Dan Singer - Start-up Nation

In 1991, the government created technology incubators—twenty-four of them. These incubators gave most Russian scientists the resources and financing they needed in the early stage of R&D for their innovations. The goal was not only to develop the technology but to determine whether or not that product could be commercialized and sold. The government funded hundreds of companies through payments of up to $300,000. This got many of the new Russian immigrants working at their craft, but those doling out the money had little, if any, experience with start-up ventures. The government financiers were unable to give these entrepreneurs the support and management they needed to turn these R&D successes into commercially viable products.

“Every year when I tried to review the success of these small companies, it was disappointing,” said Erlich. “While they may have succeeded in R&D, we didn’t see them succeed in growing companies.” 12He became convinced that a private venture capital industry was the only antidote. But he also knew that in order to succeed, an Israeli VC industry would need strong ties with foreign financial markets. The international connections were not just about raising funds; aspiring Israeli VCs needed to be mentored in the art of business mentoring. There were thousands of venture capital firms in the United States that were involved in the nuts and bolts of successful tech start-ups in Silicon Valley. They had experience building companies, understood the technology and the funding process, and could guide first-time entrepreneurs. That’s what Erlich wanted to bring to Israel.

That’s when a band of young bureaucrats at the Ministry of Finance came up with the idea for a program they called Yozma, which in Hebrew means “initiative.”

As Orna Berry told us, “John Lennon once said about the early years of rock and roll, ‘Before Elvis, there was nothing.’ On the success of venture capital and high-tech entrepreneurship in Israel, to paraphrase Lennon, before Yozma, there was nothing.” 13

The idea was for the government to invest $100 million to create ten new venture capital funds. Each fund had to be represented by three parties: Israeli venture capitalists in training, a foreign venture capital firm, and an Israeli investment company or bank. There was also one Yozma fund of $20 million that would invest directly in technology companies.

The Yozma program initially offered an almost one-and-a-half-to-one match. If the Israeli partners could raise $12 million to invest in new Israeli technologies, the government would give the fund $8 million. There was a line around the corner. So the government raised the bar. It required VC firms to raise $16 million in order to get the government’s $8 million.

The real allure for foreign VCs, however, was the potential upside built into this program. The government would retain a 40 percent equity stake in the new fund but would offer the partners the option to cheaply buy out that equity stake—plus annual interest—after five years, if the fund was successful. This meant that while the government shared the risk, it offered investors all of the reward. From an investor’s perspective, it was an unusually good deal.

“This was a rare government program that had a built-in get in and get out,” said Jon Medved. “This was key to its success.” And it was also rare for a government program to actually disappear once it had served its initial purpose, rather than continue indefinitely.

At the time, most business-savvy Diaspora Jews were not investing in Israel. They viewed philanthropy and business as two distinct activities. While they would make huge donations to not-for-profit organizations that benefited Israel, for the most part they were reluctant to invest in Israel’s high-tech endeavors.

There were exceptions, of course.

Stanley Chais, a money manager in California, helped raise money for the first round of Yozma funds by setting up parlor meetings in California with wealthy Jews. He raised millions of dollars for the funds. Erel Margalit, who left the Jerusalem Development Authority to manage one of the first funds, said that most of the first round of funding was raised from people who had a “warm place in their heart for Jerusalem or Israel.” Margalit’s first institutional investor was the French insurance giant GAN, whose chairman was a French Jew Margalit met by chance on a flight to Paris.

“The government was used as the catalyst,” said Erlich. The first Yozma fund was created in partnership with the Discount Israel Corporation, an investment bank, and Advent Venture Partners, a premier VC firm from Boston. It was led by Ed Mlavsky, the longtime director of the BIRD Foundation, and Yossi Sela.

Clint Harris, a partner at Advent, said he knew something was different about Israel on his first trip. In the taxicab on the way from the airport to his Tel Aviv hotel, the driver asked him why he was visiting Israel. Harris replied that he was there to get a sense of the venture capital industry. The driver then proceeded to give Harris a briefing on the state of VC in Israel.

The Advent-sponsored fund would be called Gemini Israel Funds. One of its first investments was in November 1993, when it allocated $1 million to Ornet Data Communications. This investment, as well as the managerial help, was just what Ornet needed to succeed. Recognizing the company management’s lack of business experience, Mlavsky and Sela helped recruit Meir Burstin to serve as chairman of the board for the new company. Burstin was an old hand in the high-tech entrepreneurial world, having founded and led Tekem, one of Israel’s first software companies, and then served as president of Tadiran, one of Israel’s big defense-technology companies. Burstin brought instant credibility and experience to Ornet.

When the company was teetering on the brink of closing down after wasting the first big financing round, Yossi Sela from Gemini took over as interim CEO of the company and commuted from Ramat Hasharon to Karmiel, a two-hour drive, four days a week. “It took six months of single-minded determination,” Sela recalled, “from both Gemini and the Ornet founding team, to sell the company and keep the management team from splintering—not to mention more hours driving from Ramat Hasharon to Karmiel than I’d like to remember—but we did it.” 14

The other piece that was critical to the company’s success was Gemini’s ability to bring Walden Venture Capital in as an investor. Walden, an established firm in Silicon Valley, had experience in the kind of technology Ornet had developed. Returning over three times its investment in about two years made Ornet Gemini’s first success story.

The ten Yozma funds created between 1992 and 1997 raised just over $200 million with the help of government funding. Those funds were bought out or privatized within five years, and today they manage nearly $3 billion of capital and support hundreds of new Israeli companies. The results were clear. As Erel Margalit put it, “Venture capital was the match that sparked the fire.” 15

Several of the Yozma funds had high-profile successes early on, with investments in companies such as ESC Medical, which designed and built light-based medical solutions like lasers; Galileo, a high-end semiconductor firm; Commontouch, an enterprise e-mail and messaging provider; and Jacada, which builds online work spaces for customer-service employees at leading companies.

Along the way, others jumped into the venture capital world—even without the government’s Yozma backing. Jon Medved just missed the Yozma financing. Years after he sold the company he and his father had built, he heard that there was a $5 million Yozma allotment available to invest in very-early-stage companies. Known as seed funds, these investments tend to be considered the riskiest, so Yozma offered a one-to-one match: investors had to bring $2.5 million to the table to get the government’s $2.5 million.