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2015-09-15 04:44:35
Jeff BussgangOmri Stern
September 10, 2015
Israel has been branded the startup nation. For good reason: A tiny country
of only 8 million people 0.1% of the world s population has more companies
listed on the NASDAQ than any country in the world save the United States and
China. Frequently cited as one of the world s most vibrant innovation hubs,
Israel boasts more startups per capita than any other country in the world.
That s the good news. The bad news is that Israeli startups are struggling to
scale. Only a handful of so-called unicorns companies that have achieved a
valuation of over $1 billion in the last 10 years come from Israel, and only
one Israeli firm, Teva, ranks in the world s 500 largest companies by market
capitalization. As a result, tech-sector employment has declined as a percent
of the workforce, from 11% in 2006 2008 to 9% in 2013. That s disappointing for
a country with so much potential. But is all of that changing? Are Israeli
companies on the verge of developing a repeatable playbook to scale their
companies and become market leaders, not just acquisition fodder for the
Silicon Valley giants?
We think so.
Why Is Israel So Entrepreneurial?
Israel is home to one of the most vibrant tech startup clusters in the world
why? Many explanations have been offered. Research has highlighted the early
role of military R&D, which, much like in the U.S., helped to create the nation
s tech industry. (At nearly 4% of GDP, Israel spends more on R&D public and
private combined than any nation in the world.) The government also took more
direct measures to boost the tech sector. In the 1990s it subsidized venture
capital, incubators, university R&D, and technology transfer programs.
Daniel Senor and Saul Singer offer additional explanations in their book,
Start-Up Nation. Somewhat counterintuitively, they argue that mandatory
military service helps build entrepreneurial culture. They write, You have
minimal guidance from the top and are expected to improvise, even if this means
breaking some rules. Senor and Singer also cite immigration policy and a
culture that tolerates risk-taking and failure as contributing to Israel s
startup success.
Good relations with the U.S., too, have undoubtedly helped, connecting Israeli
entrepreneurs to investors and a large market.
The final reason for Israel s entrepreneurial dynamism is based on the logic of
innovation clusters: Early success breeds continued success. Once enough
technologists and startups are concentrated in one place, that place becomes a
magnet for venture capitalists and more talent. Israel s early embrace of tech
and VC continues to pay off.
Decades ago, the thesis of Yossi Vardi, a prolific technology entrepreneur who
has invested in 75 Israeli startups, was that Israeli entrepreneurs should seek
quick exit opportunities through global corporations interested in buying a
window into Israeli talent and technology. Today, this thesis is less relevant.
For the first time in history there are Israeli companies scaling up
successfully as global market leaders, and the ecosystem is evolving to support
them. Indeed, the pattern of scaling seems to be changing meaningfully in
recent years. In 2014, for example, 18 IPOs raised a record-breaking $9.8
billion, compared to just $1.2 billion in 2013.
So how do Israeli ventures scale up? What are the challenges and lessons of
scaling up? To answer these questions, we built a database of 112 Israeli
companies founded between 1996 and 2013 that have met or exceeded $20 million
in revenue. We selected this benchmark because it reflects the phase in which
companies have proven product viability, achieved initial product/market fit,
and are now expanding sales and growing more complex operations. We also
interviewed over two dozen Israeli entrepreneurs and the investors from these
companies the leading thinkers in the region to determine the playbook that
these startups are executing in order to scale.
Here s what the data say about Israeli startups:
They re Israeli-run but with global footprints. Eighty-two percent have global
offices, and yet 91% are still run by Israeli CEOs, as opposed to foreign
executives hired from the outside.
American VCs are critical. Ninety-one percent of the firms have received
funding from foreign (mainly American) VCs.
The founders have started companies before. Sixty-three percent of startups
currently scaling up are run by Israeli entrepreneurs with prior founding
experience.
This evolving model is being supported and encouraged by the local Israeli VCs.
According to Izhar Shay, a general partner at Canaan Partners, The investment
community has matured to recognize they need to plan for scale. They are
seeking to build companies so that they are attractive to late-stage funds.
And the late-stage global funds are swarming in, from Accel to KKR to Li
Kai-Shing s Horizon Ventures.
This article outlines some of these patterns, seeks to characterize them, and
draws out patterns in the data.
Pack Your Bags Early.
Despite hosting a rich startup ecosystem, Israel is simply too small a country
for entrepreneurs seeking to build big companies. As a result, Israeli
entrepreneurs need to begin immediately thinking outside of Israel since their
primary market is often the U.S. The common approach is to incubate the
business locally in Israel with a small development team, prove early product/
market fit, and then build a sales and marketing organization abroad, usually
in the U.S. In the old model of Israeli startups, many Israeli executive teams
would hire a vice president of sales in the U.S. to assist with the local
go-to-market approach. More recently, Israeli founders are themselves moving to
the U.S. to build the satellite office and to personally oversee the
recruitment and management of American executives who can lead the sales and
marketing efforts.
However, waiting to move to the U.S. until the late-stage go-to-market phase
may be too late. All of the risks inherent in launching a startup are
exacerbated by the geographic distance between Israel and the U.S. Hiring
talent and gathering customer feedback are even harder when teams are so
physically far apart, and this separation can make it harder to build culture,
forge partnerships, and raise capital.
So how early should the founders pack their bags and ship out to the U.S.? Our
analysis and interviews suggest the prevailing wisdom has shifted toward a
simple answer: as early as possible. Although the technical team often remains
in Israel, many of the executives interviewed recommend departing for the U.S.
as early as a year or two after founding. A move allows the business to get
close to the customer, learn their pain points, and adapt accordingly.
Understanding the market and establishing product/market fit is a critical
seed-stage milestone.
When Udi Mokady and Alon Cohen launched CyberArk the darling of the
cybersecurity industry, with a market capitalization of nearly $2 billion the
founders abandoned the local strategy early on. We began selling to local
Israeli companies but had a strong feeling we were developing a product and
go-to-market strategy that was missing the larger opportunity, said Mokady. As
soon as CyberArk raised Series A funding, they set up a U.S. headquarters, in
Massachusetts, to immerse the team in the American market. At the time, moving
close to the market was not a given, and venture capitalists did not have a
clear playbook. Nowadays the argument is very clear.
Similarly, when Yaron Samid launched BillGuard, his team debated whether to
build an enterprise or a consumer company. One-and-a-half years after founding
the company, Yaron moved to New York and discovered that consumers, rather than
banks, were the primary customer of BillGuard s service, which helps customers
identify fraudulent credit card charges. With the development team based in
Israel, Samid shuttles between New York and Tel Aviv, where he shares weekly
insights garnered from conversations with partners, consumers, and investors in
the market. Viewing this as the typical challenge of running a global company,
Samid believes there is no substitute for the learning that comes from being
close to the market.
The second reason to move early is to hire the absolute best sales and
marketing talent. Again and again, the most challenging issue we heard about
from entrepreneurs and investors is finding and retaining exceptional talent, a
problem exacerbated by geographical and cultural distance. According to Modi
Rosen, general partner of Magma Ventures, The challenge of scaling is
primarily in hiring for the sales and marketing front. Having the founder
[locally] present for this process can be the difference between success and
failure. Companies should strengthen the Israeli management team with local
talent who understand how to define the market, how to sell into it, and how to
gather feedback. Furthermore, companies need particular executives to serve as
the primary liaison between the sales and marketing team in the U.S. and the
development team in Israel. There are many Israeli professionals who have
worked in the U.S. and have gained management experience at large organizations
such as Google, Microsoft, and Amazon. There are also American executives who
have experience working with startups with R&D in India, China, and Israel.
Both cohorts can bridge cultural and geographical gaps.
In CyberArk s case, Mokady admits the team faced major challenges in hiring
talented and seasoned American executives. We had a rough start, he says. As
an unknown Israeli company breaking in to the U.S. market, we were not able to
attract A-rated sales and marketing professionals. It took some time to gain
momentum and learn how to attract local talent.
One of the key lessons CyberArk learned is to partner with VCs in order to
source top talent. Mokady believes that partnering with a Boston-based VC would
have helped CyberArk address its talent problems more effectively because the
VC would have vouched for the company. With that said, the founding team had
big dreams of becoming a global company from the beginning. Although their
investors were not local, CyberArk still benefitted by partnering with foreign
VCs that helped them make the leap from Israel to the U.S.
Think Bigger.
This takeaway surprised us. After all, Israeli entrepreneurs are known to be
tenacious and eager to tackle complex technological and entrepreneurial
challenges. However, in our interviews with Israeli venture capitalists, we
learned that around the board room, Israeli entrepreneurs tend to become overly
preoccupied with the product and core technology. This fixation generates a
short-term view on the potential of the venture to expand beyond the immediate
product line. Of course, almost all entrepreneurs are preoccupied with
near-term priorities, but our interviews uncovered a pattern of Israeli
companies putting too much focus on the product at the expense of building a
broad vision for growth, even after achieving product/market fit.
Scaling up begins with thinking about how you build a bigger story and a bigger
vision once the company is expanding. Alan Feld, cofounder and managing partner
of Vintage Partners, cautions Israeli entrepreneurs not to define their product
category too narrowly. The big idea is to think as a potential industry leader
rather than a one-product company. Think of where you want to be in five years
and begin building a product pipeline to get there. For Netanel Oded, of
Israel s National Economic Council, the critique is more poignant: In Israel,
nobody is saying I m going to completely disrupt transportation. Israeli
entrepreneurs are first and foremost focused on applying technology to create a
business, not necessarily on disrupting big markets through the use of
technology. This subtle difference risks limiting the scope of the
opportunities Israeli entrepreneurs are chasing.
Once startups begin to scale up, founders need to ask long-term strategic
questions such as: How do I support growth in human capital? How do I
strengthen my market position through acquisitions and innovation? How do I
prove the unit economics to justify raising a growth round that will let me
expand more rapidly? These are also questions that will concern late-stage
investors who provide the companies the opportunities to scale and, eventually,
go public.
Partner with Foreign VCs
Israeli entrepreneurs are becoming more focused on getting foreign (mostly
American) VC partners in the early stages to help them pursue these
opportunities from the onset. American VCs have a significantly wider network
and have a capability to access management talent, data, partners, and
customers to help a company scale. American VCs think about scale from the
start, because their large fund sizes necessitate bigger returns. They spend
more time on strategy, go-to-market, business development, and financing.
The data reveal how dramatically foreign investors impact the growth of Israeli
companies, as measured by annual sales and number of employees. Israeli
companies funded solely by foreign investors generated more growth than those
funded by both Israeli and foreign VCs and significantly more growth than
companies funded by Israeli investors alone. (One caveat: This may not point to
causation, as some investors are better than others at picking rapidly-growing
companies.)
W150820_BUSSGANG_FOREIGNVENTURE
But American VC partners might not always be the right choice, especially in
the earliest stages. Many entrepreneurs and investors argue that Israeli VCs
are more frugal and that this discipline is an important early attribute for
startups. According to Ori Israely, investor and former general partner of Giza
Venture Capital, There is more fit between [an] Israeli entrepreneur and [an]
Israeli investor in the seed stages. Israeli funds often know how to work
better with the early stage companies because they provide efficient capital,
not necessarily more capital. Israeli VCs seek to invest relatively smaller
amounts not to squeeze out the entrepreneurs, but to help them be more
efficient in the early stages.
The extra runway from an American VC can come with strings attached. Once
entrepreneurs bring in an American VC that typically invests at higher
valuations, there is greater pressure to hit bigger milestones, move to the
U.S., and pursue larger outcomes. So the decision on when to bring on an
American VC is an important and strategic one.
Lead Your Company to Scale.
A decade ago, the traditional model for building up Israeli companies was to
hire an American CEO. Our interviews and analysis suggest that this model
failed. Today, companies reaching scale are run by Israeli founders and/or
Israeli CEOs. Studying the liquidity events of Israeli firms valued over $150
million, Vintage Partners found that 81% were run by Israeli founders, while
half of the remaining 19% were run by professional CEOs who were Israeli. In
short, Israeli entrepreneurs are leading their companies to scale.
This conclusion is an interesting one. On one hand, Israelis need to continue
to lead their companies to scale effectively. On the other hand, they need to
attract foreign VCs to help them do so typically by moving to the U.S. and
recruiting a U.S.-based executive team.
So how can Israeli entrepreneurs effectively lead their organization to scale?
Our interviews suggest Israeli founders have worked hard to mitigate the risks
associated with a move to the U.S., developing techniques to effectively manage
distributed teams and cut through cultural barriers:
Focus on culture from day one. Startups are incredibly fluid early on, and
these early days are critical to building teams that can communicate and
function effectively in geographically distributed circumstances. Over the
course of 2 3 years, the product, the value proposition, and the competition
will change dramatically. Yahal Zilka, of Magma Ventures, emphasizes that for
the company to be aligned in multiple locations and react effectively to
rapidly changing circumstances, employees need to develop a culture of trust
and respect that transcends continents.
Place one founder on each continent. If the founding team contains more than
one person, an effective formula that we ve witnessed is placing one founder in
Israel and one abroad, where he or she will recruit the management team.
Typically, these founders know each other very well, have a deep mutual trust
and respect, and can communicate seamlessly, often from years of serving in the
military together. Alon Cohen, cofounder and former CEO of CyberArk, moved the
company headquarters to Dedham, Massachusetts, just one year after founding in
Israel. Cohen said that moving the headquarters to the United States had been
talked about for some time after the company was founded, in 1999. Shortly
after the move, the company hired 25 30 people in the U.S. while maintaining R&
D in Israel. Fifteen years later, CyberArk employs more than 500 individuals
worldwide and serves more than 1,800 customers, including 40% of Fortune 100
companies.
Get a mentor with a solid track record. It may sound obvious, but unlike in
Silicon Valley, there are not many entrepreneurs from Israel who have built
unicorn-sized companies. Over the growth stages in particular, Israeli
entrepreneurs need access to mentors that can deliver contextual insights and
ask tough questions about scaling up in the United States, says Dror Berman,
of Innovation Endeavors. The mentors who serve this role in the U.S. know how
the entrepreneurial game is played, know the relevant growth-stage investors
and investment bankers, and are adept at navigating exits at different stages.
There are also more institutions and infrastructure for training managers, such
as MBA programs, executive education, and certification programs. Most Israeli
entrepreneurs have not been through this whole cycle at scale. Those that have
are gold.
Israeli entrepreneurs are influenced by the success stories of their past. From
1995 2010, the Israeli startup ecosystem was not focused on creating big
companies. Things have changed dramatically in the past two decades. What was
once the story of ICQ s $287 million exit to AOL is now the story of MobileEye
s NYSE IPO and $12 billion market capitalization. Years from now, Waze s $1
billion sale to Google may look like merely a solid outcome, rather than the
canonical case study of Israeli entrepreneurship that it is today.
It is time for more Israeli entrepreneurs to swing for the fences. Building big
companies means Israeli entrepreneurs should pack their bags and move to a
large market early, partner with American VCs, continue to lead the company
through the mid-to-late stages, and focus on building a culture.
In our data set, we found over 100 companies that have the potential to become
unicorns and decacorns. We look forward to watching that list grow and evolve.
Jeff Bussgang is a general partner at Flybridge Capital and a Senior Lecturer
at Harvard Business School. He is author of the book Mastering the VC Game.
Omri Stern is an Israeli entrepreneur working on a new venture in the on-demand
economy. He recently graduated from Harvard Business School. Follow him on
Twitter @omristern.