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VENTURE CAPITAL

What Ever Happened to Start-up Nation?

A decade ago, Israel had the highest density of start-ups in the world, and attracted more venture capital than anywhere. Today, the entrepreneurial hotbed feels decidedly lukewarm. Author Sarah Lacy analyzes why.
Café in Tel Aviv, Israel

Courtesy Subject

Sarah Lacy is a journalist, author, and TechCrunch senior editor.

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Israel was the entrepreneurial miracle of the 1990s. It attracted more venture capital per person than anywhere in the world. Start-ups popped-up fast, leading to the country having the highest density of tech start-ups in the world. Through the '90s—and well into the 2000s—the tiny nation produced more Nasdaq-traded tech companies than anywhere else outside of Silicon Valley. "But a curious thing happened on the way from being a place that had nothing to lose to a place that everyone expected to win," writes TechCrunch senior editor Sarah Lacy in her new book, Brilliant, Crazy, Cocky. "Somehow, as Israel developed more of the ingredients that academics would consider crucial to high-growth company formation, returns from those start-ups have plummeted." Inc.com's Christine Lagorio recently spoke with Lacy.

Your book is subtitled "How the top 1 percent of entrepreneurs profit from global chaos." How does Israel fit into that idea?
The best way that I've found to cover business is to follow where the money is going. I spent about 10 years in Silicon Valley doing that and during that time there was this current of money flowing away from Sand Hill Road and Silicon Valley and going to developing countries. Israel is not an emerging market the way some of the other countries in the book are—it's a pretty stable economy. But Israel was really the place that inspired a lot of emerging market investment. It was like getting into emerging markets with training wheels, and it became the first place that wasn't the United States where big venture capitalists invested heavily. We get so wrapped up in demographics, like in India and China, but this isn't just about demographics. It's about other factors, too, like how friendly the government is to entrepreneurship.

What about something else that makes Israel stand out: the mandatory military service?
If you had to pick two or three ingredients that really created this culture of thriving entrepreneurship, that's probably the biggest or second-biggest one. Even women have to serve in the military, and that creates a different economy, gender-wise. They are these very lean operations, and decision-making is pushed way down the food chain. Authority asks to be challenged. There's this idea that the smartest, scrappiest people should be in charge, not the ones that have the most experience.  They are forced to creatively problem-solve, and often with constraints. A lot of what you use to, say, track down terrorists, are the same skills you use to find someone who is laundering money from your company, for instance. The culture of the military is in part a finishing school of sorts. The other factor is that there's actually innovation directly coming out of the Israeli military. It itself is a place start-ups are born.

We talk about Silicon Valley, and say thing like, if someone turns down $100 million, they're the bravest man in the world. In Israel, that would be the silliest thing. They actually understand what risk is. So the idea that quitting your job and starting a company, it's not seen as an insane risk. There's not this pressure around it that there might be in India or, really, many other countries.

What else makes Israel ripe for more start-ups?
The other two big ones are that, first, the government has really smart policy for entrepreneurs. In the United States, we always think the way for the government is to get out of the way. Israel's government played it better than anyone. In Israel, if you were Jewish, you could instantly immigrate. You can show statistic after statistic and it always shows that more open immigration creates companies. You had this inpouring of all these really intelligent people, and from day one people could come in with an idea, and also bring in talent.

Israel has a lot of easy laws for entrepreneurs. It costs like a dollar and takes a day to start a company. There's another thing that people don't talk about very much: Israel had incredible market timing. It aligned perfectly with the United States and allowed companies to both take investment and freely move back and forth, and to keep their research and development in Israel. Now, today, in this consumer Internet phase, would it have worked? I don't know. But they did it right when Nasdaq couldn't get enough technology companies, and Israel did that well.

Then what happened?
In a way, that set up Israel for a tough next 10 years. But in a way, it showed a whole generation how lucrative a start-up could be. How valuable stock options could be, for example.

Michael Eisenberg is quoted as saying that Israel's start-up ecosystem is in danger, that returns haven't been great. How does it compare to Europe—or London in particular?
London has definitely been pretty weak as well. The advantage with London is that it has had some big home runs: Skype, Bebo, and Last.fm. The problem is that Israel hasn't had a lot of home runs. Israel is in a strange place where it's trying to build consumer software, and it's hard to make that work for the United States. The challenge for Israel is that it excels at solving really big problems, and the tech market has moved away from that.

What areas outside of consumer Internet that are still ripe for start-ups in Israel, especially considering that and other strengths?
There is a big opportunity for Israeli clean technology. there are few places in the world that want the world to get off of Arab oil more than Israel. There's actually a lot of good gambling industry things done in Israel, because they're solving cryptography and fraud issues. If you have to look at it practically, you have to say, look, building consumer software isn't working for you. I don't think it's an Israel thing, I just don't think that paradigm works anywhere.

My advice to Israel, they were so smart to partner and align with the United States when it was in a growth phase. Now it's not growing. If they want to get back to solving big problems and make big things, they need to focus on parts of the world that are still growing. The key with small countries, they are nimble; they can create policies to foster entrepreneurship better than a big country can.

Can you talk about the role for Israel of having hostile neighbors? Can that be considered an advantage at all in fostering entrepreneurship?
Of course there's the idea that hostile neighbors give people a different perspective on what it's like to live and fail. We think here in the United States that we give start ups in San Francisco and Silicon Valley so much permission to fail, but it's nothing compared to there. The Israelis really are good at living like there's no tomorrow.

But I think it's a disadvantage that makes a start-up story so amazing. If you pick a company in Western Europe, Spotify or Skype, they do well by selling to the rest of Europe. The ones who have done it have built huge franchises in Europe. You need some proximity to friendly neighbors and proximity to other huge domestic markets.

Israel followed that strategy well through the 90s tech boom, partnering with the United States. But when partnering with someone so far away, and in a different language, and different cultural universe, it means Israel is operating, in a sense, like an island.  

Haven't Israeli entrepreneurs at times been able to use that to their advantage?
Indirectly, yes.  That's always the sign of great entrepreneurs, they're able to take something that's a challenge for everyone else and create a benefit for themselves out of it. Take Shai Agassi, whose company is based in the U.S., for example. He was going to be the co-CEO of SAP—one of the world's biggest business software companies—which would have made him one of the highest ranking Israelis in the tech world. But he walked away from it because [Israeli Prime Minister] Shimon Peres convinced him to start a car battery exchange.

So he used Israel as a test market, because he wanted a small place, but a significant one. And Israelis, well, can't drive out of their small geographic area. So you can populate that with battery swapping stations.

What's your takeaway from your reporting there, and from your conclusions that both useful—in a Western sense—innovation is lagging, and that VC investment in Israel is overblown?
I think the big question for Israel, which is the question I raise in the book, is that it has had a great run in the 90s—but it hasn't had great returns in the past 10 years. The reason we're having this conversation, is because Israel always outperforms elsewhere. Now, that seems to not be happening, but people are still sticking their heads in the sand saying "no, we're doing great." Israel is at this pivotal point, because the current venture capital always lags, so it's tough to gauge. You've already seen some funders pull back from Israel. But they're doing it really slowly and quietly. On the other hand, there are a lot of local investors, lately, and there are enough people who are kind of doubling down there for the next 10 years. Still, if nothing comes out of these most recent rounds of funding within the next five or 10 years, then we'll be able to see it from the outside.

Last updated: May 10, 2011

CHRISTINE LAGORIO-CHAFKIN | Staff Writer | Senior Writer

Christine Lagorio-Chafkin is a writer, editor, and reporter whose work has appeared in The New York Times, The Washington Post, The San Francisco Chronicle, The Village Voice, and The Believer, among other publications. She is a senior writer at Inc.




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