Eran Wagner, a Managing Partner at i3 Equity Partners, is an Israeli entrepreneur and investor with a long-term experience from Silicon Valley. On December 2, 2016, he will take part in the most prestigious startup event in Slovakia, the STARTUP AWARDS, as a member of the jury. In the interview, he reveals the success factors of Israeli startup ecosystem, explains the role of the government and shares his most common advice for startups.
I would start with your personal story. How did you get into the world of startups?
I graduated from the Israeli intelligence forces and the University of Tel Aviv. In parallel to doing my master’s degree, I started my first company with a friend. We built a professional services company, and in the early days of IP networks, we provided critical systems management, network management, security and some application development services. It was complete bootstrap, we started with our own money in a garage if you will.
After this first company we decided that building a company selling products could be a really exciting experience. At that point, I moved to California and worked on our next company for approximately 7 years, exiting it to another big Israeli company called Amdocs.
I spent some time with Amdocs and then went to a mid-ranged company with 10 mil. USD of revenue growing it to approximately 50 mil. Afterwards, I decided to come back to Israel, which is when I moved to the Dark side – what they call it here –, joining a venture capital firm Gemini, one of the more established older institutionalized investors in Israel.
What does the Israeli economy look like today?
Israel is about 8.5 million people with a very diversified population including Jews, Muslims, Christians, spread across 13 000 square kilometres. Even though we are situated here, in the Middle East, with a very complicated political situation, we are currently at less than 5% unemployment rate, growth rate of 2.8%, GDP of about 305 billion USD and about 36,000 USD per capita, which is rather high.
The economy is generally recognized as an innovation ecosystem. If you have read the book called The Startup Nation, it gave it a name. Over the period of 20 or 30 years out of less than 70 years of existence, the country has over 350 multinational corporations with about 1,400 startups formed in 2015. We probably have probably the highest number of engineers per capita in the world. Among the OECD countries, Israel is the second highest after South Korea in R&D spending as a percentage of GDP with a value of 4.3% GDP.
What about the tech industry?
If you look at the high-tech capital raising, we are talking about almost 4.5 billion USD in 2015, which is a 30% increase from the last year, and 3.2 billion of that is VC backed. After 20 something years of being a startup nation, it looks like the local ecosystem is maturing. We have bigger deals, we have more mature companies, startups that are sold rather early, we know how to raise larger amounts and hopefully build bigger companies. We have much more management skills.
A lot of people look at us and say “Wow, such a big success!“ and to me, it seems we are just starting. We are only approaching the second part of the opening section of the evolution curve. However, the most important message is that the ecosystem is resilient and maturing. The next book might be called The Scale-up Nation or something like that.
Can we look into the “why and how” of such evolution?
It’s based on a very unique system that is comprised of a few important components. I’d say there are five of them.
First of all, we have a high quality and low-cost education system: schools, universities, colleges. The environment is very adaptive and creative.
Another very important aspect is the cultural ability to tolerate risk. „I’m gonna go for it, and if I fail, it’s okay.“ I learned a lot and nobody around me is going to think that I’m a failure or an idiot. On the contrary, they may then respect me more and want to work with me in the future. This enables young people to choose to take the risk and start their own company.
What about the other components?
We have almost no market here. Compared to Italy, France, UK, Germany, the US and China or India, it’s nothing. Therefore, most of the tech we develop is oriented from day one to be exported to other places.
Up until recently, we hadn‘t had any natural resources. There was some natural gas found, but generally, there is not much. We can’t rely on anything other than the human capital and the ability to create ideas and innovate.
Last but not least, there is the military. At the age of 18, I joined the army and found myself in a one-year crash course on developing software that is today still the best anywhere in the world. I knew very little when I got in and knew a lot more when I got out. More importantly, immediately after graduating this crash course, I got a job. It wasn’t a paid job as I was a soldier, but it was an opportunity to work on some of the most exciting technologically complex projects.
People can get to spend one, two, three years in a very exciting and challenging job. You simply learn a lot. It doesn’t matter if you develop some sort of an HR system in one part of the army or you develop real-time systems improving F16s. It’s just the matter that you get out into the free market, and you have already written many lines of code.
Is there any government support towards startups?
In the early 90s, the government identified that there was an opportunity here, and the Office of the Chief Scientist (OCS) launched a program that basically created the VC market. They started giving money to startups as funding and easing the risk of international investors to come and invest here. The program works with the budget of about 400 million USD a year, supporting R&D programs all over the country.
I would like to ask about the details of the program, if we can talk about that. It might be inspirational also for our country.
The OCS is responsible for the overall budget for hundreds of projects across the startup and industrial lifecycle. That covers the early stage startups with nothing but a PowerPoint presentation as well as large corporations trying to implement new technologies.
The support is focused only on innovative technologies. There are people in the Office who are responsible for checking the projects and make sure that they are specifically developing new technologies that do not exist anywhere else and that are competitive with what the market has to offer in other places. There are specific laws and programs that govern that activity.
One of the most important aspects, in my opinion, are the early stage, pre-seed and seed companies. The approval process is more relaxed from procedural perspective but is very strict and focused on things that are looking 3, 5 or 10 years into the future, depending on the technology and the market.
The support is up to 50% of the cost of research and development; it also includes some recognition of the commercialization and marketing expenses. But the total support for the projects is up to 5 mil Shekels for a period of 2 years. It’s about 1 to 1.5 million USD.
The OCS is more focused on the project itself – is it really innovative or not? Is it really something that does not already exist elsewhere? Does it have commercial value? They collaborate with the private sector to help them identify the best projects. If it’s a larger corporation, they require matching funds by the corporation, and if it’s a smaller company, they send them looking for external funding from the private sector to match the funds of the OCS.
You mentioned that the support is 50% of the costs. The remaining 50% is funded by VCs?
Right. One of the things that is unique about the program is that you get the approval first, but you don’t get the money. As they only support you up to 50%, you have six months to go and find investors to cover the other half. The government might say the project is good and scientifically unique, but then you have to find your commercial partner out in the free market.
Are there any other important initiatives worth mentioning?
Another program is called the Technological Incubators. It’s a program targeting individual entrepreneurs and very early stage startups. Investors or people with bigger pockets from multinational corporations set up incubators. They need to bid with OCS for specific locations and specific programs.
If they win the bid, they enter the program where they do the selection of startups. The OCS is committed to 85% of the expenses and the incubator covers 15% per project plus the cost of maintaining the stuff and people that manage the incubators. Afterwards, they do one to two year projects with the budgets framed in about 3 million USD per year or around $600K per startup. From an equity perspective, they don’t ask for a big part of equity. The entrepreneurs get 50-70% of the company, the incubator that licenses the projects gets about 20%, and the rest goes to the government.
Can we reveal what the process of picking up the startup projects in i3 Equity Partners Fund looks like? What do you look for in startups?
It varies from fund to fund, but at the end of the day, it’s much like any other investor in the world. You look for three main things: very strong team with a unique solution operating in a large market.
I don’t think that when you talk about different stages, the decision is the same. It’s different decision-making process for pre-seed and seed and different for series A or later stage companies.
Talking about the later stage, we have a lot of data to analyze, it’s very empirical, there is a lot of information to be processed. If you do a good job collecting all the data, you get a pretty good image of the company. If we talk about pre-seed and seed, there is nothing to learn about the company. There’s, however, a lot to learn about the market, the potential and the team.
If we talk about series A or early stage, that’s where there is a very fine line between doing one thing and the other. You need to identify the opportunity, the market and analyze the team. But at the same time, the team has probably already been operating together for about a year or two, and there’s a lot to learn about the knowledge they have gained. That’s part of our role as early-stage investors.
What is the most common advice you give to startups as a mentor?
The most important thing to do is to be aware and actively try to balance two different things. Number one is being stubborn and never giving up building your product and focusing on your vision and execution.
Number two, on the other hand, is that you need to keep your ears open to what people around are telling you. You go and meet VCs, and whether they invest or do not invest, listen to what they have to say. You don’t have to implement any of it, but you need to listen to it.
It’s a constant struggle between being stubborn, sticking to your vision and listening to what the market and investors are telling you. It takes a lot of patience and a lot of mental resources.
We bring you the interview in cooperation with the STARTUP AWARDS.
Photos: Eran Wagner