Avi Hasson, chief scientist of the Ministry of Economy. Photo by Everton Amaro/Fiesp
Avi Hasson, chief scientist of the Ministry of Economy. Photo by Everton Amaro/Fiesp

Last year may have been a record-breaking year for exits and IPOs in Israel’s high-tech industry, but Israel’s Chief Scientist, Avi Hasson, predicts that the best is still to come.

“Though 2014 was a hallmark year for Israeli startups, we are far from reaching the industry’s full potential,” Hasson said in a new Innovation Report on Israel’s high-tech industry.

The report is the first of what the Office of the Chief Scientist (OCS) at the Israeli Ministry of Economy expects will be an annual examination of Israel’s most successful and rapidly-growing areas of industry.

“I believe such a picture is necessary to analyze the trends developing before our eyes and to identify the main challenges we must face and the new opportunities at hand,” said Hasson.

High-tech is one of Israel’s most robust areas of the economy today, but the report warns that while the startup sector is strong, and new companies continue to sprout, too many are making quick exits, rather than growing into mature companies.

The growth of mature domestic companies is crucial to Israel’s economy, the report says, because large companies employ a higher number and wider variety of employees, and also help develop know-how within Israel.

As such, it recommends creating incentives and conditions that will make it worthwhile for Israeli companies to continue their growth in Israel. More companies like Outbrain  or ironSource are needed for Israel to become a market leader, says the report.

 

Aside from efforts to turn more startups into mature companies, the recently released first edition of the report identifies three other areas Israel must address to keep the tech sector strong – new funding, the development of new technologies in traditional industry and the public sector, and smarter and more efficient government involvement.

 

Crowdfunding vs venture capital

 

Today the two main funding options for Israeli startups are either raising money through corporate venture capital funds, or strategic acquisition by a major corporation with large cash reserves, but the report states that as more startups mushroom, other sources of cash flow are needed.

 

“The available capital is relatively limited considering the number of companies vying for it,” it states in the report. “The lack of Round A funding makes it difficult for many companies to finance their continued activity and sometimes they must either cut back or even close down (series A crunch). In the US, this phenomenon acted as a catalyst for the creation of funds specializing in investment in early-stages (micro-VC), and this trend is now coming to Israel. The Round A funding gap in Israel is estimated at $100-200 million.”

 

Micro-VCs manage sums in the low tens of millions and invest small amounts in companies at their early stages. In the years 2011-2014, Israeli micro-VCs raised $440 million, 14 percent of the total capital raised by Israeli VCs.

 

Crowdfunding and “smart investor clubs” such as Jerusalem-based OurCrowd, have also become a solution for early-stage companies. This model is based on raising larger sums from a select group of wealthy and experienced investors. In less than two years, OurCrowd has raised more than $90 million, invested in 55 companies and recruited more than 6,000 investors.

 

As for foreign funding, the report notes a growth in foreign investors in Israeli tech companies. In 2013, foreign investors funded 75% of investments in Israeli companies and 85% of all capital raised by Israeli VCs.

 

According to the report, foreign funding is responsible for up to about half the R&D funding in Israel. Most foreign funding invested in Israeli VCs comes from the United States, but in the last three years, there has been increasing interest from investors in Asia, mainly from China.

 

“The ecosystem in which the high-tech industry operates is multifaceted and complex. We identified five core components in this ecosystem: innovation policy, human capital, funding, industrial innovation and international activity,” said Hasson.

 

“The report raises issues affecting anyone concerned with advancing the high-tech industry and implementing innovation in the private and public sectors. Reviewing these issues is meant to serve as a basis for ongoing dialogue between the industry, investors, entrepreneurs and the government, and to direct our joint efforts towards attaining economic prosperity through technological innovation.”