The process of executing a technological idea is quite lengthy and places numerous hurdles before the entrepreneur. One of the most significant hurdles when setting up a start-up company is finding a source of funding and/or initial investment (“SEED”), which will establish the infrastructure of the project and will assist in providing the initial required to examine the project's efficacy and feasibility.
The entrepreneur has several financing options: investment by a venture capital fund, investment by a private investor (“angel”), a credit line for financing activity, and even utilizing an “accelerator”.
An additional funding track is the use of technological incubators (“OCS Funded Incubators”).
This article shall review the technological incubators investment track (hereinafter: “the “Technological Incubator Program”), and its main ramifications.
What is a technological incubator?
A technological incubator is one of the leading tracks used by entrepreneurs when trying to promote a project involving a significant technological development. The Technological Incubators Program enables suitable project to receive significant financial support for the development of the project.
The Israeli model operates through a franchise granted to the franchisee by the Innovation Authority (or, by its former name: “the Chief Scientist”), which operates the incubator compound.
The State provides significant financial support by investing NIS 2-3.5 million in each project over a period of two years, which constitutes 85% of the approved budget, thereby taking upon itself most of the investment risk. In return for its financial backing, the State is entitled to royalties from the project's revenues, without receiving any proprietary rights in the project. In this way, the decision takers in the project focus on the research and development of the technological product in order to examine its technological and economic feasibility, while taking a minimal economic risk.
The franchisee, for his part, invests 15% of the approved budget in return for receiving shares in the entrepreneurial company. In addition, the franchisee undertakes to provide every project that is found to be suitable for receiving finance, a comprehensive assistance package that includes, inter alia: a physical place of work and infrastructures, administrative services, technological and business guidance, legal and marketing assistance, business customization to the project's sphere of activity, etc. However, the great advantage of this program lies in the fact that the incubator is an experienced partner, with a wealth of experience and expertise in leading projects which is helpful when it comes to raising funds and preparing for the marketing the product.
In this regard, it should be clarified that determining the size of the incubator's investment depends on the type of project and the geographical location of the incubator. The Innovation Authority provides a broad range of programs according to the nature of the project. A common example is the area of biotechnology projects. The approved budget rate for projects in this field is significantly higher than it is for other technological projects, and the support period for these projects is longer and currently stands at three years.
The entrepreneur's considerations in using the Technological Incubators Program
The entrepreneur must take into account a broad range of criteria before deciding whether to actualize the project through a technological incubator:
Firstly, the location of the incubator is a critical consideration, since apart from determining the level of funding by the franchisee, the incubator and the State, the owner of the project must recruit suitably qualified personnel from outlying regions.
Secondly, the shareholding rate in the company is also an important consideration. During development of the product, with the aid of the incubator program, shares in the Company are issued to the incubator franchisee as consideration for the investment, the services and support provided by it. The shares are allocated at the time when the contract is entered into with the incubator, that is, before the funding and services which the incubator undertook to provide have actually been received. The allocation of shares as aforesaid prior to receipt of the initial funding, may dilute the entrepreneur's share in the project later on, when additional investors enter it, and occasionally even before completion of the product's development and the determination of its future course.
There are also additional internal legal considerations which require thorough preliminary reflection before using the incubator programs.
One of the main considerations is how the intellectual property (IP) is to be used and its transfer abroad. In the past, companies that developed their products with the Innovation Authority assistance could not commercially exploit their intellectual property or transfer it abroad due to the constraints imposed by the Encouragement of Research, Development and Technological Innovation in Industry Law, 5744-1984 (hereinafter: “the Research and Development Law”), before its amendments. These constraints made it difficult to enter into transactions with foreign companies.
The Research and Development Law was therefore subsequently amended to allow the transfer of IP abroad, subject to obtaining prior explicit approval from the Innovation Authority and payment of an amount prescribed in a statutory formula.
However, the amendment of the Research and Development Law significantly increased, without setting any limit, the sum payable to the State in the event of sale or transfer of IP outside of Israel, a predicament which led many corporations to seek alternative ways of financing their ventures. Thus, in practice, the State lost the incentive for keeping the corporations' activities in Israel.
This subject was addressed within the framework of a further series of amendments to the Research and Development Law and the enactment of regulations which capped the sums charged by the State for transfer of IP abroad. Thus, within the framework of regulations enacted pursuant to the Research and Development Law in 2012, ceilings were imposed on the sums payable to the State in the event of commercial exploitation of the IP, and it was prescribed that (1) a company which transfers IP abroad while continuing its research and development activity in Israel, shall be required to pay a sum of up to three times the amount of the grant which was received by the scientist; (2) in the event of a cessation of all activity in Israel, the company shall be required to pay up to six times the amount of the grant received by the company's scientist.
The issue of arranging payment of the consideration owed to the State in the event of commercial exploitation of the intellectual property by licensing IP (for example, through an exclusive license or cross licensing agreement with an international company) is especially prominent in the context of pharmaceutical, medical instrumentation and biotechnological ventures, the licensing of intellectual property being an integral part of cooperation in this field. It should be emphasized that clarifications have recently been made within the framework of the Innovation Law and the Authority's regulations pertaining to this matter. The project must receive appropriate approvals from the Innovation Authority's Research Committee and the company shall be required to pay royalties in accordance with the nature of the information license.
The Technological Incubators Program is an excellent initial solution for entrepreneurs who have a technological vision and idea with profitable business potential. The extensive assistance received from the franchisee and the State means that most of the entrepreneur's operational activity is focused on product development. However, many considerations regarding a program of this type raise points which ought to be borne in mind: whether it makes economic sense for the entrepreneur to relinquish a substantial percentage of his shares in return for the investment and range of services provided, various technical issues such as the location of the project – the balancing of geographical location versus budget, and of course bureaucratic hurdles in being accepted for the program and the accessibility of the IP to foreign investors. The range of considerations is broad and the advantages and disadvantages must be thoroughly weighed up before applying to be accepted to the Technological Incubators Program.
Originally Published June 2019
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.