Solon Partners

I am always on the lookout for new ideas on how to spark entrepreneurial spirit and create fertile conditions for growth of innovative start-ups. As such, as soon as I got my hands on Senor and Singer’s book ”Start-up Nation. The Story of Israel’s Economic Miracle” I tore into it looking for what could be transferred or copied by Estonia.

In theory, the two nations have much in common – tiny nations with small populations and unusual languages, menacing presence of oil rich neighbors (that have more than on one occasions invaded), no abundance of readily convertible natural resources or cash crops, and a recent past dominated by central planning and socialism. In reality, the likelihood of successfully localizing the Israeli model in Estonia is rather low.
In “Start-Up Nation” Senort and Singer describe how within just 20 years Israel created a world famous high-tech economy and one of the biggest venture capital markets in the world. Authors illustrate the uniquely Israeli landscape that created synergy from the close proximity of great universities, strong gorvernment investment into high-tech R&D, and a particularly strong and innovative national character forged by the government through the national service sytem.
When in the 1990s the government provided funding to encourage venture capital to invest in Israeli startups – the synergy was commercialized into an $18.1 billion technology export industry (2008) from near zero. As Erel Margalit put it “Venture capital was the match that sparked the fire.”

“Start-Up Nation” leaves the impression that Israel’s success can be generally divided into three broad influences: investment into education, investment into military R&D, and investment into culture of innovation.

Investment into Education
Israeli educational system is very effective at producing scientists and engineers, while successfully absorbing Russian, Ethiopian and other emigration in the millions. According to the OECD, 45% of Israelis are now university educated, and these universities are very good.
In 2008, Weizman Institute and the Hebrew University were chosen as the best two places to work in academia (outside of the US) by Science magazine. Israel now produces more scientific papers per capita than any other nation. Israel is a top 10 producer of patents in the field of nuclear science. Hebrew University is ranked #12 in in global biotech patent rankings (Telaviv University is #21). Israel has numerous nominations for Nobel Prizes and has recently won several prizes in economics and chemistry. Of course, all of this has required consistent government support for investment into raising the quality of the education to the world class level.
Investment into Military R&D
Constant threat of military conflict with hostile oil rich neighbors has forced Israel to invest billions of dollars every year into military R&D. Investment into projects such as the Merkava tank, Lavi jet are known by name, but in addition to these specifically military applications, there were many international projects with readily transferable technologies and innovations in the fields of  satellites, missiles, optics, communications, cryptology and many others. The military R&D projects trained several generations of highly qualified and experienced engineers and technology professionals with unique cutting-edge know-how and expertise. Moreover, the Israeli government through its mandatory national military service targets for extra development the most promising leaders and scientists through specially designed military leadership programs.
Every year all high school students have an opportunity to try out for the elite military units topped by the Talpiot. Talpiot only considers the top 2% of the students, less talented students have to settle for less prestigious military units. If Talpiot  candidates pass the 41 month training course they then commit to six years of further development in advanced military service. Today many of the Isreali NASDAQ listed tech companies are founded or run by Talpion alumni. As a result the authors claim that:

In Israel, one’s academic past is somehow less important than the military past. One of the questions asked in every job interview is , Where did you serve in the army

Thus Israel’s start-up engineers and future CEOs have by age 25 not only faced academic challenges, they have learned improvisation and innovation in leading combat operations against terrorists with millions of dollars in technology, learned responsibility in leading troops into battles and made rapid executive decisions literally under enemy fire. Israel has masterfully managed the technology transfer in leadership and technology skills learned through modern military service into profitable uses in the civilian technology markets.

Investment into a culture of innovation
Authors describe how Israelis are brought up in a culture of improvisation and innovation on the “edge of chaos.” A key to survival in the environment with few natural resources and hostile neighbors is thinking outside the box and challenging conventions in order to even up the odds.
The geopolitical reality of Israel is that it is surrounded by 250 million Arab neighbors (some more friendly than others) that are financed by the proceeds from the sale of 1/3 of the world’s oil reserves. In such difficult environment Israeli leaders have had to adapt to finding unexpected and unconventional solutions. Isrealis have learned that to tease out the best from a team a real leader should be ready to resist group-think and defending the status quo:

Maximize resistance—in the sense of encouraging disagreement and dissent. When an organization is in crisis, lack of resistance can itself be a big problem. It can mean that the change you are trying to create isn’t radical enough . . . or that the opposition has gone underground.

This is something that is specifically taught to everyone in the military through the after-action review process for analysis of all military missions. The ability to accurately and honestly admit and assess own and teams’ weaknesses and thus find ways for improvement is highly valued and rewarded. Israelis learn from early on that:

It’s ok to try and fail. Success is best, but failure is not a stigma; its an important experience for your resume”

An excellent demonstration of this culture has been the Yozma venture capital fund of $20 million combined with $100 million investment into creating 10 Venture Capital funds (each made up of local VC in training, foreign VC, and Israeli investment bank/company). Today these funds manage approximately $3 billion of capital and support hundreds of Israeli high-tech companies. There are now over 45 venture capital funds actively operating in Israel, and Israel has over the same period doubled its share of the global VC investment with respect to Europe (15% to 31%). The key for gaining support from the VCs was that from the beginning the government wrote in a cheap buy out clause (equity plus reasonable interest if the fund was successful). The idea of the program was: “while government shared the risk, it offered investors all of the reward.”

Relevance for Estonia
Unique synergies of the Israeli ecosystem is instructive, but not readily transferable to Estonia. Despite strong efforts none of the Estonian Universities have ever broken into the the top 500 rankings, and are unlikely to do so in the next decade based on the current level of investment and international professors’/students recruitment policies. Under the given budgetary and political limitations it would be difficult to finance, but effective and rapid change can be achieved for example through making it possible for all Estonian university students to study abroad for 1 year, and making it a graduation requirement. But long term solution will require more investment form the state as well as strategic private partners.

Israeli military history is also difficult to transfer to Estonia. Estonia currently has virtually no military to civilian technology transfer. The last remaining Estonian military company E-Arsenal (which had been attempted to bring optical technology manufacturing into Estonia) was recently turned into a real estate company to manage its Tallinn property. Estonia should certainly consider providing direct government financing for private companies able to bring high-tech military R&D projects into Estonia. Estonia’s current active participation in NATO operations, NATO’s cyber-defence centre in Tallinn, and Tallinn potentially winning the EU IT headquarters project – Estonia should be able to participate at a minimum in communications and cryptography projects which could bring unique know-how with advanced technologies to Estonia.

Finally, there is much to be learned from the Israeli experience of venture capital incubation through building incentives for privatization into the program. The likelihood that local VC firms begin to strengthen and emerge would be significantly enhanced by this approach. The private VCs are much better able to deliver the “smart” part of smart money – by providing, in addition to investment, better level of access to credible mentoring, introductions to international investors, top professionals, prospective acquirers, new customers and strategic partners. This seemed logical enough for the Irish in 2008 when they launched a €500 million “innovation fund” designed to copy the Yozma model.

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Benchmark Capital’s Bill Gurley wrote in his Post that we may be on the verge of witnessing a drastic reduction of the venture industry.

Before joining Benchmark in 1999, Gurley was a partner at Hummer Winblad Ventures. As if that is not enough street cred, he has a background as a highly touted research analyst at CS First Boston. So banter of a 50% reduction from Gurley should be taken pretty seriously - considering the full implications for entire sectors of technology that are entirely dependent on venture financing. No wonder that the new mantra being repeated at all start-up events is “cash-flow is king.”

Mind you 50% figure is not a hyperbolic tweet taken out of context, but a very well reasoned analysis showing how  pension funds, insurance companies and foundations  have lost a lot of money by exposing their portfolios to more venture capital investments. The credit crisis  combined with the inability of  the venture industry to deliver significant returns from  IPOs or blockbuster M&A deals spells - reallocation.

Predicting that  institutional investors will likely cut exposure to “alternative assets” by reducing their portfolio allocation by 50%. Logically, Gurley expects a proportional cut in money available to those venture capitalists raising new funds.

This very much mirrors the comments from my contacts in the venture industry - trouble has hit home with many Estonian and Scandinavian VCs that have been unable to start new funds, or have to settle for unexpectedly small funds.

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Printing money is hard work

When writing my March6 blog entry I wondered when we would the United States be added to the list of countries resorting to printing money to boost the economy.  That day has already come.

In the words of Goldman Sachs analyst Jan Hatzius, the Fed is going to the “kitchen sink” strategy of throwing everything it had to jolt the economy out of its downward spiral.

The Federal reserve is dropping a $1.15 trillion money bomb into the bond markets to boost lending. Yes this money will literally be eased out of the printing machine in major quantities (official term being “Quantitative Easing”). Ok maybe I am not using  exactly the proper description they teach in the MBA program.

Wickipedia defines QE as follows:

The term quantitative easing refers to the creation  of a pre-determined quantity of new money ‘out of thin air’ through open market operations by a central bank as the start of a process to increase the money supply. It can, more simply, be understood as an indirect method of printing money.

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Technology Partner at PVP

Sim Simeonov of Polaris Venture Partners offered good advice on writing better executive summaries and described the VC’s love/hate relationship with these summaries:

You need to sell enough to get there but no more. Don’t over-educate or over-sell. It will lead to a wordy and heavy exec summary. Avoid the common hyperbole such as “this is a $56B market” or “we have no competition.” Statements like these only make you look immature.

read more at High Contrast Blog. Simeonov also makes reference to another good posting entitled “Writing a Compelling Executive Summary” by Garage Ventures which can be found here.

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In the midst of the current financial crisis some VC funds are having trouble raising additional financing, and have even turned to selling portions of their portfolios at substantial discounts. The cash drought is largely due to institutional investors’ (retirement funds, hedge funds, insurance companies, and others) inability to meet investment commitments as they lose money on investments and cannot liquidate assets. When Limited Partners do not invest then VC funds have limited resources to invest in companies. In this environment entrepreneurs should know the financial status of the VC they are negotiating with.

Brad Feld has provided sensible advice in his article for Entrepreneur.com regarding due diligence that you should do on your potential VC partner:

… ask your venture capitalists these important questions:

• What year (vintage) is your fund? Almost all VC funds are set up as 10-year partnerships that can be extended several years. They usually spend their first three to five years investing in new companies and the balance of the partnership managing those investments.
• Have you raised a new fund since you invested in our company? The long-term health of a VC firm can be measured by how recently it has raised a new fund. Optimally, a VC firm raises a new fund every three to five years, so it’s always actively investing in companies.
• When are you planning to raise a new fund? If the answer to this question is sketchy, pay attention. It usually takes at least a year to raise a new fund unless your VC firm is well-established with a long history.

Do not be afraid to ask fair questions regarding financial health of the fund and to clarify the potential for any follow up rounds. Unnecessary politeness may come back to haunt you.

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