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Paper to be presented at the Summer Conference 2009
CBS - Copenhagen Business School
Solbjerg Plads 3
DENMARK, June 17 - 19, 2009
VC POLICY: YOZMA PROGRAM 15-YEARS PERSPECTIVE
UNC at Chapel Hill
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
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.
Israel’s 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.
1.1 The Role of Venture Capital in Cluster Emergence
The identification of new forms of intermediation lies at the heart of the creation
of new industries. Gompers and Lerner (1999) have been very clear that VC (a new
‘supply agent’) mediates between capital and startups in ways that the traditional
banking system (old "supply agent") did not, thereby overcoming "market failures"
with startup and innovation financing. Thus, the VC industry has an important role in
creation of new industries and clusters. According to Florida and Kenney (1988), the
VC industry plays a central role in coordinating various high-tech agents: entrepreneurs
and managers; professional employees; specialized suppliers; investors and capital
markets; and product markets. Therefore, we can conceptualize the role the VC
industry as both providing direct value to startups through direct interaction with their
portfolio companies (Gompers & Lerner, 1999, 2001) and as providing indirect value to
the innovation process within the cluster.
2. The Development of the Israeli ICT Cluster
Chapter 5 described the development of the Israeli ICT cluster in five phases. We
will briefly describe the second and the third phases of development.
At the Pre-Emergence (phase 2, 1986-1992) there were first signs of regional
high tech industrial concentration. A central feature of this phase is the appearance of
entrepreneurship. Some startup financing took place. However, a VC industry did not
exist yet. A critical mass of startups accumulated towards the end of this phase and,
correspondingly, a measure of ‘demand’ for the VC services. As a result significant
startup and VC-related experimentation and learning took place.
Two major conditions for transition to the Pre-Emergence phase were: the
ongoing technological revolution that made the pool of technological opportunities
continuously renewable1, and the significant diffusion of R&D and innovation
capabilities throughout the Israeli business sector. This is necessary for the country to
transform a pool of technological opportunities into a stream of potential business
The Emergence process (phase 3, 1993-2000) presented rapid quantitative growth
of startup and VC activities and the eventual emergence both of the startup-intensive
ICT cluster and of the VC industry. Israel's VC industry was triggered by a government
targeted-program – the Yozma program. The rapid growth of the cluster was an
outcome of the VC industry emergence and of a few early successful startups (many of
them backed by VCs) that were the source of spin-off and imitation by many new
agents. This enhanced a critical mass that created cluster externalities. Emergence
began with a fluid sub-phase (1993-1995) followed by rapid growth (1996-1998) that
eventually led to the bubble (1999-2000).
During the fluid sub-phase significant experimentation and collective learning
took place both with respect to startup and VC strategies and with respect to their form
of organization. During the rapid growth sub-phase an accelerated entry of startups and
VC companies occurred. A domestic VC industry was created. It is then that the cluster
attained a size, which enabled it to sustain a large number of supporting services. This
induces entry of additional leading multinational companies and of additional domestic
and foreign VCs, rapid creation of startups and rapid growth in the IPOs and acquisition
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).
3.1 Triggers for VC Emergence
In the late 1980s a new phase in the globalization process began: foreign high tech
startups could more easily float in NASDAQ, provided the economy had adapted to the
new opportunities. Part of Israel’s adaptation involved new government programs,
which complemented the existing R&D support program. These included Targeted
programs supporting VC (Inbal and Yozma), and complementary programs raising the
demand for VC-services (e.g. the Technology Incubators’ Program, and the extension
of the regular R&D program).
The actual trigger was implementation of Yozma in 1993. This provided the
critical mass for the cumulative, self-reinforcing process of growth of VCs and startups.
Yozma funds raised 263M$ up to 1998 and significant amounts were invested. In
addition, significant imitation by other private VCs occurred during this period. This
triggered strong collective learning processes, which contributed to attain the critical
mass, which made this process effective and self-sustaining. This further stimulated
entry of new VC companies, and accelerated creation of second and third funds by
existing Yozma VC companies and other VC companies. The cumulative process was
also fueled by favorable changes in the external environment in particular the rise of the
NASDAQ Index, and deregulation of communications markets. Additional internal
factors were the Oslo peace agreements, the highly educated Russian immigration to
Israel, Israeli highly experienced returnees from the U.S. during the early 1990s, and
domestic regulatory changes favoring VC investment and entrepreneurship.
ITP in Israel
The Israeli Government’s ITP towards the business sector began in 1969 with the
implementation of the industrial R&D support program. The new “R&D legislation” of
1984 further consolidated Israel's support of business sector R&D. This program was
the first of the set of programs comprising Israel’s Program Portfolio; and it was the
backbone of Israel’s innovation and technology strategy. This R&D support program
was widely regarded as having been a success in terms of stimulating R&D in the
business sector, in stimulating exports resulting from R&D, and in contributing to the
creation of a high tech sector during the 1980s (Justman & Zuscovitch 1999).
Moreover, the dynamic processes unleashed by its successful implementation led to the
other programs comprising Israel’s ITP of the 1990s (see Box C1).
Box C1: New ITP Programs in Israel during the 1990s
1) Inbal (1992-1998) - a Government owned Insurance company, which gave partial (70%) guarantees
to traded VC funds. Four VC companies were established under Inbal regulations.
2) Yozma (1993-1998)—a 100M$ Government owned VC company, which invested in 10 private earlyphase oriented VC Funds which operated in Israel (8M$ per fund).
3) Magnet Program (1992--)—a Horizontal Program supporting cooperative, generic R&D involving
group of firms and at least one University (annual budget 40-60M$).
4) Technological Incubators’ Program (1992--)—a program supporting startups during the first three
years of their operation. The incubators are privately managed (since 2001 they became also privately
owned). Both they and the projects approved get financial support from the Government (annual total
program budget 25-30M$).
Table C1: OCS Grants and VC Investments 1970-2008 (in M$)
Sources: OCS (2009) and IVC (2009).
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.
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.
4.1.1 Lessons from Inbal failed VC program
Inbal supported publicly traded VCs with guarantees to the downside. There was
no mechanism for drawing professional VC agents into the program; it did not generate
VC investors and partners with adding value capabilities; and it was exposed to 'stock
market sicknesses' and short-term thinking. Other Israeli VC agents did not imitate this
form of VC organization. However, our interviews reveal that policymakers and
businessmen alike learned from Inbal's weak impact: the difficulty in publicly traded
VCs of having investors contribute to the operation of the fund; greater difficulty to
rapidly exploits the reputation earned from early successful exits in order to raise new
capital, limits on decisions making flexibility and on management compensation; and
the absence of incentives for the “upside” (an important factor in attracting professional
VC partners and investors). We conclude that the indirect contribution of Inbal to the
eventual design (see Box C2 and C3) and implementation of a successful VC policy in
Israel was quite high (such as influencing Yozma’s selection of Limited Partnership as
the form of VC organization and the selection of the early stage investment focus).
4.2 Yozma Program2
There is wide consensus that one of the major factors triggering emergence of
Israeli VCs was Yozma. Four sets of factors seem to have been responsible for Yozma
to become an effective trigger of Israel's ICT Cluster: a) favorable background
conditions; b) policy and market forces’ experimentation during the pre-emergence
period; c) timing - the time overlap between Yozma implementation on the one hand
and the rising Nasdaq index and expanding market for ICT on the other; and d) the
successful design and implementation of the Yozma program.
Let us recall some of the background conditions, which were operating at the
time, that transformed Yozma into an effective trigger of Israel's ICT cluster: the
industrial R&D support Program; the restructuring of the military industries, the
massive highly educated immigration for the former Soviet Union, and new global
innovation opportunities opened by the ICT revolution. These, together with a cultural
shift where entrepreneurship were increasingly being considered prestigious in Israeli
society, generated a spurt of startup activity during the early 1990s. More specifically,
we argue that at the beginning of operation of Yozma, there was a clear demand for VC
services. The pool of startups included also some very high quality ones (such as RAD
Group, Checkpoint, Ornet, Galileo, and M-systems) who made a significant direct and
indirect contribution to emergence (see also Ellies at el., 2008). In addition, we should
not underestimate the specifics of the design and of the implementation of Yozma.
4.2.1 Yozma Design
The program began operating in late 1992 and the first fund was created in 1993.
The explicit objective was to create a solid base for a competitive VC industry with
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 wellestablished 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
system’s 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 wellexperienced foreign VC companies – See table C2).
Table C2: Yozma Funds – capital, foreign investors and portfolio
Est. Capital Foreign LP
$20M Daimler-Benz, DEG
$20M Van Leer Group
$20M AVX, Kyocera
$20M TVM Siemmens
$39M Vertex Int., Singapore tech
$33M Walden International
USA , Singapore
Box C2: Critical Dimensions of Yozma Program Design
Yozma Funds were Independent Israeli Limited Partnership VC Companies
A focus on early stage investments in high tech startup companies
Target level of capital aimed at $250M (Government Support $100M)- an assumed Critical Mass
A multiplicity of privately-owned Israeli VC funds (10), each one managed by a local management
company and involving a reputable foreign VC company (and one domestic financial institution)
Government Participation in each Fund $8M (representing 40% of the capital raised)
Strong incentive to the “upside” – the possibility, within a 5-year period, of purchasing government’s
share at cost (all funds except two made use of this option).
Planned ‘Privatization’ of Yozma Venture Fund and its Hybrid Funds: has taken place since 1998.
These previous features assured that the Yozma program was a Catalytic Program.
Box C3: Factors explaining the differential Yozma-Inbal impact
The program was promoted by the OCS and
structured as Fund of Funds (equity investments
in the hybrid funds without intervention in the
operation of the funds)
Single Objective: Creating a competitive
domestic VC industry in Israel
A targeted level of capital aimed at $250M
(government support of $100M)
critical mass of capital
A clear objective to create a competitive market
– aiming at creating 10
LP form of VC organization - the ideal form of
organization according to U.S. experience
Investments focused on early stages – Focus
Strong incentive to collective learning and to
'learning from others' (through requirement of
having a reputable foreign financial institution)
The Government owned fund started to invest
immediately - encouraged VCs to invest fast.
Managers’ abilities were also an important
criterion for selection of 'Yozma Funds'
Limited number of Yozma funds- created an
incentive to join fast, and a clear way out of the
program pre-planed privatization.
Leveraged incentives to the upside - a 5-year
option to buy the government’s share at cost
Attracting professional VC teams.
The program was promoted by the treasury and
structured, as a government Insurance company
(guarantees to the funds)
YOZMA - Impact
INBAL - Impact
Created a critical mass of VC investment
Most 'Yozma fund' are among the 20 leading
VCs in Israel
Very high private VC performance
Follow up funds & strong growth of capital
Yozma Funds were models for the design of
many other VC companies in Israel
Critical mass of VC activity was not achieved
Non of the INBAL funds are among the 20 leading
VCs in Israel
Low private VC performance
Very few secondary issues
Very few other public traded VC were established in
Dual objective: Promoting the Israeli local stock
exchange and promoting VC activity in Israel.
No targeted level of capital
did not lead to a
critical mass of capital
No clear objective regarding the competition in the
VC market only 4 funds were created
Publicly traded form of VC- hard to leverage current
success to fundraising and bureaucracy
Investments also in later stages and non-high tech
No incentive to collective learning, to learning from
others or to VC cooperation. Did not attract any
global financial nor strategic investor into Israel
No mechanism to encourage VC firms to invest
Administrative and financial criteria figured
prominently in selection of Inbal VCs
No explicit limit to the number & timing of funds
that could enjoy the INBAL benefit; and a complex
way out of the program.
Downside guarantees, which favor entry of nonprofessional VC firms
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 rate”3 (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.
Table C3: Yozma Initial Funds and Follow-up Funds 1993-2000
Entire IL VC-backed
Entire IL SU
Table C4 visualizes the emergence of the Israeli VC industry during 1993-2000,
in which period the private-VC fundraising average annual growth rate was 85%. At
the same time, the other PE agents experienced moderate growth rates. The time trends
of VC/PE fundraising growth rates within sub-phases during 1991-2000 suggest that
while capital market trends (mostly NASDAQ) influences both VC and PE, Yozma
program, which triggered VC emergence, crowd out PE activity for a while.
The big jump in Israeli VC activity occurred in 1993 when Yozma and Private
The VC literature (such as Gompars & Lerner, 1999) usually suggests an average exit rate of 20%-40%.
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 1990’s, 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.
Table C4: Capital raised by PE organization in Israel
These observations sustain our presumption that Yozma’s 250M$ raised in 19931996 (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.
Note that during 1992 publicly traded VCs and PE funds played a dominant role in total capital raised—133M$
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
Entire IL VC-backed
Entire IL SU
Table C6: Top-10 VC Management Companies in Israel 1996-2008
Top10 - 1996 Capital
Top10 - 2000
5 Yozma Funds
5 Yozma Funds
Top10 - 2004
5 Yozma Funds
Top10 - 2008
4 Yozma Funds
* The Capital row present the total capital (M$) raised by the management company in the last 5 years.
5.1 Indirect Impact
The VC ‘emergence state’ materialized during the second sub-phase of the cluster
emergence (1996-1998). This phase was characterized by accelerated growth of VC
activity; by entry of large numbers of players both on the supply side (VCs) and on the
demand side (startups); and by ‘selection/reproduction’ of critical features of the
industry. Table C8 shows figures on VC fundraising and investment, on startup
creation, VC-backed startups and exits (IPOs and tradesales). The number of new
startups created in the three years prior to the implementation of Yozma is
approximately 200 companies. Significant increases during 1993-1995 (approximately
440 companies) and sharp increases year by year after that (up to 2000). This reflects
the impact of implementation of the Yozma Program and the increased availability of
VC. While the direct impact of Yozma is reflected in 164 backed companies, the
indirect impact also includes the acceleration of startup formation in the cluster.
Another indirect impact is the rapid entry of non-Yozma related funds, something
triggered by the handsome profits obtained by Yozma Funds (see table C7). In 1993,
eight new VC management companies were created (six of them were Yozma funds)
and in 1997 a new wave of VC management companies creation began as a result of the
early successful exits of Yozma funds. Thus, while during 1990-1992 VC-backed
startups represented only 10% of startup creation, during 1993-1996, VC-backed
startups represented 55% of startup creation.
Table C7: The Development of the Israeli VC Industry
Closed MC* T. Active MC New Funds
T. Active Funds
* We define a closed management company either one that was actually closed or one that did not raised a new fund
at least 7 years. An active fund is a fund raised at the last 7 years (the investment period of a fund).
VC Exits :IPOs and M&As
Only small numbers of Israeli companies undertook an IPO in NASDAQ (or in
other markets) till the late 80s. Today Israeli (or Israeli-related) companies traded in the
U.S. are the third largest group behind only the U.S. and Canada. Moreover, many
Israeli (or Israeli-related) high tech companies are also traded European stock market
such as the London-based AIM stock market.
The number of Israeli high tech companies IPOs jumped in 1993 and then again
in 1996 with the first exits of firms backed by Yozma funds. This led to the indirect
impact of Yozma program, which was expressed by acceleration of startups formation
and exits (IPOs and M&As) and other networking and reputation effects. The picture,
which emerges, is one of increasing maturity of Israel’s ICT cluster and VC industry
(due to learning), a process that is accompanied by the increase in the NASDAQ
index6. The number of IPOs increased considerably during 1995-2000 compared to
1990-1994, as well as the share of VC-backed issues. Moreover, Yozma funds exits had
a significant effect during the years 1998-2001 with over 50% of the Israeli IPOs in
Nasdaq (see table C8). The picture which emerges is one of increasing maturity of
Israel’s ICT cluster on the one hand (due to learning and other cluster effects such as
the creation of the VC industry itself), a process which accompanied the increase in the
Nasdaq index (which by itself would also induce an increase in IPOs). There is no
doubt that within this process Yozma funds had a significant role. We cannot avoid
noting also that prior to 1993, there was already a non-insignificant number of IPOs (12
during 1991-2 alone) all of whom excepting one being non VC-backed issues. This in
part reflects the fact that very good; high quality startup began populating the scene in
the early 1990s.
Table C8: VC invested and high tech startups foundation, IPOs* and M&As**
IL IPOs in
IL IPOs in
IL IPOs in
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&A—one 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
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.
Table C9: Yozma Funds Exits by Years
IPOs in the U.S.
(% of Total)
IPOs in Europe
(% of Total)
IPOs in Israel
(% of Total)
(% of Total)
Source: IVC (2009), OCS (2008), VentureOne (1997) and authors calculations.
* Excluding Firesales and an exit backed by few Yozma funds is count only once – this explains the gap with table C2.
6. Cumulativeness and VC Emergence
VC emergence in Israel is closely related to the onset of a cumulative process
where VC activity and profits led, at least till the end of the decade to more VC activity
and profits. Cumulativeness involves four main sub-processes, which interact; and a
The ‘simple’ types of M&A seem to be easier to learn during early phase of the VC industry development
compared to ‘preparing a company for IPO’. The latter requires paying attention to management, financial and
marketing capabilities since, for floating, a company needs a selling product (although it need not be profitable). In
contrast, most M&A are based on the technology and technological excellence of SU and of its staff.
fifth (VC-startup Co-evolution), which integrates some of these and comprises a central
part of the overall process. The four component sub-processes are: Entry, Collective
Learning, Exploitation of Economies of Scale, and Reputation and Networks Effects.
Strong collective learning took place during five years of Yozma operation (19931998) and beyond, triggered by Yozma, who contributed to attain the critical mass of
activity for an effective and self-sustaining process. Learning pertained to screening
deal flow, due diligence, investing in startups, monitoring startups, providing value
added, and in the exiting. Collective learning of VCs together with some very good
‘early exits’ (through demonstration, networking and reputation effects) stimulated
entry of new VC companies, and accelerated creation of second/third funds by the
existing Yozma management companies. Yozma, by creating a quantum jump in VC
activity accelerated individual and collective learning8 by VC and startups, and
interactive VC-startup learning. Moreover the learning process involved a significant
component of learning from foreign agents in particular from the foreign ‘limited’
partners of Yozma Funds9.
The enhanced VC and high tech activity enabled a better Exploitation of
Economies of Scale in the domestic generation of non-traded (or partially non-traded)
inputs to high tech e.g. accountants, lawyers, investment bankers, consultants, providers
of knowledge inputs, and independent suppliers of production inputs. This factor,
together with the existence of networks of personal links, presumably contributed to
reductions in Transactions Costs and through this, facilitated deal making in the VC
industry. Through time after 1993 Israel’s high tech cluster became better integrated
and increasingly capable of providing effective services to new startups, both through
VC and through a gamma of other input and service suppliers. The cumulative process
was also fueled by favorable changes in the External and internal Environment (which
were mentioned in section 3).
6.1 VC-startup Co-evolution
VC-startup co-evolution is a central axes in the cumulative process leading to VC
emergence and beyond. The interaction between the two types of agents of the business
sector is both direct and indirect. Direct interactions parallel supply-demand effects and
Yozma Funds were connected in a network by the fact of a common OCS board member.
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 subprocesses 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 VC—Atena (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
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.
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.
Box C4: Sub-processes operating during VC emergence
1. Yozma Funds and other VCs founded prior to 1996 created follow-up funds.
2. Entry of non-Yozma VCs during 1996-1998 and follow-up funds of these organizations.
3. Successful Exits of these early entrants enhanced their reputation and led to more VC fundraising
both by the successful VCs themselves and by other new Israeli VCs. During the process, foreign
investment banks set up offices in Israel. This further facilitates the creation and growth of high tech
4. Since 1996 strategic partners e.g. IBM, Cisco, Intel, etc. became limited partners of Israeli VCs. This
in turn led to further reputation and networking of portfolio companies, which strengthened their
activity and performance. It also led to enhance direct investments by such partners and to enhance
reputation and networking benefiting the high tech cluster as a whole. Collective learning of the VC
industry and interactive learning involving Israeli VCs, Israeli startups, and foreign strategic partners.
5. “Cluster Effects” from the higher scale of activity which enhanced the local production of inputs and
services for the high tech sector (e.g. accounting, consulting, legal, patents offices, etc)
6. Increase in the M&A activities of multinational companies in Israel. Leading both to a new
significant exit channel for Israeli startups and to an increase in R&D activity of multinational
companies in Israel
7. Significant direct foreign VC activity in Israel, starting in 1997 (represent 50-60% of the VC
investments in Israel). Some foreign VCs established domestic offices is Israel, starting in 1999
8. A comprehensive cluster - the structural hole in the innovation process in Israel’s ICT cluster was
closed and the VC industry became one of its central coordinating agents.
Cumulative self-reinforcing process of growth
The infusion of VC supply by Yozma program triggered a cumulative process
with positive feedback in which more profitable VC activity at present spurred even
more profitable VC activity in the future12. At the center of this process was VC-startup
co-evolution. The sub-processes mentioned in Box C4 have both direct and indirect
effects on startup and VC development. For example, the ‘cluster effects’ mentioned in
Box C4 would enhance the efficiency of startups and thereby also indirectly affect the
growth of VC activity. Similarly, the reputation resulting from successful exits would
both enhance foreign resources invested in Israeli VCs and the possibility that startups
would gain access to the global product and capital markets. Overall, each new sub-
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
Interactive learning and creation of strong user-producer links
In young markets users learn from producers and vice versa - a phenomenon
called interactive learning (Lundvall 1988). The reason why interactive learning is
relevant for the dynamics of VC emergence is that it involved creation of a new
industry/market. Interactive learning represents one component in the process of
creation of user-producer networks—a widespread phenomenon in clusters and also
very relevant for VC. In the VC industry, these networks enable VCs to have access to
deal flow, to a wide variety of ‘added value services’, and to global capital markets.
The high impact of these networks is also related to other events and processes such as:
startup entrepreneurs becoming VC partners; VC strategic investors becoming direct
investors in startups; VCs sponsoring “home entrepreneurs” or founding startups, and
VC partners becoming entrepreneurs.
Class A market forces
Yozma’s success also derived from the strength of the market forces operating in
the area prior to implementation of the program or who entered the industry shortly
after its implementation. This factor seemed to have contributed to spark a selfsustained cumulative process of VC emergence. The high quality and strong
capabilities of ‘early entrants’ to the VC industry were ascertained through a
microeconomic analysis of 40 leading VC companies (Avnimelech & Teubal, 2004b).
We found that those companies indeed possessed strong capabilities, were eventually
highly profitable and had a significant indirect impact on the subsequent growth and
development both of VC and of the high tech cluster as a whole. Prevalence of such
conditions explains both the rapid process of growth during VC emergence and the high
impact of the targeted policy implemented for this purpose.
Class A Market Forces and Industry Emergence
We argue that under the uncertain and harsh global selection environment,
existence of sophisticated and even profitable domestic market forces operating prior to
industry emergence may actually enhance, rather than diminish, both the justification
for implementing targeted policies and the probability that such policies will lead to
industry emergence. Our empirical work has demonstrated this link between the Class
A market conditions that prevailed in the Israeli VC industry in the early 1990s and the
strength of the subsequent policy-enhanced VC emergence process. Under Class A
market conditions and with the enhancement of targeted policy we should anticipate a
faster emergence process with a stronger economic impact. While, the unaided
operation of (even) Class A market forces, might generate a cumulative process which
is ‘too little and too late’. This is due to our observation that in order to efficiently
translate private firm success into positive externalities and cluster emergence, a certain
critical mass should be reached.
We argue that there are a number of reasons for believing that despite the
presence of Class A market conditions during the early 1990s, Yozma was critical for
Israel’s successful VC emergence13. The previous chapters suggest that in addition to
Class A market conditions, VC emergence required: (1) accessing reputable foreign
partners14; (2) a complex coordination process linking the reputable foreign agents with
highly skilled domestic VC entrants; (3) assuring that a significant part of the domestic
VC agents adopt an early stage investment strategy, the LP form of organization and of
other aspects of VC activities (this would enable the exploitation of increasing returns
to scale in VC activities); (4) assuring that a cumulative process with positive feedback
would be initiated and completed within a short period of time; and (5)
‘country/government signaling’ (the substitute for lack of VC market-tested reputation).
In our opinion most of the above were system failures that unaided market forces
by themselves (even if they were Class A) could not overcome. This is even more so
once we recognize the relatively narrow window of opportunity for high tech
transformation (i.e. both VC emergence and a significant economic impact could not
have taken place prior to the next downturn in the global VC industry without the
trigger and acceleration induced by Yozma). It meant that even if unaided market
forces could have led to VC emergence by themselves it would have been a much
slower process (with the risk of not attaining sustainability) and presumably one with a
much lower economic impact. There is also sufficient evidence to support our view that
the design and mode of implementation of Yozma succeeded in overcoming each one
of the specific system failures causes mentioned above (see chapter 6).
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.
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
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
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).
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.
A weak Reputation effect could lock–in VC into a low-level 'equilibrium' trap.
increase the potential deal flow and therefore lead to additional increase in potential
7. Imitation of Yozma Program in Other Countries
Since 1999, as the tremendous success of the Israeli VC industry and the related
Yozma program became famous around the world many countries tried to adopt the
model of Yozma. Some countries had a formal process of learning from the Yozam
program (meetings with policy makers in Israel and with Israeli researchers that
analyzed the Yozma experience) these include: New Zealand, Latvia, and Russia. Other
countries started some formal or informal processes of learning from the Yozam
program, but did not implement a similar program eventually. It is still too early to
assess the success of these policies. However, the significant imitation of the program is
by itself a signal for it high reputation.
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.
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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