Israeli high-tech companies had a good year in 2006. 402 such companies attracted $1.62 billion (€1.24 billion) from local and foreign investors, 21 percent above the amount deployed in 2005, according to a quarterly survey by the Israel Venture Association and the IVC Research Centre.

The fourth quarter in particular saw an eye-popping increase, with 105 companies raising $477 million, an 80 percent jump from the $264 million raised in the fourth quarter of 2005.

Despite last summer's military conflict along the country's northern border, foreign investors showed no wariness of investing in Israel's world-renowned technology activity. Sixty percent of last year's investment was from foreign investors, compared with 51 percent in 2005.

“It's similar to the number of foreign investors we saw in 2000,” says Zeev Holtzman, chairman of IVC Research Centre and Giza Venture Capital. “Despite the geopolitical situation that happened recently in the area, it's still a very attractive place for the technology and life sciences sectors.”

Joseph Shoendorf, a partner with Accel Partners in Menlo Park, which manages $4 billion, says even with the recent conflict and the growing innovative strength of India and China, Israel remains a dominant centre for innovation. Of the $400 million Accel has invested since 2001, he says, more than half was invested in Israel.

“Israel is probably second only to the United States in innovation,” he says. “There were half a dozen [Israelis] who worked here in the United States in the early 70's, and they went home. They knew how to do a start-up, and then they developed the Israeli model, which says we do innovation in Israel and we market globally.”

Schoendorf says he's not surprised that the country saw such an increase in investment in the fourth quarter after the summer's war. Conflict, he argues, is what has driven innovation in Israel in the past.

“Necessity is the mother of invention,” he says. “It seems to me the more Israel is challenged geopolitically, the more it rises to the challenge to protect itself. I don't think it's a coincidence that we're seeing a peaking of innovation now.”

Yossi Sela, a managing partner with Gemini Capital in Israel, says it has been a busy year for Israeli VC firms. In a separate ranking compiled by IVC, Gemini was ranked as the second most active fund in 2006 with nine first investments, just behind Pitango Venture Capital with ten.

“For some reason we're seeing today deal flow that rose in quality and quantity, surpassing past years,” he says. “Last year and this year are the two years when fund flow is very active in investing. And the number of opportunities presented to us last year was large. Many hundreds of deals were screened by our team last year.”

Among the ten most active funds, the software sector attracted the highest number of first investments, with 22 deals, followed by communications and the internet. Along with life sciences, these have traditionally been the powerhouses of Israeli innovation, although it is interesting to note that life sciences companies attracted only three investments from the most active funds.

Mirroring the same stage in the cycle for VC investment in the US and Europe, new fund formation continued to be slow in 2006, as Israeli VCs focused on putting existing funds to work. Just three Israeli funds closed in 2006 – Sequoia Israel III at $200 million, Poalim Medica III at $125 million and Vertex Israel III at $150 million.

“Generally speaking this wasn't a very strong year for fundraising,” says Holtzman. “More Israeli firms will come to market in 2007, and there will start a new cycle of capital raising by experienced and strong funds that will finish the cycle investing. The last cycle was 2004, 2005. It will start again by the end of the year.”