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Israel Start Up Nation: Path to Becoming an Innovation Hub

Israel began its path to becoming a world renowned innovation hub in the 1960s with the formation of companies such as ECI Telecom, Tadiran and Elron Electronic Industries, which came to be known as the “Fairchild of Israel”.  Growth over the next two decades was slow but sure and was accelerated by the contracts with foreign multinationals that set up R&D units in Israel, efforts to develop a technologically-based advantage over the country’s military foes and the dispersion of dozens of serial entrepreneurs throughout the Israeli economy from proving grounds such as the RAD Group.  While military-related R&D provided the basis for an array of new products, including a mini-computer that was developed in the 1970s by Elbit, digital printing systems and medical imaging devices, Israeli companies had difficulties with successfully commercializing those products due to shortcomings in the marketing area.  Israel’s ability to design hardware products had become evident; however, it had no particular comparative advantage in that area and the technology industry struggled until the 1980s and early 1990s when Israel began to tap into its deep reservoir of human capital to become one of the serious players in what was become a global software market.  A number of software companies were established and many of them were able to identify and exploit niches that had not yet been discovered and dominated by US firms.  Further development of Silicon Wadi during the 1990s was facilitated by the arrival of scientists and engineers who had emigrated from Russia after the Soviet Union dissolved and the beginning of a period of relative peace that improved the overall environment for investment.  Like other parts of the world, Israel also participated in the dot-com boom of the late 1990s and saw thousands of startups emerge between 1998 and 2001, over 50 of which completed initial public offerings in the US and on other international stock markets.

The evolution of the Israeli technology industry has been accelerated by growing global demand for products using the technologies in which the Israelis excel including software, electronics and sophisticated industrial equipment and the country has created a fertile environment for innovation through support of high education, R&D, openness to immigration and the availability of low interest loans for startup businesses.  In addition, many Israeli university graduates are highly likely to seek positions in the IT industry or join startups, thereby gaining experience in the pursuit and development of technology products.  On the downside, however, is the reality that Israel is heavily dependent on outside sources for raw materials and energy and the small size of its local market means that entrepreneurs must move quickly to find international markets for their products in order to survive and grow.

The emergence of the high technology sector and globalization has had a number of positive influences on Israel; however, it has also created new challenges, notably in the area of human resources management.  In the workplace, managers have needed to transition from their traditional narrow focus on productivity and efficiency toward development and utilization of the talents of their workers and incorporating new motivational strategies and processes into their day-to-day interactions with their workers.  At a societal level, Israel has been changing rapidly and most citizens are being introduced to influences, opportunities and challenges that could not have been dreamed of forty years ago.  Multinational companies injected unprecedented levels of competition into the Israel domestic market, including new consumer expectations that needed to be understood and respected by Israeli firms.  For example, competition brought decreases in prices accompanied by improvements in product quality and this led to consume demands for improved quality services.  The construction of large shopping malls all around Israel changed buying habits of Israeli consumers and set new standards for Israeli manufacturers and retailers. 

At the same time, Israeli society had to grapple with new social issues such as an expanding income gap between the rich and poor.  The erosion of collectivist values and institutions within Israel society has undermined the sense of collective social responsibility that was so important during the early decades immediately following independence and the shift toward more open markets and abandonment of socialist ideologies has widened gaps in Israeli society even as per capita incomes and standards of living have continued to rise.  Workers can no longer rely on Israel’s once powerful trade unions to protect their interests in negotiations with employers and employers are now free to adopt differential wage systems that create clear winners and losers among their workers.

Israel has been a somewhat remarkable success story in the pantheon of innovation clusters given the many apparent challenges that must be overcome by growth-oriented entrepreneurs in the country including a small local market, geographic isolation that separates Israel’s emerging companies from inputs and customers, language barriers, cultural and religious differences and, of course, several and continuous political conflicts internally and externally.  In spite of these difficulties, Israel has a long record of developing large globally-active companies—Senor and Singer reported that as of 2009 Israel was second, behind the US, with regard to the number of companies listed on NASDAQ, exceeding the combined total of China, Europe and India—and launching and nurturing technology firms that eventually became desirable acquisition targets for multi-national corporations.  Several reasons have been offered for Israel’s entrepreneurial success including, in the words of Grotsky, “. . . its strong technology-oriented military, its emphasis on education and research and development, a few visionary government policies that went a long way . . .  a tradition of flat organizational structures and informality in the workplace . . . [and] . . . its existence as a melting pot of international cultures within an isolated society”.  Another factor perhaps is the experiences that Israeli entrepreneurs gain during mandatory military service that have arguably served them well in developing and maintaining the energy and focus required to successfully launch and manage a startup.

Israel has enjoyed an astounding, and in many ways quite surprising, transformation from a semi-socialist state continuously focused on defense and security issues to a global technology leader in a variety of fields.  A number of books and articles have chronicled this journey including “Start-Up Nation: The Story of Israel’s Economic Miracle”, written by Senor and Singer.  However, a 2011 article in The Economist described several key issues that Israeli policymakers, investors and entrepreneurs must address in order for the country to move “beyond the start-up nation” including expanding the role of high-tech firms as employers, building global technology players and successfully transferring know-how and talents to new emerging areas such as Internet content, water management, agricultural science and alternative energy.  Another concern, which will not go away regardless how the intensely volatile political issues in the region are resolved, is how Israel ultimately integrates Arab-Israelis and ultra-orthodox Jews, who will together be about one-third of the population by 2025, into its business culture.

As of 2013 Israel had more engineers, scientists and PhDs per capita—135 per 10,000 in the workforce—than any other place in the world and half of the country's exports came from the technology industry.  Best known for defense- and military-inspired technologies, Israeli entrepreneurs have recently turned their attention to creating and developing healthcare products and applications using artificial intelligence and digital technology.  R&D expenditures in Israel, even excluding spending on defense-related R&D, are an impressive 5% of GDP as of 2013, a level that is higher than any other Western country, and the government's office of the chief scientist has a substantial budget that includes funds that have been used for co-investment alongside the private sector, particularly in risky projects.  R&D in Israel is also supported through the activities of a large number of multinationals including Amazon, Apple, Google, Intel, General Motors, Microsoft and GE, and each of the companies have recruited local talent to assist in uncovering innovations for use in Israel and around the world.  Multinationals have found Israel to be particular attractive because of the audacity and confidence of the country's young scientists and engineers who have been trained not to follow instructions and to focus on leadership and solving problems.  Multinationals provide space and other resources for Israeli startups and have been eager to acquire the most successful local companies as they matured.


Documenting Contributions of Technology for Shares

In most cases, the founders or key employees of a new corporation will purchase their shares in exchange for a nominal amount of cash or past services rendered to the corporation in connection with its formation or organization. There are, however, situations where a founder or key employee may also contribute his or her rights in technology to be used in a corporation's business. Intangible assets are lawful consideration for shares; however, the parties must carefully describe the transferred technology and assets by reference to the actual and proposed business of the corporation so as to minimize the risk of future disputes regarding ownership of technology that turns out to be key to the success of the corporation. 

In some instances the assignment may be done in the context of a broader agreement that includes undertakings and promises from the assignor to provide the corporation with ongoing technical assistance in connection with the transfer and use of the assigned technology. 

When you are transmitting a draft of an assignment agreement it should be accompanied by a letter or e-mail that seeks assistance from the founders in describing the assigned technology with specificity and also reminds them to be sure that procedures will be implemented, either in the assignment agreement or elsewhere, to make sure that the transferred technology is fully and efficiently integrated into the company’s development activities (e.g., including undertakings from the assignor to provide all necessary technical assistance for transferring the technology). 

In addition, your communication should make it absolutely clear to each founder assigning technology to the new corporation as consideration for his or her shares that the assignment is permanent and irreversible and that he or she will have no rights to use the assigned technology in the event that his or her employment with corporation terminates in the future.


Israel Start Up Nation: High Technology Sector

The significant impact that the growth and development of the high technology sector has had on Israel warrants further examination in light of the influence on the attitudes and skill requirements of managers and workers and the required shift in national economic and political priorities.  The foundation for the emergence of an Israeli high technology sector was already in place during the 1950s when the country was heavily involved in development of advanced defense systems.  During that period, Israel was able to develop the technological and human infrastructure that would eventually be deployed to first establish an electronic industry and then was expanded, in both the public and private sectors, to include new areas such as communications, medical products and printing.  Interestingly, while many Israeli private firms were developing an international reputation for technological excellence and innovation, the government paid relatively little attention to the potential of the high technology sector until the 1970s when Israeli companies first achieved listing status on the US stock exchanges and many well-known multinational companies began investing in the research and development activities of Israeli companies.  A shift in governmental policies to encourage free market activities, which began in earnest after the stranglehold on political power held by the Labor Party was ended in 1977, included support for research and development, removal of currency controls, encouragement of foreign investment and removal of protectionist barriers that injected competition into domestic markets for the first time.  This quickly led to establishment of production facilities by large multinational technology companies, some of which also launched their own Israeli research and development labs that were well capitalized.  An Israeli venture capital community emerged, government investment in research and development increased substantially and high technology sales grew from $1 billion in 1980 to over $7 billion in 1997, of which about 75% was exports.  Harpaz and Meshoulam reported “Israeli hi-tech companies are taking the lead in some fields worldwide and actually defining new markets, for example, in the medical equipment field . . . Israel was rated by ‘Wired Magazine’ as number four in advanced technology centers in the world”.

Globalization is an external environmental factor that has had a substantial impact on Israeli society in general and on the country’s economy in particular.  Israel’s early history after independence was defined by isolation, protectionism and a strong focus on absorbing immigrants from the turmoil of World War II and defense of the country’s borders from continued attacks by Arab neighbors.  Characteristics of the Israel economy through the 1950s and 1960s included shortages of foreign currency, a massive allocation of public funds to defense, high unemployment, limited activities in the industrial sector and high customs duties.  However, changes in Israeli political conditions coupled by security-related developments that helped reduce the barriers between Israel and the international community ultimately led to a dramatic opening of the Israeli economy which included substantial foreign investment and the emergence of a small, but influential, group of Israeli multinationals that became world leaders in areas such as textiles and pharmaceuticals.  Harpaz and Meshoulam mention several reasons for “Israel’s globalization shift”, including the slow and steady progress of the peace process, which while not bring a final solution to borders in the region has at least improved overall security conditions; the growing reputation of Israel human capital, which is now routinely viewed as rich resource for high trained and innovative talent; the development of an advanced scientific infrastructure; large amounts of government support for research and development relating to technology and products with commercial, as opposed to strictly military, applications; international treaties, including numerous free trade agreements; and a general opening of the economy both inwardly and outwardly with explosive growth in the export sector and the introduction of large foreign multinational operators in Israel (e.g., McDonalds, Benetton, Toys R Us, etc.).


Preparing Founder’s Common Stock Purchase Agreements

One of the most important documents in the incorporation process is the common stock purchase agreement used to formalize the issuance of shares to a founder of a new corporation and set out various restrictions with respect to transferability of those shares and requirements typically imposed on the founder with respect to his or her continued employment by the corporation as a condition to obtaining the full benefits of share ownership.

Drafting and finalization of such an agreement requires careful consideration of a number of issues, many of which can be quite sensitive to one or more of the founders. For example, a choice may need to be made among various types of consideration for the shares including assignment of intellectual property and other assets. Perhaps most importantly, the founders and their attorneys need to hammer out the procedures for vesting of the founders’ shares based on continued employment with the corporation and decide what other restrictions on transferability of the shares should be included in the agreement.

Once the initial draft of the agreement has been prepared you should forward it to the members of the founding group of the new corporation along with a letter or e-mail that specifically highlights and summarizes the key issues that need to be considered before the agreement is finalized.  In addition, given the length and complexity of these agreements you should strongly recommend setting up a time to discuss each of the provisions in person or in a conference call. You should also make sure that your communication includes clear language directing the founders to seek independent legal advice from their own personal attorney regarding the terms of their proposed purchase and ownership of shares in the new corporation.

Finally, you’ll usually need to prepare a few additional documents to complete the issuance of the shares including a stock power, an acknowledgement and statement of decision regarding Section 83(b) election, an election under Section 83(b) of the Internal Revenue Code of 1986, a receipt for consideration for stock and a receipt for share certificate and consent to escrow.

Examples of all of the agreements mentioned above are available for you to view and use in Business Transactions Solutions on Westlaw Next.



Israel Start Up Nation: Economic and Societal Overview

Israel has a population of approximately 7.59 million as of 2010 and a land mass roughly the size of the US state of New Jersey.  Jews make up about three-quarters of the population while Arabs account for 20% of the inhabitants.  While Judaism is the largest religious group in Israel, Islam and Christianity are also significant influences within the country.  Almost one-third of the population was born outside of Israel and the country has experienced significant waves of immigration from areas within the former Soviet Union (estimated to be as many as one million new residents since 1989).  In fact, Israel was actually placed in the Latin European societal cluster by the GLOBE researchers along with France, Italy, Portugal, Spain and French-speaking Switzerland, a decision that was based on the belief that Jews who had migrated to Eastern Europe from Southern Europe centuries ago to escape religious prosecution were largely responsible for founding Israel and had retained their social and business ties with the Latin European region.  All in all Israelis include former residents of over 100 countries which explains the cultural diversity of the country and appetite for newspapers and magazines published in wide array of languages including Hebrew, Arabic, English, French, Polish, Yiddish, Russian, Hungarian, and German.  Israelis are highly educated—education is compulsory from age 6 to 16 and is free up to age 18—with a literacy rate of about 97%, and enjoy a life expectancy of just over 80 years.  Music and art also play a big role in Israeli society and there is extensive interest in, and support for, symphonies and orchestras, ballet and dance companies, repertory companies, museums and art galleries.

Israel has a diversified, technologically advanced economy with substantial but decreasing government ownership and a strong high technology sector.  Israel has forged a global reputation for innovation and has achieved notable success on a number of high technology projects in areas such as aviation, communications, computer-aided design and manufactures, medical electronics and fiber optics.  Metal products, processed foods and chemicals also play an important role in the Israeli economy and the Israel has proven to be a world leader in software development.  It is expected that technology will continue to be a driving force in Israel economic growth in years to come.  Israeli exports to major partners such as the US, Germany, Hong Kong and the UK include polished diamonds, electronic communication, medical and scientific equipment, chemicals and chemical products, electronic components and computers, machinery and equipment, transport equipment, rubber, plastics, and textiles.  Significant natural resources in Israel include copper, phosphate, bromide, potash, clay, sand, sulfur, bitumen and manganese.  The consensus among expert observers is that the physical infrastructure for business activities in Israel is good and that new and growing firms, as well as established businesses, are well supported with respect to access to roads, communications, electrical power, water and the like.

During the 1950s and 1960s, after Israel’s creation and independence, the country enjoyed rapid and impressive economic development and growth rates that often exceeded 10% annually.  The 1973 Yom Kippur War severely disrupted the economic path of the country and the ensuing ten years included frequent periods of stagnation and triple-digit inflation.  An economic stabilization plan was successfully implemented in 1985 and was followed by the introduction of market-oriented structural reforms.  The economy received an unexpected infusion of additional resources—nearly one million immigrants from the former Soviet bloc—beginning in 1989 and into the 1990s.  A number of these new residents were highly educated and brought the skills needed for ongoing development of Israel’s high technology sector.  In addition, as consumers they contributed to the strengthening and expansion of Israel’s domestic market. The byproduct of all of these changes was a resurgence of the Israeli economy that led to rapid growth in the 1990s.

Israel’s agricultural sector focuses on citrus and other fruits, vegetables, beef, dairy products and poultry.  The strongest Israeli industrial sectors include high-technology projects (including aviation, communications, computer-aided design and manufactures, medical electronics, fiber optics), wood and paper products, potash and phosphates, food, beverages, tobacco, caustic soda, cement, construction, plastics, chemical products, diamond cutting and polishing, metal products, textiles, and footwear.  Sectors and activities with the high percentage of members of the Israel workforce, estimated to be just over three million as of 2009, include manufacturing (16.2%); business activities (13.4%); education (12.7%); health, welfare and social services (10.7%); and transport, storage and communication (6.5%).  At that time it was anticipated that Israel’s high technology sector would remain a major driver of the Israeli economy in the years to come.  High technology products were a large contributor (45%) to Israeli exports and transfer of technology and know-how with major innovators from around the world was facilitated by the presence of companies such as Intel, Motorola, IBM, and Cisco in Israel.  The US has long been a dominant trading partner of Israel—the countries have been trading under a free trade agreement since 1985—and the principal goods exported from the US to Israel have included civilian aircraft parts, telecommunications equipment, semiconductors, civilian aircraft, electrical apparatus and computer accessories.  In turn, Israel’s chief exports to the US have included diamonds, pharmaceutical preparations, telecommunications equipment, medicinal equipment, electrical apparatus and cotton apparel.