Opinion

Startup Nation Is in Peril: The Armis Model Could Save It

Sharing the wealth with employees would keep profits inside Israel and encourage a new generation of entrepreneurs

Armis offices in Tel Aviv, January 6, 2020.
Moti Milrod

If you need more evidence that Israel’s high-tech industry is alive and well, look no further than the two billion-dollar-plus exits over the last month. Habana Labs, an artificial intelligence startup, was acquired by Intel for $2 billion last month and this week Armis, a cybersecurity company, was sold to Insight Partners for $1.1 billion.

But alive and well isn’t good enough. Israeli tech doesn’t begin to contribute to the economy the way it should and the flow of new startups is narrowing. But, apart from the billions of dollars they earned, Habana and Armis could also point the way to making the high-tech industry a better citizen.

Startup Nation hasn’t produced a single global-straddling tech giant in its roughly quarter-century of existence, but it has created a unique and weird industry of making and selling startups. Last year, we sold $9.9 billion of them either through merger and acquisition deals like Habana and Armis or through stock offerings to the public.

Over the last decade, the value of exits reached $70.8 billion and, if you count companies that were sold a second time (i.e., the first buyer flipped it), the figure jumps to $107.8 billion. With fundraising by startups growing quickly – over the last decade it’s increased four-fold –  there will likely be startups on the block for years to come.

But Startup Nations is having problems, one of which is a severe shortage of skilled talent. Israel also has a problem: it may justifiably boast about local technological prowess but the fact is, these companies get their funding abroad, which means their owners aren't Israeli. So they send their earnings abroad and pay taxes there too.

What makes Habana and Armis interesting is the extent to which employees joined the payout. Gili Raanan, Armis’ chairman, says the sale will create 30 to 40 millionaires, from a payroll of 250 people. At Havana Labs, founders and employees owned 60% of the company when it was sold and will be sharing $1.2 , according to co-founder Avigdor Willenz. 

Startups are traditionally generous with stock options, but as private companies it's hard to know how common big-time payouts to workers upon exit really is, but it seems 60% is unusual. Willenz, a semi-legendary serial entrepreneur with four exits to his name, implied as much in a public forum last year where he boasted that founders and workers had held between 50% and 60% of the stock in his three other companies too when they were sold.

More tech entrepreneurs should follow his example. That’s not necessarily because the poor souls slaving away at their PCs on a diet of double espressos and takeout meals need the money. They earn about twice what the ordinary Israeli mortal makes, on average. Rather, sharing the wealth with the tech employees would likely attract more to the industry, encourage more entrepreneurship and contribute more to the economy. Here’s why.

It’s easy to forget that every time a headline flashes up of another tech company being sold or going public in the hundreds of millions or billions of dollars that most of that money doesn’t stay in Israel.

To start with, most of the money Israeli startups raise is from foreign investors, so most of their profits go abroad too. Israeli venture capital funds account for less than 15% of all the money invested in Israeli startups. Israeli institutions, which should be the VCs’ natural backers, don’t invest in high-tech, so Israeli funds have to go abroad to raise capital.

This comes at a cost to the Israeli economy. VCs, and especially foreign VCs, are generally exempt from tax on their profits. Israeli founders and employees have to pay capital gains of 25% to 30% and some other taxes as well.

Because its Israeli founders and employees owned so much of the company, the tax take for the Israeli from the sale of Habana Labs will likely be in the range of $250 million to $350 million. 

In a more typical exit – the sale of Mellanox to Nvidia – the taxes accruing to Israel will be a just few hundred million shekels even though Mellanox is being sold for more than three times what Habana Labs is. But its shareholders are mostly foreign.

Sharing as patriotism

Sharing with employees would mean more money staying in Israel not just for the Tax Authority but for the economy as a whole. True, it would exacerbate the already yawningly wide income inequality we have, but at least the money would stay inside the Israeli economy.

It might even encourage more employees to seed their own startups and help reverse the dangerous slide in the number of new tech firms being founded.

It would be naive to think tech entrepreneurs will hand over more equity to their employees than they think they need to for the good of the country. But there are two trends in the industry that might cause them to do the right thing anyhow.

One is the severe shortage of skilled techies, leading to competition over staff by the hundreds of multinational research and development centers in Israel. Startups can’t compete on pay or job security but they could entice potential hirees with the chance of a bigger payout than they could ever expect as a salary-jockey at Intel or Microsoft.

The other reason entrepreneurs can and should be moved to more generosity is that startup valuations have become enormous. Entrepreneurs can raise all money they need while handing smaller equity stakes over to investors that they would have had to five or 10 years ago. That leaves more equity to distribute to employees.

The startup world prides itself on its ethos of teamwork: just look at the stock PR photo that’s released with every exit, showing the entire staff posing with faces smiling over their achievement. It’s time to give them and Israel something even bigger to smile about.