Over the past two years, driven by the rapid advancement of information technology, startup tech companies around the world have delivered strong performances. Israel, a leading technological powerhouse, is no exception. According to an analysis released by the Israel Innovation Authority, there are currently about 1,500 deep tech companies operating in Israel, which together raised more than USD 28 billion in funding between 2019 and 2025. This has made Israel the leading technology financing hub in the Western world outside the United States. The data also show that Israel attracts roughly 20% of global investment in cybersecurity, as well as about 10% of investment in medical devices and agri-food technologies. All of this can be attributed to the country’s highly developed venture capital ecosystem. However, the growth of Israel’s venture capital industry is more of a result of necessity rather than choice.
In the early years following the founding of the state, the broader historical context led Israel to place greater emphasis on the development of large enterprises. After the Law of Return was passed by the Knesset in 1950, approximately 700,000 immigrants arrived within just eight years, nearly doubling the country’s population. During this period, the core policy objective was to create jobs as quickly as possible, and the government therefore prioritized support for large state-owned enterprises or union-controlled industrial systems, such as Dead Sea Works (DSW) and Israel Aerospace Industries (IAI). It was not until 1960 that the cabinet first provided an official statistical definition of “small enterprises”, but this concept was used solely for industrial census purposes and was not accompanied by any financial or tax incentives. As a result, small and medium-sized enterprises remained on the margins of the economy.
From the 1970s onward, Israel’s economy came under sharply intensified external pressure. Between 1970 and 1982, defense spending at times surged to more than 25% of GDP. At the same time, the combined impact of two oil crises and the rapid expansion of welfare expenditures significantly weakened the drivers of economic growth. As traditional industries lost competitiveness and massive defense spending delivered limited economic returns, fiscal space was increasingly constrained. It was only after 1984, when there was increased U.S. assistance and a declining defense burden, that the Israeli government gained some room for adjustment. It then began to plan systematically on converting its long-accumulated strengths in education and military-industrial technology into civilian productive capacity. In this context, supporting the development of small, technology-oriented enterprises emerged as a top priority.
During this period, Israel initially opted for a classic mix of fiscal policy instruments, i.e., interest-subsidized loans and R&D grants. A 1980 cabinet resolution established a fund for small industries, through which the government provided banks with a 2% interest subsidy to encourage them to issue low-interest loans to small and medium-sized enterprises. Under this model, the government bore only the cost of the interest subsidy, while project screening, lending, and debt recovery were all handled by the banks. In practice, however, this approach revealed structural flaws. Driven by risk-control requirements, banks insisted on high levels of collateral, leading many technology-oriented firms to be excluded outright due to a lack of fixed assets. Once a loan defaulted, losses were borne almost entirely by the banks, meaning that the interest subsidy did little to alter the underlying risk–return structure. By the late 1980s, write-off rates for such loans had reached as high as 18%, with net loss rates exceeding 60%. After two state-owned banks made substantial provisions for bad debts in their annual reports, they rapidly tightened lending standards, effectively marking the failure of the interest-subsidy mechanism.
The shortcomings of R&D subsidies were equally apparent. Israel supported technological innovation through R&D grants and low-interest loans, causing the size of the program’s budget to rise rapidly between 1985 and 1989, making it the world’s second-largest public R&D funding system after the U.S. SBIR program. Its fundamental flaw lay in what could be described as “zero equity, zero exit, and zero recycling”. If a project failed, the fiscal loss was total; yet if it succeeded, the government could recover only limited returns through sales-based royalties, which were subject to explicit caps and did not allow the state to share in increases in corporate valuation. As a result, public funds could not be recycled through exits and reinvestment, instead becoming a one-off expenditure. In effect, this amounted to using taxpayers’ money to subsidize elite firms capable of global expansion without requiring any equity return, is essentially a regressive form of redistribution. Moreover, as immigrants from the former Soviet Union poured into Israel, the government rapidly expanded budgets to absorb these “tech refugees”. While this sparked a short-term boom in entrepreneurial activity, it also laid bare the fiscal unsustainability of the approach. At the time, central bank estimates showed that continuing with the R&D subsidy model would require funding levels far beyond what public finances could bear.
It was precisely under these constraints that policy thinking was forced to shift. In 1989, the first successful equity investment in Israel by a U.S. venture capital firm gave the government a clear, concrete understanding of the advantages of equity instruments in terms of risk sharing and capital leverage. A World Bank report published in 1991 explicitly recommended that Israel attract foreign limited partners through a fund-of-funds model and replace one-way subsidies with equity-based financing. By 1992, a cabinet consensus had emerged that R&D subsidies would no longer be expanded. Instead, public–private partnership equity investment funds would be established, and foreign investors would be allowed to buy out the government’s stake. This consensus directly led to the creation of the Yozma Fund in 1993.
The Yozma Fund was capitalized with USD 100 million from the government and operated as a fund-of-funds, investing in ten newly established private venture capital funds. Each fund had to be formed jointly by Israeli institutions, foreign venture capital firms, and local financial institutions. Within this framework, although the government was one of the investors, it did not participate in project selection, post-investment management, or operational decision-making of the portfolio companies. All investment decisions were made independently by the fund GPs. The government held no more than 40% of each fund’s equity and could, after five years, be bought out by private shareholders at original investment plus interest, effectively functioning as a call option. Meanwhile, foreign GPs could earn a 20% performance fee, which was higher than the roughly 15% typical in Europe at the time. With the capital gains tax reduced to 10%, the system’s attractiveness was significantly enhanced. Under these conditions, the government’s USD 100 million investment attracted USD 150 million in foreign capital, which in turn drove follow-on investments of USD 800–1,000 million in subsequent rounds. OECD calculations estimated the leverage ratio reached 1:8. By the end of 1999, twelve companies from the Yozma fund portfolios had gone public on NASDAQ, with a total market capitalization of USD 12 billion. Foreign investors exercised all buyout rights, allowing the government to recover its USD 100 million principal plus USD 18 million in interest, for a net return of 18%. At the same time, the government voluntarily relinquished an estimated USD 800 million in equity appreciation, because the policy goal was always to develop the market rather than maximize profits.
Driven by the Yozma Fund, Israel’s venture capital (VC) assets under management, which were less than USD 100 million in 1993, surpassed USD 10 billion by 2000. Between 2000 and 2015, Israel ranked first in the world in per capita VC investment as a share of GDP. It was precisely after this institutional turning point that Israel completed its transformation as a start-up nation, with VC becoming the institutional backbone of its technological prosperity. Throughout this process, government concessions remained the key mechanism for leveraging private capital. The difference was that the approach shifted from “spending big” to “earning small”, significantly enhancing the sustainability of public finances.
Today, cultivating new forms of productive capacity and expanding strategic emerging industries have become key levers for China to optimize its economic structure and guard against systemic risks. To this end, the Chinese government is accelerating the improvement of relevant institutional arrangements. For example, at the end of last year, China launched its National Venture Capital Guidance Fund, and recently, clear regulations have also been issued regarding government investment funds. Israel’s experience suggests that guidance and investment funds can indeed offer a higher ceiling and mobilize more resources. However, whether they can truly fulfill this role depends on “guidance” itself. Such funds must adhere to market-oriented principles, entrusting investment decisions to professional institutions and avoiding administrative interference. At the same time, through a system design that provides reasonable incentives, they should improve the risk–return profile and enhance their appeal to various types of capital. Only in this way can they continue to provide funding, resources, and patient capital to technology enterprises under increasing external constraints, thereby laying a solid foundation for the development of new forms of productive capacity.
Final analysis conclusion:
Israel leveraged the Yozma Fund to attract foreign and private capital and has successfully established a venture capital ecosystem. Its core lay in the government’s relinquishment of administrative intervention, entrusting decisions to professional institutions, while enhancing capital appeal through buyout mechanisms and tax incentives. When developing state-backed guidance and investment funds, China can follow a similar approach. It will need to maintain market-oriented operations, ensure reasonable profit-sharing, and share risks. This can genuinely stimulate enterprise vitality while preserving fiscal sustainability.
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Peng Maosheng is a researcher at ANBOUND, an independent think tank.
