Due Diligence

Startup Nation Is Growing Up, but It’s Not Maturing With the Years

The giant exits of 2013 don’t mean that Israeli high-tech is creating many jobs, benefiting local investors or generating much added value for the economy.

Another round of backslapping and hardy handshakes accompanied last week's sale of the Israeli startup Trusteer to IBM for a reported $900 million.

Websites and newspapers were full of pictures of smiling employees, who might now finally be able to afford to buy a home with their share of the payout. Venture capital funds were counting up their double-digit returns. Meanwhile, industry executives were explaining how the giant buyout – coming weeks after Google paid more than $1 billion for the navigation app startup Waze – marked a new phase for Startup Nation: Entrepreneurs and investors are more mature, they are ready to build businesses and think long-term, rather than look for a quick and easy exit.

It is true that 2013 is shaping up to be the year of the big deal. According to IVC Research, only nine Israeli startups were sold for an excess of $400 million in the years 2003 through 2011. But in 2012 alone there were nine sales of $400 million or more. And this year, with more than four months left to spare, the number has already reached six.

Setting the bar at a lower but still formidable $100 million, the number of mergers and acquisitions so far this year has reached 10, versus 13 last year. Besides the instantly mythic Waze deal, the feathers in Startup Nation's cap for the year include Prolor Biotech ($480 million), Intucell ($475 million), Adapt.tv ($405 million), CyOptics ($400 million), ScaleIO ($250 million), dbMotion ($235 million), Alma Lasers ($221 million) and ChooChee ($100 million).

But let's remove three of these immediately. Adapt.tv, CyOptics and ChooChee have some weak Israeli links, but for all intents and purposes they are American companies. Adapt.tv was started by Israeli Amir Ashkenazi and its investors include Gemini Israel Ventures, but it has no presence in Israel and only three of its eight top executives are Israeli. CyOptics was founded in Israel in 1999, but it left for Pennsylvania years ago. Its CEO was an American and none of its employees were Israeli. ChooChee is likewise based in America and counts Israelis as only three of its top six managers. There were certainly some Israeli brains behind these companies, but hardly enough to qualify them as three of our own.

As for the rest, they don't testify to any real change in the take-the-money-and-run philosophy that has characterized Startup Nation for the past decade.

The valuations of companies have certainly grown and their founders are often prepared to take them a step or two further in developing into full-fledged businesses, but basically Israeli startups rarely go far beyond the R&D stage.

Their payrolls testify to that: Waze employed just over 100 people when it was sold, Intucell 80, ScaleIO 20 and dbMotion 110. (CyOptics, the American company, had 900.) Moreover, the checks being written out to buy these companies continue to be mailed mostly abroad. And when the sale is complete, the acquired startup becomes the local R&D center for the multinational that bought it, meaning whatever innovations emerge will belong to the multinational that bought the startup.

Waze to go

Waze, which has now become the poster boy for the new Startup Nation, is a case in point. The company has tens of millions of users but it didn't begin to start trying to make any money from them until the final months of 2012; its revenues when Google's $1 billion offer came in were likely in the single-digit millions. Waze's navigation app was yet another example of Israeli ingenuity but its sale to Google was also an example of Startup Nation's aversion to creating actual businesses.

Then there are the profits from the deal. While the three founders - Noam Bardin, Ehud Shabtai and Amir Shinhar, plus others - are reportedly making about $150 million, the rest is going to an assortment of foreign investors, among them the Hong Kong billionaire Li Ka-shing, the U.S. venture capital funds Blue Run Ventures and Kleiner Perkins, and the American tech companies Microsoft and Qualcomm. Two Israeli funds are also among Waze's backers, but, of course, most Israeli venture capital is raised abroad, so their share of the Waze deal will also ultimately go overseas.

Finally, Waze negotiated to keep its identity and employees here in Israel for the next three years – and the founders should be given all due credit for their Zionism – but in the end Waze will share the same fate as scores of other Israeli startups and become an R&D center for Google.

The other big exits this year have pretty much followed the same pattern. Prolor Biotech is an R&D company with no revenues, although the Israeli public owns three quarters of the company because it is traded on the Tel Aviv Stock Exchange. Intucell started generating revenues only in 2011. Its founders and employees will enjoy a $125 million payout from its sale to Cisco, with the rest going to venture capital funds, including the U.S.’s Bessemer Partners. ScaleIO, which was sold to EMC, was backed by Norwest and Greylock Partners, two U.S. venture funds.

To be sure, not all the M&A deals of 2013 fit this pattern. Trusteer is a real company, which made about $100 million in revenues last year and has 400 employees. Although one overseas VC fund invested in the company, the payout is going mostly to founders Shlomo Kramer and Micky Boodaei, and to employees. But Trusteer, like other startups, is being turned into an R&D center by IBM, so that marks the end of Trusteer as a business.

Meanwhile, Wix is planning an initial public offering, which means it plans to stay independent. Babylon and Conduit are acquiring startups themselves, rather than being acquired.

It is not at all clear whether this marks a new countertrend or a few exceptions to business as usual. But it's probably the latter. An initial public offering - the Plan B most high-tech entrepreneurs have after an M&A deal - is difficult to make these days because there isn't much appetite for risk in the stock market. Stiffer regulatory requirements make the job of running a publicly traded company unattractive. The $100 million-plus buyouts are having the perverse effect of tilting the risk-reward ratio of IPO versus M&A toward the latter.

Apart from feel-good headlines, Startup Nation isn't producing the goods that the economy needs. It's not creating many jobs, it's not profiting local investors and it's not generating much value-added. And what it does produce is essentially shipped abroad every time a company is sold. Technology is supposed to be Israel's business, but we have yet to make it into one.

waze
Bloomberg