Join the startup boom, Israel tech tells local investor funds

IATI, an umbrella group for the tech industry, urges Finance Ministry to pave way for more institutional investment

Shoshanna Solomon was The Times of Israel's Startups and Business reporter

Attendees at the IATI MNC Forum 2016 (Courtesy: Nir Shmul)
Attendees at the IATI MNC Forum 2016 (Courtesy: Nir Shmul)

Representatives of Israel’s high tech industry are calling on the government to take steps to help encourage institutional investors to put their money in Israeli technology.

“Institutional investors must immediately increase their investments in the high tech and life sciences industry, both directly and via venture capital funds,” said Erez Tzur, co-chair of IATI, Israel Advanced Technology Industries, an umbrella organization of tech players in Israel and a lobbyist for the industry.

“The high-tech industry is a leading one is Israel and should rely more on Israeli investors and not on foreign investment. We see it as a national duty to ensure that also the citizens of Israel should enjoy the fruit of the industry’s success.”

Members of IATI, including CEO Karin Mayer Rubinstein and VC members of the board, presented Finance Minister Moshe Kahlon with a report on the issue last week. At the end of the meeting the parties agreed that in coming weeks Kahlon and IATI would meet with institutional investors to advance the report’s recommendations.

The absence of Israeli institutional investors in the Israeli tech scene was highlighted most recently in the Mobileye sale to Intel Corp. for $15 billion, where the lion’s share of the deal money is expected to go to the foreign institutional investors and funds that were invested in the company. There are no Israeli institutional investors listed among the major shareholders, meaning that Israeli pensioners will be largely excluded from the bonanza.

Amnon Shashua, co-founder and chairman of Mobileye arrives to a Mobileye and Intel Workers Conference in Jerusalem, March 14, 2017. (Yonatan Sindel/Flash90)
Amnon Shashua, co-founder and chairman of Mobileye arrives to a Mobileye and Intel Workers Conference in Jerusalem, March 14, 2017. (Yonatan Sindel/Flash90)

“The only clear-cut losers from this massive Mobileye deal are Israeli institutional investors, and the Israeli citizens they serve,” said Steven Schoenfeld, chief investment officer of BlueStar indexes, at the time of the deal in an interview with The Times of Israel. BlueStar is a financial firm that has developed indices and exchange traded funds (ETFs) with a focus on the Israeli capital markets.

The 2017 IATI report presented to the finance minister highlights the fact that there is a “very low ratio of investments” in the Israeli VC industry by Israeli investors, compared to the much higher ratio of US investors in American VC funds and European investors in European VC funds.

“We are troubled by this finding as we see it a long term instability factor for the Israeli tech industry in general and particularly for the early stage startups,” the report said.

And whereas the Israeli venture capital industry has played a “substantial” role in the growth and success of the Israeli technology sector, the local VCs are “over-reliant” on international investment capital, with “close to zero domestic investment.” This model is not sustainable, the report said, and Israeli institutional funds “earn almost nothing from the Israeli start-up industry success.”

The average percentage of holdings in VC funds among institutional investors stands at 0.22% (0.18% are Israeli VC funds), as of December 2016.

Karin Mayer Rubinstein (Coutesy)
Karin Mayer Rubinstein (Courtesy)

Israeli VC funds are central to the success of the Israeli innovation and technology sector, with some 4,600 tech startups in Israel funded by VCs over the past 15 years. There have been some 400 successful exits made by Israeli VC-funded startups over the same period, and there were some 2,700 active Israeli VC-backed startup companies in Israel, as of 2015, the report said. VC backed-startups have been six times more successful than privately backed companies, the report said.

Even so, investments by Israeli VC firms in Israeli companies are not growing in pace with the growth of the market. On average, these Israeli VCs invest some $600 million per year in Israeli tech companies, which is just some 12%-16% of total investments made in Israeli technology – a figure that has remained somewhat static over the years, even as deal flow has increased. The remaining funding comes from foreign investors.

The main reasons for the lack of participation are based on taxation considerations, the report said, where the Israeli tax regime provides incentives to venture capital firms to minimize the proportion of Israeli investors in the funds. In addition, limitations on management fees discourage local funds from investing in Israeli VCs. For example, the general partners of VCs pay no VAT on management fees from foreign investors while they pay the standard VAT fee for services provided to Israeli investors.

Finance Minister Moshe Kahlon at the weekly cabinet meeting in the Prime Minister's Office in Jerusalem on July 31, 2016. (Ohad Zwigenberg/Pool/Flash90)
Finance Minister Moshe Kahlon at the weekly cabinet meeting in the Prime Minister’s Office in Jerusalem on July 31, 2016. (Ohad Zwigenberg/Pool/Flash90)

IATI suggests regulatory changes to narrow this gap. These include reducing or removing regulations that discourage Israeli VCs from seeking local investor funding and also discourage local investors from investing in Israeli VCs; setting regulations to allocate a preset percentage of the institutional funds to be invested in Israeli high tech; and providing tax incentives that will encourage more investment.

The report also recommends institutions prepare quarterly reports on their investments in Israeli high tech and VC funds and says their investment managers should receive training on alternative investments, including spending a year working with US institutional investors.

“These proposed changes will increase the amount of investments of institutional investors in Israeli high tech and will encourage the setting up of additional Israeli VC funds, as an alternative to the foreign VC funds,” the report said. “This will strengthen the high-tech industry which is one of the economy’s main growth engines.”

The Israel Securities Authority (ISA) has led a committee for the promotion of investments in public companies that operate in the high-tech field, the recommendations of which were enacted later in a law passed by the Knesset in December 2015.

A 2014 report commissioned by the ISA to promote investment in publicly traded tech companies showed that Israeli institutional investors shy away from investing in technology shares because such shares are perceived as being more risky, investors often lack the expertise to understand the technologies involved, and tech companies are relatively small and don’t offer the liquidity these investors require.

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