ISRAEL’S CHIEF SCIENTIST AVI HASSON INTRODUCES ISRAEL'S FIRST ANNUAL
INNOVATION REPORT

Hasson: “Our challenge in the coming years will be to remain at the
forefront of global technology while implementing innovative measures in all
aspects of the market and the economy."

The report identifies four significant measures that should be taken to meet
these challenges:

* Creating new sources of funding for industry

* Turning more hi-tech companies into major companies

* Implementing and developing technologies in traditional industries and in
the public sector

* Smarter and more efficient government involvement

JERUSALEM. April 15th, 2015 – The Office of the Chief Scientist (OCS) at the
Israeli Ministry of Economy has introduced its first annual Innovation
Report. This report presents an overview of the Israeli hi-tech industry
while describing the trends, challenges and opportunities in different
sectors of the industry. The report was written in cooperation with several
authorities, including the ministry's Employment Department, Digital Israel,
the Program for Returning to Industry and Academia in Israel and others. It
illuminates, in one place for the first time, different aspects of the
country’s innovation ecosystem - from the state of human resources to the
European framework program (Horizon 2020), from the life sciences program to
a review of the growth and potential in the phenomenon of crowdfunding.

According to the Chief Scientist in the Israeli Ministry of Economy, Avi
Hasson: "This first innovation report summarizes current trends in Israel's
hi-tech industry. With it, we begin an annual tradition of presenting an
overall picture of the state of the industry in this country. I believe such
a picture is necessary to analyze the trends developing before our eyes and
to identify the main challenges we must face and the new opportunities at
hand. It is incorrect to look at the hi-tech industry as monolithic - the
“startup sector” and the more mature industry operate differently and
require different tools if we are to move the market forward. Though 2014
was a hallmark year for Israeli startups, we are far from reaching the
industry's full potential."

Additional highlights from the report:

* Launching the Hi-tech Index – the first Israel Hi-tech Index examines the
current state of the industry and offers a positive picture of the Israeli
hi-tech market, reflecting an impressive boost in startups and a market
recuperating from the crisis of the last few years. The index, however,
tells the story of two separate but related "industries": the startup
industry, which has been blossoming over the past few years, and the more
mature industry which has been treading in place in the same period.

* The lack of expected growth in the mature industry is also expressed
through the fact that not enough major hi-tech companies are emerging in
Israel.

* The "startup industry" is flourishing with $3.4 billion in capital funding
and $7 billion in exits in 2014.

* Israeli hi-tech is becoming more dependent on foreign funding - only 20%
of funding comes from Israeli venture capital funds.

* The industry in general suffers from a significant lack of personnel – in
particular engineers and technicians.

* Over the past few years, we have witnessed alternative modes of funding:
corporate venture capital funds, micro-funds, crowdsourced funding and
increased involvement of institutional financial bodies.

The full report (in Hebrew): http://madan.mag.calltext.co.il

Chief Scientist Avi Hasson added that: "The innovation report allows us, for
the first time, to examine characteristics and trends which were until now
isolated, to connect the dots and create an overall picture, with desired
horizons of activity, clear goals and ways to meet new challenges. The
ecosystem in which the hi-tech industry operates is multifaceted and
complex. We identified five core components in this ecosystem: innovation
policy, human capital, funding, industrial innovation and international
activity. The report raises issues affecting anyone concerned with advancing
the hi-tech industry and implementing innovation in the private and public
sectors. Reviewing these issues is meant to serve as a basis for ongoing
dialogue between the industry, investors, entrepreneurs and the government,
and to direct our joint efforts towards attaining economic prosperity
through technological innovation."

The Need for New Funding Sources for the Industry

2014 was a record year for raising capital for the hi-tech industry, but a
look at the long-term trends reveals that sources of funding for the
industry are not sufficiently robust: the venture capital model was shaken
in recent years due to economic crises and relatively low yields, and this
led to a selective reduction of the number of funds and to mergers by many
players in the market. Moreover, the local stock market's position has been
eroded and many companies choose to go public and raise money on foreign
stock exchanges.

In light of these changes, the industry must increase funding and diversify
such sources as institutional bodies or the greater public through
crowdfunding platforms. This would ensure that there are sufficient sources
of funding for companies with different needs and that there won't be
dependency on one dominant source. The OCS, whose budget has also diminished
over the years, is partnering with the industry to pinpoint new sources of
funding and remove obstacles limiting the use of alternative channels.

Apart from increasing funding, there is great importance in diversifying
sources which can be utilized as “Smart Money” - i.e. investments that will
help companies grow and enter new markets. Even if capital-rich sources are
found, “Smart Money” would still be lacking in some areas, i.e. investment
which is not purely financial but which comes from investors with experience
and ties in new markets, who can help companies grow and develop wisely.

Growing More Hi-tech Startups into Major Companies

Israel has been blessed with a plethora of startups but many of them are
quickly sold to larger companies and never grow to become major companies
within Israel. Some claim that these "speed boats" - startups with quick
exits - are where our market's competitive edge lies, but the OCS believes
that growth of local "large ships" - i.e. mature companies - is crucial.
Large companies employ a higher number and wider variety of employees and
develop know-how within Israel. It is also more difficult to move their
activities abroad. The challenge of company growth is not purely
technological but also requires identifying market trends, grasping foreign
cultures and understanding different markets - with the business development
this entails.

Therefore, the OCS shouldn't oppose entrepreneurs heading for exits, but
rather create incentives and conditions that will make it worthwhile for
Israeli companies to continue their growth in Israel. The OCS has seen many
web-related companies that have demonstrated significant growth in recent
years such as Outbrain or IronSource, but this is not enough - more
companies like these are needed to become market leaders.

Implementation and Development of Technologies in Traditional Branches and
the Public Sector

Traditional industry in Israel is characterized by low-level technological
proficiency and low productivity. Increasing access to innovative
technologies and R&D and providing the means to implement them are the basis
of increasing productivity in these branches. The Office of the Chief
Scientist is leading a program supporting R&D in traditional industries and
has invested NIS 1.5 billion in these industries in the past few years.
Government services to citizens can also be greatly improved through
technological innovation. To this end, the OCS is cooperating with Digital
Israel, the bureau in charge of modernizing public services.

Efficient and Smart Government Assistance

Today, the structure and defined purview of the OCS is not in sufficient
sync with its clients' needs and makes it difficult to provide timely,
focused solutions. Therefore the OCS has recently led a wide-ranging
strategic process examining how the OCS must adapt itself to the dynamic
reality, while updating its instruments of support in light of the above
challenges. With the establishment of the new government, the OCS intends to
begin promoting the organizational changes this entails. The OCS is getting
ready for a significant strategic-organizational shift, intended to increase
accessibility for industry, focus the missions it undertakes and adapt its
capabilities according to these goals. This will be accomplished by moving
from an agency with a single funding structure to five centers of
innovation, each with its own mission and target audience.

According to Chief Scientist Hasson: "As an organization serving the
innovation industry, we will strive to innovate the tools we utilize and
increase experimentation with the diverse, creative means at our disposal.
This, while maintaining our existing core of support for industrial R&D
always with an eye towards what’s good for the market and advancing industry
as a whole."

The Hi-tech Index

The Hi-tech Index is designed to differentiate between fledgling startups
and more mature companies, and therefore help create a more focused work
plan adapted to these different characteristics. The Hi-tech Index will help
analyze the innovation ecosystem in Israel and outline a policy and the
means to implement it, while keeping in mind a company's characteristics -
first and foremost through clearly differentiating startups from mature
companies. The startup industry is highly influenced by shifts in the
financial world and behaves dynamically. The index allows us to follow flows
and ebbs in startup activity and their connection to global developments. On
the other hand, mature companies characteristically enter crises in a more
controlled manner and usually recover relatively quickly.

A major part of the report deals with new funding alternatives:
strategic Investments and Corporate Venture Capital Funds

Two main alternatives for Israeli tech firms other than raising funds or
going public have become available in recent years. The first option is
strategic acquisition by a major corporation with large cash reserves and
the desire and ability to buy a startup or promising technology. This is
much more than a purely financial deal since these major companies often
serve as platforms for wide-scale distribution and an interface with a
global crowd of consumers. This phenomenon has transformed the goals of many
startups, which see it as a value-added proposition due to major
corporations' willingness to pay sums exceeding the startup’s market value,
following considerations like “synergy” or eliminating competition. This is
backed up by recent examples in the global arena such as the acquisition of
WhatsApp by Facebook for $22 billion in October 2014 and in the local arena
with the acquisition of Waze by Google for $1.1 billion in June 2013.

Another option is raising money through corporate venture capital funds,
which are gradually becoming key players in the local industry, despite the
fact that their scope of activity in Israel is still far from that in the
US. Several foreign corporate venture capital funds are currently active in
Israel, while Israeli corporate VCs investing in local ventures are all but
nonexistent. Despite popular misconceptions, corporate VCs seeking
innovative value for their activities are willing to invest in all stages of
a company, particularly in their early stages. This is evident by the high
number of corporate accelerators in Israel, from companies like Deutsche
Telecom, Citi and others.

The obvious advantages are the strong ties corporations have with the
industry and access to infrastructure and know-how unique to the
corporation. The main disadvantage can be an occasional conflict of interest
between a corporation and the invested company. However, companies in the
seed and pre-seed stages still do not sufficiently enjoy this channel of
investment, many times because of the difficulties in identifying the
appropriate contact who will open doors at the major corporation.

More Alternatives: Micro-funds and Crowdfunding

A wider look at the funding needs of Israeli technology companies shows that
in the current business environment that enables sufficient funding for
companies in early stages, many new startups are cropping up. As a result,
there is "inflation" of seed companies reaching the first significant
capital-raising stage (Round A). This typically involves a significant
increase in companies' capital needs and the supply of concentrated capital
by VC funds. On the other hand, funds have moved more and more in recent
years to a "bigger bets" strategy, i.e. investing larger sums of money in a
smaller number of companies which are predicted to make successful exits.
Thus, the available capital is relatively limited considering the number of
companies vying for it, especially in light of the extra demand for funding
described above. The lack of Round A funding makes it difficult for many
companies to finance their continued activity and sometimes they must either
cut back or even close down (series A crunch). In the US, this phenomenon
acted as a catalyst for the creation of funds specializing in investment in
early-stages (micro-VC), and this trend is now coming to Israel. The Round A
funding gap in Israel is estimated at $100-200 million.

The blossoming of micro-VCs also comes from a change in companies' funding
needs and the character of exits, especially in web, mobile and new media
companies. Companies in these fields need relatively low amounts of money
and strong competition leads to quick exits for relatively low sums. In
answer to this need, micro-VCs have arisen, managing sums in the low tens of
millions and investing small sums in companies at their early stages. They
thus fill the gap left by large funds, interested in investing larger sums
of money with an eye towards greater gains from large-scale exits. In the
years 2011-2014, Israeli micro-VCs raised $440 million, 14% of the total
capital raised by Israeli VCs.

Another platform providing solutions for early-stage companies and gaining
traction in recent years is crowdfunding. A more selective type of
crowdfunding is the model of "smart investor clubs." This model is based on
raising larger sums from a select crowd of wealthy and experienced
investors. The Israeli OurCrowd equity-based crowdfunding platform is a
trendsetter in this field. In less than two years, the company raised more
than $90 million, invested in 55 companies and recruited more than 6,000
investors.

Increased Interest by the Financial Sector in Hi-tech

Another trend in early-stage funding is the increased interest shown by the
financial sector in hi-tech. Recent steps taken by major banks show that the
banking system understands the added value of hi-tech and is investing
resources and efforts in harnessing it, both to facilitate
intra-organizational innovation and to leverage credit for hi-tech
(especially in an economic environment with a 0% interest rate). The lion’s
share of funding in hi-tech today is supported by private equity. With an
eye towards developing the field of debt financing in hi-tech, Bank Leumi
and Bank Hapoalim have established tech branches giving this industry
targeted solutions. A bank's tech branch will offer deep financial expertise
in the world of hi-tech and increase the package of services given and the
credit allotted to this field. Through services and funding options not
currently available, and by giving added value to the companies themselves,
banks intend to become major players in funding hi-tech companies.

Another main channel of activity for advancing organizational innovation and
improving banking services and user experience is investment in companies
specializing in financial technology (fintech). Thus, Bank Leumi teamed up
with The Elevator accelerator to launch a unique program for advancing
innovative initiatives in the fields of finance and banking. Bank Hapoalim
established a unique fund that will invest NIS 80 million in technology
companies specializing in developing products for the financial markets. The
Israeli financial sector’s openness to adopting and promoting technological
innovation, as both investors and advisors, is expected to greatly assist
the hi-tech sector. The OCS has begun examining additional ways to support
this activity and increase the presence of the Israeli finance sector in
Israeli hi-tech, especially where growing companies is the goal.

It should be noted that the OCS runs 45 support programs in five main areas
of activity: startups, technological infrastructure, growing companies,
international activity and R&D programs. These programs enjoy a budget of
NIS 1.5 billion annually and offer assistance in many fields, including:
cyber-security biotechnology, life sciences, communications, software,
cleantech and others. Chief Scientist programs reach all parts of the
country and every branch of industry.

The presence of foreign funds in Israel has been growing and as a
consequence, so has Israeli hi-tech's dependence on foreign capital. So, for
example, in 2013, foreign investors funded 75% of investments in Israeli
companies and 85% of all capital raised by Israeli VCs. In effect, foreign
funding is responsible for up to about half the R&D funding in Israel. Most
foreign funding invested in Israeli VCs comes from the US, but in the last
three years, there has been increasing interest from investors in Asia,
mainly from China.


For more information contact:
Headline Media | Foreign Media Adviser to the Economy Ministry
Aaron Kliner - ministryofeconomy@headline-media.com