Scale-up nation?

‘Turn failure into fodder,’ Prof. Dan Isenberg urges unsuccessful start-ups

Prof. Daniel Eisenberg (photo credit: COURTESY DANIEL EISENBERG)
Prof. Daniel Eisenberg
(photo credit: COURTESY DANIEL EISENBERG)
ON THE evening of Thursday, April 19, Israel’s most prestigious award, the Israel Prize, will be bestowed on Check Point Technologies cofounder and CEO Gil Schwed and Ormat Technologies cofounders Yehuda and Yehudit (Dita) Bronicki. Dita Bronicki is, as I write this, the only woman chosen to receive the Israel Prize this year; only one candidate in every seven was a woman. The impressive award ceremony traditionally marks the end of Independence Day celebrations and dates back to 1953.
On a sweltering July day in 1993, Schwed and two friends, Shlomo Kramer and Marius Nacht, stocked up on cases of Coca-Cola at an apartment in Tel Aviv and wrote a business plan for a start-up that became Check Point Technologies – a world market leader in cyber security. Their friendship began in an IDF technology unit.
The business plan they wrote is a master-piece of clarity and succinctness: I teach it to all my students.
It has five short sections: The need, the product, unique features, the market and future developments.
Check Point Technologies is one of the last Israeli start-ups to grow to global size and re- main independent and Israeli; the exceptions (Amdocs, Mellanox) are scarce as hounds’ teeth. Schwed is a rare example of a start- up founder who, as CEO, continued to lead his company to global size – and so are the Bronickis.
In 1965, Yehuda Bronicki and his wife Dita sold their modest apartment in Jerusalem to establish Ormat, perhaps Israel’s first industrial hi-tech start-up, in Yavneh.
Many have claimed the title of “Father of Israeli Technological Entrepreneurship.” I believe that title rightly belongs to Bronicki.
At Ormat, Bronicki pioneered energy technologies, including a unique turbine generator, solar ponds and some 37 other patents.
Under Bronicki, as chief technology officer, and his wife Dita as CEO, Ormat grew into a global giant, installing over 150 power plants, and generating some 2,000 megawatts of power, in many countries, including geothermal, solar and shale oil production. They served in those roles for nearly 50 years, until 2014. Some of the sites that Ormat operated were remote and challenging, like that in northern Alberta.
What is unique about Check Point and Ormat is that their founders doggedly scaled up tiny start-ups into global giants. Check Point is one of the last Israeli start-ups to scale up to global size and remain indepen - dent, rather than be acquired . The question is, why? Why are Check Point and Ormat so unusual? Why can’t the Start-up Nation become the Scale-up Nation?
To find some answers, I spoke with Prof. Daniel Isenberg. Isenberg, an American Israeli, is now a professor of Entrepreneurship Practice at Babson College Executive Education where he established the Babson Entrepreneurship Ecosystem Platform. From 1981-1987 and 2005-2009, Isenberg was a professor at the Harvard Business School. In the interim (1987-2005), he was an entrepreneur in Israel and a general partner in venture capitalist Jerusalem Venture Partners in the early days. Since 2005 he has been an investor in a dozen or so Israeli start-ups.
I asked Isenberg about the dramatic fail- ure rate for Israeli start-ups . A study by Israel Venture Center, along with ReversExit, examined over 10,000 start-ups during the period of 1999-2014. Only 4 percent achieved success, defined, admittedly draconically, as achieving $100 million in revenue and 100 or more employees.

The Report
: Why do so many start-ups fail? What can policy makers do to improve the odds and reduce the failure rate?
Isenberg: “These questions are like asking how we can wag the tail to make a healthy dog. They are the wrong questions. The right and tractable question is how can we get more Israeli companies to increase their growth? By ‘growth,’ I mean real business growth: growth in revenues and cash flows or profits. I do not mean growth in shareholder value, which is better treated by policy makers as a byproduct of venture growth.
“That does not mean that shareholder value cannot be created without growth; it can be, but one of the policy problems of the Israeli entrepreneurship phenomenon is that policy [including ‘soft policy’] is subtly and not-so-subtly over-focused on shareholder wealth. Broadly-based business growth per se has broad benefits for society, as long as there are well-regulated markets and balanced taxation policies.”
“If more Israeli firms enter into new growth trajectories, or increase their current trajectories, some of the dysfunctions of the current “start-up nation” are more easily ad- dressed. There will probably be fewer people launching start-ups, but more of those who do will have the aptitude and attitude to create growth firms. As a result, those ventures will have better access to employable talent, which is typically the biggest growth bottle-neck everywhere.
“As a result, income inequality will be mitigated, as by definition there will be more participants in the growth, typically as well-compensated employees, but also as shareholders. More firms growing mean that local supply chains (including both strategic and non-strategic services) will be denser and deeper, fostering a second ring of firm growth, and so on.”
Isenberg stresses that the positive spill- overs from scaled up growth are large and pervasive. But unless start-ups achieve such growth, spillovers are lost.
The Report: Can government policy foster more venture growth?
Isenberg: “In part it depends on how one defines policy. Certainly, growth contains much of its own incentive, so policies offering what I call “hard incentives” (tax breaks, subsidies, direct funding) are less impactful and frequently boomerang (generating what economists call “perverse outcomes”). On the other hand, there are many opportunities for policy makers to offer “soft incentives” – training, encouragement, media attention and so on.
Isenberg told me that there is a global movement rising, of which he is one of the promoters, to focus more on scale up than on start-up.
Isenberg: “One of the reasons there is a “scale- up movement” on the horizon is that policy makers are beginning to realize the lack of measurable results, the inefficiency and the perverse outcomes of encouraging people to start companies. Indeed, the real social and economic impact of entrepreneur - ship manifests itself when the growth “dog” wags the start-up “tail,” and not the other way around.”
In Israel, very few policy makers appear concerned about the extreme inefficiency of the start-up ecosystem. The IVC-ReversEx- it report analyzes not only the thousands of start-up failures, but also over 5,000 walking-dead zombies – start-ups not strong enough to grow and thrive, or be acquired, but not weak enough to shut down in bankruptcy. These zombies use financial resources, talent, engineers – and are nearly invisible, with attention focused on high-profile exits.
Investment companies are complicit because they often prefer to keep start-ups alive rather than close them, to avoid recognizing financial losses on their books.
One of the key principles of innovation originates with the Silicon Valley design firm Ideo and its founder Dave Kelley . “Fail early to succeed faster .” Isenberg has written in the Harvard Business Review that “it’s important to train entrepreneurs to fail small, fast and cheaply, ” although he also argues that success, not failure, is what needs to be celebrated. “Inexpensive failures don’t make headlines – and don’t cause embarrassment or shame. Policy makers can support the training of entrepreneurs in risk-mitigation strategies and skills.”
“Turn failure into fodder,” Isenberg urges, but do not defer or disguise it.
I know that the Innovation Authority successor to the Chief Scientist’s Office – headed by Aharon Aharon – is keenly interested in learning why a handful of start-ups do succeed to scale up globally, while most others do not. So far, we do not have good answers for Israel.
A fascinating study of Massachusetts start- ups, by Jorge Guzman and Scott Stern, finds that quick exits are powerfully helped by not naming the firm after the founders (a damag ing footprint of ego), but using a short name; registering in Delaware (because investors think that is a good idea); owning patents; and getting mentioned in the Boston Globe (publicity helps growth).
A study by the Israel Venture Center and Meitar analyzes Israel’s start-up exits, from 2005 through 2014. An ‘exit’ occurs when investors – usually venture capitalists – sell their stake in a firm to realize gains (or loss- es) . This is done by selling the start-up (ac- quisition) or through an initial public offering of shares, which can then be sold in the marketplace.
The IVC study reveals a serious challenge. Most exits are done when start-ups are, say, about 10 years old – not even adolescents. This is because venture capital funds need to return profits to their investors.
A decade may be long enough for software, Internet and communications start-ups. But it is definitely too short for Cleantech and life sciences. There is thus a mismatch between the structure of venture capital finance and the life sciences/biotech start-ups that rely on them. In short, Israel’s scientific prowess, reflected in Nobel Prizes, smashes into the impatience of investment money and start-ups do not get a chance to grow from adolescence to true maturity .
True, many start-ups that are acquired by foreign companies are transformed into the acquiring companies’ R&D centers in Israel. For instance, Anobit, cofounded by Ariel Maislos, was bought by Apple in 2012 and now employs many R&D engineers at its Herzliya site. But nations cannot make a good living solely on R&D. Much of the income, jobs and exports generated by Anobit’s pioneering technology will migrate abroad.
Traditionally the 70th anniversary is “platinum.” Israel’s platinum 70th is a landmark. It is a good time to stop quaffing our own Kool- Aid, as Start-up Nation, and start asking hard questions. Why is Israel unable to grow major independent Israel-based global companies, whose jobs and income benefit mainly Israelis? How can Israel, in its next 70 years, become Scale-up Nation?
Unless the benefits of hi-tech entrepreneurship spread much more widely, beyond the 8% to 10% of the labor force it employs, the worrisome gap between rich and poor in Israel will continue to grow.
Let Israel’s 70th birthday mark the start of strenuous efforts to grapple with this problem.
The writer is senior research fellow at the S. Neaman Institute, Technion and blogs at www.timnovate.wordpress.com.