[author: Michal Herzfeld]
World Law Group member firms recently collaborated on a Global Venture Capital Guide that covers more than 30 jurisdictions on investment approval processes, typical investment sectors and investment structures on Venture Capital deals (and more!).
The guide does not claim to be comprehensive, and laws in this area are quickly evolving. In particular, it does not replace professional and detailed legal advice, as facts and circumstances vary on a case-by-case basis and country-specific regulations may change.
This chapter covers Israel. View the full guide.
Herzog, Fox & Neeman
- In your jurisdiction, which sectors do venture capital funds typically invest in?
VC funds invest with the greatest frequency in high-tech companies: AI, cybersecurity, internet of things, FinTech, automotive, big data, and digital health.
- Do venture capital funds require any approvals before investing in your jurisdiction?
A preexisting fund does not need approval simply to invest in an Israeli company. Some transactions may require specific approvals, depending on the company, field of business, and the size of investment. This usually applies to targets that have received funding or other support from governmental entities.
- Are there any legal limitations to an offshore venture capital fund acquiring control or influencing the business, operations, or governance of an investee entity?
There are no specific legal limitations preventing an offshore VC fund from acquiring control or influencing the business, operations, or governance of an Israeli company.
If an offshore fund wishes to make this kind of investment, it would need to review together with its advisors the typical restrictions and requirements that apply in any change-of-control circumstance (such as restrictive trade practices laws, internal corporate governance documents and shareholder voting agreements, etc.). A foreign VC fund may also be required to file certain undertakings with governmental agencies in order to acquire control or influence the operations of an Israeli company. For example, prior to making an investment of this kind in a company that received funding from the Israel Innovation Authority, the investor would need to sign an undertaking to comply with the relevant laws and IIA program rules. Targets that operate in the defense industry may be required to update the Ministry of Defense upon an investment and provide undertakings by foreign investors and foreign directors, including an acknowledgement that they will not have access to classified information.
Israeli law prohibits the conduct of any commercial or investment activity between Israelis and the governments and residents of certain jurisdictions (Iran, Syria and Lebanon), as well as certain terrorist organizations and other entities and individuals listed on government-issued restricted parties lists. Thus, if the fund were controlled by a person or entity included within these sanctioned laws, it would be prohibited from investing in the Israeli company.
- Would an investor be required to undertake an antitrust analysis prior to investment? When would such a requirement be triggered?
In general, an investment will not require an analysis of the Israeli antitrust laws unless the investor will be receiving 25% of the company’s share capital, 25% of the voting rights, the right to receive 25% of the company’s profits, or the right to appoint at least 25% of the board of directors. If the investment will approach more than one of these thresholds, we would advise consulting on a case-by-case basis with legal counsel.
- What are the preferred structures for investment in venture capital deals? What are the primary drivers for each of these structures?
The most common investment structure for VC funds is the purchase of preferred shares. Other structures include convertible loans, SAFEs and, less commonly, the purchase of ordinary shares. Typically, the VC would take a minority position with veto rights.
VC funds are more likely to invest in more mature targets that are likely to already have preferred shares in their capital structure, and thus the investment would yield more senior preferred securities. If a company is not ready to set a valuation because it is early-stage, or is reluctant to set a valuation at a certain time because external factors (such as COVID-19) are driving down valuations generally, the parties may agree to the convertible loan or SAFE structure. Similarly, if the investor is willing to forego the formalities of a full round in order to provide bridge funding and rely on the protections that will be negotiated in the context of the next equity financing, these convertible securities would be a reasonable choice.
- Is there any restriction on rights available to venture capital investors in public companies?
There is no absolute restriction on rights available to VC investors in public companies. Such investments may, however, have tax implications for those VC funds that are operating under a ruling granted by the Israel Tax Authority. We recommend consulting with tax and legal advisors about any particular circumstances.
- What protections are generally available to venture capital investors in your jurisdiction?
A venture capital investor will typically take a minority position in a target, and thus may benefit from the variety of protections that are available to minority investors as well as protections that are typically offered to all substantial investors. VC investors will likely negotiate for veto rights in the target’s articles of association, which would prohibit the company or its board from taking certain important actions, such as consummating an exit transaction below a certain valuation, winding up the business, changing the composition of the board, or entering into related party transactions, without the investor’s approval. A VC investor will also likely enjoy preemptive rights to participate in future issuances by the company and a right of first refusal and right of co-sale with respect to proposed sales by other shareholders. The extent of each of these rights would be negotiated in the company’s articles of association as part of the transaction terms. Similarly, VC investors can negotiate to include certain limitations within the articles to prevent being dragged to an undesirable exit, such as a requirement that investors need only give certain minimum representations in a drag sale.
Israeli statutory law also contains provisions to protect minority shareholders from a forced sale. Under these provisions, a potential buyer whose offer has been accepted by the disinterested holders of at least 80% of the target’s shares (or other threshold set out in the company’s articles of association) may force a sale of the remaining shares by notifying all shareholders who did not accept the initial offer, who are then given one month to petition a court to enjoin the sale.
Furthermore, Israeli law affords minority shareholders some protection from oppression by the majority shareholders, as well as the benefit of equal treatment by the board of directors, whose fiduciary duties require them to consider the interests of the minority on par with those of the majority.
- Is warranty and indemnity insurance common in your jurisdiction? Are there any legal or practical challenges associated with obtaining such insurance?
Warranty and indemnity insurance is not common in Israel but it is becoming more so. There are no Israel-specific legal or practical challenges associated with obtaining the insurance. Many insurers may not provide coverage for small deals (below USD 100 million), and this may restrict its availability for the majority of Israeli transactions.
- What are common exit mechanisms adopted in venture capital transactions, and what, if any, are the risks or challenges associated with such exits?
The most common exit mechanisms are M&A (sale of shares, assets or merger) or IPO. The explosion of SPACs in other markets has only slightly affected Israel, and all business combinations are carried out with SPACs listed in foreign jurisdictions. Secondary exits outside of sales of an entire portfolio are uncommon.
The primary risk of an IPO is that its success depends on the state of the capital markets at the relevant time. The primary challenge of M&A is that it is subject to much more negotiation between the parties. VC funds typically desire as clean an exit as possible, with no remaining indemnification obligations remaining after closing. In that respect an IPO carries less risk than a private M&A transaction, which usually carries indemnification obligations that last anywhere from 12 months to a number of years, or even longer in the case of fraud-based claims or for certain fundamental representations.
- Do investors typically opt for a public market exit via an IPO? Are there any specific public market challenges that need to be addressed?
Investors typically do not have a real choice of whether a company in which they are invested exits via IPO or otherwise. If the capital markets are favorable at the time and an underwriter is willing to assist, then the IPO path may be viable. One challenge the company will have when planning for an IPO is determining where to list. Different markets have different strengths and weaknesses, and some may be more suitable for companies in certain fields of business or with other particular profiles. NASDAQ has been a popular choice for Israeli high-tech companies, with approximately 80 such entities currently quoted on that exchange.
*Herzog Fox & Neeman