Your taxes: Investing in the start-up nation

What else do you check apart from chutzpah before investing in an Israeli company?

By LEON HARRIS
Jerusalem Startup 311 (photo credit: Daniel Alster)
Jerusalem Startup 311
(photo credit: Daniel Alster)
Some Israeli businesses have done surprisingly well, according to Dan Senor and Saul Singer in their book Start-Up Nation, The Story of Israel’s Economic Miracle. The cover says, “While Americans emphasize decorum and exhaustive preparation, Israelis put chutzpah first.”
But what else do you check apart from chutzpah before investing in an Israeli company? Before investing in any company, you should carry out due diligence and consult legal and professional advisers in each country. Here is a non-exhaustive review of things to review.
• First, what is their product? Does it work or does it still need “just a few more months” of development? The easiest way to answer that is to check there are successful sales or at least sales orders.
• Second, what is the “value proposition” that makes it special in the marketplace? Is there intellectual property (IP)? Is it legally protected by patents or similar? Or is it a “me too” product hoping to do well until the next “me too” product comes along? • Third, do their goals match yours? If the company doesn’t have goals, it certainly won’t achieve them. In hi-tech, homeland security and medical devices, you may hope for an exit in three to five years. An exit may be by way of acquisition or initial public offering (IPO) on a stock exchange. In biotech it may take 10- 15 years. In other sectors you may be more interested in a steady annual return over many years.
• Fourth, what is the deal on offer? What will your money be used for? How much do they need and what percentage of the action would you get? This is often a controversial area, as most Israeli entrepreneurs have trouble going below 50.1 percent even if they will still be a major force at, say, 40%. Later rounds of finance are even tougher. The later investors must generally pay more and should check what their percentage will be, especially if an earlier investor benefits an antidilution. And do you get a seat on the board and veto rights? • Fifth, who are the major players? The entrepreneur(s) pushing the operation, the inventor if any, the other investors, the CEO, CFO, CTO, the other key employees, the lawyers, the accountants, the bankers and any mentor behind the scene.
• Sixth, how do you rate the management? Do they have vision or just tunnel vision? Is each executive well educated, experienced, fit and able to devote their time and energies to the venture? Is there a chief financial officer? If not, walk away; you can’t hand over money if there is nobody to look after it. Are there regular orderly board meetings? And are there detailed monthly and quarterly management accounts? There should be, as the Israeli tax regulations require proper accounting records to be kept.
• Seventh, are their finances in reasonable shape? How well did the company do last year and this year? Have future projections been prepared based on reasonable assumptions? Do they show reasonable growth? If the company is still at the development stage, what is the cash burn rate? When is your payback expected? Is there sufficient cash flow? Have you checked for liens and mortgages at the Companies Registry and elsewhere? Are costs reasonable? • Eighth, what is the marketing strategy for generating revenues? Has sufficient money been earmarked for personnel and promotion? And what is the business model? Will customers be charged for products, time, usage, monthly subscription? And what are the risks for the company and for you? • Ninth, what is the tax strategy? Don’t wait until start-up losses are used up. Israel offers attractive tax breaks for preferred enterprises that are productive and generate at least 25% of their revenues competitively on international markets. And foreign investors should be exempt from Israeli capital-gains tax on a sale of their shares.
• Tenth, will there be growth by acquisition of other companies? What are the criteria? Will all aspects be reviewed, such as synergies, removing duplication, safe financing and improving the operational and tax posture? Will you be consulted? All in all, will the management go all out and try and make the company succeed? This will take more than chutzpah. Expect the unexpected and be prepared to win or lose.
As always, consult experienced tax advisers in each country at an early stage in specific cases.leon@hcat.co Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.