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 it's built on a different legal base. Check four things a US-only checklist misses: which entity you're 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.

Same company, different foundation. The Israeli layer is where a US checklist runs out.

Everything else (the founders, the technology, the customers, the terms) gets 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

Start by confirming what you're actually buying: stock in an Israeli company, in a Delaware parent that owns an Israeli subsidiary, or in an Israeli company that has promised to flip. Each one has different tax, QSBS and exit consequences, and the IP may sit in a different entity from the one issuing your shares.

Parent and subsidiary. Know which box your shares come from, and which one holds the IP.

Most Israeli companies that raise from US funds become Delaware corporations through a share exchange. The Israeli company becomes a subsidiary and 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. As an investor, you want three answers. Has the flip happened? Will it be a closing condition of your round? And do the tax ruling's conditions (the IP stays in Israel, minimum holding periods) constrain the company's plans?

Israel Innovation Authority grants

From an investor's seat, an Innovation Authority grant isn't free money. The company repays it as a royalty on revenue, and the know-how it funded generally can't 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.

Grant-funded know-how comes with a cord attached. It can leave Israel, but only with approval and a payment.

The rules that matter most:

• Royalties. The company pays 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, it goes to 120% of the grant where 25% to 50% of production moves, and 150% where half or more moves.

A grant doesn't make a company uninvestable, and plenty of good Israeli companies carry them. But an exit to a US acquirer that plans to move the R&D gets priced net of a payment to the Authority, and you should know the size of that payment before you wire. Confirm current terms 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. It 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 says a lot about how well the company has been run.

Section 102 awards sit with a trustee for two years from grant. Check the clock started on time.

Check that the plan was adopted and filed properly, that grants were deposited with the trustee on time, and that 102 awards went to employees, officers and directors (not controlling shareholders, broadly anyone holding 10% or more, and not consultants) while everyone else got the correct alternative. If the company has flipped or will, confirm the plan was, or will be, rolled into the Delaware parent in a way that keeps the trustee track. A broken 102 plan can be fixed. It costs money and goodwill, though, and the bill usually comes due at the next financing.

What the cap table tells you

An Israeli cap table carries signals a US investor may not read. Look at who the local angels and funds are, whether a known Israeli seed fund led the round or just followed, and whether early investors are taking their pro-rata. Together those tell you how the local market has priced the company.

Who led, who followed, who is taking pro-rata. The names tell you how the local market priced the company.

Then look for structures that are common in Israel and rarer at a US seed: SAFEs issued by the Israeli entity before the flip, convertible loans on Israeli-law terms, founder shares without vesting, and significant holdings by a university technology-transfer company, which usually come with a license to the IP rather than an assignment. Any of these is manageable if you know about it. Discovered at the Series A, each one gets expensive.

Operating realities

Two practical questions belong in every Israeli diligence: how the company handles reserve duty, and where it sells. 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.

Reserve duty can take a key person away for weeks. Ask who covers each role before it happens.

On the market side, a company building for the US from Israel needs a US go-to-market plan and, usually, a US-based commercial leader. The deck should say who and when.

For defense and dual-use companies, add export control. Technology that's 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're 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 from someone who works in both markets and reads the Hebrew documents costs less than finding out 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.

A second, independent read on the parts you can't check yourself.