Israeli companies have been especially active in semiconductors, along with telecommunications and software.At first, it sounds like Erel Margalit is telling some sort of weird joke. “If you
could take an Israeli engineer and mix him with a Japanese engineer, you’d have the perfect match,” said the founder and managing partner of Jerusalem Venture Partners. “The Japanese engineer would be the most disciplined and on time, while the Israeli engineer would always work outside the lines and be creative.”

Granted, it’s a bit of a strange comparison, but when it comes to technology, Israel holds a lot of surprises. During the past 20 years, this small, young country with almost no natural resources has virtually transformed its economy away from what Margalit calls “academia, tourism, government, and God” into a thriving and innovative high-tech promised land where half of its $20 billion in exports in 2000 were in high tech.

Margalit and most of his peers attribute the country’s metamorphosis to a variety of factors. But what is perhaps most surprising is that none of the factors is esoteric or unique. Rather, Israel’s success in developing its high-tech community and attracting the foreign venture capital needed to fund it comes from a combination of very ordinary things including the nation’s government, people, military, and educational system.

To begin with, Israel has more engineers, researchers, and medical doctors per capita than any other country. It also has the third-highest proportion of university graduates and patents per person and has more technology startups and more companies listed on NASDAQ than any other country except the United States and Canada.

In addition, Israel rivals the United States in home-computer use, national spending on education, and national spending on technological research and development. And all this is packed into an area smaller than New Jersey, with a population less than that of the city of New York.

Today, Israel is home to about 1,800 technology companies that range from homegrown startups like Mirabilis, which developed the instant-messaging program ICQ and then sold the technology to America Online for $407 million to high-level branches of such American technology giants as Compaq Computer, Intel, IBM, and Hewlett-Packard. And while particularly active in telecom, software, security, and semiconductors, Israel is also beginning to make its mark in biotech and nanotechnology.

If anyone had the initiative to get Israeli technology going, it was the country’s government. Over the course of Israel’s 53-year history, the nation has been active in encouraging high-tech development for projects that are deemed important to the country.

Amon Agassi names this support as one of the major reasons he thinks his country is a good investment. “Israel is a very modern country,” he said. “There are world-renowned medical institutions, a highly advanced banking and financial sector, and strong government support.” As the director of business development at the Consulate General of Israel in San Francisco, Agassi is charged with encouraging U.S. interest in Israeli companies, particularly in high tech.

Agassi points to a wide variety of Israeli government initiatives including a stable currency, tax holidays and loans for startups and research, matching government funds for international VC investments, and government-developed technology parks and incubators, which, like their counterparts in the United States, provide support for fledgling companies.

Heading most of these projects is Israel’s Office of the Chief Scientist, a branch of the Ministry of Industry and Trade. Margalit sees this collaboration as a distinct advantage. “When governments act as a facilitator, rather than an investor or something like that, I think that’s when they do their best job. And I think that when the Israeli government, and primarily the Office of the Chief Scientist, got involved, they did their job exactly.”

Intel spokesman Chuck Mulloy agrees and said that Israel has been an ideal location for his company ever since it opened its first facility there in 1974. “It’s a combination of talent, experience, relationships with communities, and a desire by the government to have us there,” he said. “It’s a good relationship.” Intel has 5,200 employees in Israel in two wafer-fab plants in Jerusalem and Qiryat Gat and a research and development center in Haifa.

But, while supportive in many ways, the government has also posed its share of problems. In a May 24, 2001, report, Morgan Stanley Dean Witter & Co. largely praised Israel’s technology opportunities and governmental support, but warned the country about its complicated tax structure. Israel’s corporate tax rate is 36 percent (compared with 20 percent in the United States), and the country is stricter than the United States with regard to merger and acquisition deals that involve startups.

“We need a more complete reform of the tax system in Israel,” said Ogen Perry, investment director and head of Vertex Management Israel’s U.S. office. “It’s been done partially, but it’s not always advantageous to investors. It’s a real inhibitor.”

Pressure on the government from both sides finally provoked a decision announced Sept. 24 where Israel would collect zero capital-gains taxes from all foreign investors provided that they were actively investing a certain amount of money in the country. Margalit said that he remembers the day well. “It opens the door again and simplifies things,” he said. “I think that when you look at some countries with great technology and you ask why the venture industry didn’t develop, in most cases, they had a major business and tax complexity.”

The U.S.-Israel Binational Industrial Research and Development (BIRD) Foundation also sees the tax change as a benefit. Set up by both the Israeli and the U.S. governments in 1977, BIRD encourages bilateral relationships between Israeli and American companies through a sort of matchmaking. Companies from both countries are paired up for development projects, and BIRD provides loans from an endowment of $110 million.

Though his organization was primarily set up to encourage joint projects between U.S. and Israeli companies, Dov Hershberg, BIRD’s executive director, said it also encourages U.S. companies to invest in Israel. Like most of his peers, Hershberg is quick to identify the reasons for U.S. interest in Israeli technology. He sees the relationship between the two countries as a strong one, despite any security concerns in the region or a shaky economy.

Since the 1990s, a popular idea advocated by Israel’s high-tech and venture community is a comparison between Israel and Silicon Valley. It may be a cliché, but the concept is not lost on Margalit, who speaks at length about the attributes that both locations hold. “I think they are two societies that are very direct, informal, and creative,” he said. “Israel and California were places where you could set your own standards, unlike the (U.S.’s) East Coast, where the standards were already set by others. The other element is immigration. Both (places) are very diverse societies where people are thinking differently and wanting to prove themselves.”

Steven Schoenfeld, director of product management at security-software firm Check Point, said the Israeli workforce is especially attractive to technology companies. Check Point, an Israeli-founded company, maintains co-headquarters in Redwood City, Calif., and outside of Tel Aviv. “There’s a strong entrepreneurial spirit in both places; there’s a good pool to choose from in both places. There’s a strong academic background, a lot of people there went to college, and so many people speak English,” Schoenfeld said. “It’s the kind of thing that feeds upon itself, like in Silicon Valley.”

But, while attracting good employees may be easy, attracting good management is another matter. Although both Compaq and Intel say that the management in their Israeli facilities is largely Israeli, they also acknowledge that much of it is multinational. Agassi said that the issue is more a matter of an “everybody wanting to be in charge” syndrome, but Vertex’s Perry attributes it to the relative youth of most Israeli companies, as well as to a lack of MBA graduates in the country.

Despite all that Israel’s technology industry has going for it, even the government has acknowledged some serious challenges in the near future.

In a report by the Office of the Chief Scientist last year, several challenges facing Israeli biotechnology were named. They included a lack of a clear national vision and focus; an insufficient industrial and regulatory infrastructure; a lack of managerial skills and industry background; a limited coordination of governmental, industry, and academic efforts; and a lack of “smart” pre-seed funding for late-stage applied research. Vertex’s Perry said that developing new sectors is difficult, as Israeli companies tend to focus only on what they do well.

“Israel has a vertical focus of things that are very, very good in Israel,” he said. “So other technology you don’t really go looking for.”