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The Israeli take on start-up risk

Financial Times, February 19, 2014

Avi Hasson photo

Failure v upside: Avi Hasson aims to step in if private funding is not backing an innovative idea because the prospect of success is not high  

From his government office in Jerusalem, Avi Hasson undertakes an esoteric-sounding but important job at the centre of Israel’s innovation-rich, high tech-focused economy.

As Israel’s chief scientist, he oversees a department with a budget of $450m, through which the state funds research and development, and primes the pump for private-sector in­vestment in new businesses and technologies by signing on as an an­chor lender itself. Its funding projects range from incubators for new start-ups to costly research and development schemes undertaken by long-established Israel-based companies.

“In our office, we like risk,” says 43-year-old Mr Hasson, a former fund manager in the US and Israel, whose entrepreneurial drive and geekily en­thusiastic manner might seem more fitting for a Silicon Valley whizzkid or Wall Street analyst than a government functionary. “When one of our evaluators presents a project and says, ‘This is a really risky project’, it gets us excited.”

The signature lending programme of the Office of the Chief Scientist (OCS), which sits within Israel’s Ministry of Economy – run by former software entrepreneur Naftali Bennett – is a loan for new ventures and tech­nologies that are promising but also risky. The Israeli state puts up money without asking for equity and demands repayment through a royalty on relevant sales if the business succeeds. “I share the failures and you enjoy the upside,” Mr Hasson says.

The OCS has played a supporting role in scores of Israeli companies that have grown into successful international businesses, including Waze, the navigation software company that Google bought last year for $1bn in one of Israel’s biggest high-tech buyouts.

Chroniclers of Israel’s rise to become one of the world’s foremost centres of innovation describe the OCS as a “killer app” for promoting new businesses. “A lot of countries have been looking at Israel as an innovation model, and a lot have been looking at and admiring the Office of the Chief Scientist and studying it carefully,” says Saul Singer, co-author of Start-Up Nation , the 2009 book whose title provided a nickname by which Israel is increasingly known overseas.

“The scale of state funding going to new business has not passed without comment or controversy.”

Mr Hasson, now three years into a six-year term in office, came to the job after 20 years in the private sector, including a decade in telecoms followed by a role as a general partner at Gemini Israel Funds, one of the country’s top venture capital firms, working in both Boston and Israel.

Before entering business he spent five years as an officer in military intelligence, serving in Israel’s elite Unit 8200, which has been a training ground for many top businesspeople. (When asked what he did in the highly secretive division, he laughs and says: “Don’t push it.”)

Countries around the world, from southeast Asia’s tiger economies to western Europe’s struggling ones, invest heavily in science, technology, and innovation, or use the levers of the state to try to promote new business. Some are overtly emulating Israel: Finland’s Prime Minister Jyrki Katainen said this week that he planned to use the country’s success in high-tech innovation as a model at a time when Finnish industrial output and productivity are falling.

The pull of Israel’s technology

Israel’s prime minister Benjamin Netanyahu said this week that foreign companies were pounding a path to his country, and “they all want the same three things: Israeli technology, Israeli technology and Israeli technology”.

His comments came in a speech decrying calls for an economic boycott of Israel because of its occupation of Palestinian lands. Science and tech, like much else in the Jewish state, has a political aspect.

While the international Boycott, Divestment and Sanctions movement wants the world to pull out of Israel, the technical prowess of the “Start-up Nation” is exerting a powerful reverse gravitational pull.

The Office of the Chief Scientist has bilateral co-operation agreements with about 50 countries on research and development, and receives a steady flow of foreign visitors. “We are probably the most highly networked country out there in terms of R&D collaboration,” says Avi Hasson, OCS head. “This is an area where people desire our partnership.”

Few other countries, however, offer the same ecosystem of support for science, technology, research and funding under one roof, or extend quite the amount of risk capital the OCS does. For example, the office underwrites 85 per cent of the lending made by business incubators, leaving private shareholders with the other 15 per cent.

“They give you $6 for every $1 you invest,” says Astorre Modena, managing partner with Terra Venture Partners, an Israeli fund that invests in clean-tech companies, and which rec­ently won a licence to run an incubator. “You won’t find anywhere such big matching: most projects have 1:1.”

At the same time, in Israel – as in other countries where the state dabbles heavily in industrial policy – the scale of funding going to new business has not passed without comment or controversy. Some Israelis, including Mr Singer, question whether the state needs to be involved in co-funding companies in incubators, when many of its most successful busines­s­es are started elsewhere using private capital.

Mr Hasson has had to defend his office’s budget, which he says has dec­lined in real terms, at a time when Israel is imposing fiscal austerity. He also has to demonstrate that the OCS is continually addressing market failure – areas of broad economic benefit that private investors do not serve – rather than cherry-picking opportunities venture capital companies might well have taken on by themselves.

“The first question I asked when I came here was, ‘What per cent of our projects are being fully repaid?’” Mr Hasson says. “If they had said 70 per cent it would have been high, and meant we were not taking enough risk – and crowding out private sector money.”

In fact, he says, his office has invested in many worthwhile projects where it was not repaid but which benefited Israel Inc. True, the OCS made good business on Waze: it lent about $1m to the company, and got about $3m back; the Israeli tax authority also reclaimed about $230m on the sale to Google in taxes paid to transfer the company’s intellectual property overseas. Other businesses funded by the OCS have gone on to be bought by companies such as Microsoft, Cisco or Facebook, suggesting the market might have best been left to itself.

However, Mr Hasson also points out that his office funded Modu, a mobile phone company founded by the creator of the first flash drive. It failed, but more than 30 new start-ups emerged in its wake. “Is this a bigger failure, or more of a success than Waze?” he asks. The OCS also recently gave one of its grants to develop Israel’s first human tissue bank – an investment likely to benefit the growing biotechnology sector, which no company would be likely to undertake itself.

State intervention in the Israeli economy has a history that stretches back to the early days of Zionism. The OCS was established in the late 1960s, an era long before “Start-up Nation”, when Israel’s best-known export was Jaffa oranges. Planners were determined to build a knowledge economy; the OCS has enjoyed official support through numerous changes of government since.

In the 1990s, the OCS helped to bring Israel’s homegrown venture capital industry into being through Yozma (Hebrew for “initiative”), a programme under which the government co-invested to create new funds. Mr Singer says Yozma “played a huge role in jump-starting ‘Start-up Nation’,” though he notes that most credit for Israel’s innovation economy should go to “bottom-up” work by the private sector itself.

Mr Hasson points to research by the Hebrew University of Jerusalem, which found in a recent study on research and development in Israel that every 1m shekels lent by the government generated further R&D of two to three times the amount of the grant given.

“I am not good at building companies, I am not good at mentoring companies, but I am very good at taking risk,” he says. “We come in, we fill a [market] failure, and – if possible – we move out.”

By John Reed.


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