How to diligence an Israeli startup as a US investor: IIA grants, Section 102 and the Delaware flip

What is different about an Israeli startup

An Israeli startup raises like a US one but is built on a different legal base. Before a US investor wires, four things need checking that a US-only checklist misses: which entity you are buying into and whether it has flipped to Delaware, any Israel Innovation Authority grants and the strings on the IP, the Section 102 option plan, and what the local investors on the cap table signal.

Everything else (the founders, the technology, the customers, the terms) is diligenced the same way as any seed deal; see the startup due diligence checklist. The Israeli layer is where US investors most often find out too late that the structure limits what the company can do, or what an acquirer will pay.

Which entity are you investing in

Confirm whether you are buying stock in an Israeli company, a Delaware parent that owns an Israeli subsidiary, or an Israeli company that has promised to flip. Each has different tax, QSBS and exit consequences, and the IP may sit in a different entity from the one issuing your shares.

Most Israeli companies that raise from US funds become Delaware corporations through a share exchange, with the Israeli company as a subsidiary that keeps the employees and the IP; the mechanics and the Israeli tax ruling are covered in how an Israeli startup redomiciles to a Delaware C-corp. For an investor, the questions are whether the flip has happened, whether it will be a closing condition of your round, and whether the tax ruling's conditions (the IP stays in Israel, minimum holding periods) constrain the company's plans.

Israel Innovation Authority grants

An Innovation Authority grant is not free money for an investor. The company repays it as a royalty on revenue, and the know-how the grant funded generally cannot leave Israel without approval and a payment that can reach a multiple of the grant. Ask for every grant file, the amounts, and the royalty balance.

The rules that matter most:

• Royalties. Companies pay a royalty on revenue from the funded products, 3% for smaller companies and up to 5% for large ones, until the grant plus interest is repaid. For files approved from January 2024, interest is the higher of 12-month Term SOFR plus 1% or 4%.
• Transferring know-how abroad. Moving the funded know-how outside Israel, including in a sale to a foreign acquirer that moves the technology, needs the Authority's approval and a payment based on the Authority's share of the company's total R&D spend, capped at six times the grants plus interest.
• Manufacturing abroad. Moving production of funded products out of Israel raises the repayment cap: for applications after October 25, 2023, to 120% of the grant where 25% to 50% of production moves, and 150% where half or more moves.

None of this makes a grant-funded company uninvestable, and many good Israeli companies carry grants. It does mean an exit to a US acquirer that plans to move the R&D is priced net of a payment to the Authority, and a US investor should know the size of that payment before wiring. Current terms should be confirmed with Israeli counsel; the Authority revises its rules.

Section 102 option plans

Israeli employee options are usually granted under Section 102 of the Income Tax Ordinance, which lets employees pay 25% capital gains tax instead of income tax if the awards sit with a trustee for two years from grant. For an investor, the plan's health signals how well the company has been run.

Check that the plan was adopted and filed properly, that grants were deposited with the trustee on time, and that employees, officers and directors (not controlling shareholders, broadly anyone holding 10% or more, and not consultants) received 102 awards while others got the correct alternative. If the company has flipped or will flip, confirm the plan was, or will be, rolled into the Delaware parent in a way that preserves the trustee track. A broken 102 plan is fixable, but it costs money and goodwill, usually at the next financing.

What the cap table tells you

An Israeli cap table carries signals a US investor may not read. The names of the local angels and funds, whether a known Israeli seed fund led or merely followed, and whether early investors are taking pro-rata all say something about how the local market has priced the company.

Look also for the structures that are common in Israel and rarer at a US seed: SAFEs issued by the Israeli entity before the flip, convertible loans with Israeli-law terms, founder shares without vesting, and significant holdings by a university technology-transfer company, which usually come with a license rather than an assignment of the IP. Each is manageable if it is known; each is expensive if it is discovered at the Series A.

Operating realities

Two practical questions belong in every Israeli diligence. First, reserve duty: after October 2023, founders and engineers may be called up for extended periods, so ask how the company has operated through call-ups and who covers each key role. Second, where the company sells: a company building for the US market from Israel needs a US go-to-market plan and, usually, a US-based commercial leader, and the deck should say who and when.

For defense and dual-use companies, add export control: technology that is controlled in Israel or the United States may limit who can invest, what information investors can see, and who can buy the company. Flag these questions for counsel before closing.

When to bring in an outside read

If you are a US investor looking at an Israeli company and the open items are the grant files, the 102 plan or the entity chain, an outside read by someone who works in both markets and reads the Hebrew documents is cheaper than learning at exit. Olivent Diligence offers an Israel Structure Review ($3,000, two business days) as an add-on to a Full Diligence ($8,500, five business days), paid only by the investor. Adam Yohanan works between Dallas and Tel Aviv.