Israel’s hi-tech industry is booming as the eternal stream of start-ups in the sector continues to flow. The country is attracting more and more interest from foreign companies looking to invest in innovation.
For a long time t
he sector has been given support by the Israeli military, which is keen to invest in new technology. This, combined with the country’s political and geographical position, has helped to create a unique business culture where start-ups appear regularly and in big numbers.
“The emphasis the military places on developing technology has been one of a number of drivers for the tech industry,” says Barnea & Co founding partner Simon Jaffa. “Similarly, it’s been argued that the inherent insecurity here means people are much less afraid of taking risks. If you’re living somewhere where there’s already an inherent risk in your day-to-day life, starting a company and going it alone doesn’t seem such a big deal.”
This culture has led Israel to be described as ‘the start-up nation’ and, as these companies grow, the hi-tech sector is seeing an increasing number of market exits.
Exit numbers
According to data from IVC Research Centre the value of hi-tech exits in Israel increased by 16 per cent in 2015, from $7.78bn (£5.35bn) to $9.02bn. The figure is the third-highest for 10 years, after 2006 and 2012 saw exits totalling $10.75bn and $9.75bn respectively.
The stats for 2006 and 2012 are somewhat misleading as a low number of very high-value deals masked the true trend. By removing all deals valued at $1bn and above the data shows 2015 to have seen the highest total exit value in 10 years. On this basis 2015 also had the highest average value per deal at $75m, compared with the 10-year average of $48m.
“The inherent insecurity here means people are much less afraid of taking risks”
The research was carried out in conjunction with Israeli firm Meitar Liquornik Geva Leshem Tal and corporate partner Dan Shamgar who understands the start-up culture in the country but believes the market is slowly changing.
“There’s still a culture of setting up companies and trying to sell them early and move on to the next venture,” says Shamgar. “However, more and more companies are now realising that they can generate much better returns if they stay around for longer periods, especially if you look at entrepreneurs who are leading their second or third start-up and have already sold a company.
“With this extra experience they realise that if they spend an extra few years with their company they can create better value, and more companies are willing to go for the long run and try to get better valuation.”
Shamgar adds that there are still companies looking for a quick exit but as a whole more business owners are holding out in the hope of better returns. As a result, Shamgar notes that there has been a rise in the number of exits valued between $100m and $500m and a decline in those valued at less than $100m.
Specialist services
The rise in M&A and IPO activity has allowed law firms to thrive across the country but has also meant firms have had to adapt to new requirements from clients. This has often involved hiring specialist lawyers to provide additional services.
“You can no longer afford to have no antitrust or tax capabilities,” says Nitschitz Brandes Amir head of hi-tech Gil Brandes.
“For some of the bigger firms, such as Herzog Fox & Neeman [HFN], tax was a specialty as it was part of how the firm grew. If I look back 10 years at our practice we had a tax specialist, but when it came to doing sophisticated and complex mergers we called in the Big Four.
“You can no longer afford to have no antitrust or tax capabilities”
“This is no longer the case as the volume of work means you need a tax team and you need antitrust people, which we’ve had for the past six or seven years,” Brandes adds.
This is largely due to the increased volume of work coming through the doors of Israeli firms, but also to the increased number of deals with a cross-border element.
Cross-border expertise is needed as foreign companies act as the acquirer in most exits in the hi-tech sector. Without the expertise needed to work with these companies Israeli law firms could miss out on the vast majority of exit deals.
Cross-border work
The majority of acquirers acting on the hi-tech sector’s M&A deals are foreign companies. Last year 53 per cent of these companies were from the US, 9 per cent were European and 3 per cent were from East Asia.
For many firms, increasing their knowledge of how overseas companies do business has become essential to being able to represent their clients as well as attract new ones from overseas.
“To be involved in many of the deals you need to have access to the target companies as well as the potential investors,” says Erdinest Ben Nathan Toledano & Co (EBN) partner Roy Caner.
“We recognise that today a hi-tech company would like you to represent it during its life cycle and during its M&A transaction, so we established a team to do it.”
“Quite a few Israeli companies have become strong on their own and are acquiring other start-ups”
Caner notes that EBN has a strong history of representing start-up hi-tech businesses and has recently equipped itself to increase the level of work it carries out for private equity companies. It did this by hiring Doni Toledano and a team of 10 lawyers from Zellermayer, Pelossof, Rosovsky, Tsafrir, Toledano & Co.
Toledano and his team of M&A specialists have strong connections with private equity funds in the US, Europe and China. This means they are perfectly suited to acting for their domestic clients and have the potential to link them with potential investors overseas.
However, for Nitschitz Brandes Amir, knowledge of how overseas companies operate takes place at an early stage, with the firm sending two lawyers a year to train with foreign firms. This allows them not only to develop their language skills but also means that the firm has an expert in understanding how law firms work in different countries.
Cultural challenges
Despite only 3 per cent of M&A deals involving East Asian companies, China is fast becoming a major investor in Israel. But the differences in the way Israeli and Asian companies operate have often caused challenges.
“Pace is a big thing for the Chinese,” says Tadmor & Co Yuval Levy & Co corporate partner Elie Sprung. “They have their own pace and things work much, much slower than in Silicon Valley or in Israel.
“We’ve spoken to many Chinese investors who were interested in a specific company and by the time they were ready to sign a terms sheet the entire transaction had already occurred.”
“Legislative changes in China have eased the flow of funds into Israel”
In an attempt to bridge the culture gap between Israel and China Tadmor Levy has a partner dedicated to Chinese investors. The firm also has a presence in Shanghai and works with Chinese law firms. This allows it to increase its understanding of how Chinese law firms and businesses work.
A number of Israeli firms also cite cases where Chinese companies have pulled out of deals at the last minute with little or no reason given.
Despite this a number of exits still take place involving Chinese businesses, such as the acquisition of the medical equipment manufacturer Lumenis by XIO Group. EBN’s Toledano advised Lumenis throughout the deal but he admits the acquisition differed from the typical Israeli exit as the Lumenis is “very established”, having been formed 15 years ago. As the Israeli company is far from being a start-up, it may have appealed more to XIO as a low-risk venture that did not require a hasty sale.
HFN co-head of hi-tech Yair Geva is confident that interest from Chinese companies will continue. In particular, he says that Chinese internet and mobile companies have been increasing their interest in Israel’s tech sector. He also says legislative changes in China have “eased the flow of funds into Israel”.
The home front
Although most acquirers of Israeli hi-tech companies are from overseas many in the legal market have noticed an increase in the number of deals between domestic firms.
“There is a new trend – quite a few Israeli companies have become strong on their own and are acquiring other start-ups in Israel for significant amounts,” says Caner. “This is something that was quite rare a few years ago.”
In 2015 30 per cent of M&A deals in the hi-tech sector saw an Israeli company purchase another domestic business.
“Israeli companies are getting bigger,” adds Caner, “and more and more are getting to the point where they are worth $1bn.
“If the Chinese, the Americans and the Europeans are coming to shop here that means there is good technology here that is worth shopping for,” he adds. “It’s much easier to do it at home.”
With Israeli companies such as Check Point continuing to grow in value as well as beginning to acquire domestic start-ups the market could soon change. Israelis may start competing with US businesses for the latest hot company and boost the market from within. The speed at which these companies may be willing to operate could also mean the Chinese are left behind, wondering what happened to their piece of the action.
Capital markets nerves may hit IT sector
HFN [Herzog Fox & Neeman] has traditionally advised multinational companies and foreign investors on their transactions in Israel. Since Israel began to evolve as a major hub of technology and innovation – a process that started more than two decades ago – we have seen that a growing portion of our cross-border practice involves the hi-tech industry.
Around 10 years ago the firm started to focus on the representation of local tech start-ups, as well as our traditional client base of foreign investors.
Our hi-tech department acts for a wide range of players in the Israeli hi-tech scene, and each type of client has its own set of legal needs. First are the emerging-growth technology companies, which the firm usually starts representing soon after an idea is conceived by the innovators. These founders will seek advice related to initial incorporation and IP protection. We continue to support these enterprises during their life cycle, including investment rounds, commercial activity and, eventually, to exit through M&A or IPO.
Next are investors in Israeli technology companies, who can be private individuals making a small seed investment, venture capital or private equity funds, or strategic investors. Here, we have recently seen a major shift. For many years investments in Israeli technology came almost exclusively from the US, but in recent years we have seen much more activity from Asian investors, especially from China, Japan and Singapore.
Third are the multinational companies looking to acquire cutting-edge Israeli companies. In each representation, we look to offer our clients a business-driven approach taking advantage of the fact the HFN is a full-service law firm, where teams with various specialties collaborate.
Market outlook
Early indications are that 2016 will be robust for our practice, following a great 2015. In 2015 we handled major transactions for Israeli technology companies (such as Checkmarx, Mantis Vision Sisense, Thetaray, and more), financial investors (such as Vertex, Longtech Medical, Pico and others) and multinational companies (such as Abbott, Cisco, Fosun, Microsoft and Sandisk). While capital markets have been nervous in recent weeks, which may lead to some slowdown in the tech market, we look forward to another strong year.
Hanan Haviv, co-head of hi-tech, Herzog Fox & Neeman