3 Special Edition March 2008 / 5.00 Euro

Das Magazin für Investoren und Entrepreneure

VentureCapitalMagazin

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IsraelIsraelA Hot Spot for Venture Capitalists

Israel’s achievement in venture capital – Up-to-date market figures – Lessons from recent developments – The government’s role in innovation –Legal set-up of venture capital investments – Cleantech case study

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Special Edition “Israel”2 www.vc-magazin.de

Foreword

“The golden age of the Israeli entrepreneur”

ContentsOverview

Israel’s venture capitalists have cause to celebrate 3From zero to hero in 15 yearsVC investments at a six-year high 6Healthy final quarter for Israel's high-tech companies Becoming a global center of innovation 8The government’s role in one of Israel’s greatest achievements“First the need, then the technology” 9Interview with Stefan Herbert, Managing Partner, MagniGroup

InvestmentA ray of hope 10The situation of venture capital in GermanyLegal set-up of venture capital investments in Israel 12Legal environment and contractual deal structure for VC investmentsKnowledge transfer from Israel 14Hasso Plattner Ventures: more than an incubatorNon-polluting oil-free solutions 15Better PLC develops the infrastructure for a clean future

Supplement of VentureCapital Magazin, issue3/2008: “Israel – A Hot Spot for Venture Capitalists”Publishing House:GoingPublic Media AG, Hofmannstr. 7a, 81379 München, Tel.: +49(0)89/2000 339-0 , Fax: +49(0)89/2000 339-39, E-Mail: info@goingpublic.de, Internet: www.vc-magazin.de,www.goingpublic.de

Editors: Torsten Paßmann (project manager), Andreas Uhde(editor-in-chief), Mathias Renz, Silke Schneider

Contributors: Yifat Adoram, Orna Berry, Inga Bricker, BerndFrank, Zeev Holtzman, Wolfgang Weitnauer

Translation: Claudia Ade Team, Stuttgart

Design: Silke Schneider

Printing: Joh. Walch GmbH & Co. KG, Augsburg

VentureCapitalMagazin

Fifteen years after the establish-ment of the venture capitalindustry in Israel and on the coun-try’s 60th birthday, the IVA’s (IsraelVenture Association) agenda is tostrengthen the global competitive-ness of the Israeli venture capitalindustry. The strength of an indu-stry relies greatly on the maturityof the whole ecosystem withinwhich it operates. This ecosystemincludes the VCs; the various go-vernment incentive programs tar-geted at fostering entrepreneur-ships such as R&D budget; govern-ment regulation; the educationsystem; institutional investors thatinvest in VCs (both Israeli andforeign); incubators and others.While it is true that the Israeli eco-system is well matured, it is ob-vious that in order to stay ahead ofthe competition we have to be pre-pared for the next stage.

Starting with the 2008 IVA annualconference on May 19th – 20th, weshall be focusing on leveraging theindustry’s past successes to createeven greater success for thefuture. That is why our confe-rence’s main theme this year is“The golden age of the Israelientrepreneur”. A showcase of suc-cess stories will cover topics suchas “Life starts at 60 (million): late-stage start-ups” – strategies forpassing the tough stage of movingfrom the smaller to the larger scale– or taking innovation into truecommercialization; “The relations-hip of investors and Entrepre-neurs: debating the Alternatives”,which explores the different fund-ing alternatives available to entre-preneurs among the multiple fun-ding models. Each type entails adifferent kind of value and rela-tionship between investors and

entrepreneurs: VCs, angels, incu-bators, private equity, investmentcompanies and others. “Future glo-bal technology trends”, a furthertopic at the conference, examineswhere the industry is going fromthe perspective of analysts, themarkets/industry and VC funds.

We believe that a strong under-standing of our current successalong with analysis of future globaltrends and competition is the key totaking the lead in coming years.

Yifat AdoramPresident IVA (Israel Venture Association)

Overview

Special Edition “Israel” 3

In Israel we have a double celebration this year. We aremarking 60 years since the establishment of the modernState of Israel. At the same time, it is the 15th year sincethe rise of Israel’s venture capital industry, which, likethe State of Israel, has accomplished much in its shorthistory.

In the beginning…In 1993, the Israeli government sponsored a programcalled Yozma – which translates as “initiative” – to en-courage private investors to establish venture capitalfunds. With 100 million USD, a government-supportedinvestment company was set up with ten “drop down”funds that each had capital of 20 to 25 million USD. In-vestors in these drop down funds partnered with thegovernment, but were granted the right to purchasethe government’s interest within five years at pre-determined conditions. Most did buy out the govern-ment stake, effectively jumpstarting a venture indu-stry that today is regarded as one of the most success-ful in providing young vibrant companies with their re-quired start-up capital.

Past decade scores major achievementsLet’s look at some of the results, which to my mind aretruly incredible. In the last decade, Israeli venturefirms raised some 12 billion USD. In the same period,Israeli technology companies attracted 15 billion USD,which includes funds raised from both local andforeign investors. Venture capital-backed companiesraised 4 billion USD through IPOs on the world’s stockexchanges and attracted a whopping 27 billion USD inM&A activity. Israeli companies have become especial-ly familiar to Nasdaq investors. In fact, today on Nas-daq, there are more Israeli companies trading thanfirms from any other country outside of the UnitedStates and Canada.

Emergence of industry leadersMany global technology leaders have originated in Is-rael. Israel has, for example, produced Amdocs, CheckPoint, ICQ and Mercury in the IT and internet areas;

DSP, M-Systems, Orbotech and Zoran in semiconduc-tors; Comverse and Verint in communications, and Gi-ven Imaging, Teva Pharmaceutical and Medinol in lifesciences. Some of these companies have been ac-quired and now continue to operate in a different formand shape under their new corporate parents.

Israel compares favorably with US and EuropeWhile Israel is relatively small in terms of its popula-tion (a mere seven million), there is no denying that itpacks a strong punch in investment impact. In 2007,total venture capital investment in Israeli companiesreached more than 1.7 billion USD. In the UnitedStates, the venture powerhouse of the world with a po-pulation of about 45 times that of Israel, total ventureinvestment was 30.3 billion USD. Another way of look-ing at it is that Israel has just 2% of the population ofthe United States but has received venture investmentequal to 5.6% of that of the United States. Comparisonswith individual states are also of interest. Israel ranksthird in venture capital after California and Massachu-setts and ahead of states such as New York, Texas andNew Jersey. Set against European countries, Israelranks a close second to Great Britain and far outpacesother countries including France, Germany, Sweden,Denmark, and Switzerland.

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Israel’s venture capitalists have causeto celebrate

From zero to hero in 15 years

1999 2000 2001 2002 2003 2004 2005 2006 2007

Capital invested by Israeli VCs in Israeli high-tech companies

1,500

1,250

1,000

750

500

250

0

Source: IVC Research Center

million USD number

800

600

400

200

0

436

479

1,270

792

656

812466

481

464

421

565

665

594

655

548

651

546

678

Number of TransactionsCapital invested by Israeli VCs in Israeli companies

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Special Edition “Israel”4

Foreign investors take to Israeli innovationWhy did Israel’s venture capital industry develop sorapidly and successfully? The answer of course is thatit had a good product – Israeli technological innova-tion – in which to invest. As more and more successstories began to emerge from Israeli industry, in-creasing numbers of overseas investors wanted to bepart of the process, making it easier for new venturefunds to be formed and for the existing funds to raisefollow-on funds. Foreign institutional investors are themain shareholders in Israeli venture funds. Traditio-nally, there has been little participation from Israeliinstitutional investors, partly due to structural rea-sons and partly due to a slow-moving, ingrained con-servative approach to investing. While this has begunto change in recent years, foreign investors continueto supply the bulk of funds to all of Israel’s leading ven-ture capital funds.

Numerous factors spark successIsrael’s technology industries developed rapidly withfunds supplied by venture capital, but their successhas been due to more than just available funds. Seve-ral factors converged over the past 15 years which ac-count for the strong performance of Israeli companies:

• High quality human resources must be ranked top ofthe list. Israel’s leading universities and research in-stitutes have turned out top class flight engineersand entrepreneurs in a variety of key disciplines. Theinflux of well-educated technically-oriented immi-grants from the former Soviet Union that began inthe early 1990s and continued throughout that de-cade added to the pool of talent. Many of Israel’sentrepreneurs got their start in the military, whichpermitted young researchers to acquire knowledgeand hone their skills early and in a real-life setting. Is-

rael ranks number one amongst the world’s leadingeconomies with 135 engineers per 10,000 employees.This compares favorably with the US which followswith 70, Japan with 65 and the Netherlands with 53.

• Also key to the development of industry was theentrepreneurial culture that developed, patternedon that in the West, principally the United States.The fact that this spirit could develop from a socia-listically oriented society, which dominated the ear-ly years of the State, is particularly remarkable.

• In the 1970s and 1980s, the only technology of pro-minence in Israel emanated from the defense industry.A strong push to convert and transfer defense-relatedtechnologies to commercial applications was unusu-ally successful. The success of Israeli companies inthe communications and software fields, for example,is the result of adapting a wide array of military exper-tise and products to civilian uses.

• Global technology companies have recognized theadvantages of Israeli human resources and innova-tion, leading many multinational technology firms toestablish operations in Israel. Motorola, Intel andApplied Materials are among the world leaders toestablish major corporate research centers in thecountry. Significant operations are also maintainedby Siemens, Novartis, SAP, Philips, Alcatel, Cisco,Texas Instruments and Samsung among dozens ofleading companies. Not only have these companiesbenefited from Israeli manpower and brainpower,but these companies have also contributed stronglyto the Israeli economy, bringing in managementexpertise, market knowledge and the business per-spective of highly accomplished firms.

• The successes of the past have enabled Israel toreach a critical mass of capital, investors, VC fundsand start-ups – all the ingredients needed to main-tain the strong flow of financing for the establish-ment and growth of new companies.

• The Israeli government has taken a positiveapproach to research initiatives. Company R&Dspending has also been a key factor in generatingadvanced technology. Most telling is the total expen-diture on R&D as a percentage of gross domesticproduct. Based on the latest available figures from Is-rael’s Ministry of Industry, Trade and Labor, Israelleads all nations with 4.55%, ahead of runners-upSweden, Finland and Japan with 3.95%, 3.48% and3.20% respectively.

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1999 2000 2001 2002 2003 2004 2005 2006 2007

Capital invested in Israeli high-tech Companies by Israeli VCs, foreign and other investors

3,500

3,000

2,500

2,000

1,500

1,000

500

0

Source: IVC Research Center

million USD

1,013

3,092

1,986

1,1381,011

1,465 1,337

1,622 1,759

Foreign & otherIsraeli VC

Overview

Special Edition “Israel” 5

• Government support has also been present in otherways. Israel has modern legal and financial systems.Its favorable tax regime with zero tax for foreigninvestors in VC funds and export-oriented industriesholds important appeal.

• Some venture funds in Israel have been reluctant tofund seed stage companies, preferring the lesser riskof investing in companies that have reached severalmilestones or have attracted customers or partners.One means by which the deal flow of young compa-nies has been maintained is through a government-supported incubator program. This has providednew entrepreneurs with administrative help andhandholding and has enabled budding entrepre-neurs to focus their efforts on developing their ideasbefore emerging into a competitive commercial en-vironment. Israel’s incubator program included, atits peak, 27 incubators throughout the country. Theprogram led to the emergence of many firms thateventually went on to attract venture capital and be-come commercial successes.

• Overseas venture capital firms have made direct in-vestments in Israeli companies. Some, such asBenchmark, Sequoia and Greylock, have establishedIsraeli dedicated funds with domestic Israelimanagement and have led investments or have co-in-vested along with Israeli funds. Others, such as AccelEurope, Partech and Bessemer have made allocati-ons to Israel from their general funds and have open-ed an Israeli office or use Israel-based representa-tives to advance their investment program. Typical-ly, these co-invest with Israeli funds. Another ap-proach, that of GIMV for example, has been to put inplace co-investment agreements with an Israeli fund,while many others, such as Kleiner Perkins, Oxford,NEA, and MPM among others, have no set policy butinvest as opportunities arise. Foreign venture fundshave accounted for more than 50% of investment in

Israeli technology companies for the past severalyears. Generally, foreign fund investment is viewedas complementary to Israeli fund investments, notcompetitive.

• Corporate VCs have made important strategic in-vestments. Intel Capital, Motorola, Siemens andJohnson & Johnson have been among the moreactive investors in this category, making invest-ments based on their own corporate requirementsand visions for the future.

Savvy investors will still choose IsraelI believe we will continue to see favorable develop-ment of Israel’s venture capital industry. Leading Israe-li VCs have raised, or are in the process of raising, afifth generation of funds. While some investors areeyeing Asia for new opportunities, many experiencedinvestors understand that leapfrog technologies won’tbe found there. They are instead interested in thepotential of the huge Asian markets. Savvy investors –those wanting to find the next technology megastar -–will assuredly be keeping Israel squarely on theirradar.

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The author

Zeev Holtzman is Foun-der and Chairman of GizaVenture Capital, a pio-neer investor in seed andearly-stage technologycompanies. He is alsoChairman of Israel Ven-ture Capital ResearchCenter and was a foun-ding member of the Is-rael Venture Association(IVA).

Tel Aviv is Israel's economic hub, the home of Israel’s only Stock Exchange, and many corporate offices as well as research and development centers

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Special Edition “Israel”6

So far, the Israeli venture capital scene has remained im-pervious to turbulence on the capital markets and themuted international venture capital market. Last yearsaw venture capital investment in Israeli high-tech firmsreach 1.76 billion USD. This made 2007 the best yearsince 2001 – and with a superb final quarter. The mostnotable star amongst the target sectors was the field of se-miconductors.

Growth in the cleantech sectorIsrael has had a vibrant venture capital scene since the90s, built up on the basis of various programs of statesubsidies. Since then, this small country – similar to theGerman federal state of Hesse in size and population –has been home to a large number of newly-establishedcompanies, mostly in the high-tech sectors software,communications, life sciences, semiconductors, andthe internet. In recent times, the cleantech sector –clean technologies launched in the context of climatechange and the CO2 question – has become increasinglyprominent and is set to create a new market trend.

A good regulatory frameworkState subsidies, relatively high investment in researchand development coupled with a generally good (le-gal) framework (e. g. tax regulations) have nurtured avaried high-tech sector, mainly composed of small andnewly-established firms. Israel is home to a total ofaround 5,000 high-tech companies, approx. 3,000 ofthem start-ups. The country thus has an extremely

high proportion of technology firms. Over 50 local VCcompanies are active on this market; the largest are Pi-tango, Evergreen, Gemini, Genesis, Star Ventures (Ger-man-Israeli) and Benchmark Israel.

An international focusIsrael is, moreover, a party to important internationaltrade agreements, extremely important consideringthe role the export industry plays in the national eco-nomy. “Hardly any other country has so many freetrade agreements,” says Stel Pinhasov Beck, Directorof the Trade Center of the State of Israel. “This is ofgreat importance both for investments and to thecountry’s attractiveness as a technology business lo-cation.” The Israeli economy and the CEOs of Israelicompanies are internationally-oriented: around aquarter of the country’s exports come from the high-tech sector. Links with the USA are particularly goodand large technology companies such as Microsoft, In-tel, IBM and the German company SAP all have R&Dcenters in Israel.

Strong links to the USAOnly a small number of VC companies from Germanyinvest in Israel. Those currently holding Israeli firms in

VC investments at a six-year high

Healthy final quarter for Israel's high-tech companies

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2000 2001 2002 2003 2004 2005 2006 2007Source: IVC Research Center

Capital raised by Israeli high-tech companies by sectors in %

100

80

60

40

20

0

CommunicationsSoftware

CleantechSemiconductors

InternetLife Sciences

Others

in %

2000 2001 2002 2003 2004 2005 2006 2007Source: IVC Research Center

Capital raised by Israeli high-tech companies by stage in %

100

80

60

40

20

0

Early StageSeed

Late StageMid Stagein %

Overview

Special Edition “Israel” 7

their portfolios are BayTech, CFH (part of the Sach-senLB Group), Earlybird, PolyTechnos, Smac Partnersand Wellington Partners. By far the greatest foreign in-vestment comes from the US, followed by the UnitedKingdom. 39 US VC firms currently invest in Israel. Fur-thermore, in terms of IPOs, the US capital market andabove all the technology stock exchange Nasdaq is themost important exit channel for Israeli VC companies.

Fundraising harder in GermanyCompared to Israel, the VC sector in Germany plays asignificantly smaller part in the national economy. VCinvestments in recent years totalled between 0.8 and1.3 billion Euro; around 100 companies are actively in-vesting in Germany. VC funds continue to experiencedifficulty in obtaining money. The effects of the burstof the New Economy bubble at the turn of the 20th cen-tury are still being felt and some VC houses lack a posi-tive track record. Regulatory conditions are, more-over, far less favorable than in Israel. The sector is stillawaiting implementation of a venture capital legis-lation (“Wagniskapitalbeteiligungsgesetz”), supposed-ly planned for the beginning of 2008. On a positivenote, certain semi-public and public VC companies areextremely active in the seed area. Follow-up funding isoften more of a problem. In this area there is a needabove all for private VC companies, which, as we havealready seen, themselves have fundraising problems.These companies also seem to lack the venturesomespirit of their Israeli counterparts when it comes to in-vestments in new, innovative businesses.

Highest investment figures since 20012007 in Israel was the best year for investment since2001. According to the Israel Venture Capital ResearchCenter (IVC), Israeli high-tech companies posted in-vestments to the sum of 1.76 billion USD, a figure 8.5%higher than in 2006 and 31.5% higher than in 2005. Is-rael thus ranks above Germany in terms of the level of

VC investments (seetable), even although thelatter country is far larger.Individual investmentsaveraged a good 4 millionUSD. The seed area experi-enced the same extent ofgrowth as the market as awhole: 78 seed companiesreceived 151 million USD –around 8% of total invest-ments – and this shareremained stable as in pre-vious years. It is worth no-ting that 503 million USD

was invested in 115 firms in the 4th quarter alone, thebest quarterly results for five years and a sign of thesector’s great ability to withstand crises. The largestsingle investment was 100 million USD in MobilEye.

Clear growth in semiconductorsMost VC investments went to communications (21%)and life sciences (20%), sectors firmly established inthe VC scene, as well as to the area of semiconductors(19%); this last showed significant growth comparedto its 10% share in the preceding year. Internet firms al-so managed to attract considerably more resourcesthan in 2006 with a 15% share of investment (5% in2006), whilst software companies received significant-ly less (13% as opposed to 22%). VC investors are in-creasingly concentrating on the cleantech sectorwhich received 4% of funds. In a similar picture to2006, just under 40% of funds – 678 million USD – camefrom Israeli VC companies; a good 60% from foreign in-vestors. Israeli VC houses themselves have few invest-ments in other countries. 50 million USD were their2007 total investment in companies abroad; in 2006this figure was 60 million USD.

Prospects:The Israeli VC business has to date been little affectedby the crisis of confidence in large-scale loans and large-scale takeovers. However, having risen significantlyagainst the USD, the strong shekel is now making US in-vestments in Israel more expensive. This could serve toslow investment activity. Market participants are ex-pecting an investment volume of the order of 1.6 billionUSD for the current year, roughly the average of the pastthree years. Much will depend on economic develop-ments in the USA (and indeed in Europe).

Bernd Frankredaktion@vc-magazin.de

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Comparison: Germany and Israel

National economy 2007

Population 82.47 million 7.08 Million

Total GDP 2,423 billion Euro 149 billion USD (estimated)

GDP per inhabitant 39,737 Euro 21,220 (estimated)

Official unemployment rate 9% 8.9% (2006)

Rate of inflation 2.2% 1.8%

Private Equity (incl. Venture Capital) 2007

Fundraising 4.2 billion Euro 470 million USD (2006)

VC investments 839.7 million Euro 1.76 billion USD

IT/Telecom share of investment volume 6.4% 36%

Seed share of investment volume 1.2% 8%

Total number of association members 278 (BVK) 108 (IVC)Sources: bfai, Statistisches Bundesamt Deutschland, BVK, IVC

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Special Edition “Israel”8 www.vc-magazin.de

In May, when Israel celebrates its 60th anniversary, it willbe able to look back upon many achievements. One of itsgreatest is the development of an exceptionally creativehigh-tech sector. The technologies Israel has pioneeredinclude Voice over Internet Protocol (VoIP), ICQ, Intel’sCentrino WiFi chip and the extraordinary “camera-in-a-pill” for the diagnosis of stomach ailments. Whilst thesetechnologies came from the private sector, the Israeli go-vernment can take much credit as well because its acti-vities have fostered innovation. Its instrument is theOffice of the Chief Scientist (OCS), which manages seve-ral schemes that offer grants and other benefits to high-tech companies.

Over 1,000 projects a yearThe Office of the Chief Scientist’s biggest program isthe R&D Fund, an initiative that assists firms with 20 to50% of the R&D costs of projects. The OCS reviews ap-plications according to criteria such as technologicaland commercial merit, risk, and the potential for gene-rating expertise. With a budget of 300 million USD, thefund supports over 1,000 projects a year at more than500 companies. One of several other OCS schemes, theMagnet Program gives financing to consortia compris-ing companies and academic institutions for the deve-lopment of generic, pre-competitive technologies. TheTechnological Incubators Program provides earlystage entrepreneurs with money, premises and adviceto help them develop ideas and set up new firms.

International initiativesThe government also runs programs to encourageR&D co-operation between Israeli and foreign compa-nies. The most significant international initiative is theBIRD Foundation, which awards grants to joint pro-jects between Israeli and US businesses. Since its in-ception in 1977, BIRD has provided 214 million USD to672 partnerships and the products developed fromthese ventures have generated direct sales of 4.1 bil-lion USD. However, Israel doesn’t just sign agreementswith countries: through the Global Enterprise R&D Co-operation Framework it signs agreements with multi-

nationals, too. The OCS helps the signatories identifyIsraeli companies with whom they can carry out R&Dand then provides the subsequent partnerships withfinancial assistance.

Creating a multi-billion dollar industry from scratchWhile the OCS is the government’s instrument for pro-moting innovation, the catalyst in the private sphere isthe venture capital sector, although even this startedout as a state initiative. In 1993, the government crea-ted a VC industry from scratch by establishing theYozma Program, which set up ten funds that raised 200million USD. The state contributed half and providedincentives for foreign investors to take part. Today,there are about 50 funds and from 1993 to 2008 VCsraised almost 14 billion USD, with the result that thereare about 5,000 high-tech companies in Israel, thehighest concentration outside Silicon Valley.

Conclusion:Without the government’s leadership, Israel’s high-tech sector would not be nearly as big, successful andinnovative as it has become. In addition to the OCS’sactivities, the state provides tax breaks and otherbenefits to attract the foreign investment that can helpfoster innovation. For any country looking to develop ahigh-tech sector, the Israeli model is worth studying.

Becoming a global center of innovation

The government’s role in one of Israel’s greatest achievements

The author

Dr. Orna Berry is aVenture Partner at Gemi-ni Israel Funds. Sheserved as Israel’s ChiefScientist before joiningGemini in 2000, and waselected Chair of the Is-rael Venture Associationin 2007.

Overview

Special Edition “Israel” 9www.vc-magazin.de

Israel is one of the world’strue technology hot spots:relative to the number of itsinhabitants, Israel producesthe most patents, has thehighest concentration ofhigh-tech companies afterSilicon Valley and the high-est per capita number ofengineers. It is not easy forEuropeans to keep track ofthis thriving technologicalscene, but Stefan Herbert,Managing Partner at the Munich-based MagniGroup,shared his insights with Torsten Paßmann, editor of Ven-tureCapital Magazin.

VC-Magazin: Mr. Herbert, which sectors dominate theventure capital scene today? Herbert: In 2007, 462 Israeli high-tech companiesraised more than 1.7 billion USD from local and foreigninvestors. 60% of this capital was absorbed by commu-nications, life sciences, and semiconductors. Theinternet sector increased its share to 15%, and mysources tell me that cleantech is rapidly growing, too.

VC-Magazin: What makes communications such a“hot sector” in Israel? Herbert: A lot of know-how in Israel was originally de-veloped by the military sector, for which communica-tions is critical. For example, it is important to dis-tribute large amounts of data, such as satellite images,over a limited bandwidth. Israelis also were earlyadopters of multiple uses for cell phones, e. g. for tak-ing pictures and sending them home, or chatting withfriends and even business partners. This is why Israelistart-ups were among the first to embrace the mobileas a base platform for ideas beyond just calling. Twogood examples are LocationNet, who offer ad-funded –and therefore free – mobile navigation, or Peerbox Mo-bile, who brought peer-to-peer-networking into themobile world.

VC-Magazin: The Israeli scene is one of the mostbooming and innovative in the world. Where do youngentrepreneurs get the ideas?Herbert: Many of them get their basic technologicalunderstanding during military service, where a lot oftraining is done in communications, IT, encryption anddeveloping new concepts based on that. But Israelistart-ups develop their business ideas by focusing onthe end-users’ needs and desires. In short: first there’sthe need, then the search for the technology. In con-trast, the typical German founder is more technology-focused and tries to find the “right” end-user later on.

VC-Magazin: You are monitoring the Israeli market forthe renowned tech congress “Demo”. Do you have anyadvice for European VCs to keep up-to-date? Herbert: Reading blogs, looking at bulletin boards orbeing on mailing lists is the first step to watching themarket. However, since the community is very fast-paced and you are sitting more than 1,500 miles away,you need a local partner for real insight. This partneralso helps you to overcome the language barrier. A lotof information is written and published in Hebrew on-ly, and not everybody is fluent in English. You aresimply cut off from information, if you don’t clearthese hurdles.

VC-Magazin: Mr. Herbert, thank you for talking to us.

torsten.passmann@vc-magazin.de

“First the need, then the technology”

Interview with Stefan Herbert, Managing Partner, MagniGroup

The interview partner

Stefan Herbert, Co-Founder and Managing Partnerof MagniGroup, Munich, has a strong IT back-ground and has held management positions withinIsraeli as well as American companies.

Stefan Herbert

Inve

stm

ent

Special Edition “Israel”10

Foreign markets have much to offer the German VCscene, for example Israel in the incubator sector or theUSA in financing IT start-ups. A look back at recent deve-lopments is, however, also useful: the years since thecrash of the New Market have seen a sobering round ofconsolidation. What are the main lessons to be learned?

Content and contextMere ideas no longer clinch investment decisions, nomatter how promising they may sound. In the late-stagearea, funding goes above all to tangible “content” in theform of a mature product. There should be a “proof ofconcept”; this must at the very least form part of a mile-stone plan. Hence promoters “of a wish and a promise”have also become something of a rarity.

There is also, however, increasing focus on the“context”, i. e. the presence of a management teamwith broad and detailed sector or industry-specific ex-perience and a network of strategic partners, if possi-ble in real terms in the form of cooperation agree-ments. In the biotech sector in particular, the focus iscurrently on “partnering” with the pharmaceutical in-dustry.

Marketability and returnsFounders’ and early stage investors’ hopes for a conti-nual rise in share prices to compensate for dilutionhas turned out to be a hollow illusion; this is due part-ly to the current scarcity of exit possibilities and lon-ger time frames.

The failure of founders’ and early stage investors’ ex-pected returns to materialize was also due to the nowcommon preference for liquidation coupled with dilu-tion protection for later stage investors. The latter arethus now “a step ahead” when it comes to exits –another reason the “time to market” needs to be keptbrief and capital requirements covered as quickly aspossible through internal financing, i. e. through per-sonal turnover. This will succeed best once VC financ-ing takes as its basis a product which will becomemarketable in the foreseeable future (“content”).

Research The exceptional research environment at universities,Max-Planck Institutes and other research institutionsis continuing to have a positive effect. However, themisplaced ambition of national and regional politici-ans has led to excessive “fiddling” in this area. Insteadof the 30 or so self-styled biotech clusters, it would, forexample, be more effective to have significantly fewersites but in close proximity to excellent research insti-tutions.

In the event, the abolition of the “Hochschullehrer-privileg” (dispensation which had allowed all teachersat higher education institutions the right to dispose ofany discoveries/inventions made in the course of theirwork as they saw fit; its abolition meant the universi-ties are now required to register such discoveries andmay also exploit them) in 2002 did not spark a spate ofnew start-ups: many university institutions were un-able to cope with the implementation of industrial pro-

A ray of hope

The situation of venture capital in Germany

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Investment

perty law. On the other hand, there is now also a needto allow more time for technologies to be developed inscientific research institutions before there can be anyquestion of marketing or a transfer of technology.

Seed area funding gapVenture capital investors’ preference for more maturetechnologies is creating an early stage funding gap.This gap must be closed, for example using the High-Tech Gründerfonds (High-Tech Founder Fund). Thisgovernment supported fund provides newly-estab-lished companies with up to half a million Euro in sub-ordinated loans coupled with private participation atthe company’s nominal value. Yet if it is to be success-ful, this seed financing must also be accompanied bythe development of business angel networks to sup-port founders not only with money, but also with helpand advice.

Conclusion:Despite the dark clouds which have blackened theventure capital skies in recent years, there is now a rayof hope. Funding packages, in particular from theredesigned ERP-Startfonds (ERP Start-up Fund), the

High-Tech Gründerfonds and the relevant regionalfunds should help reanimate investment activities; thefew but nevertheless recently successful IPOs, in parti-cular in the field of renewable energies (such as Cen-trotherm and Q-Cells), or the model deal betweenSkype/Ebay should also help reawaken the founderspirit.

The Author

Dr. Wolfgang Weitnaueris a lawyer and foundingpartner of WeitnauerRechtsanwälte Wirt-schaftsprüfer Steuerbe-rater (Lawyers, Auditorsand Tax Consultants). Hespecializes in corporateand commercial law,company restructuring,M&A and company fun-ding and holdings.

wolfgang.weitnauer@weitnauer.net

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Since the early 90s, Israel has been known as “SiliconValley II” with its fast developing high-tech and informa-tion industry reaching new peaks each year. Governmen-tal encouragement of young high-tech companies throughspecial funding by the Office of the Chief Scientist at theMinistry of Industry and Trade and tax incentives throughthe Investment Center coupled with a pool of highlytalented IT professionals have resulted in the fast growthof research and development centers for advancedtechnologies. This high-tech powerhouse has been highlyattractive not only for domestic but also foreign venturecapital funds; the latter created the demand for legal andtax advice with international expertise and languageskills. In Israel, foreign venture capital investors enjoy astable and transparent legal system, English proficiencyat all levels, and a contractual set-up for their invest-ments similar to the well-established US model.

General legal frameworkThe Israeli legal system is generally based on the Eng-lish common law system, with German contract andproperty law principles having been incorporated intothe equivalent Israeli law, and notable influence by UScorporate and securities law. It is stable, largely pre-dictable, and enforcement is relatively effective. Eng-lish is the dominant language in the venture capitalbusiness and legal world. Administrative and govern-mental bodies can be contacted in English, most start-up companies keep all their legal and financial docu-mentation as of the seed level in English, and manylawyers and accountants have academic and practicalexperience in the US or Europe. Such an internationallanguage culture and expertise enables legal due dili-gence reviews by foreign investors to be in English andfacilitates a smooth negotiation process in connectionwith later exit potentials, such as going public on aforeign stock exchange, strategic partnerships or M&Atransactions that mostly involve foreign companies.The contractual and corporate set-up is quite flexibleand less statutory and burdensome than in Germanyand most other European countries. The Charter orArticles of Association of an Israeli limited liability

share company (which is the customary legal form ofIsraeli companies, including start-ups) do not have tobe notarized by a public notary, but rather only needto be registered with the Israeli Registrar of Compa-nies. The authorized share capital does not have to beidentical to the issued share capital and this allows foran option pool reserve and future share issuances bymere board resolutions. Most corporate decisions re-quire only a simple majority of the shareholders, andboard meetings can be held by conference call. Con-tractually, the new investors first agree with the com-pany, founders and prior investors on the key busi-ness points in a non-binding term sheet, in order toavoid “deal killers” at a later stage. The second step isthe negotiation of definitive agreements for the trans-action in parallel to a close business, financial and le-gal due diligence review of the company.

Contractual set-up – the main agreements in a nutshellThe typical structure of a venture capital investmentin Israel, like in Europe or the US, is the acquisition ofthe equity security of the company, usually preferredshares of the most senior class to be created in con-nection with the investment. An alternative invest-ment vehicle is convertible debt, such as bridge loansand convertible debentures, ordinarily complementedby the issuance of warrants convertible into such pre-ferred shares. All such securities would eventually beconverted into ordinary shares under certain circum-stances. Similar to VC investments in the US, investorstypically negotiate the following four main documents:

(1) An Investment or Share Purchase Agreement,concluded between the company, the investorsand in young companies also the founders. Thisagreement details the terms of the purchase andissuance of securities of the company and servesas the fundamental disclosure vehicle; the mainbody of the agreement consists of representationsand warranties from the company and/or thefounders. The investors’ representations mainly

Legal set-up of venture capital investments in Israel

Legal environment and contractual deal structure for VC investments

www.vc-magazin.de

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Special Edition “Israel” 13

cover issues related to US securities regulations. Inaddition, such an agreement sets out a roadmap ofthe steps that need to be taken prior to closing thedeal.

(2) The company’s Articles of Association, a public do-cument which serves as the company’s constitutionand covers all corporate matters, particularly thespecial rights of the investors as preferred share-holders. Such investor rights typically include divi-dend and liquidation preferences; anti-dilutionrights (full ratchet, mostly for first rounds, orweighted average ratchet protection), often coupledwith pay-to-play provisions; preemptive rights ap-plicable to future issuances of shares of the com-pany, and special veto rights with respect to majordecisions such as changes to the Articles of Associa-tion or extraordinary business decisions.

(3) An Investors’ Rights Agreement that mainly pro-vides for registration rights in the event of an initialunderwritten public offering of the company’sshares. It usually also grants the investors month-ly, quarterly and annual information and inspecti-on rights as well as preemptive rights.

(4) A Shareholders’ Rights Agreement that customa-rily includes special voting agreements regardingthe appointment and removal of shareholder re-presentatives to the board of directors, rights offirst refusal and co-sale or no-sale rights on mosttransfers of shares by the founders and/or othershareholders. In addition, investors will receiveseveral ancillary documents, such as shareholderand board resolutions, indemnity letters for boarddesignees, a legal opinion, and officers’ certi-ficates.

D&O insurance and indemnityAs investors that make significant investments in thecompany usually appoint members to the board ofdirectors in order to influence and supervise the

management, it is recommendable and customary todemand indemnity agreements for their designees andD&O insurance to cover risks of personal liability. Is-raeli law imposes on directors the duties of care, loyal-ty and good faith with an enhanced risk of liability inconnection with extraordinary corporate actions andtransactions, such as changes of control, distributionsto shareholders and liquidation events.

Tax implicationsThe Israeli tax ordinance subjects all capital gainderived from the sale or exchange of shares in Israelicompanies to Israeli taxation, ordinarily at the rate of25%. However, Israel has signed tax treaties for theavoidance of double taxation with many countries,including Germany. Under such treaties, a foreign in-vestor selling shares in an Israeli company is often ex-empt from capital gains tax in Israel. This is also thecase under the Israel-German tax treaty in the event ofan investment by a German individual or fund with nopresence in Israel. It is noteworthy that some Israelistart-ups establish themselves as an Israeli subsidiaryof a US holding company. In such cases, the invest-ment is in the US parent and the US-German tax treatythen applies.

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The author

Inga Bricker, admittedas a lawyer in Germany,New York and Israel, is asenior counsel withGoldfarb, Levy, Eran,Meiri, Tzafrir & Co., LawOffices, a leading Israelilaw firm, specializing inhigh-tech, venture capi-tal and cross-borderM&A transactions.

Tel Aviv was noted in 1998 by Newsweek to be one of the top 10 most technologically influential cities in the world

On the surface, Hasso Plattner Ventures (HPV) seems likeevery other early stage investor in IT: the focus is on soft-ware applications, the preferred stage is “seed”, and ahigh rate of return should be earned. But if you take acloser look, HPV’s unique character is clear. The investorbrought the Israeli incubator model to Germany and com-bined it with a venture capital fund. No other venture ca-pitalist in Germany has taken this direction.

VC fund plus High-tech ParkFirst there was just a vision that Hasso Plattner, formerCEO of SAP AG, had about some kind of “technologypark”. Next came the offer from a member of the Mana-ging Board of SAP, Shai Agassi, to find someone tomake this vision reality. This someone was Eran David-son, an Israeli with a strong background in venture ca-pital and incubators. Thanks to twelve years in earlystage investments he had a great deal of personal ex-perience in commercializing academic research. Thismade him the ideal CEO for HPV and the “Hasso Platt-ner High-tech Park”, both started in 2005. In that park,located in Potsdam near Berlin, capital meets entre-preneurial spirit: the two buildings house the fund it-self, which is equipped with 50 million Euro, and threestart-ups. Unlike with “traditional” incubators, resi-dence at the park is not a condition for funding – nineother investments are scattered around Germany.

Investment strategySo far, more than 1,000 companies have applied, butmost were rejected. “People here are very talented,”states Davidson, “but I miss the entrepreneurial spiritand broad horizons. Most founders limit themselvesto the German market, even if they have the potentialfor more.” According to Davidson, there is another ma-jor difference: while Israeli founders “sell a productfirst and then develop it custom made”, the dominantapproach in Germany is “to develop a product until itis excellent, but no thought is given to the customer’sneeds.” Surely this knowledge helps him to recognizethe few start-ups with the required attributes: innova-tive and application-oriented development, solutionsto “intricate problems” or the implementation of serious

improvements, applicable for large and fast growingmarkets. If they overcome that hurdle, they are offeredrespectable conditions for a seed stage company: theinitial investment is 500,000 to 1.5 million Euro; thiscan be followed by further investments of up to 4 mil-lion Euro. The first three investments Inchron, Factonand D-Labs are still based at the High-tech Park. D-Labs in particular is one of Davidson’s favorites: “Thiscompany is simply unique with its user-centric designapproach. It will grow to become a global leader insoftware design and re-design solutions.”

Conclusion:To date, there are twelve investments in the portfolio.At least six more should follow; the first exit is plannedfor the end of 2008. HPV found its niche by combiningone VC fund with an incubator, and investors believein that concept: a second fund was closed (but not dis-closed) earlier this year, and it reached the hundredsof millions Euro.

torsten.passmann@vc-magazin.de

Knowledge transfer from Israel

Hasso Plattner Ventures: more than an incubator

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The team of Hasso Plattner Ventures in front of HPV’s main building

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Within the first four months since its launch in October2007, the cleantech company “Project Better Place” hasmade landmark achievements which other start-upscould only dream of. In its first financing round, BetterPlace collected an impressive 200 million USD, and astrategic partnership with a global player, car maker Re-nault-Nissan, was announced in January. Even with thisbackground, plans to deploy a regional and global infra-structure to support electric vehicles are still ambitious,but the prospects are good.

Newly found interest in cleantechBetter Place is the brainchild of Shai Agassi, an expertwith an outstanding reputation in the fast-changingworld of IT. This serial entrepreneur has startedseveral companies such as TopManage (distribution)and Quicksoft Media (software), and reached the Exe-cutive Board of SAP. Rumours say he quit in March2007 because it took him too long to reach the nextstep as CEO. Though he never claimed to be tired of IT,he found a new interest in cleantech. The public inte-rest in climate change – various studies raising theprospect of the end of cheap oil reserves, steadily ris-ing oil prices, a Nobel prize for Al Gore – made himthink about alternatives and consider an appropriatebusiness model. Since people do not seem to beabandoning the car, the change has to be made else-

where, e.g. in a switch from fossil fuel-based energy tonon-polluting oil-free solutions, as Agassi suggests. Hesees electro vehicles and the accompanying infra-structure as the best solution.

Widespread grid of charging spotsAgassi believes that “it will be the consumer, not theindustry, who drives the tipping point” of electro carsinto the mainstream. Whilst there is extremely easyaccess to fossil fuel, the difficulty in accessing otherfuels is the main barrier to alternative vehicles. That’swhy Agassi aims to deploy first a regional and then aglobal infrastructure to support electric vehicles. Thefirst country chosen for a widespread grid of chargingspots was Israel. Agassi anticipates “regions withdense populations where people drive less than 100miles per drive 99.5% of the time” to be the mostpromising areas for initial implementation. In Israel,most people drive less than 70 miles per day. The busi-ness model will be similar to that used by mobilephone operators. Consumers subscribe to energy, in-cluding the use of the battery, and pay for kilometres“used”; the ownership of the car is separated from therequirement to own a battery. With a view to the suc-cessful launch of electric vehicles onto the mass-mar-ket, Agassi forged a powerful alliance: while Renault-Nissan will supply the cars, the Israeli government willprovide tax incentives to customers. Electric vehiclesare expected to be available for customers in 2011.

Conclusion:With rising oil prices on the one hand and increasingunderstanding of the reasons for climate change onthe other hand, Project Better Place has found fertilesoil for its business model. Since Israelis are open-min-ded towards new technologies, Shai Agassi’s idea hasthe potential to be successful, at least in this country.Only one thing must be ensured to offer a truly “green”alternative: nuclear power must not be used to re-charge the batteries.

torsten.passmann@vc-magazin.de

Non-polluting oil-free solutions

Better PLC develops the infrastructure for a clean future

Renault-Nissan is first to market electric vehicles using rechargeable batteries byProject Better Place

Case Study

weitnauera partnership of Attorneys | Tax Advisors | Public Accountants

FinancingWEITNAUER initially made its name as a venture capital firm, but has grown to include comprehen-sive consulting services in all matters of commercial financing for both investors and investment targets.We have extended our focus from young technologystart-ups to the medium-sized business segment. The main areas of focus include funds structuring, structuring of shareholder agreements, mezzanine financing (silent partnerships, profit participationsetc.), project financing, prospectus drafting and review, IPO.

TransactionsCompany acquisitions, real property transactions,estate planning and succession rights are an important part of our work. Here, the cooperationamong attorneys and tax advisors /CPAs provides us with an essential advantage. We can offer comprehensive advice (“one stop shopping”), from an initial “quick scan” through financial, tax and legal due diligence to fiscal and legal structuring and evaluation (indicative evaluation, purchase price allocation, evaluation ofreal property, trademarks and licenses). We are alsoexperienced in specifically structured transactionssuch as spin-offs or management buy outs. Finally,we provide advice on estate planning, particularlywith a view to business successions, including thefull range of legal and financial issues.

For further information: www.weitnauer.net | www.weitnauer-vc.net

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