Almost half of all new startups set up by Israeli entrepreneurs during the first six months of the year incorporated their businesses outside of the country, according to a new survey by the Israel Advanced Technology Industries (IATI), an umbrella organization of high-tech and life sciences firms operating in Israel.
The survey, which is based on data collated from 13 of Israel’s leading law firms catering to the local high-tech sector, showed that in the first two quarters of 2023, about 45 percent of new start-ups were incorporated outside of Israel compared to 20% in 2022.
During the first half of 2023, the law firms participating in the survey handled the founding of a total of 260 new startups out of which 118 were incorporated outside of Israel and 142 in Israel. In addition, about 52 local tech firms were in the process of reincorporating to become a US company.
“In the first quarter of 2023, we saw a dramatic change in the transition of new startups incorporating outside of Israel, marking a reversal of the trend that dominated the industry for many years, but these data reflected only one quarter,” said Dan Shamgar, partner at Tel Aviv-based Meitar Law Offices, one of the largest law firms in Israel adding that the analysis of the data for the first six months of 2023 indicated that this is not a short-term phenomenon.
“The change in choice patterns regarding the place of incorporation in which nearly half of the startups prefer to incorporate outside of Israel is a significant phenomenon in terms of business and economic volume,” continued Shamgar, who also serves as the chairman of the IATI attorneys and accountants’ committee. “Even if at this stage the choice regarding the place of incorporation is mainly a formal legal consideration, over time a reality may arise in these companies in which a large chunk of their activities is biased towards abroad.”
This reversal is happening after local tech leaders over many years and with great efforts nurtured an understanding that incorporation in Israel has many advantages and that the registration of a company as Israeli reflects added value, Shamgar noted.
“Now the great bias towards incorporation outside of Israel is leading to a process of erosion of activity in Israel,” he warned.
The concern is that the trend could have far-reaching economic repercussions as the Israeli high-tech ecosystem is the key engine of growth for the country’s economy, responsible for about 16% of GDP, and accounts for about 30% of payroll taxes collected by the Israeli government. In addition, Israel’s high-tech sector employs about 11% of the country’s workforce.
Back in May, the Israel Innovation Authority already warned about a growing trend of Israeli startups being established outside of the country, which started in February and accelerated in March as the government’s controversial plans to shake up the judicial system is fueling uncertainty among investors. Between 50% and 80% of the Israeli startups that were opened in March incorporated through a foreign company, according to the government agency responsible for the local tech ecosystem.
Since the start of the year, leading Israeli entrepreneurs, investors and tech workers have voiced their opposition to the proposed changes which would grant the government more weight in the selection of judges while curbing the Supreme Court’s power to strike down legislation. The prospect of a weakening judiciary system is being perceived as a threat that could undermine Israel’s standing as a stable hub for investments from abroad, on which the local high-tech ecosystem largely relies on for its existence.
The decision by entrepreneurs and startups on the place of incorporation of their business has implications for the future activity of the startup, including the location of its main assets, or intellectual property, the center of research & development, sales and management operations, and where taxes are paid.
For the most part, the discussions and consultations over the place of incorporation reflect both professional analysis and the requirements of potential investors, business partners and customers, it was noted in the IATI report.
The decision over where to incorporate a business is also the outcome of negotiations with investors in the company who dictate their requirements as a condition for their commitment. The reincorporation of Israeli startups is also the result of discussions and consultations among the company’s management and its shareholders regarding the appropriate place of registration, which is in the best interest of the company, and sometimes the decision is an unequivocal demand from investors, according to the survey.
“The current results are not encouraging and it is clear that we want to see companies continue to incorporate here in Israel because this is an important part of the country’s economic resilience,” IATI CEO Karin Mayer Rubinstein told The Times of Israel in e-mailed comments. “However, it is important to remember that we are part of a global economic slowdown and we will continue to act on all professional and regulatory fronts to increase certainty and business stability in the industry.”
Among the law firms that participated in the survey are Gornitzky, Herzog Fox & Neeman, Arnon Tadmor-Levy, Meitar, Naschitz Brandes Amir, Shibolet, Sullivan & Worchester, and S. Horowitz.