University of Haifa

Center for Study of Organizations & Human Resource Management

Project Report

Supported by the

Commission of the European Communities DG Enterprise

Project: IFISE; IPS029032PR

Workpackage 3

1

December 2000

The Innovation System, the Technological Incubators and

Yozma Programmes as Tools for the Encouragement of

High-Tech Industry in Israel

(Israeli Literature Survey)

Arie SADOVSKI*

*Arie SADOVSKI is a Research Associate at the University of Haifa, The Center for Study of Organizations and Human Resources Management

2

Introduction

The Israeli Hi-Tech industry

In the last ten years the Israeli economy has witnessed an intensive growth. The

growth rate of Gross Domestic Product (GDP) averaged 6 percent during 1990-

1996, and 5.5 percent during 1998-2000 (in 1997 it fell to 1.9 percent). The per

capita GDP ($16,950 in 2000) places the Israeli economy 21st among 200 countries

in the world. The contribution of the high-tech industry to this economic

development is realised in its share in the industrial exports – for example in 1997

High- tech industry export value was $7.2 billions out of a total of $20 billion

industrial exports. (CBS 2000).

The Israeli industry has been undergoing drastic structural changes since the

beginning of the 70s. The main trend of these changes is a migration of the high-

technology industries from a defence-related to a civilian market environment. In

1990 the ratio of the revenues from defence related products to the total revenue of

the electronic industry was 1/1.7, in 1995 it was 1/2.5 whereas in1999 this ratio

was 1/3.3. (IAEI 2000).

These changes have peaked in the 90s and facilitated the establishment of an

amazing number of high technology start-up companies that has been estimated to

be 3,000. The significance of this evolution has been underlined by an observation

that “Israel has the largest number of high-tech start-ups in absolute terms after the

U.S” (OCS 1997).

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A typical characterisation of the high-tech industry in terms of its sectors

distribution is presented in Table 1. The main sectors in this industry are software

and communication.

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Table 1. Industry Sector Distribution*

Industry Distribution %

Computer & Electronics 12Medical Devices 7Electronics-Components 6Software 43Communication 21Other 19

*Source: ICTAF 1999

The development of the high-tech industry coincided with the development of the

venture capital industry and other financial instruments as discussed further on.

The financial environment for Hi-Tech industry in Israel

The most difficult problem that entrepreneurs are facing in their efforts to set up a

new technology start up company is raising funds.

The government of Israel, similar to governments in most of the economically

developed countries, offers a variety of programmes that intend to support and

encourage the genesis of start-up companies.

Government encouragement programmes

The major landmark in the development of a policy with regard to industrial research

and development in Israel is represented in the Katchalsky Committee report

(Katchalsky report 1968). Following the committee’s recommendations the Office of

the Chief Scientist (“OCS”) at the Ministry of Industry and Trade was established and

entrusted with the responsibility to the government’s activities in this area. The OCS

has then began to implement an industrial research grant programme in which the

government participates in the research and development costs of the firms at a rate of

5

80%. The Government encouragement programmes were further defined and

formulated with in a framework of a state law: The law for the encouragement of

industrial R&D of 1984 (“1984 Law”), that was implemented under the responsibility

of OCS since September 1999 (OCS 1999).

The purpose of the “1984 Law” was to encourage the industries to invest in R&D

projects by the participation of the government in the risk inherent in such projects.

Any company, registered in Israel, is eligible for the benefits given under the law.

Within the framework of this law, OCS operates a number of different support

programmes that include R&D grants, Technological Incubators programme,

programme for generic research and Bi-national programmes such as the US-Israeli Bi-

national Industrial Research and Development Foundation (“BIRDF”).

The Israeli Export Institute, an organisation which is sponsored by the Ministry of

Industry and Trade, operates an Export Marketing Encouragement Fund (“IEI”).

Another law that provides a framework for financial support is the Law for the

Encouragement of Capital Investments of 1959 (“1959 Law”) that is implemented

under the responsibility of the Investment Centre at the Ministry of Industry and Trade.

The “1959 law” is an important instrument for stimulating growth by attracting foreign

and local investment capital. The objective of the law is to encourage the establishment

and expansion of industrial plants, industrial structures, hotels and tourist projects by

granting "approved enterprise" status to applicants seeking investment assistance. This

status allows entrepreneurs to receive the following benefits available under the law: a

disbursement of a grant for the acquisition of fixed capital or a full tax exemption on

undistributed income as specified in the investment plan approved by the Investment

Centre.

6

The government support programmes became an essential financial source for the start-

up companies. In fact until the mid 80s, all financial sources were from the government.

This situation has changed dramatically during the 90s but even today the OCS support

programmes, with a budget of nearly $400 millions, is a significant financial source for

the start-up industries.

In a recent study performed by ICTAF (ICTAF 1999) the extent of utilisation of these

programmes was determined (Table 2). In this study high-tech companies that were

established after 1990 (n=200) were surveyed.

The findings of this study indicate that 72% of the companies used some government

financial support programmes and the R&D grants were the most commonly used

(42% of the surveyed companies) followed by the marketing fund (27% of the

companies). At the same time it is noteworthy to observe that some 28% of the

companies did not use any of these programmes, a finding that may deserve additional

examination.

Table 2. The frequency of utilisation of government support

programmes by the Hi-Tech Industry *.

Programme Used Utilisation Frequency(% of Companies)

Incubators 7.6

R&D grants 42.2

BIRDF 11.1

Marketing fund 27.3

Investment Center 18.2

Non of the above 27.8

Source: ICTAF 1999.

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Other financial sources

The information on other financial sources that is used by the start-up companies in

Israel is not fully characterised.

The ICTAF study (ICTAF 1999) shows (Table 3) that private investors were an

important source for funding. The venture capital funds were the second commonly

used source for funding and only 9% of the companies of that population turned to the

stock exchange for their funding source.

Table 3. Type of funding used by the Hi-Tech industry*

Type of funding Utilisation frequency

%

Start-up capital** 26.3

Venture capital 27.3

Private investors 68.7

Stock exchange 8.6

*Source: ICTAF 1999. ** $0.5-2M, normally obtained from VC funds.

Until 1993 (The year when the Yozma programme was installed) the financial sources

that were available to entrepreneurial activities in Israel were very scarce.

For example, the total capital raised in 1991 amounted to $58 M and in 1992 to $160

M (Reiter and. Klein 1999).

The first Israeli venture capital Company (VC) was established in 1985 with the

establishment of the VC Athena. Ten years later the situation had changed in a rather

dramatic way. The growth of the VC industry is described in the following sections of

this report. But another important source should be mentioned here: the foreign stock

markets.

In 1996 Israeli firms provided the third largest number of initial purchase offerings

(IPOs) on the NASDAQ (over-the-counter stock exchange) in New York, after the US

and Canada, and the second largest number of IPOs on the relatively new AIM

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(Alternative Investment Market) in London (after the UK). Many leading American

investment houses and venture capital funds have established a presence in Israel in

order to support Israeli high-tech firms and benefit from the current boom (Cohen

1999).

The Yozma and the Technological Incubators Programmes

The YOZMA and the Technological Incubators Programme (TIP) were intended to

provide take-of support for new industrial enterprises in the high-tech fields.

The TIP is more attuned to support projects at their inception stages and the YOZMA

programme intends to entice private money to take part in the risky yet lucrative

activity of the venture capital industry.

The YOZMA Programme

The YOZMA programme was inaugurated at the end of 1991 and commenced its

operation in 1993.

The idea was that the participation of the government in the risks involved in VC

activity will encourage, private money and especially from foreign investors to enter

the Israeli VC industry.

The Government of Israel established a wholly owned Yozma Venture Capital

Company Ltd. with a total capital of $100M.

The purpose of this company was to participate as a partner along with investors from

the private sectors in the establishment of other VC companies.

The new VC companies that were established under this programme had a specific

commitment to invest in start-up companies having strong growth potential in the

high-tech fields and that were engaged in the development of exportable products.

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The operational guidelines:Yozma invested in the new VC companies in a minority position. The investment sum

was $8M per company or up to 40% of the new company capital.

An entering incentive was granted to the other partners in the VC. It was in the form of

an option to buy the government (Yozma) shares under pre-determined and favourable

conditions. These include a buy-out option during the first five years of the fund’s

existence at the government investment price plus 6% annually.

Yozma in itself has managed to raise 45% of its own capital from foreign VC or other

companies.

Yozma achievements and present status:

The YOZMA programme prompted the establishment of 11 VC companies that are

listed in table 4. The total capital raised by these companies was $200M in a period of

three years of operation (1993-1995) and they invested in 130 start-up companies.

Table 4. Yozma funds

FUND NAME LEADING FOREIGN INVESTORAPAX

Eurofund Daimler-Benz, DEG(Germany)

Gemini Advent(USA)

Inventech Van Leer Group (NL)

Jerusalem Pacific Ventures Oxton (US/Far East)

Medica MVP(US)

Nitzanim AVX, Kyocera (Japan)

Polaris

Star TMV(Germany)

VERTEX Vertex international funds

Walden Walden (US)

Total capital: $200 M

10

The average size of the Yozma funds was approximately $20 M and the largest one

(Gemini Israel Fund was $33M). These values may be considered modest compared

with the current sizes of the VC companies in Israel but their impact on the venture

capital industry and on the investments hungry high-tech industry was very substantial.

The financial environment and opportunities for the high-tech firms in Israel today have

changed considerably from the 1993 reality.

In 1998, 101 capital sources were recorded with a record high capital of $ 2,865 M

(Table 5). The data in that table represent accumulative values for the years 1991-1998.

Table 5. Funds and Capital Raised (as of December 31,1998)

Fund Number $ Millions % Invested

Technology venture capital funds

Yozma Funds 10 256 90

Private Funds 43 1,512 60

Public and Other Funds 4 98 67

Total 57 1,866 53

Other private equity Funds 31 764 79

All Funds 88 2,630 60

Investment companies 13 236 70

All Capital Sources 101 2,865 60

(Source: REITER, A. KLEIN, Y. 1999)

The Yozma was privatized in 1997 and is no longer a governmental programme.

This commendable act is a good example for government intervention that has been put

in place to a good cause and at the right time and has been withdrawn when the job was

done and the market forces were able to proceed in an independent way.

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The amazing growth of the VC industry is generally attributed to the changes that

occurred in Israel between 1993 to 1996. These included the progress in the Middle

East peace process and an increase in foreign investment influx that followed.

The Yozma programme should be given a credit as an important contributor to this

story of success.

The Hi-Tech industry used the opportunity with an ever-increasing demand for more

investments and made a distinct contribution to the country’s economy that grew at an

average of 5.5% in terms of its GDP (Reiter and Klein 1999).

The growth in capital sources for investment is demonstrated in Table 6.

The dramatic increase in venture capital investments was observed since 1993 which

coincided with the implementation of the Yozma programme.

Table 6. Capital Raise by Year ($ millions)

1991 1992 1993 1994 1995 1996 1997 1998 Total

Technology Venture capital FundsYozma Funds 0 0 149 40 15 20 5 27 256

Private Funds 49 27 33 72 45 244 599 443 1,512

Public&OtherFunds

0 54 22 o o o 22 o 98

Total 49 81 204 112 60 264 626 470 1,866

Other PrivateEquity Funds

0 45 128 242 91 110 66 83 764

All Funds 49 126 332 354 151 374 692 553 2,630

Investment Companies

9 34 10 20 5 23 20 115 236

All capital sourcesTotal

58 160 342 374 156 397 712 668 2,865

( Source: REITER, A. KLEIN, Y. 1999)

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The close interaction between the developments of the VC funds and that of the high-

tech industry is further shown in table 7. As indicated in the table, the investment

distribution of the VC funds in various industry sectors correspond to the relative sizes

of the industry sectors. And as expected the software and communication industries

receive greater portions of the overall investment.

Table 7. Industry Sector Distribution of 450 Venture Capital Backed Investments

Industry Distribution %

Medical Devices 16Computer & Electronics 12Software 29Communication 27Biotech/Pharma/Healthcare 10Other 7(Source: Fellus and Maor. 1999.)

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Summary - The highlights of the Yozma Programme

The Government shares the risk involved in setting up new Venture Capital Funds

The programme is designed to encourage the participation of existing foreign

Funds not only as a financial source, but also as a source of knowledge and

experience in the operation of venture capital industry.

The involvement of the government is for a limited period of time and the

conditions for privatisation were set as part of the basic guidelines of the

programme.

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The Technological incubators Programme

The Technological incubators Programme was adapted by the Israeli government in

1990 and during three years of operation (until 1993) brought to the establishment of 28

incubator organisations throughout the country, 26 of those are still in operation. (OCS

1997). A full list and description of the incubators may be found at

http://incubators.org.il or at www.science.co.il/incubator.asp. The idea was imported from the USA and was modified and fitted to the Israeli reality.

The objectives of the Israeli TIP

The objectives of the TIP are presented in official publications of the Ministry of

Industry and Trade (OCS 1994, OCS 1997) and include the following points:

To support the initiation of high-Tec (Knowledge-based) industry by supporting

novice entrepreneurs at the earliest stages of technological entrepreneurship.

To encourage new export oriented industry (To help reducing the deficit in the

trade balance).

To create new employment opportunities for skilled persons. (The programme was

adapted when the immigration waves from the Soviet block countries began to

swell, and the government was concerned with their employment situation. It was

therefore decreed that 50% of the workers in each of the projects that were

accepted to an incubator had to be new immigrants).

The preference that the programme had given to the employment of new immigrants

should be further qualified. According to Pridor (2000), the Director General of the

TIP, this preference was critical for gaining political acceptance and public funds. And

indeed, the programme was an important instrument in assisting the relocation of many

new immigrants in Israel. But from the beginning, the programme management has

been careful to insist that the quality of the proposed projects was the most important

consideration criterion for admittance and that the programme had never to function for

new immigrants exclusively.

In addition to the specific objectives of the Israeli TIP, there are other important

features that distinguish the Israeli programme from similar programmes else were:

15

The TIP in Israel maintains an identity of “technological incubator” and refrains

from drifting to a “business incubator” status.

Project are admitted to the incubator only if they are intended to develop products

that have a practical and commercial implementation potential.

The Programme supports technological development processes and refrains from

support of other aspects of development such as trade, services or strictly scientific

developments.

The support is exclusively offered to new products that are based on innovation.

The support is exclusively offered to individual entrepreneurs and not to existing

firms.

The proportional participation of the government in the budget of the incubators is

much larger and in fact dominant compared with the existing reality in the US

incubators.

The operational details of the incubator programme

Founding an incubator:The programme facilitated the establishment of incubator organisations throughout the

country. The government has established a Central Incubator Administration that

developed the policy and guidelines and monitored and inspected its implementation. It

has also the responsibility to report to the government on the use of the appropriated

funds.

The establishment of an incubator has to be initiated by a non-government public, or

industrial organisations (PO).

These organisations were selected from a list of proposers that applied in response to a

“call for proposal” that was issued to the public by The Central Incubator

Administration.

Three types of POs were considered:

Research institutes and Universities.

Municipal and Regional Authorities.

Industrial organisations in the hi-tech area that were well established, experienced

and of significant size.

The PO who were interested to set-up an incubator were screened and chosen according

to several criteria:

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Their ability to offer an adequate facility for housing an incubator.

Each incubator facility had to be suitable and sufficiently large to house some 20

projects.

Their ability to provide financial and organisational support and assist in business

development of the incubator projects.

This support could be in the following forms:

- Municipal authorities waved the incubators from local taxes.

- The PO had to recruit the incubator manager and the board of management.

(The board members did not receive payments from the incubator).

- The PO had to demonstrate its ability to raise or provide the funds needed to

complement the government grants for the budgets of each of the projects that

were admitted to the incubator.

As it were, Pridor (2000) made a comment that the number of POs that applied to

become an incubator founder was larger than was necessary or desired.

Operating an incubatorThe incubators are functioning as non-profit organisations. They provided housing,

administrative and business support to entrepreneurs who initiated projects within the

incubators’ premises.

Each project was expected to employ approximately 5 workers. As indicated before,

each incubator was intended to have a capacity to house some 20 projects. This number

has been often debated and sometimes challenged. However experience has shown that

to ensure success this number had to be proportional to the ability and the capacity of

the incubator management to provide individual attention and guidance to each of the

projects. Modena and Shefer (1998) found that the typical project number in the

incubator is 8.

The government participation in the incubator management expenses is up to $184K

per annum for the administrative, infrastructure and operational costs (OCS 1994).

17

The operational duties of the incubators management includes:

a. Searching and selecting of project ideas.

This is done with the help of a stirring committee that is chaired by the incubator

manager and includes experts from the business community, industry and academia.

These persons performed their services without remuneration as a service to the public.

b. Managing the financial affairs of each of the projects and having the responsibility of

reporting to Incubator Administration on the progress made in each of the projects.

c. To assist in the business affairs of the projects and in the search of additional

investments.

The guidelines for the incubators companies:

Each individual project within an incubator is being incorporated into a Ltd. company,

and the project entrepreneurs transfer all intellectual property rights of the project's

inventions to this company.

The ownership distribution in the companies is set in accordance with guidelines that

are determined by the Incubators Administration.

The incubator organisation retains 20% ownership. Additional 20% is allocated to

external investors for their participation in at least 15% of the company’s budget, and

10% is kept by the incubator in escrow for the company’s employees. The

entrepreneurs retain 50% ownership.

The government assistance to the incubators companies

The financial support to the projects:

For each project a development plan and a budget request is prepared. Following

its evaluation and if approved, the project is entitled to a grant of 85% of the

approved annual budget and up to $150k for two years (total of $300k).

15% complementing funding is expected to come from the entrepreneurs or the

public organisation that sponsor the incubator or from other investors.

Obligations of the incubators companies:

The finished product that is developed by the Incubator Company must be

produced in Israel.

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There is an obligation for a payback of the grant in the form of royalties. These

are paid from the sales revenues of the new product at a rate of 3% annually and

up to a ceiling of 100% of the grant. (The Government in return, circulates the

money back to its industry assistance programmes).

Project Selection criteria for admittance to an incubator:

These criteria are one of the key factors of success of the projects (OCS 1996).

1. The innovation level of the proposed project.

2. Export potential of the new product to be developed.

3. Possibility of the incubator company to become self sustainable within 2 years

since its admittance to the incubator.

4. The ability to secure funds to complement the government funding (15% of the

budget).

5. The quality of the project management (The manager of the project must have

proper qualifications and experience).

6. The project may not be supported by additional public grant.

Spatial distribution of the incubators and Technological specialisation

The technological incubators in Israel are widely distributed through out the

country. This is apparently a result of political preferences and most probably due

to the fact that in the regions the readiness of public organisations, such as regional

authorities, to sponsor the establishment of incubators and availability of non-

government public funds that is needed, is larger then in other areas.

Modena and Shefer (1998) studied the effects of the spatial distribution on the

performance of the incubators and concluded that the wide geographical dispersal

counteracts their rate of success. There are however exceptions to this observation

and the hot success story of the incubator graduate company: Compugen Ltd. is a

19

good example to that. This company originated at a remotely situated incubator in

Sde-Boker (Negev Desert).

The question of technological specialisation of the incubators has become

indirectly linked to the geographical location.

As stated before, the incubators are expected to provide their protege projects,

support, guidance and coaching in business development. To be successful at that,

the incubator organisation must have proper competence both in management and

in technology. Specialisation of the incubators by limiting the technological fields

of its incubating projects to a specific spectrum is important for building such

competence. At the moment most of the Israeli incubators are not specialised. Few

that are located within the metropolitan areas are considering specialisation for

improving their performance. Specialisation of incubators that are located at the

remote regions is even less likely to occur due to the relative scarcity of specialist

entrepreneurs in one particular field in the sparsely populated areas.

It seems that this question needs further attention both at the research and at the

policy planing levels.

Some performance details of the Incubator Programme

Since the beginning of the programme until the end of 1998 the government

invested approximately $180M and supported some 750 projects – approximately

500 of those, graduated. 200 projects are currently in progress (OCS 1999).

Although as stated before one of the criteria for project selection was the prospect

of it being self sustained after two years of operation the Incubators Central

Administration realises that this goal is hard to attain. It is therefore recommended

20

that this criterion should be used as a measuring yard for assessing the practical

and applied nature of the projects.

Measuring the performance of the incubators (Goncharoff 1998) with a venture

capital industry outlook will show a much lower return on investment rate

compared with the 20% rate that is common in the VC industry. But in general the

Israeli TIP is considered to be a success story and is directly linked to the success

of the Israeli high-tech industry. Pridor’s statement on the matter is:

“The essence of the programme is to start, motivate and encourage entrepreneurs

and to support an environment of innovation”. It is true that some of the projects

that were admitted to the TIP would not have been chosen by private financing

sources. Sometimes due to the nature of the entrepreneurs and other times, due to

nature of the projects. This may be cited as a drawback but at the same time it

should be considered as an asset being an efficient instrument for extracting and

realising the full innovative potential of the population.

The incubators programme objectives has both social and economic outlook. The

Israeli experience has indicated that the programme must fit the specific population

for which it is intended. It must consider the social make up of this population and

its cultural and business traditions. Another important observation is the very

important role that the management of the incubator plays in the success of its

protege companies.

One of the evaluation parameters of the TIP performance is the survival rate of the

incubators' companies following their graduation from the incubators. Table 1.

presents the available data on this parameter and indicates that some 50% of the

companies have survived the graduation phase and maintained their activity. Most

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of them (78.7%) with additional investments that they were able to raise form

various sources.

Table 8. The Survival of Graduated Companies

C o m p a n i e s ( n u m b e r - % ) *

Total Incubator

Graduate

476 - 100%

Continuing entity 239- 50.2%

Received outside investment :78.7%

----------------------------------

Self generated funding: 21.3%

Ceased

functioning

237 - 49.8%

During Incubation period: 19.4%

-----------------------------------

Following Incubation period : 80.6%

(*. Source: Pridor 1999)

Of the 239 companies that graduated from an incubator and continued their

activities, 188 companies (79%) succeeded in attracting outside investments

following their incubation period. The total amount invested in these companies

amounted to $202 M that came mostly from Israeli sources (76%) and the rest from

various overseas sources. It is important to note that most of these sources were

venture capital companies.

Another important parameter is the ability of the incubators companies to become

self sustained and to generate revenues from the sale of their own products.

Table 9 presents the available data on this parameter and indicates that 50% of the

companies were able to generate annual revenues of $ 100K and more.

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Table 9: Commercialisation of Incubators Graduated

Companies: Income Generated from Sales

Sales % of company numberNumber of companies: 110

$50-100k 50%

$101-500K 27%

$501K-5M 23%

(*Source: Pridor 1999)

Summary - The highlights of the Technological Incubators

Programme

The programme is designed to maximise the innovative potential that exists in the

population.

Upon migration of the programme from one country to another, the programme

must be adapted and fitted to the new cultural and business environments.

The programme provides support for projects at their infancy stage and thereby

fills in a gap in which other financial organisations refrain from operating.

The Israeli programme scope is strictly in technological development of products

or technologies that have practical commercialisation potential in the export

markets.

The Israeli incubators have a countrywide distribution even to the remote regions.

The Israeli incubators operate in all technological and industrial sectors without

specialisation.

The incubation time and funds that are made available to the incubators’ company

are equal to all the protege companies and in all the industrial sectors and is limited

to two years and $ 300K respectively.

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Goncharoff, N. 1998. Do incubators work? . Global Tech Ventures. December1998.www.globaltechventures.com IAEI. 2000. Israel Association of Electronics &Information. Industries. www.iaei.org.il

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