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Gil Avnimelech
UNC at Chapel Hill
gilavn@gmail.com
Abstract:
This paper deals with a policy instrument supporting the emergence of VC industries. It is based on the Israeli
experience with the Yozma program, which triggered the creation of the VC industry. This program dealt with
specific system failures of the entrepreneurship process the early stage equity gap and the lack of complementary
assets and skills in entrepreneurial firms.
VC emergence in Israel was a policy-enhanced process in the sense that a targeted government policy directed
to this goal (Yozma Program, 1993-1998) triggered it. Accompanying the process of VC emergence was the
transformation of Israel's high tech sector toward a startup-intensive ICT cluster. We suggest that the feasibility
of building a dynamic and innovative cluster, which exploits the ICT revolution, may be depended on the
emergence of a capable domestic VC industry. Therefore, understanding the specific characteristics of Yozma
program and the process it triggered could generate significant policy implication related to the process of VC
industries and high tech clusters development in other countries. Therefore, the paper present a full case study
of Yozma program 15 years after its implementation.
JEL - codes: C, E, -
VC Policy: Yozma Program 15-Years perspective
1. Introduction
This paper deals with a policy instrument supporting the emergence of VC
industries. It is based on the Israeli experience with the Yozma program, which
triggered the creation of the VC industry. This program dealt with specific system
failures of the entrepreneurship process the early stage equity gap and the lack of
complementary assets and skills in entrepreneurial firms.
Israels high tech cluster development was strongly related to the development of a
local VC industry (Avnimelech & Teubal 2004a, 2004b, 2004c). VC emergence in
Israel was a policy-enhanced process in the sense that a targeted government policy
directed to this goal (Yozma Program, 1993-1998) triggered it. Accompanying the
process of VC emergence was the transformation of Israel's high tech sector toward a
startup-intensive ICT cluster. We suggest that the feasibility of building a dynamic and
innovative cluster, which exploits the ICT revolution, may be depended on the
emergence of a capable domestic VC industry. Therefore, understanding the specific
characteristics of Yozma program and the process it triggered could generate significant
policy implication related to the process of VC industries and high tech clusters
development in other countries.
1
Such conditions occurred in Israel at the mid-80s (the creation of the software industry and the PC industry, and the
change in the business model in the semiconductor industry toward the fables model).
activities. As long as external and internal conditions remain unchanged, the process of
creation of large numbers of startups continued and the cluster continue to grow.
3. VC Emergence
VC emergence involves two groups of conditions: first, those underpinning
demands for VC services; second, those underpinning rapid growths of VC supply. The
existence of an adequate demand for VC services in Israel depends on a prior
appearance of a critical mass of startups in the pre-emergence phase. The supply-side
pre-conditions for VC emergence include liberalization of capital markets, other
institutional changes, restructuring of defense industries, the appearance of the startup
business model, experimentation with VC-related activities since the late 1980s, and the
implementation of the Yozma program (1993-1998).
4. VC Targeted Policies
New national priorities emerged with the beginnings of the massive immigration
from the former Soviet Union during the early 1990s. The government of Israel began
searching for means to employ the thousands of engineers that came to this country.
Simultaneously the military industries had laid-off hundreds of engineers; and there
were many attempts to create startup companies, which largely failed.
One of the main targets was enhancement of startup formation, survival, and
growth. Till the 1990s, the percentage of successful young companies was extremely
low and the accepted view was that this resulted from weak management abilities.
Experts in the field realized that despite massive government support for R&D there
still was a clear 'market failure', which blocked the successful creation and development
of startup companies. The head of OCS at the time, Yigal Erlich, pondered about how
to make OCS support more effective. The basic problem was lack of capability to grow
after the product development phase. He thought that the missing link was marketing
and management skills; and that the way to get it was to foster VC activity. At the time,
there were only 2-3 VCs in Israel, and it was clear that the total capital available and
the scope of VC activity were inadequate for the task at hand.
4.1 Inbal
It is important to consider not only programs like Yozma, which were successful
but also precursor programs like Inbal, which, even though they failed to generate a VC
industry, indirectly promoted the successful program. The Inbal Program was the first
attempt at implementing a targeted ITP directed to the VC industry. It was launched in
1991, 1-2 years before the implementation of Yozma. Its central idea was to stimulate
VC funds by guaranteeing the downside of their investments. The mechanism used was
a Government insurance company ("Inbal") that provided a 70% guarantee to VC funds
traded in Israeli stock market (TASE). The program imposed certain restrictions on the
investments of the 'protected' funds. Four funds were established. They and the Inbal
program, as a whole was not a great success. Fund valuations in the stock market were
low and the funds encountered bureaucratic problems. In addition, publicly traded VCs
has greater difficulty in exploiting reputation earned from early exits to increase the
capital invested (in LP form of VC organization it would be easy to rapidly raise a
second fund); and they absence of incentives relevant to the upside. Eventually all of
Inbal funds attempted to leave the program, which they eventually succeeded in doing -
all the (former) Inbal Funds were merged into other investment/holding companies.
2
Most of the material below was obtained from two interviews (01/1998 and 05/2000) with Yigal Erlich the CEO of
Yozma and one of the most important architects of the Program. Additional material was obtained from joint work
with him at the UFISE and ESTER research programs during the years 2001-2006.
critical mass of capital and activity; to learn from foreign limited partners; and to
acquire a network of international contacts. It was based on a 100M$ Government
owned VC fund (with the same name) oriented to two functions: a) investment in ten
private VC funds ('Yozma Funds'-80M$); and b) direct investments in high tech
companies-20M$. The basic thrust was to promote the establishment of domestic LP
VC funds that invested in very young Israeli high tech startups with the support of
government and with the involvement of reputable foreign VC investors. Each Yozma
Fund had to engage as LPs one such foreign institution together with a well-
established Israeli financial institution. However, the VC Company itself had to be a
completely new organization not own by any existing financial institution (this was
made to assure a competitive industry, which is not lacked-in to the old financial
systems routines). When a fund fulfilled these conditions, the Government would
invest (through Yozma) 40% (up to 8M$) of the funds raised. Thus the $100M of
Government funds would draw at least $150M of private sector funds (domestic and
foreign). Each Yozma fund had a call option on Government shares, at cost (plus
interest) for a period of five years. Thus, Yozma did not simply provide supply, risk
sharing incentives to investors, but it also provided an upside incentive (the private
investors could leverage their profits through acquisition of the government shares).
The incentives to the 'upside' also stimulated entry of professional VC firms and
managers (when you have higher returns the government incentive becomes more
significant). The program also assured the realization of learning through the
compulsory participation of foreign financial institutions (most of them were well-
experienced foreign VC companies See table C2).
5. Yozma Impact
In total the Yozma Program created ten private VC funds (and the Yozma fund
itself that was eventually privatized in 1998). Six funds were founded in 1993: Gemini,
Star, Pitango, Walden, Invantech, and JVP; two in 1994: Nitzanim and Eurofund; one
in 1995: Medica; and one in 1996: Vertex. The total capital raised by Yozma funds was
$263 million (100M$ out of it government capital) and they invested in 164 startup
companies (the aggregate number of portfolio companies in table C2 is 217, however
there were syndications between various Yozma funds in a few investments).
Eventually, these funds had an Exit (IPO or M&A) rate of 56%, which is much above
the regular VC Exit rate3 (in table C3 we can see that the Exit rate in the entire Israeli
VC industry during 1993-2000 is 27%; and the exit rate of the entire population of
Israeli startup is 14% compared with exit rate of the Yozma funds funds in the same
period was 48%). These very high rates of return of the Yozma funds4 suggest both the
very supportive environment that existed when the program was implemented and the
successful design and application of the program.
3
The VC literature (such as Gompars & Lerner, 1999) usually suggests an average exit rate of 20%-40%.
4
Out of the 10 Yozma funds 6 had over 100% IRR.
VCs raised 162M$ compared to 27M$ the year before5. Thereafter, there was a rapid
growth of the Israeli VC industry both in terms of capital raised and in terms of number
of funds. Total capital raised per year by Israeli VCs grew rapidly during the 1990s.
During the second half of the 1990s, the Israeli VC industry became a significant
industry. It was then that the first foreign VC companies began to invest directly in
Israeli startups. Later on, a few of them (e.g. Benchmark, Sequoia, Intel Capital and
others) established Israeli offices. To sum up, the Yozma funds initiated a dynamic,
cumulative process involving: learning by doing and learning from foreigners. It was a
collective learning process, which also contributed to exploitation of economies of
scale and specialization.
These observations sustain our presumption that Yozmas 250M$ raised in 1993-
1996 (the remaining 13M$ were raised after 1996 only from the private investors)
significantly contributed to create a critical mass which triggered a cumulative process
of growth in the VC industry during the second half of the 1990s, and that the Inbal
Program did not directly generate a cumulative process of growth (although it did have
some important indirect learning effects). This and the insights received during our
interviews are the basis for our inference that Yozma triggered VC emergence.
Another indication of Yozma Funds success in triggering growth of the industry
is their expansion, which took the form of Yozma follow up funds (see table C5).
Most Yozma funds were followed by three or more additional funds managed by an
expanding core of managers. The total sums managed by this group was 3.2B$ at the
end of 2000 - 54% of the total capital raised by the entire VC industry during the years
1993-2000 (the total sums managed by this group is currently 5.9B$ - 48% of the total
capital raised by the entire VC industry). Table C6, shows that 4-5 former Yozma funds
are among the top-10 VC companies in Israel during the years 1996-2008.
5
Note that during 1992 publicly traded VCs and PE funds played a dominant role in total capital raised133M$
compared to 27M$ capital raised by LP VCs. This in part reflects the Inbal incentives on Public VC; but capital were
also raised by the other two categories of financial institutions-PE Funds, and Investment Companies.
Table C5 Yozma Initial Funds and Follow-up Funds 1993-2008
Name Funds T. Capital Portfolio Active Exits Closed
Eurofund 2 $72M 25 6 (24%) 12 (48%) 7 (28%)
Gemini 5 $686M 105 38 (36%) 41 (39%) 26 (25%)
Inventech** 2** $40M 33 3 (9%) 17 (52%) 13 (39%)
JVP 4 $783M 85 34 (44%) 33 (38%) 18 (20%)
Medica 3 $195M 33 14 (43%) 13 (39%) 6 (18%)
Nitzanim
(Infinity, Concord)
3+5 $896M 132 44 (33%) 52 (40%) 36 (27%)
Polaris (Pitango) 5 $1,342M 140 62 (44%) 57 (41%) 21 (15%)
Star 14 $987M 113 36 (32%) 55 (49%) 20 (19%)
Vertex 6 $640M 94 42 (45%) 34 (36%) 18 (22%)
Walden 3 $184M 47 12 (26%) 19 (40%) 16 (34%)
Yozma 3 $150M 55 14 (25%) 24 (44%) 17 (31%)
Average 5 $543M 78 28 (36%) 31 (40%) 19 (24%)
Entire IL VC-backed 171 $12,243M 1,193 520 (44%) 244 (20%) 429 (36%)
Entire IL SU 6,107 3272 (53%) 477 (8%) 2358 (39%)
Table C8: VC invested and high tech startups foundation, IPOs* and M&As**
IL Startups IL IPOs in IL IPOs in IL IPOs in Significant IL
VC Raised
Year Foundation The U.S. Europe Israel M&As
(VC Invested)
(VC Backed) (VC back) (VC back) (VC back) (VC back)
1990 5 (NA) 53 (4) 1 (1) 0 (0) 1 (0) 1 (0)
1991 49 (NA) 51 (5) 4 (1) 0 (0) 7 (0) 0 (0)
1992 81 (NA) 94 (12) 9 (1) 0 (0) 7 (0) 1 (0)
1993 204 (NA) 124 (73) 11 (4) 0 (0) 9 (0) 1 (0)
1994 122 (NA) 140 (85) 8 (4) 1 (0) 7 (0) 2 (2)
1995 108 (NA) 175 (87) 9 (4) 2 (0) 3 (0) 7 (3)
1996 317 (293) 231 (117) 16 (10) 3 (1) 0 (0) 11 (3)
1997 643 (440) 263 (119) 12 (3) 0 (0) 2 (1) 7 (3)
1998 653 (589) 332 (152) 7 (4) 6 (1) 2 (0) 16 (6)
1999 1,160 (1,011) 587 (208) 12 (9) 6 (1) 4 (0) 15 (9)
2000 2,712 (3,233) 665 (372) 19 (12) 13 (3) 10 (3) 32 (11)
2001 1,319 (1,985) 371 (159) 2 (1) 0 (0) 0 (0) 8 (6)
2002 497 (1,138) 355 (76) 1 (0) 0 (0) 0 (0) 5 (3)
2003 6 (1,011) 410 (113) 0 (0) 0 (0) 0 (0) 9 (8)
2004 589 (1,465) 580 (141) 6 (2) 1 (0) 3 (2) 15 (7)
2005 1,644 (1,337) 511 (117) 4 (2) 11 (1) 4 (3) 16 (9)
2006 903 (1,620) 521 (121) 2 (2) 4 (2) 10 (3) 28 (23)
2007 1,096 (1,759) 596 (119) 6 (4) 1 (0) 20 (5) 26 (16)
2008 967 (2,076) 580 (177) 0 (0) 0 (0) 0 (0) 21 (15)
Source: IVC (2008), OCS (2007), VentureOne (1997) and authors calculations.
* Only of high tech startups; ** not including fire sales (at least $20M or at least $5M with annual ROI above 25%).
The picture about the emerging ICT cluster will not be complete without
considering the phenomenon of M&Aone of the main mechanisms of exit for VC
investors and for startup entrepreneurs. There is no clear market place where M&A
transactions (which are private capital market transactions) are negotiated and
implemented. It follows that the conditions for an emerging cluster to facilitate M&A
activity on a continuous basis differ from those required to provide access to public
6
Both factors were at work here - NASDAQ index growth, it did not induce other countries firms to float more
capital markets. Clear reputation effects are required in order to trigger MNEs to
undertake a costly search for technological opportunities in a specific cluster. The
Israeli case suggests that a critical mass of IPOs might play a crucial role in creating the
conditions for cluster emergence and that M&A only come in increasingly large
numbers later on, probably starting in 1994 (became significant in only since 1996
see table C7). The link could be as follows: public capital market links early in the
game generate conditions for the emergence (given a suitable Government program like
Yozma) of a distinctive VC industry. The new industry develops a capability for M&A
and in fact, many VCs become oriented towards the M&A form of exiting rather than
to the IPO strategy7 (see table C8). With the onset of cluster maturity and with
enhanced cluster reputation, MNEs start coming and this creates a very strong wave of
new M&A. Table C7 show that during 1996-7 the number of significant VC backed
M&A was still 20% lower than IPO numbers for the period; but that the former
exceeded the latter by about the same percentage during 1998-2000.
8
Yozma Funds were connected in a network by the fact of a common OCS board member.
9
Yozma was instrumental in bringing to Israel important financial institutions (see table C2). These companies
became a source of know-how, networking and reputation for the young VC industry. They presumably were
instrumental in triggering new elementary dynamic processes, which directly and indirectly contributed to the overall
high tech momentum of the period.
user-producer links in young markets e.g. VC and startup entry; and interactive
learning. Indirect links also occur through the wider cluster via one or more sub-
processes of cumulativeness10.
In Israel the starting point of VC-startup co-evolution can be found in the early
1980s when new opportunities in Software induced the foundation of a group of
startups and emergence of the startup business models. These were linked to new forms
of finance including the financing of startups by investment companies; and the first
formal VCAtena (created in 1985). A more rapid process of startups creation began
in the early 1990s fueled by the ongoing ICT revolution, by the globalization of capital
markets for technology companies, and by the growth of the NASDAQ index. By 1993
more than 300 startups were operating in the country and seeking for capital. Thus,
prior to Yozma, an excess demand for VC services arose. However, this excess demand
and the other background conditions probably could not by themselves trigger VC
emergence without the help of a program like Yozma. System failures prevented the
un-aided emergence of a domestic VC industry. These included lack of market-tested
VC reputation and a critical mass of VC activities that would enable partnering with
foreign VCs; and coordination problems between startups, VC firms and risk capital
(see Gilson, 2003). Yozma program assured a highly dynamic response to the excess
demand for VC services generated during the pre-emergence11. This led to very high
profits of early VC entrance and high expectations regarding future VC performances,
which stimulated VC entry and expansion.
The new VC supply was directed to existing startups and to a new wave of
startups, which expressed the entrepreneurial response to the increase in VC activity.
The number of startup creation vs. VC-backed startups for the years 1989-1992
reflected the excess demand for VC financing (only 10% of startups were financed by
10
There were three steps in the VC-SU co-evolution: Pre-Emergence: the numbers of startups operating and the
small share of those, which were VC-backed, suggests the existence of unsatisfied demand for VC services;
Emergence: The rapid policy response (through Yozma) to such a deficit led to a quantum jump in VC raised and,
due to the availability of a pool of skilled potential VC entrepreneurs, to a corresponding increase in VC activity.
This in turn led to a temporary excess supply of VC services. As a result we observe not only an increased share of
startups that were VC-backed but also significant increases in gross additions to startups during 1995-1996. These
were either a reaction to the excess supply of VC services or to the expectation that new startup foundations would
easily find new VC sources of finance if required. Increasingly Synchronous Growth: Starting in 1996 startup
demand for VC services and VC supply become increasingly synchronous i.e. rapid mutual adjustment. During
the rest of the decade, the share of startup which are VC-backed increases.
11
The rapid VC supply response would seem to contradict the assertion that there is supply inelasticity in the VC
industry (Gompers & Lerner 1999). However, we argue that the real bottleneck to expansion is not risk capital but
experienced VC managers. This inelasticity was not present in Israel during VC emergence, due to the accumulation
of VC-related experience in the pre-emergence phase, and due to returnee of experience Israelis from Silicon Valley
and elsewhere. Thus, Yozma's addition to capital translated immediately into sharp increases in VC activity-although
a strong process of individual and collective learning was still required for the VC industry to become efficient.
VC) prior to Yozma, the figures for the years 1993-1994 reflect the impact of
implementation of the Yozma Program and the increased availability of VC (60% of
startups were financed by VCs), and the figure for the years 1995-2000 (49% of the
startups were financed by VCs) and the years 2001-2006 (33% of the startups were
financed by VCs) represents the entry of new type of financing agents.
12
Because of these cumulative effects and the growth of NASDAQ index during the relevant period Government
VC equity did not crowd out private VC investments. In fact the opposite was the case: by triggering a cumulative
process of growth, it led to the creation of new business opportunities, which the private VC sector exploited.
process increased the set already in operation thereby reinforcing the cumulativeness of
VC emergence.
13
The failure of the Inbal Program, which began operating only one year before Yozma strengthens our argument
that Yozma was critical for the emergence of Israel's VC industry. The requirements below and the associated system
failures should be dated at 1993. For additional details of Yozma and Inbal Programs see chapter 6.
14
This was difficult without Yozma due to the lack of market-tested reputation at the level of the VC industry.
The upshot is that within a certain range, an increase in the sophistication of local
VC capabilities could enhance the justification and the expected impact from
implementing a targeted policy15. However, beyond a certain level of capabilities,
policy would not be justified since a high impact VC emergence would occur without
government intervention. Similarly, when conditions are not Class A, policy may not be
justified since even the best policy design might not trigger VC emergence. The role of
government could be different in such Class B conditions (early entrants to an infant
VC industry have low private profitability levels and/or low Pp-Ps correlation). Rather
than targeting the industry itself the role of government under these conditions could be
directed to stimulate favorable pre-emergence conditions such as fostering high tech
startups, supporting business experiments, or ascertaining other functional
requirements. The upshot is that targeting should be withheld, at least for the time
being, or should focus on other industries where Class A conditions prevail.
We argue that Class A market forces should be considered as pre-condition for
the implementation of targeted policy due to the fact that a necessary condition for the
first VC funds created to trigger entry of subsequent funds is that the former be highly
profitable. Such a performance would generate what we termed market-tested
reputation, which would considerably facilitate the raising of additional capital and the
participation of a wider set of foreign partners. In Israel, the strong early profitability
was due to very good exits (during 96-97) from early investments (during 1993-1994);
and this led immediately to venture capitalists worldwide to consider investing in
Israeli VCs and startups, hence the onset of cumulativeness16. The Israeli experience
shows that, once several Yozma funds had high returns, the individual reputation
effects spilled-over to the VC industry and high tech cluster as a whole; and that this
led not only to expansion of existing VCs but also to entry of new VCs. By the same
token, early funds and early investments, which are not highly profitable, risk
truncating the subsequent process of industry emergence17. This pattern of early
success leads to initial reputation that leads to additional capital and added value
networks may lead to a self-sustained cumulative process of growth. In addition, the
early reputation enhanced new high potential entrepreneurs to establish startups, which
15
This contradicts both the theory of infant industries support where the prior existence of strong market forces
would seem to pre-empt the need for policy (Stoneman, 1987; Bell at el., 1984) and the underpinnings of a simple
market failure justification for policy according to the neoclassical perspective (Arrow, 1962).
16
This effect has been analyzed by Gompers (1996) who focuses on how early exit successes of young, unknown
VCs enhanced the flow of capital to follow up funds of these organizations.
17
A weak Reputation effect could lockin VC into a low-level 'equilibrium' trap.
increase the potential deal flow and therefore lead to additional increase in potential
future success.
8. Conclusions
We now summarize and complete our argument concerning the role of Yozma.
First, Class A Market Forces in the VC area were necessary but probably not sufficient
for industry emergence - additional capabilities and other elements were also required;
Second, these would not automatically be generated to the extent and the speed
required without Yozma; Third, either Yozma caused emergence, or it only accelerated
emergence, our assessment is that Yozma was a successful policy with a significant
impact. Due to the narrow window of opportunity even if Yozma only accelerated
emergence its economic value was significant i.e. unaided market forces would have
created a smaller VC sector and a slower growth of high tech cluster as a whole18.
It is important to mention that the Israeli experience cannot be easily repeated in
other countries. However there still may be valuable lessons, which could be learned
from that experience. Also a dynamic interpretation of that experience which also
integrates others experiences could contribute, through an evolutionary process, to a
broader framework for analyzing VC policies in a variety of countries/contexts.
The analysis of Yozma also suggests that in some cases of clear system failure
in the market a targeted temporal government intervention could have significant value.
18
David (1985, 2001) has emphasized that effective policies implemented under conditions of strong path
dependence enjoy only a narrow window of opportunity a statement which fits our view of the impact of Yozma.
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