Israel is widely hailed as a startup nation, hosting more NASDAQ-listed companies per citizen than any country. But not so many years ago, it was the opposite of that—a country that prized socialism and distrusted capitalism. Five key events transformed Israel, according to Uri Goldberg, who worked in the office of Israeli President Shimon Peres before a stint at McKinsey & Co. and who spoke on the topic on March 18 during Babson College’s “Israel Startup Strategy Offshore” elective.
1. Chose self-sufficiency
Following the Six-Day War in June 1967, Israel’s socialist approach began to erode. After shifting its political alliances to Arab countries that had lost ground in the war, France decided to stop supplying Israel with defense equipment such as fighter jets and tanks. Israel responded by setting the goal of becoming self-sufficient in defense, food and intelligence.
2. Created a talent pool desperate for work
This new direction spurred government investment in a project to build Lavi, an Israeli-designed military jet. But in the early 1980s, Israel suffered a banking crisis that led to a $7 billion government bailout of its banking system, putting significant pressure on Israel’s resources. Lavi continued for a few years until Israel realized that the U.S. F-16 was a cheaper alternative. So Israel cancelled the project, tossing 10,000 workers and 50,000 contractors out of their jobs.
3. Tapped demonstration effect
With their backs up against the economic wall, these workers decided to start companies that would commercialize military technologies. NICE Systems, for example, developed technology to record sound for companies—such as insurers—and went public three years later.
Another startup, Gilat Satellite Networks, developed a communications system using military satellite technology that enabled retailers to validate credit cards quickly. Gilat started selling its product to big U.S. companies in 1985 and had a $100 million IPO in 1988—then a big number.
Government failures and these entrepreneurial successes produced a cultural change in Israel. More specifically, Israelis realized that it was a mistake to rely on government to help them survive economically and that startups could help make the world better while yielding significant personal wealth.
4. Created a stable investment climate
In 1977, the Likud government put in place a series of Friedman-esque economic policies that led to less government involvement in business but also runaway inflation—400 percent in 1984. In 1985, Israel made key economic policy changes that stabilized the investment climate for entrepreneurship. At that time, Peres was Israel’s minister of finance. According to the book Start-up Nation, he directed changes in policy that lowered government debt, cut spending, spurred privatization and altered the government’s role in the capital markets. This created a more favorable climate for startup capital formation.
5. Made outside investors an offer they couldn’t refuse
The 1990s featured another big shift in Israeli society that spurred more startup activity. The collapse of the Soviet Union led to an influx of about 1 million Russian immigrants, many of whom were trained as mathematicians, physicists and engineers.
Israel spent $3 billion trying to create factories in which the Russian immigrants could work, but it was Yozma, a tiny, $2 million project, that made the difference. Yozma matched every $1 in investment from a U.S. venture capital firm with $2 from its fund. When a firm sold its shares, Israel required it to repay the $2 leaving most of the gains to the firms, according to Goldberg.
Israel also sponsored incubators that took equity in the startups, alongside big companies like Intel that paid entrepreneurs to do R&D. According to Steve Gray from the educational center Keshet, who worked with Intel Capital in Israel, Israel’s chief scientist paid for two years’ worth of R&D if the entrepreneur kicked in 20 percent of the start-up’s capital. Intel and Teva, a generic pharmaceutical company, were among this program’s corporate sponsors that covered operating expenses.
These programs—plus the demonstration effect—have spurred investment in Israeli startups that have yielded good returns. In 2011 and 2012, 56 Israeli startups have been acquired by 10 leading US companies like IBM, Cisco, HP and Apple, totaling $15.2 billion, estimates Canaan Partners’ General Partner Izhar Shay. And Shay believes that those capital providers earned many times their investment.
It’s impossible for others to replicate what Israel has done, but cities looking to spur more startup activity may be able to draw useful insights from the five stages of Israel’s journey from socialism to startup haven.
