The Unique Aspects of Conducting M&A Deals with Israeli Companies

Foreign companies and Investors are familiar with governmental and other authorities’ grants, as we can see when they are inquiring about diligence services. However, most foreign investors who are conducting their first investment in an Israeli company, may come across grants granted to their Israeli target company by the Israel Innovation Authority (IIA). Such grants may be a great opportunity for the Israeli company to get funds and support new opportunities for growth.

However, while Israeli investors are well familiarized with the Israel Innovation Authority’s obligations, such grants and the rules and regulations they are subject to, are not known to foreign investors and may affect their decision with respect to investing in such companies.

The Israel Innovation Authority, is an independent government agency, aimed to help fund companies through various stages with specific concentration on R&D and innovation. Its mission and rolls to promote, support and assist technological innovation in the industry and the infrastructure for such are actually defined in the Israeli Law for the Encouragement of Industrial Research and Development—1984 (The R&D Law), and one major assistance is granting grants to companies to support their innovative R&D. Such grants have prerequisites of the programs approved by the Innovation Authority Committee, and shall be subject to further provisions, as specified in the R&D Law and correspondent regulations and rules.

Although it is most likely that the intellectual property and know-how of developing a product under a certain grant given by the Innovation Authority will be owned by the recipient of such grant, some conditions of the receipt of such grant may require a special attention under the due diligence process and decision making.

Here are some of the notable stipulations:

Royalties – A company that has used a grant provided by the Innovation Authority may have to pay royalties from the revenues it generates from the developed product under which it was granted the grant. The royalties’ percentage is decided by certain regulations providing guidelines on establishing the rate and how and when to pay. The rates are usually 3% and up to 6% depending on the size of the company, if it manufactures abroad and if the final price of its product is known. Usually, when there are revenues, royalties will be paid until they reach the full amount of the received grant. Needless to say, that in case that the company does not generate revenues from the abovementioned product, there is no need to pay the IIA the related royalties.

Subcontractors – When the development process is conducted by a subcontractor, the know-how (IPs) should belong to the recipient of the grant. In case of a foreign subcontractor there is a need for prior approval from the Innovations Authority’s Research Committee, and such approval will only be granted if the committee was convinced that there is no way to do the R&D in Israel.

Transfer of Know-How – Transfer of know-how from the recipient requires an approval of the Innovation Authority Committee, and if such transfer’s aim is for consideration, then the royalties’ provisions. Transferring know-how abroad (for example to a foreign entity), will require payment to the Innovation Authority. The maximum payment in such case shall not exceed 6 times the received grants plus annual interest and minus the already paid royalties. If the foreign entity commits to keep the R&D activity in Israel for at least 3 years, then the amount shall not exceed 3 times the received grants plus annual interest and minus the already paid royalties.
Licensing know-how may be construed as transfer of know-how abroad.

Change in Means of Control – Any change in means of control of the recipient of the grant should be reported to the Innovation Authority, and if the new holder of the means of control is not an Israeli citizen or corporation then with such report it shall sign an obligation in the form published by the Research Committee.

Issuance or Sale of Shares – In the event that the company receiving the grant issues or sells shares, there is no requirement of prior approval from the Innovation Authority, as long as there is no influence on the ownership of the know-how. However, such action has to be reported to the Innovation Authority.

Transfer of Manufacturing – In the event of transferring no more than 10% of the manufacturing to a site abroad, then there is only a need to send a written notification to the Research Committee of the Innovation Authority, and if the committee did not send any disagreement within 30 days, then it is automatically approved. However, the royalties shall be probably higher than before the shift and with a higher cap. Transferring any larger portion then the committee may subject it to a higher cap and royalties for revenue for products manufactured abroad.

Source Code – Depositing source code as part of an agreement with customers, requires the approval of the Research Committee. The Innovation Authority may approve it if it is provided to an Israeli citizen and the agreement is under the Israeli law, and is compatible with the trust agreements published by the Innovation Authority.

When investing in or acquiring an Israeli entity, it is important to understand the regulations and rules involving a grant from the Israel Innovation Authority. Such grants may open doors to new partnerships, new cooperation opportunities, new ideas and innovative technologies, yet it could also come with certain restraints on the company and the know-how it develops under the grant.
Knowing these opportunities and restraints help us understand better the target company that received such grants from the Israel Innovation Authority.