Startup Nation: rooted in socialism and military technology

Israel's first computer credit: Weizmann Institute of Science archives
Israel's first computer credit: Weizmann Institute of Science archives

"Globes" traces the development of Israel's tech industry back to the need for military self-sufficiency, government assistance and investment by US Jewry.

The weakness Israel's tech sector is currently demonstrating - whether due to the industry’s global crisis or economic uncertainty resulting from judicial reform - belies the fact that this sector is still alive and kicking, and its role in the domestic economy is stronger than ever. Miraculously, even during a crisis, Israeli tech continues to grow. Last week, the Central Bureau of Statistics reported that while the number of people employed in the industry has not increased over the past year, it has also not decreased significantly, remaining at 370,000-plus workers, close to 10% of the Israeli workforce.

Tracing the roots of Israel's tech industry back to the 1960s and 1970s, shows the extent to which this industry has always maintained continuous contact with government officials and ministers, cooperation with US corporations, foreign banks, and the US-Jewish community. Mapai (Mifleget Poalei Eretz Yisrael - the Labor party), the Likud party, MIT, Israel Discount Bank, the NYSE and Nasdaq all played a decisive role in forming the building blocks of Israeli tech in its formative years. Even if sometimes political considerations were behind certain decisions, they helped in founding a knowledge-based industry, in a country with no natural resources.

Globes traced the formative years of Israeli tech, the politicians, government officials, military generals, industrialists, and investors who made it what it is today.

The French arms embargo and Mapai-style capitalism

Two major events befell Israel in the late 1960s: the economic recession prior to the Six Day War in 1967, and the arms embargo imposed on Israel after its victory by then-French President Charles de Gaulle. These circumstances compelled Israeli politicians to increase spending, and plan the establishment of institutions that heralded the growth of Israel's tech industry.

In those years, the young country that had procured French-manufactured planes, ships, weapons, and technologies, and sent its best and brightest to study at the Sorbonne, suddenly found itself without a strong ally. "The decision made by the government in response to the boycott was one that ruled out the possibility that Israel would ever be dependent on another foreign power," says Prof. Dan Breznitz, Munk Chair of Innovation Studies, and Co-Director of the Innovation Policy Lab at the University of Toronto. "Instead, starting in 1967, the Mapai government invested in developing advanced weapons systems such as radar-guided missiles, tanks, fighter planes and ships."

But even socialist Mapai, says Breznitz, realized that without elements of a free market, it would not be possible to promote a profitable industry, one that would turn Israel into a global scientific and technological center, as envisioned by senior party leaders Levi Eshkol and Pinchas Sapir. Eshkol and Sapir benefitted from enormous political stability that allowed them to conduct a consistent and long-term policy and, in practice, shape Israeli economic policy (assisted by dozens of professionals and graduates of the Hebrew University of Jerusalem recruited specifically for this purpose).

At the same time, Sapir was engaged in a high-profile conflict over free-market competition with the Secretary General of the Histadrut (the General Organization of Workers in Israel), and Histadrut-run construction company Solel Boneh. The upshot was the Secretary General’s resignation, making clear to all the importance the ruling Labor party ascribed to private property.

Israel’s first 20-year-old super entrepreneur

Sapir and Eshkol were not operating alone in the 1960s. They already had several successful private companies at their disposal, all linked to one person. Uzia Galil was an entrepreneur and mathematical genius who had immigrated from Romania as a young man in 1941. After heading the Israeli Navy’s electronics R&D department, and becoming director of the electronics department at the Technion Faculty of Physics, at only 20 years of age he founded Elron in a small workshop. This would later become Israel’s first international privately-owned tech company, one that blazed the trail for those that followed.

Elron, founded in 1961, became famous less for the products it developed and more for its business breakthroughs. It was the first Israeli company to receive venture capital investment, thanks to funds raised that year from Israel Discount Bank and the US-based Rockefeller Group. In doing so, it became the first Israeli company listed on Nasdaq, and the first to connect with the US venture capital community. Among the companies spun-off from the Elron group to operate as independent entities were giants such as Elbit, Elscint, Orbotech and Zoran - all of which, in time, went public on the Nasdaq.

Galil was not satisfied with just founding companies, but proactively sought financing for them. It was he who convinced Discount Investments to make investments, understood before anyone else the importance of commercializing military technologies, comprehended the importance of obtaining US capital for this purpose, and was among the forerunners of the plan to encourage government investment in companies like those in the Elron Group. "Galil was extremely optimistic, almost irrationally - and often this is what enabled his companies to survive," says Dr. Micha Angel, who joined Discount Investments in the early 1960s, and served as its deputy general manager. "Even when a difficult problem arose, Uzia knew how to find the right solution by connecting with the right organization or person."

The first Israeli supergroup

Shortly afterwards, Discount Investments became the first private investment company in Israel's tech industry. The owners of Israel Discount Bank, brothers Raphael and Daniel Recanati, who lived in the US, hired retired Air Force Commander Dan Tolkowsky to manage their investment division in Israel, called Discount Investments. Tolkowsky invested in the more traditional Israeli enterprises, such as citrus fruits, paint, and paper, but a meeting with charismatic entrepreneur Uzia Galil in 1961 interested him in a new and growing market: commercialization of military technologies for civilian use.

At that time, banks tended to shy away from technology investments. Tech was a high-risk industry with little chance of success. However, Galil, together with Tolkowsky and his team, brought in Discount Investments as the main backer of Israel's first high-tech corporations: Elron, Elbit, Elscint, and Scitex.

The string of IPOs did not come by chance and is closely related to US Jewry. The owners of Discount Investments, as well as its senior managers, were exposed to what was happening in the US, and, in particular, to the Jewish community. This led it to not only adopt an innovative liberal approach to investments in the growing tech industry, but also to strengthen its connections with a community of Jewish investment managers and executives working in the US banking and financial system.

Tolkowsky tried to interest the growing US-based venture capital industry in investing in Israel. He even tried to convince Arthur Rock, one of the first investors in Intel and Apple, to make immigrate to Israel. Rock politely declined, but referred Tolkowsky to another Jewish person with warm sentiments towards Israel: investment banker Fred Adler, who had a network of Wall Street connections, and had aided some of the huge IPOs of that period. Adler agreed to meet with Tolkowsky, just to hear about his exploits in aerial combat while serving in the British Air Force during World War II. Adler decided to invest in Israel for other reasons: he understood the opportunity created for him by issuing these portfolio companies Thus, thanks to Discount Investments, Israel was now on the radar of US capital market investors as a growing producer of paramilitary and civilian technologies.

The tragic story of a Chief Scientist

In May 1966, in the midst of the recession that preceded the Six Day War, then-Prime Minister Levi Eshkol requested that a committee be established to examine setting up a government body that would provide support for R&D. Aside from his belief in R&D as an economic solution to the country’s lack of natural resources, according to Breznitz, there were also political considerations: "At that time, David Ben-Gurion had become Eshkol’s political opponent as the founder and head of a new party, Rafi, which set the promotion of science as one of its guiding principles".

In 1974, Minister of Trade and Industry Haim Bar-Lev , appointed the first chief scientist who single-handedly designed the Office of the Chief Scientist, forerunner of the Israel Innovation Authority, as we know it today: a large, independent statutory authority that allocates millions of shekels to private companies. For the position of Chief Scientist, Bar-Lev appointed his comrade in arms Brigadier General (res.), Yitzhak Ya'akov, who had served in senior positions within the IDF technological development establishment.

Ya'akov was the one who ultimately delineated the guidelines and ways in which the state supports private companies today: government non-interference in deciding on technologies, diverting government funding from academia to private enterprises operating in problematic sectors with the understanding that private companies are more efficient and know their markets well. He also established the Preferred Enterprise (PFE) regime that to this day provides large tax benefits to factories and companies operating in the periphery, and were the forerunners of the Encouragement of Capital Investment Law - today the most effective instrument for attracting large foreign enterprises to Israel.

During that time, however, Ya'akov ran into a problem. "Ya'akov realized very quickly that he had no clients," says Yigal Erlich, who served as Chief Scientist in the 1980s and 1990s. "He had to go around and encourage companies to ask for government funding, and as there weren't too many of them, most were portfolio companies of Discount Investments, Tadiran, military industries, and the aerospace industry."

At the same time, Ya’akov had to deal with a sluggish bureaucracy, frequent conflicts with the Ministry of Finance, and - until the mid-1980s - budgets that never increased beyond $30 million per year. But he persisted: after retiring as Chief Scientist, he moved to New York and founded the Worldtech Fund , one of the first Israeli venture capital funds, and helped found the first limited partnerships that attracted US investors to Israel. These gave birth to huge companies such as Comverse, Lannet, and Technomatics, which heralded the telecom and hardware industries in Israel.

Ya’akov met a tragic fate when, some 30 years after his retirement, he was put on trial for supplying foreign officials with confidential information related to his military service preceding the Six Day War, and he was given a suspended prison sentence.

The plan to bring venture capital funds to Israel

In 1991, then-Chief Scientist Erlich was invited to an urgent cabinet meeting. On the agenda was the question of how to immediately increase the number of jobs for the one million new immigrants from the Soviet Union. The idea of employing these immigrants in tech companies was met with skepticism at first. After all, though the Office of the Chief Scientist had been financing projects, foreign investors were not forthcoming, and the number of jobs had not increased significantly.

Due to the Shamir government’s need for an immediate solution for immigrant integration, then-Minister of Industry and Trade Moshe Nissim (Likud) agreed to Erlich's proposal to establish a program for government encouragement of foreign investments and to allocate $50 million for this purpose. The program, which was called Yozma (initiative) became the driving force that, for the first time, brought a series of foreign venture capital funds to Israel that teamed up with Israeli funds and eventually founded Israel's venture capital industry.

But to pass the decision, Nissim also needed the consent of Minister of Finance Yitzhak Moda’i, who was his political rival. Erlich, himself a polished politician, enlisted Yossi Vardi, then an advisor to the Ministry of Finance and a close ally of Moda’i, to help lobby for the program that was eventually agreed. The plan’s approval was the last decision made by the Knesset Finance Committee under the Shamir government.

Several years later, with the establishment of Yitzhak Rabin's government in 1992, the new Minister of Finance, Avraham Shohat, increased the program's budget to $100 million. "In those days, governments did not erase everything their predecessors had done," says Erlich. "The Rabin government just reinforced the decision made during the Shamir government."

But there were still obstacles: the first US fund to agree to examine Erlich's proposal, Boston-based private equity fund Advent, was afraid to take the initial step alone. Until then, most US venture capital funds were afraid to invest in Israel, which in the early 1990s projected instability, given the difficult security situation in those days.

Advent asked for a local venture capital fund to be involved. Ironically, the one selected was actually among the program’s fiercest opponents. Discount Investments had initially asked to receive Yozma government funding entirely for itself, a request that had been denied. The two founded the first Israel-based VC fund, Gemini; two of its investments, Precise and superDimension, eventually sold for hundreds of millions of dollars each.

Gemini's exits whetted the appetite of other groups that also wanted to benefit from government funding. The Jerusalem Economic Corporation wished to trade in Hebrew University patents, and to this end, recruited a US fund called JPV. The result was the establishment of a fund with a similar name: JVP, short for Jerusalem Venture Partners. Rami Kalish and a group of former staffers from investment company Dovrat Shrem & Co. (Aharon Dovrat and Itschak Shrem) recruited US company SCP to found Pitango; and Yoram Oron recruited Singapore's Temasek to found Vertex Ventures.

Yozma became the model for a government funding program. Once the Yozma funds had expired after seven years, the funds involved continued to raise mainly private capital, which have helped finance hundreds of tech companies since then. Some of the funds did not survive - including Gemini, Genesis, and Evergreen - but the overarching goal of Yozma to attract foreign investors to Israel was achieved.

When the VC giant set foot in Israel

The arrival of Sequoia Capital in Israel in 1999 - the world's most prominent venture capital fund at the time, famous for its investments in Apple, Google, Yahoo and Cisco - was a mark of success for Yozma. Besides being a significant milestone in establishing Israel's reputation as a fertile investment area, it also gave the green light for other venture capital funds to channel investments towards Israel.

Sequoia's first branch outside the US - even before its branches in China and India - was established in Israel by new partners at the time, including Haim Sadger, formerly of Intel. Up until 2016, when the fund decided to exit Israel, Sequoia stayed steadfast to the local industry despite the serious security incidents that occurred during the time it entered. "It basically gave other investors the seal of approval to come here and stay here," Sadger explains.

Foreign investors were given additional reassurance after pressure on their part led Israel's senior venture capitalists, including Chemi Peres, Yoram Oron, Zeev Holtzman and Yigal Erlich, to conduct vigorous negotiations with the Israel Tax Authority, which exempted foreign investors from capital gains tax. Thanks to that decision, for over 30 years, the capital invested in Israel by foreign funds has been four times higher than that of their Israeli counterparts, in addition to the fact that the capital held by Israeli funds is, for the most part, foreign.

"Beyond the individual exemption from paying taxes, the important achievement of the tax decision was to give assurance to foreign investors - which is a critical threshold requirement for raising capital - the same certainty that investors are looking for in Israel even now, in the turbulent waters in which the Israeli economy finds itself," says Giza Venture Capital founder Zeev Holtzman, who attended talks with the Tax Authority.

Today, however, for the first time, Erlich feels that the road first paved 30 years ago is under threat: "I have no doubt that Israel is now suffering from similar political and economic uncertainty. US investors will be polite, compliment this or that company, but will not put their money here without feeling certain about the decisions to be made the next morning."

The roots of 8200

The IDF Intelligence Corps tech units, in particular Unit 8200, have produced hundreds of entrepreneurs and tens of thousands of tech employees over the years, including the founders of Check Point, Mobileye, and NICE. 8200 was established as an intelligence gathering, analysis, and code breaking unit, not necessarily technological but more an information service and monitoring unit. It received its current name only after the Yom Kippur War, but over time, began to develop technological capabilities beyond intelligence work.

After the Six-Day War, the unit recruited a succession of students from the Technion, as well as some reservists, and subsequently established internal study, training, and guidance divisions within the unit. "Very high-level people were brought to the unit, and because of the importance of the tasks, a culture developed for finding quick solutions in the face of immediate threats," says Nir Lempert, a colonel (res.) who served in the 8200, and is chairman of the 8200 Alumni Association.

But the military innovation for which 8200 is famous is a relatively new phenomenon. It was preceded by Rafael, which was the first Israeli security unit to have a computer - Itzik - the IDF’s first simulator that was already operational in the 1950s. "The ever-increasing demand for engineers at Rafael and in the security establishment also led to an increase in their historical status as an educated social stratum with a high salary already by the 1960s," says Breznitz. "Rafael related to its employees as scientists, paid them high salaries, provided good conditions, and a sabbatical year. It funded engineering studies for high-quality candidates in Israel and abroad, and is responsible for several hundreds of Israelis who attended prestigious institutions like MIT and Stanford."

Between 1967 and 1980, Israel had the highest growth rate in the number of its engineers and scientists - 260%, twice the rate shown by Japan, for example. When the 1960s boom happened, Rafael became the central trunk out of which sprouted the first limbs of Israeli high-tech: the IDF computing unit Mamram [the Hebrew acronym for "Center of Computing and Information Systems"]; Elbit, which was established in 1966 as the military arm of Elron; and Israel Aircraft Industries (today Israel Aerospace Industries), which was elevated when a team from Rafael was assigned to develop the Gabriel naval anti-ship missiles at IAI.

Published by Globes, Israel business news - - on May 3, 2023.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2023.

Israel's first computer credit: Weizmann Institute of Science archives
Israel's first computer credit: Weizmann Institute of Science archives
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