Venture Capital s Contribution to the Israeli Economy. Summary

Transcription

1 Venture Capital s Contribution to the Israeli Economy Summary June 15, 2005

2 Introduction We are pleased to present to the annual IVA conference this analysis prepared for the IVA by Economic Models headed by Dr Yacov Sheinin. Our aim is to lay the foundation for understanding the role of VC in Israel. This report analyses for the first time the contribution of VC investors to the Israeli economy in the past decade and highlights their functions and unique contribution in the present and future. We hope that this report will contribute greatly to the current dialog regarding government action including establishing policy and strategic action for the long term, encompassing areas such as education, R&D and development of capital markets. Yoram Oron Chairman, Israel Venture Association Co-founder Vertex VC 22 Draft - translated from Hebrew

3 Table of Contents Introduction..4 Summary and Conclusions 5 Growth Potential of the Economy Presented by Dr. Yacov Sheinin and Chen Herzog

4 Introduction This study, prepared for the IVA, evaluates the contribution of Venture Capital investments to the growth of Israel s economy. While VCs have been active in Israel for over 10 years, there is no complete study of the VCs contribution to the Israeli economy, which is therefore unclear. This analysis discusses only the contribution to Israel s economy and does not discuss the opportunity for investors, VC funds or fund managers. We evaluate the contribution to the economy in terms of GDP growth and an increase in employment. We place a large emphasis on the long term drivers of these factors. This study relies upon data collected and formulated by Economic Models over many years. The data on VC capital raising and investment was obtained from the IVC Research Center and has not been confirmed by us. 44 Draft - translated from Hebrew

5 1. Summary and Conclusions

6 VC Capital Raising and Investment in Israel , Mil. $ Investment and management costs of Israeli VC funds, in Israel Investment of foreign VC in Israel Total VC investments in Israel Investment of Israeli VC funds abroad and other Available resources for investment of Israeli VC funds Total capital raised by Israeli VCs and investments in Israel by foreign VCs 5,760 6,590 12,340 2,300 1,000 15,640 Source: IVC Research Center, Economic Models 66 Draft - translated from Hebrew

7 The Direct Contribution of VC Various VC investors (Israeli and foreign), have invested over 12 $B in Israel in the past decade, mostly derived from foreign sources. This amount, in proportion to GDP, represents the highest rate in the world. Most funding (about 70%) has been channeled to paying wages to Israeli workers. As the economy has a high level of unemployment, it makes a direct contribution to GDP (unlike investments in imported machinery and equipment). Fund raising and VC investments continue in We expect 1.5 $B of investments and about 1 $B to be raised by Israeli managed VC funds this year. We can therefore conclude that currently, VC investments have a direct contribution of over 1% to Israel s GDP. 77 Draft - translated from Hebrew

8 VC Contribution to Israeli Relative Advantage Escalation The rare combination in Israel of a high level of technological ability in electronics and software companies, together with enormous research capabilities, globally-embracing export ties, and a rare ability of fund raising, allows the unparalleled growth in the electronics and software sectors. This advantage of the Israeli economy can last as long as the Israeli education system safeguards these skills. VC investments play an important role in this advantage. The amount of VC invested in Israel as a portion of GDP is the highest in the world and the output of Information and Communication Technology (ICT) as a portion of GDP is also the highest in the world. 88 Draft - translated from Hebrew

9 VC Investment in ICT Relative to GDP 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% Israel USA Canada Korea Sweden UK Netherlands Ireland France Finland Belgium EU Norway New Denmark Germany Australia Italy Switzerland Greece Spain Portugal Austria Japan Source: OECD , IVC Research Center 2002, CBS (Isr.) 99 Draft - translated from Hebrew

10 The Correlation between VC and ICT Israel ICT share of GDP (%) 11 Finland 10 Korea Ireland 9 UK 8 Netherlands 7 Japan 6 Sweden 5 France Canada USA R 2 = % VC investment in ICT as a proportion of GDP *Finland was removed from the sample (Nokia biased). Source: USA Census, OECD , IVC Research Center 2002, CBS (Isr.) 10 Draft - translated from Hebrew

11 The Contribution to Human Capital Wage payments to Israeli workers for R&D lead to an accumulation of experience and expertise and creates an intangible but important asset for the Israeli economy, even in cases of start-up closure due to unfeasible business models. We should view VC investment in failed enterprises as a contribution to the overall development of Israeli technology. A failed business is not necessarily a failure from a national economic point of view. We find the cumulative experience (of failures and successes) as part of the total Israeli relative advantage in the advanced technology sectors. 11 Draft - translated from Hebrew

12 The Contribution to the Start-up Sector 90% of VC investments are in early stage start-ups; VC investment is the dominant source of capital for these companies. We believe that without VC funding, the Israeli start-up sector would not have developed to the current level. The electronics and software sectors include a range of companies that began as start-ups and matured. Growth of the electronics and software sectors is influenced by the maturation of start-ups which rely upon VC investment. Vast majority of VC investments (over 90%) is in the electronics and software sectors (including medical equipment and other implementations). 12 Draft - translated from Hebrew

13 The Contribution to the Electronics and Software Sectors Currently, over 40% of the electronics and software sectors product is in companies that were invested by VC (during the first decade of their operation), compared to about 10% in The electronics and software sectors have grown during the last decade ( ) in an average annual rate of 11%. We estimated that internal processes in these sectors allowed it to grow in a high 7% annual rate, however, an addition of 4 percentage points was created by maturity of Start-up companies. Therefore, we see the major VC indirect contribution as about 35% of the electronics and software sectors growth. 13 Draft - translated from Hebrew

14 Electronics and Software Sectors Estimated Product 2004 $B Total electronics and software sectors product Electronics and software sectors product, by companies not supported by VC Electronics and software sectors product, by companies supported by VC* * Companies supported by VC during the first decade of the company s operation. Source: CBS (Isr.), Economic Models 14 Draft - translated from Hebrew

15 Contribution 4% Annual Growth The Growth Model for Israel s s Electronics and Software Sectors,1995, Defense Industries Israeli Electronics and Software Companies Incubators / Angels 7% Internal Annual Growth Academic Office of the Chief Scientist IPO Israeli Start-up Companies Venture Capital M&A in Israel Foreign M&A operation in Israel Ceased Operation Foreign M&A operation abroad 15 Draft - translated from Hebrew

16 VC Contribution to Growth of the Electronics and Software Sectors Average annual growth rate, Growth of the Electronics and Software Sectors, without VC investment* Growth due to VC Contribution Growth of the Electronics and Software Sectors 7.2% 4.2% 11.4% *We assumed that 20% of VC investments would find alternative funding Source: CBS (Isr.), Economic Models 16 Draft - translated from Hebrew

17 Summary of the Total Contribution Under current economic conditions in Israel, it is necessary for 1.5 $B to be invested in start-ups on an annual basis to achieve 11% continuing growth of the electronics and software sectors. This ambitious level of growth is necessary for GDP growth to reach over 6% a year, allowing Israel to reach 15 th place in the world in 20 years time (Israel today is in 22 nd place). Under current conditions, it is difficult to see an alternative route to the unique contribution of VC investments in supporting startups. This is an unusual situation where few succeed in attracting foreign investors to invest in technology development in Israel with all of its associated risks. 17 Draft - translated from Hebrew

18 Implementing the Israeli Relative Advantage The scale of the Israeli economy is small and it lacks the critic mass for local market merchantable products production. It s hard for Israeli companies to reach a major international status which would allow them to continuously produce standard products for the international market. Therefore, we see the Israeli relative advantage to produce unique products and to sell the knowledge and technology to third party. This situation, in witch there s a wide variety of knowledge and technology allows part of the companies to become major and successful companies in Israel (Ishkar, Teva, Check point and other) Additionally, an industry of advanced products does not have to be based on Israeli companies. (Intel, Motorola, Vishay) 18 Draft - translated from Hebrew

19 Knowledge and Technology Export As mentioned before, the relative advantage of the Israeli economy is development of ideas and technologies and production of unique products. Therefore, we believe that a major export sector in Israel for the long run would be new ideas and technologies (the overall production potential would be much greater than the local production potential). We hope that this sector would expand and encourage Israel to become an international center for ideas and technologies (the Silicon valley is a development center, not a production center). 19 Draft - translated from Hebrew

20 No Massive Knowledge and Technology Leakage In vast majority of VC investments, the development activity stays (at least at this point) in Israel. We believe that most of the developers stay in Israel, even though some of the projects leaders stop dealing with the projects development after the exit. As much as the start-up companies in Israel succeed, it stimulates Israelis to return to Israel and establishing the development centers in Israel. Most of the Israelis who are part of the development procedures stay in Israel even if the operations move abroad. 20 Draft - translated from Hebrew

21 Investor s s Exit The foreign investor s objective is to sell their part in the projects with profit (Exit). That s the basis for their entry to the VC funds and their investment in Israel. The Exit in case of a success is made in one of 4 options: 1. IPO (mostly in the US). 2. M&A with Israeli based company. 3. M&A with foreign based company, which continue their operations in Israel. 4. M&A with foreign based company, which discontinue their operations in Israel. Each one of the options described above is legitimate and the actual action is selected by the investors according to the best market value. About 75% of the exits are made with options 1 and Draft - translated from Hebrew

22 The Fear of Transfer of Manufacturing Operations From our analysis, less than 10% of companies that have received VC investment have transferred activities abroad. In most cases, the main activities remain in Israel and definitely the development capabilities. Location of manufacturing in Israel is in accordance with the advantages of the location and we see the transfer of some operations abroad as a natural process. We are of the belief that operations in Israel can also be established by foreign companies (Intel, Motorola, etc.) and the opportunity to expand these operations are in accordance with the economic advantages of the location (government policies). 22 Draft - translated from Hebrew

23 The Technology Sales Price U.S. data shows a long-term average yield of investments in VC at 13% annually in real terms, with a high component of volatility (since 2000, yields have remained negative). We believe that this rate is reasonable for high risk investments, therefore it represents a reasonable price for the projects. Most VC investments in Israel have been made since 2000 and have not yet accumulated high yields and the complaint that foreign investors are acquiring Israeli IP and technology at low prices does not accord with reality. 23 Draft - translated from Hebrew

24 OCS Grants and VC Investments VC investments are in most cases made in new start-ups at various stages of research and development. The greater the supply of start-ups, the more Israel is attractive and the greater the amounts of VC investment in Israel. At the incubator stage, VC s usually do not invest as they are unable to evaluate the potential risks involved. At this initial and critical stage, the start-up is usually funded by the entrepreneur (and close friends) and by OCS grants. The more start-ups at incubator level, the more start-ups there will be for VCs to invest in. We therefore view favorably an increase in OCS grants to new entrepreneurs as a necessary condition for the increase in funding of VCs. 24 Draft - translated from Hebrew

25 Stage Incubator Start-Up Funding US$ Millions, % Funded by the OCS 100% Seed % R&D % Revenue growth 705 0% VC $ 1,465 M OCS $ 78 M * Excluding Magnet and international cooperation projects. Source: IVC Research Center, OCS, Economic Models 25 Draft - translated from Hebrew

26 # of New Start-ups per Year In 2004, the Chief Scientist awarded $20 million in grants to incubator-stage companies. According to this model, we can double the number of new startups in Israel at an investment of only $20 million per year. As criteria for initial start-up success is vague, the second group of start-ups (if doubled) may have less chance of succeeding to create businesses. We are of the opinion that it is preferable for VCs not to be involved at the initial stage as this is where Chief Scientist funding is most beneficial and where it can best contribute to the economy. We believe that an increase of $80 million in the Chief Scientist s budget to support new start-ups can lead to a multiple increase of VC investments in Israel in a few years. 26 Draft - translated from Hebrew

27 2. Growth Potential of the Economy

28 The Potential and its Realization Israel has a tremendous potential for growth inherent in its hi-tech industries, being the main growth engine of the economy. Israel belongs to a small group of countries that excel in this area. Fuelling the growth engine is the combination in Israel of a high level of technological ability in electronics and software companies, together with enormous research capabilities, globally-embracing export ties, and a rare ability for fund raising. While the risk in technological developments is high, the reward is proportionately high. In the past, mainly institutional bodies supported development but in recent years, private entrepreneurs and private investors have entered the arena. Israel has succeeded to attract foreign investment at a level unmatched elsewhere. The result is the high growth of the technology sector in Israel. 28 Draft - translated from Hebrew

29 The relative position of the Israeli economy The Israeli economy is ranked 22nd in the world by GDP per capita. Israel s relative rank is unchanged since 1980 (the bottom third of developed countries). When evaluating Israel s ranking, we see that Israel is among the leaders in the world in many areas of technology. In terms of potential, Israel is able to be among the 15 ranking economies in the world, but his potential is not realized. During this time, other economies such as Ireland, Spain and South Korea, have improved their relative rank significantly. 29 Draft - translated from Hebrew

30 Israel s s Rank Relative to the 30 developed OECD economies Average OECD Israel Relative Rank GDP per capita (US$ 2004) Unemployment (2004) 7.5% 10.4% 25 Gini Index of Distribution of Wealth (2002) (of 28) Science Achievements of 8 th Graders (2000) (of 28) R&D Expenses (% of GDP) 2.0% 4.5% 1 University Education (% of year olds in 2002) 15% 26% 2 Life Expectancy (2002) Draft - translated from Hebrew

31 Macroeconomic Conditions in Israel Glancing at macroeconomics, the Israeli economy is at its best since the establishment of the state though it has not managed to improve its relative international rank. Israel has no foreign debt, no deficit in its balance of payments, an enormous Forex reserve, the lowest inflation in the developed world and a budget deficit that is low in comparison with many developed economies. The Defense budget has diminished drastically to 5.5% of GDP (vs. 13% in the 80 s) and is expected to further decline to 4% in about 10 years (over 3% in the U.S.). Israel s manufacturing potential is very high due to the current high unemployment and the low output per worker. Israel has a high level of accessibility to global equity markets though the level of investments in the economy remains very low. 31 Draft - translated from Hebrew

32 Accelerated growth scenario for Israel In the analysis prepared by Economic Models for the Herzeliya Conference in Dec. 2004, we showed that Israel has the potential to reach the 15 th place in the world in terms of GDP per capita, in 20 years time (2025). The Finance Minister, Mr. Binyamin Netanyahu, and many economic leaders have accepted the approach we presented at the Herzeliya Conference and it is being used as a basis for long-term strategic planning at a national level. This scenario targets 6% average annual growth over the next 20 years and will realize most of the potential of the Israeli economy within 20 years. The main growth engine for achieving this goal is the export of the hitech sector, based on the electronics and software sectors. 32 Draft - translated from Hebrew

33 Relative Rank GDP, $B GDP per capita (US$ 2004) Israel s s Growth Potential Average Annual Growth Rate (since 2005) Export, $B Investment (without residential), % of GDP Government spending, % of GDP National Debt, % of GDP Current % 43 % 103 % Accelerated growth scenario 5.9% Source: Economic Models project prepared for the Herzeliya conference, Dec % 30 % 21 % 2025 Same rank scenario % % 34 % 48 % 33 Draft - translated from Hebrew

34 Israel s s Accelerated Growth Scenario In the accelerated growth scenario, 70% of the export would be advanced technology based, still, only 11% of employees will these sectors. Most workers will work in commerce, services and industry for the local market. The export of the advanced technology sector would allow the import of products in witch Israel has no relative advantage. The high productivity of the advanced technology sectors would allow a continuous improvement in the quality of life. The indication for this process would be the fact that most workers will be employed in the commerce and services sectors. 34 Draft - translated from Hebrew

35 Electronics Software Services Start-Ups* Projected Technology Exports Total Electronics and Software Chemicals and Pharma Metals, Machinery and Avionics Hi-Tech Sector As a % of Total Exports Other Sectors As a % of Total Exports Accelerated Growth Scenario % % *In Total 2004, Exports there was no exports from Start-ups 52.6 US$ Billions of % % Draft - translated from Hebrew % % Average Annual Growth Rate 11.2% 9.8% 12.7% 10.9% 8.0% 6.2% 9.6% 3.4% 6.8%

36 Electronics Software Services Start-Ups* Projected Employment in Hi-Tech Total Electronics and Software Chemicals and Pharma Metals, Machinery and Avionics Hi-Tech Sector As a % of Total Employed Other Sectors Total Employed Accelerated Growth Scenario Thousands % 2,136 2, % 2,904 3, % 3,576 4,033 Average Annual Growth Rate 3.2% 2.6% 5.8% 3.3% 2.6% 1.3% 2.6% 2.5% 2.5% 36 Draft - translated from Hebrew