Klepper (1996, 1997) presented a formal and empirical industry life cycle model. His model also presents three stages of development: exploratory, growth, and mature. The exploratory stage is characterized by high level of entry and intense product innovation. In the growth stage, market output grows rapidly while market entry declines, product innovation declines and process innovation becomes focused on increasing productivity. In the mature stage, output growth decline, market entry become insignificant, and shakeout occurs, market shares stabilize, and innovation becomes insignificant (4).

2.3 Regional cluster

The traditional literature on regional economics (e.g. Hoover 1971; Marshall 1890) explains the existence of the cluster mainly through the cost advantages in reduction of transportation and shipment costs, shared infrastructure, and shared training and education systems, and in the resources advantages of a specialized labor pool. The ICT revolution and the globalization processes reduce the importance of many of these traditional explanations of agglomeration advantages. However, the importance of the regional cluster as well as the academic interest in this phenomenon seems to have increased in the last two decades (Maskell 2001). This current increase in the importance of clusters (and regional innovation systems) is associated with the cluster's functions in reducing transaction costs, in the creation of knowledge and in learning and innovation. Dahlman (1979) argues that a significant advantage created by clusters is the reduction in transaction costs, including search costs, information costs, bargaining costs, and enforcement costs. Gaspar and Glaeser (1998) claim that the complexity of knowledge used in the ICT sectors has increased the importance of face-to-face interaction in knowledge creation and diffusion. Keeble and Wilkinson (1999) argue that the explanation of clustering in knowledge-intensive industries should focus on the role of knowledge spillovers and learning. Saxenian (1994) and Cooke (2002) present the cluster as a learning region embedded in networks and institutional settings. To sum up, the literature suggests that clustering creates significant advantages to firms. These advantages are related to access to networks, to knowledge spillovers, and to various learning processes. VCs often consist wide diversified networks and are located at a structural hole of the innovation system (Florida & Kenney 1988) and thus play an important role in regional innovation processes and has a significant role in regional cluster development (Bresnahan et al. 2001; Saxenian 1994).

3. THE CONCEPTUAL FRAMEWORK

We consider the VC as an industry with significant regional aspects. In the initial development phase of a VC industry in a new geographical market, there are very few VC agents and they are extremely innovative (many of the LPs in VC funds are non-institutional investors). In this phase the entry rate into the market is high. Thus, as long as the VC agents remain innovative (and risk taking), the VC industry significantly contributes to the development of the regional high tech cluster (Avnimelech & Teubal 2004b). As the market matures, the majority of the VC agents decrease their innovativeness and risk taking (Avnimelech & Teubal 2006; Gompers 1994) (5). We argue that in the VC industry this aspect of the maturation process has potential severe negative effects, due to the VC industry role in the development of the regional cluster. While a flourishing domestic VC industry should trigger and enhance regional cluster emergence and development, a mature, overfocused and conservative VC industry may lead the cluster to lock-in and decline. The Israeli VC market is a good case study for analyzing these processes, due to its rapid growth in the last 15 years (for a detailed analysis of this VC development see Avnimelech & Teubal 2006 and Fiegenbaum 2007).

4. EMPIRICAL RESULTS

The empirical part of this paper includes data on more than 5,700 Israeli high tech companies established between 1991-2007--i.e. the entire population of Israeli high tech firms established during this period; and on more than $14.4b VC investments between 19962007 in Israeli high tech startups by both Israeli and foreign VC agents. This information is drawn from the IVC database.

4.1 Growth of the VC industry--capital raised and capital invested

The diffusion of VC into Israel took place during the 1990s, and since then Israel's VC market has grown dramatically. Currently, the Israeli VC industry is a mature and global industry (OECD 2003). Israel is currently the world leader in VC investment per GDP (OECD 2004) and has among the highest absolute levels of VC investment, with a $1,759m investment (excluding PE investments) in Israeli startups in 2007 (IVC 2008).

Tables 1-3 present the growth in the VC market during the 1990s from three aspects: growth in VC fundraising, growth in VC invested, and growth in startups backed by VCs.

Table 1 presents the dramatic growth in capital raised by Israeli VC agents throughout the 1990s, from $40m in 1991 to an annual average of $1.7b during 1999-2000 (the bubble years), and an annual average of $0.9b during the years 2001-2007. Table 2 presents the dramatic growth in VC investments in Israeli startups: from less than $50m in 1991 (6) to an annual average of $2.1b during 1999-2000 (the bubble years), and an annual average of $1.5b during the years 2001-2007 (with almost 60% of investment from foreign VCs). To sum up, during 1991-2007 we see evidence of the cyclic nature of the VC industry--growth during 1993-1998, bubble during 1999-2000, bust during 2001-2003, and moderate growth since 2004 (7). Parallel to this cycle, the Israeli VC industry became a more significant node in the global VC industry--it grew from 2.3% of the US VC investment in 1996 to 2.9% of the US VC investment in 2000 and to 6% of the US VC investment in 2007 (8). This growth represents the increased role of the Israeli high tech cluster in the global high tech market. Moreover, it is clear that the VC industry in Israel is firmly based and stable, and not only an outcome of the global high volume of VC investment in the years 1999-2000.

Table 3 presents startup creation, startup closure, and the share of VC-backed startups. It represents a significant growth in startup creation during the 1990s (from 51 startups created in 1991 to 642 startups created in 2000), sharp decrease in 2001 and moderate growth since 2003 (the average level of startup creation during 19992007 was around 500). While in the early emergence (1993-1996) the role of VCs in startup financing was very significant (on average 58% of the startups created were VC-backed), it has declined dramatically since 2002 (to an average of 25% during the years 2003-2007). The decrease in VC dominance in startup financing is an outcome of the appearance and the growing dominance of other VC agents, such as business angels, corporate VC, and investment companies (see Avnimelech & Teubal 2006). It also represents the less significant role VCs have in mature high tech clusters (relative to other type of VC agents).

4.2 The globalization of the Israeli VC industry and market

Most often an initial development of a local VC industry is a pre-condition to successful foreign VC entry (Jeng & Wells 2000). Afterward, a significant aspect in the development of a local VC market is the growing activity and involvement of foreign VCs within it. In Israel, during the early phase of VC development, direct foreign VC involvement was limited, that is, either no investment at all or occasional investments without local offices (up until 1997 there were no local offices of foreign VC companies in Israel). As the VC market developed and its attractiveness grew, the foreign VC agents' activity became more significant. Since 2000, direct foreign VC investments capture almost 60% of the capital invested in Israeli startups (see Table 2, row 4). Among the foreign VC companies with local offices in Israel, we can find such leading US VCs as Accel Partners, Benchmark, Venrock, Sequoia, Kleiner Perkins, and Intel Capital.

4.3 VC stages of investments

Usually, as markets mature the level of risk that market agents are willing to take declines (the opportunity cost is higher), the deviation from known patterns of activities are rare (stable routines), and agents become more conservative (clear market benchmark and high penalty for underperformances). In the Israeli VC market this is represented by a decrease in early stage investments and investments in new sectors. Table 4a shows that seed investments decreased from an average of 13% during 1996-1997 to 5% in 1999 and 2% in 2002 (9). Since 2003 seed investment grew (to an average of 8%) mostly due to government incentives and industry leaders collective action (10). A similar picture exists in the early stage investment, which was reduced from an average of 44% between 1996-2000 to an average of 32% after 2001 (Table 4b present a similar pattern in terms of number of VC deals) (11). A similar picture of conservative investment can also be seen in the technological distribution of VC investments (see Exhibit 1)--the technological focus of VC investment in Israel became extremely focused on those narrow sectors that were successful during the 1990s (from the point of view of a broadly-technologically defined cluster this can eventually lead to cluster decline).

4.4 VC management companies and market structure

Another characteristic of VC market development is the changes in the number of active VC management companies. VC funds are managed by management companies, which often have more than one fund under management. A typical lifetime of a VC fund is 7-10 years. According to Gompers (1996), one indicator of the success of a VC management company is its ability to raise future funds. In a successful management company new funds are raised every three to five years. VC funds invest the vast majority of their capital in the first three to five years of operation. Therefore, we define an active management company as one that has raised at least one new fund in the last five years. Table 5 shows a significant growth in the number of active VC management companies, from four in 1991 to 69 in 2001. After 2001 the number of management companies started to decline, stabilizing to around 40 since 2005 (with a market share of around 70% to the top 10 VC management companies). This pattern resembles the shakeout in manufacturing industries (Klepper 1996). However, due to lower constant costs and other elements related to economics of scale, the VC industry does not seem to develop into an oligopoly market.

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