Start-up Nation

by Dan Senor, Saul Singer

  It is true that there are many models of entrepreneurship, including microentrepreneurship (the launching of household businesses) and the establishment of small companies that fill a niche and never grow beyond it. But Israel specializes in high-growth entrepreneurship—start-ups that wind up transforming entire global industries. High-growth entrepreneurship is distinct in that it uses specialized talent—from engineers and scientists to business managers and marketers—to commercialize a radically innovative idea.

  This is not to suggest that Israelis are immune from the universally high failure rate of start-ups. But Israeli culture and regulations reflect a unique attitude to failure, one that has managed to repeatedly bring failed entrepreneurs back into the system to constructively use their experience to try again, rather than leave them permanently stigmatized and marginalized.

  As a recent report by the Monitor Group, a global management consulting firm, described it, “When [entrepreneurs] succeed, they revolutionize markets. When they fail, they still [keep] incumbents under constant competitive pressure and thus stimulate progress.” And the Monitor study shows that entrepreneurship is the main engine for economies to “evolve and regenerate.”24

  The question has become, as a BusinessWeek cover put it, “Can America Invent Its Way Back?”25 The magazine observed that “beneath the gloom, economists and business leaders across the political spectrum are slowly coming to an agreement: Innovation is the best—and maybe the only—way the U.S. can get out of its economic hole.”

  In a world seeking the key to innovation, Israel is a natural place to look. The West needs innovation; Israel’s got it. Understanding where this entrepreneurial energy comes from, where it’s going, how to sustain it, and how other countries can learn from the quintessential start-up nation is a critical task for our times.

  PART I

  The Little Nation That Could

  CHAPTER 1

  Persistence

  Four guys are standing on a street corner . . .

  an American, a Russian, a Chinese man, and an Israeli. . . .

  A reporter comes up to the group and says to them:

  “Excuse me. . . . What’s your opinion on the meat shortage?”

  The American says: What’s a shortage?

  The Russian says: What’s meat?

  The Chinese man says: What’s an opinion?

  The Israeli says: What’s “Excuse me”?

  —MIKE LEIGH, Two Thousand Years

  SCOTT THOMPSON LOOKED AT HIS WATCH.1 He was running behind. He had a long list of to-dos to complete by the end of the week, and it was already Thursday. Thompson is a busy guy. As president and former chief technology officer of PayPal, the largest Internet payment system in the world, he runs the Web’s alternative to checks and credit cards. But he’d promised to give twenty minutes to a kid who claimed to have a solution to the problem of online payment scams, credit card fraud, and electronic identity theft.

  Shvat Shaked did not have the brashness of an entrepreneur, which was just as well, since most start-ups, Thompson knew, didn’t go anywhere. He did not look like he had the moxie of even a typical PayPal junior engineer. But Thompson wasn’t going to say no to this meeting, not when Benchmark Capital had requested it.

  Benchmark had made a seed investment in eBay, back when it was being run out of the founders’ apartment as a quirky exchange site for collectible Pez dispensers. Today, eBay is an $18 billion public company with sixteen thousand employees around the world. It’s also PayPal’s parent company. Benchmark was considering an investment in Shaked’s company, Israel-based Fraud Sciences. To help with due diligence, the Benchmark partners asked Thompson, who knew a thing or two about e-fraud, to check Shaked out.

  “So what’s your model, Shvat?” Thompson asked, eager to get the meeting over with. Shifting around a bit like someone who hadn’t quite perfected his one-minute “elevator pitch,” Shaked began quietly: “Our idea is simple. We believe that the world is divided between good people and bad people, and the trick to beating fraud is to distinguish between them on the Web.”

  Thompson suppressed his frustration. This was too much, even as a favor to Benchmark. Before PayPal, Thompson had been a top executive at credit card giant Visa, an even bigger company that was no less obsessed with combating fraud. A large part of the team at most credit card companies and online vendors is devoted to vetting new customers and fighting fraud and identity theft, because that’s where profit margins can be largely determined and where customer trust is built or lost.

  Visa and the banks it partnered with together had tens of thousands of people working to beat fraud. PayPal had two thousand, including some fifty of their best PhD engineers, trying to stay ahead of the crooks. And this kid was talking about “good guys and bad guys,” as if he were the first to discover the problem.

  “Sounds good,” Thompson said, not without restraint. “How do you do that?”

  “Good people leave traces of themselves on the Internet—digital footprints—because they have nothing to hide,” Shvat continued in his accented English. “Bad people don’t, because they try to hide themselves. All we do is look for footprints. If you can find them, you can minimize risk to an acceptable level and underwrite it. It really is that simple.”

  Thompson was beginning to think that this guy with the strange name had flown in not from a different country but rather a different planet. Didn’t he know that fighting fraud is a painstaking process of checking backgrounds, wading through credit histories, building sophisticated algorithms to determine trustworthiness? You wouldn’t walk into NASA and say, “Why build all those fancy spaceships when all you need is a slingshot?”

  Still, out of respect for Benchmark, Thompson thought he’d indulge Shaked for a few more minutes. “So where did you learn how to do this?” he asked.

  “Hunting down terrorists,” Shaked said matter-of-factly. His unit in the army had been tasked with helping to catch terrorists by tracking their online activities. Terrorists move money through the Web with fictitious identities. Shvat’s job was to find them online.

  Thompson had heard enough from this “terrorist hunter,” too much even, but he had a simple way out. “Have you tried this at all?” he asked.

  “Yes,” Shaked said with quiet self-assurance. “We’ve tried it on thousands of transactions, and we were right about all of them but four.”

  Yeah, right, Thompson thought to himself. But he couldn’t help becoming a bit more curious. How long did that take? he asked.

  Shaked said his company had analyzed forty thousand transactions over five years, since its founding.

  “Okay, so here’s what we’re going to do,” Thompson said, and he proposed that he give Fraud Sciences one hundred thousand PayPal transactions to analyze. These were consumer transactions PayPal had already processed. PayPal would have to scrub some of the personal data for legal privacy reasons, which would make Shvat’s job more difficult. “But see what you can do,” Thompson offered, “and get back to us. We’ll compare your results with ours.”

  Since it had taken Shvat’s start-up five years to go through their first forty thousand transactions, Thompson figured he wouldn’t be seeing the kid again anytime soon. But he wasn’t asking anything unfair. This was the sort of scaling necessary to determine whether his bizarre-sounding system was worth anything in the real world.

  The forty thousand transactions Fraud Sciences had previously processed had been done manually. Shaked knew that to meet PayPal’s challenge he would have to automate his system in order to handle the volume, do so without compromising reliability, and crunch the transactions in record time. This would mean taking the system he’d tested over five years and turning it upside down, quickly.

  Thompson gave the transaction data to Shvat on a Thursday. “I figured I was off the hook with Benchmark,” he recalled. “We’d never hear from Shvat again. Or at least not for months.” So he was surprised when he received an e-mail from Israel on S
unday. It said, “We’re done.”

  Thompson didn’t believe it. First thing Monday morning, he handed Fraud Sciences’ work over to his team of PhDs for analysis; it took them a week to match the results up against PayPal’s. But by Wednesday, Thompson’s engineers were amazed at what they had seen so far. Shaked and his small team produced more accurate results than PayPal had, in a shorter amount of time, and with incomplete data. The difference was particularly pronounced on the transactions that had given PayPal the most trouble—on these, Fraud Sciences had performed 17 percent better. This was the category of customer applicants, Thompson told us, that PayPal initially rejected. But in light of what PayPal now knows from monitoring the rejected customers’ more recent credit reports, Thompson said, those rejections were a mistake: “They are good customers. We should never have rejected them. They slipped through our system. But how did they not slip through Shaked’s system?”

  Thompson realized that he was looking at a truly original tool against fraud. With even less data than PayPal had, Fraud Sciences was able to more accurately predict who would turn out to be a good customer and who would not. “I was sitting here, dumbfounded,” Thompson recalled. “I didn’t get it. We’re the best in the business at risk management. How is it that this fifty-five-person company from Israel, with a crackpot theory about ‘good guys’ and ‘bad guys,’ managed to beat us?” Thompson estimated that Fraud Sciences was five years ahead of PayPal in the effectiveness of its system. His previous company, Visa, would never have been able to come up with such thinking, even if given ten or fifteen years to work on it.

  Thompson knew what he had to tell Benchmark: PayPal could not afford to risk letting its competitors get hold of Fraud Sci-ences’ breakthrough technology. This was not a company Benchmark should invest in; PayPal needed to acquire the company. Immediately.

  Thompson went to eBay’s CEO, Meg Whitman, to bring her into the loop. “I told Scott that it was impossible,” Whitman related. “We’re the market leader. Where on earth did this tiny little company come from?” Thompson and his team of PhDs walked her through the results. She was astounded.

  Now Thompson and Whitman had a truly unexpected problem on their hands. What could they tell Shvat? If Thompson told this start-up’s CEO that he had handily beaten the industry leader, the start-up’s team would realize they were sitting on something invaluable. Thompson knew that PayPal had to buy Fraud Sciences, but how could he tell Shvat the test results without jacking up the company’s price and negotiating position?

  So he stalled. He responded to Shaked’s anxious e-mails by saying PayPal needed more time for analysis. Finally, he said he would share the results in person the next time the Fraud Sciences team was in San Jose, hoping to buy more time. Within a day or two, Shaked was on Thompson’s doorstep.

  What Thompson did not know, however, was that the Fraud Sciences founders—Shaked and Saar Wilf, who served together in Israel’s elite army intelligence unit, called 8200—were not interested in selling their company to PayPal. They just wanted Thompson’s blessing as they proceeded down a checklist of due diligence requirements for Benchmark Capital.

  Thompson went back to Meg: “We need to make a decision. They’re here.” She gave him the go-ahead: “Let’s buy it.” After some valuation work, they offered $79 million. Shaked declined. The Fraud Sciences board, which included the Israeli venture firm BRM Capital, believed the company was worth at least $200 million.

  Eli Barkat, one of the founding partners of BRM, explained to us his theory behind the company’s future value: “The first generation of technology security was protecting against a virus invading your PC. The second generation was building a firewall against hackers.” Barkat knew something about both these threats, having funded and built companies to protect against them. One of them, Checkpoint—an Israeli company also started by young alumni from Unit 8200—is worth $5 billion today, is publicly traded on the NASDAQ, and includes among its customers the majority of Fortune 100 companies and most national governments around the world. The third generation of security would be protecting against hacking into e-commerce activity. “And this would be the biggest market yet,” Barkat told us, “because up until then, hackers were just having fun—it was a hobby. But with e-commerce taking off, hackers could make real money.”

  Barkat also believed that Fraud Sciences had the best team and the best technology to defend against Internet and credit card fraud. “You’ve got to understand the Israeli mentality,” he said. “When you’ve been developing technology to find terrorists—when lots of innocent lives hang in the balance—then finding thieves is pretty simple.”

  After negotiations that lasted only a few days, Thompson and Shaked agreed on $169 million. Thompson told us that the PayPal team thought it could get away with a lower price. When the negotiating process began and Shaked stuck to the higher number, Thompson assumed it was just a bluff. “I figured I’d never seen such a convincing poker face. But what was really going on was that the Fraud Sciences guys had a view of what their company was worth. They were not sales guys. They weren’t hyping it. Shaked just played it straight. He basically said to us, ‘This is our solution. We know it is the best. This is what we think it’s worth.’ And that really was the end of it. There was a matter-of-factness that you just don’t see that often.”

  Soon after, Thompson was on a plane to visit the company he had just purchased. During the last leg of the twenty-hour flight from San Francisco, about forty-five minutes before landing, as he sipped his coffee to wake up, he happened to glance at the screen in the aisle that showed the plane’s trajectory on a map. He could see the little airplane icon at the end of its flight path, about to land in Tel Aviv. That was fine, until he noticed what else was on the map, which at this point showed only places that were pretty close by. He could see the names and capitals of the countries in the region, arrayed in a ring around Israel: Beirut, Lebanon; Damascus, Syria; Amman, Jordan; and Cairo, Egypt. For a moment, he panicked: “I bought a company there? I’m flying into a war zone!” Of course, he’d known all along who Israel’s neighbors were, but it had not quite sunk in how small Israel was and how closely those neighbors ringed it. “It was as if I were flying into New York and suddenly saw Iran where New Jersey was supposed to be,” he recalled.

  It didn’t take long after he stepped off the plane, however, before he was at ease in a place that was not shockingly unfamiliar, and that treated him to some pleasant surprises. His first big impression was in the Fraud Sciences parking lot. Every car had a PayPal bumper sticker on it. “You’d never see that kind of pride or enthusiasm at an American company,” he told us.

  The next thing that struck Thompson was the demeanor of the Fraud Sciences employees during the all-hands meeting at which he spoke. Each face was turned raptly to him. No one was texting, surfing, or dozing off. The intensity only increased when he opened the discussion period: “Every question was penetrating. I actually started to get nervous up there. I’d never before heard so many unconventional observations—one after the other. And these weren’t peers or supervisors, these were junior employees. And they had no inhibition about challenging the logic behind the way we at PayPal had been doing things for years. I’d never seen this kind of completely unvarnished, unintimidated, and undistracted attitude. I found myself thinking, Who works for whom?”

  What Scott Thompson was experiencing was his first dose of Israeli chutzpah. According to Jewish scholar Leo Rosten’s description of Yiddish—the all-but-vanished German-Slavic language from which modern Hebrew borrowed the word—chutzpah is “gall, brazen nerve, effrontery, incredible ‘guts,’ presumption plus arrogance such as no other word and no other language can do justice to.”2 An outsider would see chutzpah everywhere in Israel: in the way university students speak with their professors, employees challenge their bosses, sergeants question their generals, and clerks second-guess government ministers. To Israelis, however, this isn’t chutzpah, it’s the norma
l mode of being. Somewhere along the way—either at home, in school, or in the army—Israelis learn that assertiveness is the norm, reticence something that risks your being left behind.

  This is evident even in popular forms of address in Israel. Jon Medved, an entrepreneur and venture capital investor in Israel, likes to cite what he calls the “nickname barometer”: “You can tell a lot about a society based on how [its members] refer to their elites. Israel is the only place in the world where everybody in a position of power—including prime ministers and army generals—has a nickname used by all, including the masses.”

  Israel’s current and former prime ministers Benjamin Netanyahu and Ariel Sharon are “Bibi” and “Arik.” A former Labor Party leader is Binyamin “Füad” Ben-Eliezer. A recent Israel Defense Forces (IDF) chief of staff is Moshe “Bogey” Yaalon. In the 1980s, the legendary IDF chief was Moshe “Moshe VeHetzi” (Moshe-and-a-Half) Levi—he was six foot six. Other former IDF chiefs in Israeli history were Rehavam “Gandhi” Zeevi, David “Dado” Elazar, and Rafael “Raful” Eitan. The Shinui Party founder was Yosef “Tommy” Lapid. A top minister in successive Israeli governments is Isaac “Bugie” Herzog. These nicknames are used not behind the officials’ backs but, rather, openly, and by everyone. This, Medved argues, is representative of Israel’s level of informality.