Facing global and local headwinds, Israeli startups see investments slump to 2018 low

Fundraising by Israeli startups dropped to the lowest level since 2018 in the first six months of the year as local political uncertainty amplifies the effects of the global downward trend in the tech industry, according to a report by the Start-Up Nation Policy Institute (SNPI) released on Sunday.

Investments in tech firms plunged 68% in the first half of the year to $3.7 billion compared to the first half of 2022. The figure marked the lowest amount since the second half of 2018, data compiled by SNPI’s report on the Israeli tech sector for the first half of 2023 showed. SNPI is an arm of Start-Up Nation Central, which tracks the industry.

Israeli startups raised $2 billion in the first quarter of the year, a figure that dropped to $1.7 billion in the second quarter of 2023 — the lowest quarterly figure since the second quarter of 2018.

Venture capital investments have declined for the sixth consecutive quarter, while real wages in this industry have stabilized in recent months, following a continuous upward trend over approximately a decade. In the report, the global slowdown in fundraising coupled with local instability stemming from the government’s highly contentious proposed judicial overhaul were cited as the main reasons for the downturn in the tech sector.

If this pace continues, total investments in the Israeli tech industry in 2023 are forecast reach $7.5 billion, a 55% drop from 2022, according to SNPI estimates. Israeli tech firms raised close to $15 billion in capital last year and, during a bonanza funding year in 2021, nabbed $25.6 billion in private investments in total.

“The data for the first half of the year is yet another warning light for anyone worried about Israel’s economic future,” commented SNPI co-chairman Prof. Eugene Kandel. “We must remember that Israel does not have a monopoly on wisdom and knowledge, and certainly not on resources. What Israel has is an enormous technological advantage that has been painstakingly built over decades that must be preserved – and that requires a strategy that dictates policies that are smart, that is consistent in its goals, and that is flexible in its capabilities.”

Illustrative: The Azrieli Center in Tel Aviv, February 2022. (Boarding1Now via iStock by Getty Images)

“We don’t have time to waste,” Kandel urged.

The global slowdown in tech investments that started in the second half of 2022 was exacerbated by worldwide inflation, interest rates that were raised to rein in price growth, and weak stock markets. The market downturn has seen thousands of workers laid off, triggering funding pullbacks and creating a bear market for new tech offerings, including for Israeli startups.

While it is “plausible” that the policies of central banks around the world could achieve a “soft landing” for the global economy in the coming months, with a gradual decrease in inflation and without a global recession, Israel’s sociopolitical crisis regarding the judicial reform is still ongoing, it was cautioned in the report.

The contested legal changes the government proposed early this year have been triggering mass protests for more than six months, drawing thousands to rallies across the country. Many Israeli tech executives and employees have been taking part in the protests amid concern that the legal plan undermines Israel’s system of checks and balances and threatens its democratic character, which in turn it is feared could drive away foreign investment. In 2021 and 2022 about 80% of venture capital investments in the Israeli tech sector were generated from foreign funds, according to the Israel Innovation Authority.

Legislation on the judicial overhaul plan was paused in March to allow for compromise talks. But the talks foundered, and last month the government restarted its legislative advance and has begun moving ahead in the Knesset with certain elements of the plan.

“At this point, the likelihood of a compromise within the parliament appears remote as negotiations between the two parties have been suspended, and the coalition has announced a partial continuation of the planned legislative steps,” it was stated in the report. “And so, it appears that Israel’s high- tech industry will have to continue to deal with this uncertainty.”

Tech workers protest against the government’s judicial overhaul: ‘time is running out for Israeli hig-tech,’ in Tel Aviv, on March 23, 2023 (Avshalom Sassoni/Flash90)

The tech industry employs about 14% of the country’s workforce, generates about 18% of gross domestic product (GDP) and is responsible for over 50% of exports and about 30% of payroll taxes.

“Our main policy recommendation has been, and still is, to reach broad consensus on legislative changes in order to stabilize the Israeli economy in general and the high-tech sector in particular,” the report said. “According to our analysis, the recent negative developments in this context are likely to continue and even exacerbate the current downward trend in the high-tech industry.”

The analysis showed that investment in all major sectors in the Israeli tech ecosystem fell significantly in the first half of 2023 compared to the same period in 2022. Fintech and enterprise IT and data infrastructure companies suffered the biggest fundraising declines, more than 80% year-on-year. The most moderate drop in investments relative to 2022 was recorded in security technologies, mainly cybersecurity firms, and in the areas of agriculture and food tech.

As Israeli tech firms continue to struggle with a downward trend in investments, there are early signs that the high-tech industry in Europe and the US is beginning to emerge from the global slowdown, showing a modest increase in venture capital investments of 34% and 15%, respectively, in the last quarter, it was pointed out in the report.

AI revolution

“This recovery relies on the AI revolution, which has primarily helped large technology companies to return to rapid growth after a year of stagnation,” the authors of the report wrote. “We are concerned that local unrest could cut off Israel’s high-tech industry from the global technology sector’s recovery, making it less competitive during this crucial time.”

Since the start of the year, Israeli tech companies have shown negative returns compared to tech companies traded on the Nasdaq and other world indices. During the first six months of the year, the Tel Aviv-35 index of blue-chip companies and the TA-90 stock index declined by about 1-3%, while the Nasdaq has jumped more than 20% and the MSCI World Index rose 12% during the same period, pointing to the first signs of a recovery in global markets, according to Tel Aviv Stock Exchange data.

Part of the global high-tech sector’s exit from the downturn is attributed to large investments in AI technologies, the report found. Hence, the question arose whether Israel could become a leader in the field and compete in the global AI race. Research compiled in the report from global rankings suggests that Israel is in an excellent position in terms of its human capital, with research skills and capabilities among the highest in the world but in terms of infrastructure and government strategy for AI, the country lags behind.

“In light of the significant changes since the beginning of the current decade – stubborn inflation and a high interest rate environment, geopolitical changes, and especially the rise of new technology, the impact of which is expected to be unprecedented – the importance of the partnership between government and industry is intensifying,” said SNPI CEO Uri Gabai. “It is precisely against this background that we are particularly concerned about the political developments of recent weeks.”

“Israel’s technological and human potential remains among the best in the world, and Israel can and should take advantage of the new wave of technology to further strengthen its position in the global innovation race. However, the continuation of the negative trend of recent months is liable to erase the achievements of the high-tech industry that have been built here over the past 40 years,” Gabai warned.

Israel boasts about 1,400 startups that are actively harnessing AI technologies, the majority of which were established in 2019 and onwards, according to data from the Start-Up National Central finder platform. In addition, there are 47 more firms that specialize in the development of generative AI technologies. Over the past two years, AI companies have attracted about 45% of total VC investments in the Israeli tech ecosystem.

Last month, Prime Minister Benjamin Netanyahu announced an initiative to formulate a national policy regarding civil and security uses of artificial intelligence, after talking with tech billionaire and Twitter chief Elon Musk and visiting OpenAI CEO Sam Altman.

In the report, SNPI urged the government to act swiftly and formulate a well-structured and ambitious long-term plan to maintain Israel’s technological edge by bolstering infrastructure and computational capabilities and making substantial investments in human capital and academic institutions in this field.

With the emergence of AI, the need for a strong partnership between the local government and the industry is even more important, it was emphasized.

“This partnership should primarily manifest itself in the preparation of the industry and economy for an increasingly AI-based economy,” it was demanded in the report. “We believe that the government should focus on restoring political and macroeconomic stability rather than attempting to ‘fix’ the decline in high-tech investments, as fiscal measures aimed at addressing a downturn in a specific market are often ineffective.”