Will 2024 see a turnaround in Israel’s tech industry?

Israel’s tech industry has been operating in crisis conditions since May 2022. Since then, we have had interest rate rises, investor flight, mass layoffs, the judicial overhaul program that rocked the industry, and now a war that has meant that many of its employees are unable to do their jobs, and has led stability-loving investors to turn their backs on it.

All the same, there are some sparks of hope. The global macro-economic environment is improving, and interest rates are starting to turn downwards, which should shortly bring more liquid money to the industry. Here are five remarks on the state of play from the report by IVC-Leumi Tech and today’s end of year presentation to 300 investors by Vintage Investment Partners at a conference held by venture capital firm Fusion LA and law firm Pearl Cohen.

1. Collapse halted, for now

The global trend of declining investment in startup companies and in money raised by venture capital firms has halted, and the numbers have stabilized in recent months at levels reminiscent of 2017 and 2018. Even the war has not substantially hit fund raising by startups, which was down 15% in comparison with the previous quarter, although down by 56% in comparison with the corresponding quarter of 2022.

If we compare the year-on-year change in funds raised in Israel in the first three quarters of 2023 with the corresponding figures for Europe and the US, we find a more extreme decline: 60% in Israel, versus 47% in Europe and 39% in the US. Part of the decline is due to political factors, but part is explicable by the small size of the local market and the fact that the Israeli industry grew faster during the Covid pandemic and was overexposed to markets such as fintech, cybersecurity, and enterprise software.

2. Fashionably late

Investors and entrepreneurs in Israel generally lag a quarter or two behind their counterparts in the US in their responses to economic fluctuations, but the war seems to have extended this gap. Fund raising rounds involving cuts in company valuations, mass layoffs, and closures of large companies, are still very rare in Israel, contrary to what has been happening in Europe and the US. Many hoped that they would be able to reach 2024 without such measures, and others are deferring them to the end of the war, or at least to the end of its intensive stage.

The partners in some venture capital firms are also procrastinating and not raising new funds. Others have slowed down the fund raising process, in order not to suffer the disappointment of discovering that the investors are not prepared to invest in them again. All this led to the astonishing figure in the IVC report: despite the war, there has been a slight rise in fund raising at the earliest stages by Israeli companies, but the investors are mostly from overseas, those who have stopped sitting on the fence and are back to investing. The Israelis, who kept their hands deep in their pockets all last year, are still waiting. Meanwhile, the number of companies founded in Israel reached a twenty-year low of just 400.

3. Cyber exits “saved Israel”

In mergers and acquisitions of portfolio companies, Israel position seems better than that of the tech industries in the US and Europe. The aggregate value of exits in Israel exceeded $4 billion in 2023, making it even better than 2022, and equal to 2020, according to Vintage. One reason for that was the high concentration in Israel of young cybersecurity companies, which were sold for very high sums this year. The sales of Dig Security and Talon Cyber Security alone generated $1 billion for their shareholders.

The five biggest technology companies – Amazon, Google, Microsoft, Meta, and Apple – stopped making large acquisitions, including in Israel, and the expectation in the industry is that a sequence of good financials and global macro-economic improvement will get them back on that track. Mergers and acquisitions have become the exit of choice for investors, since the stock market is still shut; the IPO of software company Klaviyo in the third quarter was not a lasting success, and company valuations have been steadily declining. Therefore, selling a company as early as possible, even one that has only just started making sales, is imperative for survival.

The world is recovering, but not where Israel has an advantage

“We have no advantage in artificial intelligence. This is not like telecommunications and cyber, in which Israelis have a clear advantage, partly from experience gained in the army,” said Liad Agmon of Insight Partners at the Fusion LA-Pearl Cohen conference. “Israel does not have research depth in this field. A cohort of doctoral researchers and academic experts has not formed here, and so the challenge in this area is a big one and there’s great deal not happening here sufficiently while the world has woken up big time.”

Three “unicorns” – privately-held technology companies worth over $1 billion – arose in Israel this year. One of them is AI21 Labs, the generative AI company founded by Prof. Amnon Shashua, which held two fund raising rounds because of surplus demand from investors. The company is based on research at the Hebrew University of Jerusalem, and employs many PhD holders. One can easily imagine that if competitor companies were to arise in Israel, they would succeed in raising capital and growing.

5. Reasons for optimism

Despite the war and still high interest rates, there is a mood of optimism in the industry. The expectation that interest rates will fall next year, rising stock markets, and the increase in investment in the US and Europe, have brought a little color back to the cheeks of investors and entrepreneurs. Indications of an imminent wave of immigration to Israel – investor Gigi Levy-Weiss speaks of hundreds of thousands – provide hope that Israel will experience a new influx of engineers and other experts, and perhaps even the return of some who left for countries such as the US, Canada, and France.

Published by Globes, Israel business news – en.globes.co.il – on December 28, 2023.

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