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Opinion Articles
High-Tech & Technology -
DUN’S
100
|
2016/17
18
Opinion Article
T
he year 2016 is turning out to be one
of the most prosperous years of the
Israeli High-tech industry in the last
couple of decades. This prosperity, reflected by
the enormous sums invested in local technol-
ogy firms, brought about a change in local VC
transactions, which is reshaping the traditional
mindset. It has also enhanced the effects U.S.
VC trends have on the Israeli market.
In accordance with a recent study published
by the IVC Research Institute and KPMG, ap-
proximately $4 billion was invested in Israeli
High-tech and Bio-tech companies during the
first three quarters of 2016 alone. This trend
seems to have continued into the fourth quar-
ter, leading the index to new records since its
establishment. The sums invested represent
an increase of approximately 400% from the
total investments in 2012, approximately 250%
from the 2013 figures, and approximately 150%
from the sums invested in 2014 and 2015 cal-
endar years. These are certainly paramount fig-
ures, which indicate the strength of the Israeli
High-tech sector. On the basis of past data, it
is reasonable to believe that some of these in-
vestments will bear fruit over the next few years
and lead to an increase in M&A transactions
involving local companies.
The study demonstrates another trend, which
may indicate a change in the industry and its
characteristics. Despite the meteoric increase in
volume of investments, the number of reported
transactions remained stable and even identi-
cal in comparison to the data from 2012-2013
– considered to be relatively poor years from
the VC perspective. This signifies that there has
been an incremental rise in the size of VC trans-
actions, namely that the sums invested in each
transaction and the amount of companies re-
ceiving significant investments has increased.
The reduction in volume of transactions and
simultaneous increase in investment sums per
each transaction naturally creates unique char-
acteristics, which represent this industry trend.
The increase in the magnitude of investments
leads to a certain increase in the valuation of
fundraising companies, which in turn supports
the entry of new investors or the completion of
significant follow-up transactions. It is a well-
known fact that, when compared to the average
company in Silicon Valley, the Israeli market suf-
fers from a significant valuation gap. This gap is
a familiar source of frustration for Israeli man-
agers and entrepreneurs, a fact which pushes
them to the streets of San Francisco and Palo
Alto in pursuit of foreign investors.
The increase in the volume of investment pro-
ceeds also triggers an increase in the equity
dilution of founders, managers and employees,
and as a result, their share of the desirable Exit
transaction is bound to decrease. One reason
for this stems from the equity structure of com-
panies raising VC investment and the industry’s
investment model, under which most commonly
the investors receive preferred shares. Among
the rights attached to these shares is the right
to receive their investment funds back prior to
company shareholders. In turn, the sharehold-
ers receive Exit transaction proceeds in accor-
dance with their relative pro rata share in the
company’s share capital. Therefore, as a result
of the requirement to repay the investors their
investment proceeds, considerable pressure is
applied on the founders, managers and other
company executives. Evidently such pressure
leads many of these executives to seek other
solutions that will guarantee they will not be
left behind if an Exit transaction occurs. In
other words, they attempt to ensure that they
will receive an appropriate sum, which would
reward them for their hard work throughout the
years. It is also in the investors’ best interest,
while observing the broader framework in which
they and the company operate, that founders,
managers and employees of these companies
would receive their fair share when the company
is involved in an Exit transaction. As long as they
have the power to influence the decision-making
procedures in the company and to guarantee the
adoption of resolutions that are favorable and
protective of their interests, management has
several tools in its arsenal to ensure that these
important elements are remunerated.
Some companies have adopted a “Carve Out”
Plan, aimed at guaranteeing that management
members would be the first to receive Exit
transaction funds or at the very least receive a
predetermined share of available proceeds. Oth-
er companies have adopted non-equity-based
programs, which are integrated as part of the
manager and founder employment terms. No-
tably, these two mechanisms may also be used
in combination with each other. Furthermore,
there are also other arrangements for handling
the remuneration of managers and employees
in the event of an Exit transaction, such as pay-
ing future pay-per-performance payments from
the surviving or acquiring entity. This toolbox
reflects a new set of considerations that mature
companies face as the industry progresses, the
investment size increases and the local market
becomes more complex. Such demands are usu-
ally favorably regarded by the investors, but in
more mature companies, where founders less
often fill managerial roles, this is not always
the case.
The aforementioned trends are typical for
mature companies and are closely related to
trends currently impacting Silicon Valley tech
companies. These trends are basically aimed
2016 Trends in the Israeli Venture Capital Industry
By Adv. Atir Jaffe & Guy Lachmann, Partners at Pearl Cohen Zedek Latzer Baratz
Atir Jaffe
Guy Lachmann
Adv. Atir Jaffe and Adv. Guy Lachmann are partners in the High-Tech group at Pearl Cohen Zedek Latzer Baratz