Israel’s high-tech paradox: boom conceals looming crisis
Israel’s high-tech paradox: boom conceals looming crisis
While capital raises return to 2022 levels, startups continue to register abroad, risking future growth.
Outwardly, the data looks encouraging. Capital raising by Israeli start-up companies soared in the second quarter and the first half of the year to levels not seen since 2022. For the first time in over two years, there was no decrease in venture capital investments; the volume even jumped to $2.9 billion between April and June after two quarters where fundraising volume was less than $2 billion.
The figures for the second quarter take us back to mid-2022, when the high-tech celebration had begun to fade but activity remained high, and, crucially, Israel was not in a severe war. Headlines about exits are also back to becoming more frequent. According to PWC data received by Calcalist, the cumulative amount of M&As and IPOs of Israeli technology companies reached $4.7 billion in the first half of 2024, a jump from $2.7 billion in the same period last year. The number of transactions also increased to 33 compared to 27 in the first half of 2023.
These numbers do not include the $1.5 billion sale of WalkMe, founded by Dan Adika, to SAP because, according to PWC's methodology, an exit cannot be counted twice, and WalkMe has already been counted following its IPO on Nasdaq in 2021. Including this transaction and the sale of Qwak to JFrog announced about a week ago, the total over $6 billion.
If these numbers are so positive, why is the high-tech industry broadcasting signals of distress? The distress is not yet seen in the numbers themselves but is hiding between the lines. Calcalist analyzes and identifies several weak points in the local ecosystem as highlighted by the summaries for the first half of 2024. This is not a catastrophe, but a future threat to the unprecedented achievements of the last decade.
Not all the threats and processes are directly related to Israel; global trends also play a part and exacerbate local weaknesses.
The most troubling points are the paucity of Seed and A fundraisings, when the entire increase in capital raisings is due to mega rounds for older and larger companies. What accompanies this is a significant decrease in the activity of both foreign and local investors in Israel, with a drop in the number of entities that continue to invest here. Even the apparently impressive numbers of exits do not necessarily bode well for the future of local high-tech, since in many cases, the companies are sold at very early stages for hundreds of millions of dollars and will not develop into large companies that lead their category.
Above all of these hovers the central threat, which has actually already materialized, but no one dares to measure it yet - most of the new startups that arise here are registered outside of Israel. Down the road, this will not only skew the statistics of investments in Israel but may create a drift of personnel from Israel to outside of it and harm the technological sector's contribution to the economy with a decrease in tax revenues and employment in additional circles, beyond high-tech itself.
It can be said that these are still the problems of the rich, and Israeli high-tech may return to what it was in the early 2000s: a sort of global development center, impressive and disproportionate to the size of the country, with almost no giant companies of its own. However, in the last decade, we have gotten used to being somewhere else, not just a Startup Nation, but already on the runway towards Scale-Up Nation, that is, a wide avenue of large companies that employ more than a thousand employees, sell for hundreds of millions of dollars and billions, are managed from here, and produce the platform necessary for the growth of the next generation of companies, a real Silicon Valley.
This vintage can be seen today in companies that have grown and become public, such as Monday, Global-e, JFrog, Payoneer, Taboola, Cellebrite, and others. Israel today also has another stack full of companies that are ripe for an IPO in the next year or two, but if the local tech industry wants to continue to be competitive even in another decade, especially in light of the artificial intelligence revolution, it needs to sprout the giants of another decade now. And here, as it appears from the current data, warning signs begin to develop.
Investors prefer AI
Four particularly disturbing trends emerge from among the reports on Israeli high-tech for the first half of 2024.
1. A paucity of early rounds: If you exclude from the impressive number of $2.8 - $2.9 billion raised in the second quarter the huge rounds, most of them in cyber, you are left with a modest number of only $1 billion, according to a summary of the RISE Israel. The IVC and LeumiTech data published on Sunday reinforce the actual weakness in that more than 60% of the money was raised in six huge transactions while the total number of rounds remained unchanged at 111 transactions in the quarterly summary, and in fact, it is the same level that characterized Israel in 2019. Another examination reveals that the number of Seed rounds reached an unprecedented low in the second quarter and stood at only 45 rounds, following a sharp drop to 91 rounds in the first quarter. To illustrate, since 2019, the number of Seed fundraisings by Israeli startups has been at least 150 per quarter, with quite a few quarters in which more than 200 initial fundraisings have been completed. The dangerous trend is evident even in the hot field of cyber, and according to a report by VC YL Ventures which specializes in the field, in the first half of the year, there were only 11 Seed rounds in which a total of $85 million were raised, compared to 36 rounds in 2023 as a whole during which $354 million were raised. That is, at the current rate, 2024 will be much weaker in this segment.
Why is there a decline? The reasons are also specific to Israel and include geopolitical uncertainty that does not encourage risk-taking and the establishment of new companies, many potential entrepreneurs serving in the IDF reserves for a long period, but also a global trend of less capital available for tech investments. In such a situation, investors prefer to support the existing and less risky companies in which they have already put money. Also, in what appears to be an Israeli weakness, the preference of investors today is for new startups in the field of artificial intelligence, and it is not clear to what extent Israel is keeping up with the expected pace in this regard.
2. Decrease in investor activity: The decrease in funding for new companies while favoring old and existing companies also directly involves a decrease in the activity of both foreign and local investors in Israel. RISE notes that the phenomenon of a continuous decrease in the number of investors active here worsened in the second quarter. At this stage, it is difficult to know whether this is related to the decrease in the appetite of institutional bodies and family offices for venture capital investments, or to the avoidance of Israeli risk, but the numbers are unequivocal. The number of foreign investors who invested in Israel in the second quarter reached a low of 499. The reference here is not only to venture capital funds but also to large corporations and institutional bodies. There was also a decline in the activity of Israeli investment entities, but it is mostly due to their inability to raise money and the preservation of the remaining resources to support the existing investments.
3. The new startups are leaving: The third reason for concern is the most important of all, because it can apparently be the root of the first two disturbing phenomena and will also be the one that will cause the most substantial damage to the Israeli economy over time. Although there are no official numbers for this yet and no one wants to put them on the record, in the field, it is acknowledged that throughout the last year, since the protest against the judicial reform increased and at an accelerated rate since October 7, new startups are not being registered in Israel. They do recruit employees here, but the registration is again, as it was twenty years ago, in Delaware in the USA, and the management moves to the USA much earlier. Therefore, it is possible that many recruits in the early stages of companies with Israeli ties are counted as Americans.
The most significant proof of this could be seen in the discussions between the institutional investors in Israel and the Innovation Authority regarding the definition of the "Israeliness" of companies that could receive investments from venture capital funds that raised money from the institutions as part of the Innovation Authority's program. Lawyer Yoav Sherman, partner and head of high-tech at the Arnon Segev law firm, who accompanies some of the institutional bodies in the Innovation Authority's tender process that ended last week, told Calcalist that in the end "Israeli affiliation" was defined, and it is a requirement to spend 70% of research and development expenses in Israel in the last two years. Although this is an important compromise, here again, there is a return to the emphasis on R&D while renouncing the encouragement of leaving marketing functions in Israel. However, the importance of the program is that it will concentrate on startups in the early stages and provide a security cushion for local venture capital funds to encourage them to make new investments.
4. Most of the exits are not happy: Even the most objective statistic that grabbed quite a few headlines in the last months of the many exits should not really make the local ecosystem happy. "There are signs of life from the industry, and we see them in the relatively large number of companies that have been sold," says Yaron Weizenblluth, partner and head of the audit practice and high-tech cluster at PwC Israel, but he also admits that the circumstances of the exit are not always happy. "There is a global and not only Israeli trend of compromising on the value out of a desire not to reach a violent turning point in the future. It is better that way than perhaps firing employees or closing the company down the road. As far as Israel is concerned, there is a tremendous degree of uncertainty, both security, political and inflationary. This also sometimes pushes for the decision to sell," he explains.
As proof, of the large exits of the half, a large part is the sale of companies two to four years old, which decided to give up the chance to become large and independent companies. If we end on an optimistic note, it can be found in the multitude of blue and white mergers that accounted for about a third of all exits in the first six months of 2024, and PWC emphasizes this dominance of Israeli deals on both sides.
Without huge companies to push the engine of growth
All threats and damages are still reversible and, in some cases, even circumstantial, when it is difficult to separate them from the general world situation. Although high-tech in the U.S. has already embarked on a path of recovery, it has not yet returned to full function, and despite the sharp increases on Wall Street in the first half, expectations for a large number of high-tech IPOs have been misled at this stage and have been largely postponed until 2025. But if the current trends continue and take root, Israel may find itself in seven to ten years with no new giant companies to push the engine of growth.
RISE summarizes the current state of Israeli high-tech: "Nine months into the war, against the background of estimates that it may continue at one intensity or another for a long time, and in the shadow of the uncertainty regarding the security situation in the north, the current challenges of the high-tech sector cannot be regarded as something that will change quickly. Although in many respects the sector shows admirable resilience, the stabilization of investments that are not mega rounds at a level of about one billion dollars per quarter, and the continuous decrease in the number of active investors in Israel, are worrisome signs. The Israeli government, especially with the help of the Innovation Authority, must find a way to help good startups survive the crisis period until it ends."
