in Israeli high tech and Israeli VCs by backstopping their losses through a “Safety Net”. While I agree that the lack of a local financial backbone is a problem for Israeli VCs, and even an anomaly compared with our US and European counterparts, I think this recommendation is flawed. You need a safety net when something is indeed very dangerous or when it is at least perceived to be dangerous. So assuming Israeli VCs are only perceived to have bad performance and are actually quite attractive investment vehicles, then the government doesn’t have much to lose and the industry should gain as a whole with anchor Israeli institutional investors. If, however, Israeli VC performance is not that appealing relative to other asset classes, one must ask what perverse incentive this may create, and what business the government has using tax payers’ money to prop up a failing industry? Such a move may bring needed local LP dollars, but would create a certain moral hazard with investment managers and their LPs using this tax payer stop loss mechanism to invest in overly risky ventures. My recommendation is to leave the risk there, but make the potential reward sweeter by offering tax incentives for gains from investments in local high tech. This creates a natural incentive to invest in venture capital in Israel, without the moral hazard or riskless investing.

2) Encouraging the founders of start-ups not to sell “early” (*) – This popular maxim says that Israel would be creating many more IPO candidates were investors and their founders not so eager to sell at the first opportunity. I have heard this many times, but does this really make any sense or is this just a convenient excuse? Does anyone really think that that founders and their shareholders wouldn’t hold on to their shares two or three more years if they though their share value would easily double or treble? If this is what’s going on, VCs are not doing their job, and founders are surprisingly no longer motivated by money or fame. How could it be that we Israelis are quick to forgo future profits when it’s so obvious to everyone else that we are just hopelessly impatient? I know the names of too many now defunct start-ups who had the gall to reject various offers due to shear hubris. But can anyone point out at least three companies that sold too early and what disaster fell upon it and Israel post acquisition? There is no where near enough liquidity in the local start-up scene so someone in the Ministry is out of touch. If this recommendation goes into effect, it will affect the way investors structure their deals, because it will put founders at odds with both management and shareholders.

3) Prioritization of Chief Scientist Office (CSO) funds (****) – The idea is that the CSO should have some focus with its budget favoring sectors such as biotech, cleantech or semiconductor (my suggestion) which have a greater need for financial support due to capital intensiveness and long gestation periods. Finally someone has woken up to the fact that the CSO is a first come, first serve piggy bank for hungry start-ups. But let me add two other problems. The CSO has neither a mandate nor the ability to assess the viability of a given project, and a lot of the CSO grants are simply wasted on doomed R&D projects or companies. There must be a connection between recent private funding(which presumably is indication of the potential economic gain) and receipt of CSO money to help guide it.

Additionally, stop linking all CSO funds to R&D! How myopic and highbrowed can we be? High tech is not only about engineering and certainly not volumes of patents. Most of the most successful start-ups over the past 5 years have very little to do with engineering or patents (Facebook, Salesforce.com, YouTube, Skype, Zappos, would all be ineligible for CSO funds). In fact, I would argue that Israeli companies spend a disproportionately large share of their budgets on R&D compared with their US counterparts. Stop perpetuating this myth that that the success of Israeli high tech is dependent upon more engineering dollars. It’s quite the opposite.

4) Encourage corporate R&D through tax incentives (*****). Wonderful, by all means and have it apply to foreign R&D centers as well.

5) Provide incentives to employers of Arab-Israeli and Ultra-Orthodox engineers(***). This is commendable, and I like it, but believe it won’t solve much. Those minority populations are at a disadvantage in Israel for so many other reasons, such as their ineligibility to serve in the IDF(where critical experience is gained and vital connections are formed), and living too far from the center of high tech activity. The country’s inability to integrate them into the workforce is not unique to high tech, which suggests more is needed to make this truly effective.

I have several of my own recommendations for the High Tech Committee headed by Mr. Shani:

1) Encourage the creation of new micro VCs of no more than $50M along the lines of the original Yozma plan. These VCs would raise capital from private LPs, but would get generous matching dollars from the government. The $50M number ensures a focus on profits from carry (not management fees) and a focus on early stage investing.

2) Encourage angel investing through tax incentives. Angels have become a vital part of the entrepreneurial ecosystem, but much of what they do is ignored by the government. Give them additional incentives to keep investing. It would amount to a subsidy to the wealthy, but their role in germinating start-ups is akin to oxygen for our industry.

3) Create a Marketing & Sales fund to mirror CSO dollars on the R&D side. These dollars would go towards hiring marketing, business development and sales heads in Israel and outside; and include advertising dollars. This may not create as many local jobs, but successful sales and marketing supports our beloved engineers. It’s like teaching a man to fish, rather than just giving him a fish.

4) Invest more in education, English language skills, fundamental scientific research, and don’t cut the CSO budget. Also, bring more foreign companies and skilled foreign workers to Israel.

1 comment:

  1. Very good analysis. Thanks for producing it. One action that Mr. Shani needs to take to improve the Israeli High Tech industry is to review and correct some of his policy of commandeering Intellectual Property from other entrepeneurs and then using an Army of lawyers to tie the target up in expensive litigation while marketing the technology as if it was his original work.

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