What's so good about Israel's incubators?

Israel's reputation as a startup nation is well deserved, with a host of tiny, ambitious entrepreneurs earning disproportionate levels of VC and corporate investment.

A key contributor has been the incubator programme, set up in 1991 to help translate a wave of scientific knowledge flowing in from Eastern Europe into business. That has delivered more than 1000 graduates, 60 percent of which have continued on as going concerns.

So what is it about Israel's incubators that works so well?

Oren Gershtein, chief excutive of Van Leer Technology Ventures, an incubator housed in Jerusalem's Hebrew University, says the key is in the structure: the right people are incentivised to do the right thing.

New Zealand's got incubators too, and does many of the same things as Israel's, but after discussing the scene with Gershstein I see three key differences between the Israeli and Kiwi approaches:

1. Privately owned. Ten years after establishment, the incubators were privatised by the Israel government. This changes everything: instead of being staffed by civil servants or academics, they are run by fund managers drawn from the ranks of VC; instead of being motivated by public good they are profit driven; instead of giving the proceeds back to a large university or city council, the upside is kept by shareholders and staff motivated by options and share schemes; and instead of being tied to one institution, the incubators aggressively seek new startups from anywhere in the world (they'd like to see what we have in New Zealand for example).

2. Deal structure. Once the incubator managers like the look of an entrepreneur, they apply to receive government funding of up US$600,000 for two years. This is provided as a loan – not as equity. The incubator then tops up that investment with private sector angel money; typically 15 percent comes the from the angel.

Again, this changes everything: the loan needs to be repaid so the incubators are incentivised to generate some revenue fast. It also means private investors are involved from the beginning, so these deals have to pass the angel investors' tests before they even enter the incubator.

3. Royalties not equities. About 70 percent of Gershtein's new startups come straight out of from university research.   In New Zealand the universities and Crown Research Institues have been criticised for holding on to their IP too long, rather than spinning it out early into private hands. In Gershtein's incubator, the research institution gives up its ownership in exchange for a license fee and a royalty stream. The researcher, who's leaving the safety net of the university to start the company, is given  up to 50 percent of the new company in shares.

The advantages are clear. Universities make poor business managers; they're complicated, ponderous, political. By rapidly spinning out the IP ownership into private hands the university has a much better chance of a commercial return.

There are other things that Gerhstein and his colleagues are doing right, especially in the area of mentoring the young entrepreneurs. But I don't see Kiwi incubators doing badly on that front. It's the structure of the deals that makes the difference.

"The system is a lot more successful than it used to be before private ownership," he says.

How successful? Well, 80 percent of Gershtein's startups are still in business. Not many entrepreneurs could claim that.

As for the idea that Israel is tapping into some wealthy friends in the USA, Gershtein wishes that was true.

"Money is hard to get from anywhere. I wish there was friendly money around, but the world is more complicated than than that."

[Photo credit]

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