The Day the Israeli Internet Industry Was Born

June 8, 1998: AOL buys an Israeli startup, Mirabilis, for $407 million.

Israeli high-tech workers. Rare is the Ethiopian-Israeli among them.
Alon Ron

If one has to pick a point at which the Israeli Internet industry was born, it was on June 8, 1998, when AOL snapped up Mirabilis for $407 million. Sixteen years later the industry has come of age, in quantity and quality. At the time, the deal was a ground-breaker; today the industry has reached the point of maturity that not every entrepreneur is in it just for a chunky exit.

Three years ago TheMarker and the investments company The Time mapped out the Israeli Internet industry, not seeking startups but companies turning over more than $10 million a year. Today, as they produce their second such report, the changes in the industry are striking. Internet has become one of the four pillars on which the Israeli high-tech scene stands, alongside biotechnology, software and telecommunications.

According to the data we collated, Israel has about 90 international Internet companies that expect to achieve revenues of at least $10 million a year in 2014, compared with 50 such companies in 2011. Together their revenues should approach about $6 billion, compared with $2.5 billion in 2011.

If we up the ante to companies turning over at least $100 million a year, we find 15, with combined revenues of $3.6 billion this year (more than the combined revenues of all the companies appearing in the 2011 report). That is a respectable pace of growth, as in 2011 Israel had just six companies that fit the category.

The combined value of the 10 biggest companies in the 2014 report is nearly $11 billion, compared with $3.5 billion in 2011.

Moreover, the report lists 14 companies worth more than $500 million (in terms of market cap of assessments), and 18 companies worth more than $400 million. In 2011 there were only three companies like that. Not only are these companies worth a lot: Most are profitable and growing, and have viable business fundamentals, so this isn’t bubble stuff.

Yet some feel the gap between the Israeli and American Internet scene is widening. “While we grew, say, fourfold, the construction in Silicon Valley grew 20-fold,” says one venture capitalist.

Coming out of the shadows

A glance at the areas on which Israeli Internet companies focus shows a trend we could call “coming out of the shadows.”

Three years ago, the list featured a lot of online-gambling and forex companies. In fact seven of the 10 biggest companies belonged to areas that the entrepreneurs generally perceived as shady – the above two, and porn as well. Or they belonged to the gray area of “Download Valley.”

While plenty of the companies are still in such areas, their proportion is dropping. Just seven of the 15 companies turning over more than $100 million a year are that sort. Gaming and forex are the same as three years ago, despite the regulatory sword hanging over their heads; now there’s also a new area of investment, in binary options. But “Download Valley” is undergoing profound change, including because of constraints handed down by external factors – mainly Google and a shift of the world population to mobile apps.

Download Valley refers to freeware developers and distributors, some of which had resorted to dodgy methods of drumming up income. A wave of mergers and acquisitions that swept through this sector in recent years marked the start of its contraction, not its end. Companies that diversified their income sources, such as Iron Source, weathered moves against the genre well. Others that didn’t, like Babylon, crashed. Most of the Download Valley companies (Revizer, White Smoke, Somoto, Crusader and others) are in the process of change.

Digital advertising still represents a distinguished group of Israeli companies. In native advertising, Israel is quite the world leader, thanks to groundbreaking companies like Outbrain and Taboola.com. In performance-based advertising, companies like Matomy and Supersonic demonstrate impressive growth. (Proper disclosure: Matomy belongs to Ilan Shiloach, who also controls The Time, which conducted the market research for this story together with TheMarker.)

Relative to the 2011 report, mobile advertising companies like StartApp, Taykey and Eyeview are growing; but there are companies that seem stuck such as TLV Media, Massive Impact and DoubleVerify.

Not technology (and Gil Shwed) alone

Israel was and is a technology power, but the success of its Internet industry doesn’t rely just on technological prowess. Israel is widely considered a leader in online marketing, and the tremendous knowledge accrued among the “shadow companies,” from the perspective of direct product marketing to surfers, has filtered through to other Israeli Internet companies in all areas. That isn’t surprising, since more than 20,000 Israelis work in online marketing, compared with about 4,000 in the traditional advertising business.

Moreover, augmenting their technological and commercial abilities, Israelis have gotten better at management. If in the past management had to be imported from America, today most companies have Israeli leaders, says a partner at a leading law firm advising the technology industry. It isn’t hyperbole: The fact is that 17 of the 20 companies with the highest turnover on the list have Israeli CEOs.

That doesn’t mean Israeli management can rest on its laurels: A venture capital source complains that Israel doesn’t have enough models for emulation. “How many Israelis have managed an Internet company turning over $100 million a year?” he presses. “How many have managed a billion-dollar company?” Who, in fact, beyond Gil Shwed (of Check Point Software Technologies), he presses even harder.

“It’s true there are more big companies, but note that big turnover doesn’t necessarily mean that the organization’s DNA has changed,” says another source in the venture capital scene. Big Internet companies have to be able to reinvent themselves: IronSource has that capacity, Taboola does, MyHeritage too – but a lot of companies can’t do it, he says.

Yet the trend speaks for itself: Israeli entrepreneurs can become good managers, flouting one of the theories in the book Startup Nation. Exits aren’t the begin-all and end-all any more.

Israelis are also learning to market “B2C” = business to consumer. Waze is a stunning example, but there are others. Some solicit user content, like investing.com, PlayBuzz and FTBPro. Some are e-commerce companies selling everything from food to glasses to jewelry. Some are game companies, which are growing rich in knowledge of the user experience, and some leverage communities such as Fiverr and Fixya.

Israel or the States?

One question that many startups consider is where they should be located in order to best grow. The short answer, it seems, is “that depends.” The longer one is that it depends on the clientele. If the company doesn’t need direct contact with the end consumer, and doesn’t need to be in the same time zone, there’s no real point in moving to the United States. Note the cases of IronSource and Matomy.

But if they do need contact, for instance in the case of a publishing company, then moving to their target market is critical, and that suits the cases of companies like OutBrain, Taboola and Borderfree.

Tel Aviv 2.0 and the funding conundrum

At the start of 2013 there were about 60 Israeli startups operating in the New York area. Today there are more than 200.

“New York is Tel Aviv 2.0,” says an entrepreneur. “It suits Israelis better than Silicon Valley because it’s nearer Israel and more convenient from the perspective of the time difference” (seven hours versus 10 hours). And if you operate in content or the media, New York is the navel of the world, he adds.

If there’s an area where Israeli Internet companies are languishing, it’s funding. The discrepancy between their contribution to the Israeli economy and the rate of funding from Israeli sources is “absurd,” one entrepreneur said.

According to the figures we put together, 85% of the money funding Israeli Internet companies comes from abroad. It’s a market failure across the board, from the seed stage of fledgling companies.

The cost of setting up a company is lower than ever and there are plenty of starting sources for startups, from mom & dad to angels to venture capital funds. The problems begin after that early seed stage, what’s known in the argot as the “Series A crunch.”

This financing dynamic also creates difficulties for Israeli companies when starting to tap venture capital funds for money, from the first financing found to the last.

American funds are willing to put bigger amounts into Series A funding, claims one entrepreneur. This can create a problem: A meanly-funded Israeli company competing with an American company that raised $25 million is inherently going to have a harder time achieving similar ends.

Possibly in some cases because of conservatism, Israeli institutional investors barely touch technology, let alone Internet companies. They don’t invest directly or indirectly through funds either, and certainly not in the seed stage. Israeli banks have no expertise in funding high-tech companies, which leaves the companies no recourse but to tap foreign banks – though it bears mention that Bank Leumi recently set up a unit called Leumi Tech.

Finally, the Tel Aviv Stock Exchange is no place for the Startup Nation, and the Israeli companies are usually too small for Nasdaq.

Meanwhile, the nature of the Israeli entrepreneur has been changing. The stereotype was a geek who served in the army elite technology unit and identified a technological problem. Today’s entrepreneur may begin from the consumer and a problem he has that technology can solve:

If you like, the new Israeli entrepreneur is a combination of technogeek, marketer and graphic designer.

The founder behind Get Taxi, Shahar Waiser, told Globes that the idea came to him while he and one of his workers were waiting for a taxi for more than 30 minutes in Seattle. “It can’t be that this service hasn’t changed in 100 years,” he thought, and changed it.