Israel Government and Venture Capital

The government of Israel has actively participated in the development of Israeli Venture Capital (VC) market through hybrid financing, i.e., a mix of private and public VC funds. This was done to gain the maximum advantage of private funds from foreign investors.

Formation of the YOZMA Group – Initiative of the Israeli Government

The government has continually faced the challenge in Israeli VC policies on how they can deal with a small size of their domestic market and limited availability of funds. In order to tackle this issue, the Israeli government created the YOZMA Group in the early 90s. This program followed the U.S. style VC operations. Although, it carried tax breaks and equity guarantees for foreign investors, yet, there were not enough incentives for local investors.

YOZMA group was formed in 1993 with the infusion of 100 million U.S. dollars that was supplied by the Israeli government. It is basically a VC fund that invests in high-tech startups. During the next three years after its formation, the group created a total of ten hybrid funds. The second fund was launched in 1995 with the backing of European, American and Israeli investors. Each of these funds was financed with approximately 20 million U.S dollars.

Alongside these initiatives, YOZMA was also involved in new startups, which gave rise to a professionally managed VC market in Israel. The group turned out to be a catalyst for development and growth of the VC sector in Israel. Companies at any stage of development could receive funds from the group, but its primary focus is to invest in early stage companies that target high potential companies in biotechnology and life science sectors.

YOZMA III CEO Club – Initiative of the YOZMA Group

The group also developed professional relations with a number of well-known academic institutions and IT incubators in the country. Some of the companies in the YOZMA portfolio directly arose from these institutions. With the aim to involve executives at a senior position and founders of successful firms in YOZMA’s activities, a group was formed called YOZMA III CEO Club. This group turned out to be a great success and was a valuable source of a number of investment opportunities available at a particular point in time to companies or investors.

Privatization of YOZMA and New Challenges Faced by the Government

The late 90s, the government took a decision to privatize the YOZMA group as it believed that the private sector was adequately strong and healthy. The Israeli government auctioned its direct co-investments in 14 organizations. It also sold away its interest in 9 YOZMA funds to its partners. Although, the state still holds a small interest in two YOZMA funds, yet, all the funds are privatized and the direct contribution of YOZMA related VC capital has largely declined.

Other Initiatives by the Government to Improve VC Sector

The Israeli government also undertook a number of other initiatives, including the launch of tax incentive schemes for investors, fostering the international research and development, and development of other programs.

Tax Incentives for International Business Angels

According to a research paper by Günseli Baygan, a large number of Israeli VC funds are believed to be injected by business angels in Israel and other countries, specifically the U.S. The government offered tax incentives along with other programs to connect small enterprises and VC funds with international institutions and multinational companies.

Many of the VC funds started their offices in the U.S. and Europe to provide assistance to portfolio companies in finding investors and bringing awareness of technological and market developments in the international market. Given the small scale of the local market, it was a great move to flourish VC firms.

Fostering International Research and Development (R&D) Agreements

The government also fostered international R&D agreements, including the Israel-US Binational Industrial R&D (BIRD) foundation and the US-Israeli Science and Technology Commission. The BIRD was established in the 70s to fund R&D in startup companies. Moreover, it has also made a contribution by working alongside VC community, making its matchmaking services available for their portfolio companies in order to find out the business angels.

Other Programs

Apart from the above mentioned initiatives, different government bodies, including the Export Institute in Israel, MATIMOP – an Israeli Industry Center for R&D, and MESSER – Israeli Idea Promotion Center, made their contributions by offering assistance to small firms and entrepreneurs in assessing local and foreign markets for launching their services and products.

The VC industry in Israel grew from an investment of $440 million in 1997 to $1,759 billion in 2007, and almost all the investments in the country focus on high-tech companies, including bio-technology and ICT.

China Government and Venture Capital

In emerging nations, governments have greater influence over markets than ever due to regulations and political control. The ubiquity of a government can be seen in every economy through indirect or direct ownership of investment vehicles. China is no different.

The Chinese government started relaxing its grip on the economy during 70’s, which resulted in the escalation of investment and private entities. Since 1979, private and foreign investments have contributed a major role in making China one of the fastest growing economy in the world. Despite that, the country struggled to have standard financing mechanisms for businesses, including the availability of debt finance for smaller firms or presence of efficient equity markets. Although, it gave rise to a number of challenges, yet, it created opportunities for Venture Capital (VC) in China.

Rise of VC firms in China

The VC firms started making their way in the Chinese market during the early 80’s, and the impetus for this development was public policies, because the government still plays a dominant role in the country. The National Research Center of Science and Technology for Development suggested in 1984 that China should set up a VC system to encourage high technology market development. A number of local governments in the country supported and sponsored VC funds so that they could be invested in State Owned Enterprises (SOE) so as to level them up at a global standard in terms of quality and productivity. An example of such organization was China New Technology Venture Investment that was formed in 1985. Some of them were established for years, while others were formed only to make an investment in firms, especially the SOEs.

During 80’s, the primary focus of VC firms was to invest in property and infrastructure as there was an increasing popularity in hotel development and tourism sector. However, many of these investments couldn’t perform well and private equity investors lost interest in such investments. By the end of 1980s, interest in the Chinese market started brewing again. Due to steady economic growth and the government’s interest in such investments, VC was encouraged. But it wasn’t without a conflict as the government wanted to invest in high technology market and private investors wanted to keep their focus on low risk investments.

Evolution of VC in the Chinese Market

There was a lot of investment failure in the beginning as tourism and hotel development business couldn’t produce sufficient return. Moreover, a sudden proliferation of VC also turned out to be a failure, because the government officials and entrepreneurs didn’t have that experience.

As a result of such failures, a new body was formed in 2002, called the China Venture Capital Association, to improve the professionalism in this sector. Since then, the VC ecosystem has not only evolved but also shown tremendous growth.

Current Status of VC in China

While the investors in the developed nations are cutting their stakes in startups and golden age of unicorns is reaching the end, the venture capital fund backed by the Chinese government has brought together the biggest pool of startups in the world. It has reached 10 times the amount invested by VC in startups in 2015 ($32.2 billion).

Beijing Initiative

The country recently announced the formation of a $30 billion state-backed VC fund for encouraging the reform of SOEs and bolstering innovation. The fund is backed by the State Council and China Reform Holdings Corps, and it is established to find out the market-friendly ways to combine state assets and easily channel investments toward specific projects. It can turn out to be an effective move by the government in the long run despite the concerns regarding inefficient distribution and governance of assets. With the help of this initiative, if Beijing successfully upgrades its SOEs through effective investment in promoting high-tech companies, it can be helpful in rebalancing the economy of China by taking its reliance away from investments that focused on consumption based growth.

Other Investments Made by the Local Governments

China is struggling with economic difficulties as a result of ever increasing corporate debt, skyrocketing home price and reducing trend in exports. To combat such issues, local governments in China are also entering the VC sector, investing a total of ¥30 trillion. The purpose of this investment is to trigger the development of high-end manufacturing firms, internet and bio-technology so that it replaces the eroded economic growth of stumbling sectors.

Around 780 local government funds are competing to seed the upcoming multibillion dollar startups, including online emporium Alibaba Group Holding Ltd, Xiaomi, and SZ DJI Technologies Co. (Drone maker company), as China is striving to create at least one Silicon Valley in more than 20 provinces.

If China is able to achieve a desired outcome of such investments, it will not only enable the country to avoid the middle income trap, but also scale the entrepreneurship and innovation at a massive level.

UK Government and Venture Capital

New startup have a potential for high growth, and these businesses have been emerging at a fast pace since the recession of 2008. However, the success of these companies is based on a number of factors, one of which is the availability of an appropriate source of business finance. Due to the credit crunch, new businesses suffered a lot in the UK in terms of getting finance. Therefore, it was important to rehabilitate the economy of the United Kingdom by encouraging alternate sources of investments, such as, Private Equity or Venture Capital funds.

The main challenge faced by the government of the UK was not to create high-growth firms, but to take measures in order to ensure continued growth of these companies. Innovative ideas can only thrive if the right investment opportunity is available. The businesses with a potential of high-growth need a substantial amount of funds up-front, which is hard to obtain via traditional sources of finance.

Rise of Business Angels in the UK

Right after the credit crunch, business angel network evolved in the UK and took the form of well-structured and organized groups of professionals. It allowed them to make significant initial investments and undertake subsequent investments in the same professional way as Venture Capital investors do. However, the Venture Capital funding system was not established and focused on investing in innovative ideas, but it began to change.

The UK Government Support for Venture Capital Investment

Inspired by the Venture Capital (VC) backed firms in the United States, economists and authorities in the UK showed rising interest in this alternate investment opportunity for its unique role in distributing resources and expertise to a small percentage of high potential businesses.

Every major economy in the world has implemented initiatives to promote the role of VC, and many governments have formed their own VC funds. Similarly, the UK government has established various hybrid VC funds to achieve the entrepreneurial objectives and bridge the equity gap by strengthening the VC ecosystem. The purpose of these funds is to focus on growth oriented startup firms with innovative ideas that continue to face difficulties in obtaining capital. The UK government has a history of such interventions in a financial market that goes back to 1945 the Industrial and Commercial Finance Corporation (ICFC) was formed for SMEs (Small and Medium Enterprises).

The Government VC Funds (GVCFs)

There are three main GVCFs operating in the UK, namely UK Innovation Investment Fund (UKIIF), Enterprise Capital Funds (ECF), and Angel Co-investment Fund (ACF). All of these are the hybrid co-investment schemes and their aim is to promote public-private sector investment.

UK Innovation Investment Fund (UKIIF) – It was established in 2010 to encourage VC investment in the Research and Development sectors. It supports the formation of viable investment capital and targets the high-potential IT businesses in the UK. The investment is made via two underlying funds, i.e., the UK Future Technology Fund (now ceased) and the Hermes Environmental Impact Fund. These funds invest in those VC funds that are involved in giving capital to strategically crucial sectors of the UK, such as, life sciences, digital technologies, advanced manufacturing, or clean technology.
Enterprise Capital Funds (ECF) – This fund started operating in 2006. It represents a combination of private and public investments in businesses that have a tendency of high-growth. The purpose of establishing this fund was to lower the entry barrier for fund managers to operate in the VC ecosystem as well as to increase the supply of equity in the region where small businesses do not have access to the growth capital. It is rolling a program of 19 funds around £840 million with a planned life-cycle of ten to twelve years.
Angel Co-investment Fund (ACF) – It is the UK government’s £100 million fund that was launched in 2011. The objective of this fund is to provide direct investment to SMEs with high growth potential and to support the UK business angel market. Under this scheme, funds are allocated across the UK with a goal to support companies at every stage of development in different sectors. Furthermore, it operates at an arm’s length from the UK government under the administration of the British Business Bank.

Government interventions have become more important with the rapidly changing business environment and more initiatives are required to be taken by the government to promote the innovative ideas in the country to boost the overall economic environment.

Governments and Venture Capital

Several governments around the world have started equity co-investment programs to bridge the financial gap by injecting Venture Capital (VC) to businesses that do not have sufficient capital but they have high potential. These hybrid (public/private) programs still engage private sector VC firms as a channel through which public support and a large amount of capital is invested.

Hybrid Scheme in the United States

In the U.S., models of the Small Business Investment Companies (SBIC) program, such as, hybrid schemes have been launched. It involves a participation by the state as a public guarantor or a special liability partner (LP) for the large part of the total capital raised for investment. Subsequently, full operational autonomy is entrusted to the general partnership (GP) by the state once the investment eligibility guidelines are agreed upon. This is done to attract investment returns to the investors, i.e., the LPs.

These models have been widely adopted by a large number of governments since the collapse of dot.com bubble that violently shook VC funding raising. Moreover, developing countries have also started showing interest in such models to encourage innovation and new startups.

Hybrid Venture Capital Schemes – The U.K. and Australia

Other developed countries, including the U.K. and Australia, also followed the SBIC models and designed their own Hybrid Venture Capital Schemes (HVCFs). The Enterprise Capital Fund was formed in the U.K., whereas, the Innovation Investment Fund was formed in Australia.

The UK government devised the program to provide growing startups an equity financing of £2 million ceiling. Under the program, the early stage funds, invested in the growing small and medium enterprises (SMEs) and startups, consist of private investment by the private investors with uncapped profit share and loan or equity from the government with capped profit share. A common structure of investment is one where there is an equal distribution of profit between private and public LPs. However, to increase the expected profits of private LPs, HVCF adopts a number of mechanisms where changes are made to the profit distribution, down-side protection, timings of investments, and the payment of operating cost related to the funds.

Although, SBIC wasn’t a complete success, yet, the governments that are in favor of equity enhancement programs followed its design and changed it to match their own requirements and preferences.

Issues Faced by High-Technology Companies

High tech organizations face three major issues when they try to access venture capital. Firstly, they do not have enough information about venture capitalists in the market and there are limited financial channels for technology companies. Secondly, organizations that seek public venture capital causes low demand for other VCs, and thirdly, these organizations need to have creative and dedicated management teams or else they face issues in convincing VCs to provide funds, which further widens the financial gap.

Role of Governments in a Developing Country to Counter the Issues of High-Technology Companies

Governments of different countries have taken measures to address these issues. For example, there is a “triple-helix model” that expresses a relationship between: University – Government – Industry to promote innovation in a society.

Innovation can be brought in industry and university via direct or indirect VC investment, government stock, enactment of laws, formulation of policies, and through the promotion of high-tech SMEs. Government can play its role in different ways, i.e., by having a creative function, through venture investment regulations and tax policies that directly leave an impact on VC market, and by other measures that indirectly affect VC industry, such as regulations and laws that govern the labor market, patent, stock market, pension funds, etc.

For example, there is a city in China called Suzhou where 75 percent of the science parks are backed by municipal public VC. A special institute, which is responsible to the Local Science Committee of the central Chinese government, was developed to administer these parks. The employees of the institute are directly recruited and trained by the government. Therefore, as a developing country progresses in becoming a developed nation, a shift in the role of public VC arises from its direct participation in the market environment to provision of services.

Governments usually provide support to the Venture Capital markets due to perceived market failure or financing gap faced by startups or early stage businesses, and also due to the positive impact it will have to bring innovation and create job opportunities for a prosperous economy.