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Facilitating startup growth: Overview of Israel’s OSC funding

Posted in For Entrepreneurs and Companies, For Investors and Fund Managers, Startups, VC & Private Equity

pic-trent.jpgCONTRIBUTED BY
Trent Dykes
trent.dykes@dlapiper.com

If you are reading this post, then you probably share my belief that one of the best things our government can do to spur economic and job growth is to support the startup community. In recent years, government entities ranging from state (See Maryland’s proposed tax credit to support investment in cybersecurity industry) to federal (See JOBS Act: What matters most for startups and VCs) to the IRS (See Fiscal Cliff Bill to renew 100% QSBS tax break) have enacted programs designed to enable more and easier investments into startup companies (in the US). However, many commentators have argued that such efforts are not enough.

One country that appears dedicated to its startup community, and that has a very interesting and seemingly effective model for facilitating growth, is Israel. Last week I met with Daniel Marcus of the Israeli law firm Amit, Pollak, Matalon & Co. to discuss emerging growth and venture capital markets and I took the opportunity to ask Daniel more about Israel’s government funding model via its Office of the Chief Scientist (OCS). Luckily, Daniel and his colleague, May-ad Katz, had previously written a great article titled “Exporting technology from the ‘start-up’ nation” summarizing the OCS funding system and related encumbrances.

As Daniel and May-ad explain:

This funding, granted through various government entities and programmes, including OCS programmes, is designed to support the research and development of Israeli companies, and is recognition of the fundamental position of the high-tech industry as the main growth engine for Israel’s economy. One of the governmental entities key to providing funding for the early stages of technology companies (including the seed and pre-seed stages), when such investment is considered fairly risky, is the OCS.

Receiving funding from the OCS has several notable advantages for companies: aside from the OCS’s willingness to share the risk of the loss of its ‘investment’ in the company, the OCS does not demand any equity in return for its funding, nor does it interfere with the company’s day-today management decisions. OCS-funded companies are required, however, to repay the funding they receive by way of royalties from future sales. In addition, by receiving OCS funds, a company subjects itself to the OCS’s rules and regulations.

Depending on the specific plan for research and development submitted by a company, OCS funding typically ranges from 20% to 50% of the company’s research and development expenses. The goal of OCS funding is to achieve long-term benefits by way of supporting those projects which, in the OCS’ view, (i) have a high prospect for success and (ii) are likely to yield commercialization and manufacturing activities in Israel. The Israel government reported that Israeli companies received approximately US$400 million from government resources in 2010 alone.

But OCS funding does not come without strings.  As the article explains:

The company is required to repay the funding amount, plus interest, to the OCS, by way of royalties from future sales of its products, which are produced by way of implementation of, or which incorporate or otherwise exploit, the know-how generated from the approved plan and any derivatives thereof. Among other limitations, the company will be subject to restrictions regarding the transfer of its know-how outside of Israel (but not of products which are manufactured in Israel and are subsequently exported for sale outside of Israel. This includes sales to end-users, resellers and distributors).

In this context, the Law distinguishes between two separate scenarios, both of which require the prior consent of the Committee: (a) the export of know-how derived from research and development conducted with OCS funding; and (b) the export of manufacturing rights with regard to products developed with OCS funding. Although the Law creates a distinction between these two scenarios and applies different rules and quasi ‘penalty’ payments to them, the basic rationale for discouraging each by way of applying the ‘penalty’ payments to both scenarios is the same: to increase the financial value resulting from research and development for the Israeli economy, to create jobs, to develop science-based industry, to encourage research and development in the industry, and to improve Israel’s balance of inbound/outbound payments.

Here is the full article if you are interested in reading more.