5 Steps That Made Israel a Start-up Haven

Five key events transformed Israel from a country that trusted in government to create jobs into one that leads the world in start-ups per capita.

If you are a leader in your local start-up community, you will be better off if you can attract more capital, more entrepreneurs, and more mentors to your region. That’s because my visits to start-up communities around the world suggest that entrepreneurs who run companies in cities with insufficient capital have much lower odds of success.

Moreover, if you happen to work on a region chock full of these resources, you are more likely to be able to build a successful company.

But what do you do if your start-up is located in a place without enough of those vital resources? You can either leave town for a place that offers them readily. Or you can try to transform your local community into one that attracts sufficient capital and talent to give local start-ups a good shot at success.

If you go that route, it’s worth examining Israel. It’s widely hailed as a Start-up Nation– hosting more NASDAQ-listed companies per citizen than any country. But not so many years ago, it was the opposite of that – a country that prized socialism and distrusted capitalism.

On March 18, Uri Goldberg — who worked in the office of Israeli President, Shimon Peres, before a stint at McKinsey & Co.– told me and 26 undergraduates who participated in Babson College’s Israel Start-up Strategy Offshore Elective that five key events transformed Israel from a country that trusted in government to create jobs into one that leads the world in start-ups per capita.

At its founding in 1948, Israelis trusted in big government. Many of them lived in Kibbutzim-farming communities where people shared chores in exchange for enough food and money to live and pay their bills. This economic system met basic needs without providing incentives for those who worked harder than the rest.

1. Choose Self-Sufficiency

After the Six Day War in June 1967 –in which Israel captured the Sinai Peninsula and Gaza Strip–this socialist approach began to erode. After shifting its political alliances to Arab countries that had lost ground in the war, France decided to stop supplying Israel with defense equipment such as fighter jets and tanks. Israel responded in the 1970s by setting a goal of becoming self-sufficient in defense, food, and intelligence, according to Goldberg.

2. Create Talent Pool Desperate for Work

This decision spurred government investment in a project to build Lavi, an Israeli-designed military jet. But in the early 1980s, Israel suffered a banking crisis that led to a $7 billion government bailout of its banking system.

That bailout–which was big in proportion to Israel’s then-small economy–put significant pressure on Israel’s economy. But Lavi continued for a few years when Israel realized that the U.S. F-16 was a cheaper alternative. So Israel cancelled the project – tossing its 10,000 workers and 50,000 contractors out of their jobs.

Israelis had already become wary of relying on foreign governments like France, but this cancellation led them to question whether they could still depend on their own policymakers for economic security.

3. Tap Demonstration Effect

With their backs up against the economic wall, these workers decided to start companies that would commercialize military technologies. NICE Systems, for example, developed technology to record sound for companies, such as insurers, and it went public three years later.

Another start-up, Gilat Satellite Networks, developed a communications system using military satellite technology that enabled retailers to validate peoples’ credit cards fast. Gilat sold its product to big U.S. companies in 1985 and had a $100 million IPO in 1988–then a big number.

Government failures and these entrepreneurial successes produced a cultural change in Israel. More specifically, Israelis realized that it was a mistake to rely on government to help them survive economically and that start-ups could help make the world better while yielding significant personal wealth.

The success of NICE and Gilat created a demonstration effect that gave Israel confidence in those new entrepreneurial values.

4. Create a stable investment climate

1977′s Likud government put in place a series of Friedmanesque economic policies that led to less government involvement in business but also runaway inflation (400 percent in 1984). In 1985, Israel made key economic policy changes that stabilized the investment climate for entrepreneurship.

At that time, Peres was Israel’s Minister of Finance. According to Start-up Nation, he directed changes in policy that lowered government debt, cut spending, spurred privatization, and altered government’s role in the capital markets. This created a more favorable climate for start-up capital formation.

5. Make outside investors an offer they can’t refuse

The 1990s featured another big shift in Israeli society that spurred more start-up activity. The collapse of the Soviet Union led to a wave of Russian immigrants–about a million to be specific–many of whom were trained as mathematicians, physicists and engineers. They needed work that could tap their skills.

Israel spent $3 billion trying to create textile factories, among others, in which the Russian immigrants could work. But it was Yozma, a tiny, $2 million project that made the difference. This program was designed to draw global venture capital to Israel.

Yozma–it grew to $100 million that Israel co-invested with 10 foreign VCs–would match every $1 in investment from a U.S. venture capital firm with $2 from this fund. When the VC sold its shares, Israel required it to repay the $2, leaving most of the gains to the VCs, according to Goldberg.

This program, plus the demonstration effect, have spurred investment in Israeli start-ups that have yielded good returns. In 2011 and 2012, Shay counted 56 acquisitions of Israeli start-ups by 10 leading U.S. companies like IBM, Cisco, HP and Apple, totaling $15.2 billion. And Shay believes that those capital providers earned many times their investment.

It’s impossible for others to replicate what Israel has done–but if your region is looking to spur more start-up activity, the five steps of Israel’s journey from socialism to start-up haven may offer some useful tips.


Reporting by Peter Cohan; Published by Inc.

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