Israel’s tech sector is looking back to 2022 as the start of a downturn, with funds raised by startups almost halved, dropping to $15.5 billion. Cybersecurity firms got hit hardest, while seed investment into local startups increased, according to a report published Tuesday by Start-Up Nation Central (SNC), a nonprofit organization that tracks Israel’s tech industry.
The value of investments last year slumped 43 percent compared to 2021, a bumper period when Israeli companies nabbed a staggering $27 billion in private capital in total, driving up deal valuations. During the same comparative period, the overall number of investment rounds declined by about one third, to 826 in 2022 from 1,103 the previous year.
The record flow of funds raised in 2021, which continued into the first few months of last year, led to high company valuations — and sometimes overvaluations — of companies that were not close to turning a profit. But in mid-2022 the market started to turn, and valuations and shares traded publicly took a downturn, with rising inflation and interest rates and the ongoing Russian war on Ukraine impacting supply chains and the global economy, while investors hunkered down.
“2022 is really a combination of two years. If you look at the first half, you see more of the 2021 flavor, a more bullish market, and if you go to the second half of 2022, you already see the slowdown kicking in,” Start-Up Nation Central CEO Avi Hasson told The Times of Israel. “The unrealistic quantum leap in investments, market cap, and transaction multiples in 2021 corrected itself in 2022, alongside global macroeconomic trends.”
The market downturn has seen thousands of tech workers laid off, triggering funding pullbacks and a sharp decline in the value of publicly traded tech firms. This created a bear market for new offerings, with an overall sense that the “wild party” is over and doom clouding the economy.
“In the US, tech was the market that had the highest number of layoffs. Just below 100,000 people were laid off in high tech, and the numbers in Israel are not even close,” Hasson remarked. “In Israel, we have seen companies slowing their growth or cutting 5% to 10% of their staff. That’s more optimization or working with your churn.”
In recent months, Intel Israel, the country’s largest private sector tech employer, has laid off dozens of employees. SodaStream, the maker of home seltzer-making machines, laid off 120 employees. Isracard will cut 250 employees, or 12% of its workforce, as Israel’s largest credit card company embarked on a plan to streamline costs and operations. US jet engine-maker Pratt & Whitney is set to halt manufacturing of compressor blades at Blades Technology Ltd. (BTL) in Nahariya, after more than 40 years, putting 900 workers out of their job.
“We haven’t yet seen, with very few exceptions, companies looking deep into their business, by, for example, cutting as much as 30%, and I think we’re going to see more of that in the coming year because companies will have no choice,” Hasson cautioned.
During the second half of 2022, the number of equity investment deals with tech companies fell to 313 from 519 in the first six months of the year, the second lowest half-year figure on record.
“When we look into the trend lines, it’s not about 2022 being a bad year, or worse than expected, but it’s 2021 that was a huge anomaly in terms of every indicator that you could look into,” said Hasson. “If you drop 2021, and you draw a growth line from 2015 to 2022, it looks okay that over $15 billion was invested in Israeli startups last year.”
The downward slope in investments is not unique to Israel, and is in line with what has been happening in Silicon Valley, where investments in tech companies declined by 40%, according to the SNC report.
Seed investments buck the trend
As the downturn in financial markets drove declines in total investments in most types of investment rounds during 2022 in Israel, the biggest positive trend was experienced by early-stage or seed startups, which saw an increase in investments. Seed investments in Israeli startups grew by 22% to $1.62 billion in 2022 versus $1.32 billion in 2021.
Investors who traditionally invested only in later-stage companies have been shifting investment to seed funding mainly because of extremely high valuations in the later-stage company rounds, the SNC report found.
As in previous years, the Israeli tech sectors that in 2022 drew most of the capital were software-based, including primarily enterprise software, security tech (including cyber) and fintech, as well as life sciences and health tech.
The sector that was hit hardest, suffering the largest drop in investments in 2022, was cybersecurity. Investment in cybersecurity startups in 2022 nosedived 60% to $2.7 billion from $6.6 billion a year earlier, compared with an annual decline in the entire high-tech industry of 43%. That said, the number of funding rounds was stable compared to 2021, according to analysis in the SNC report.
Over the course of 2022, there were 20 exits — defined as mergers and acquisitions or IPOs — of Israeli cybersecurity companies. The top deal was British investment fund Liberty Strategic Capital snapping up Israeli-founded mobile security solutions company Zimperium for $525 million. The second largest deal was Israeli cyber company Medigate acquired by Softbank-backed Claroty for $400 million, and the third was US-based cybersecurity firm Palo Alto Networks buying Cider Security for $300 million. As of late 2022, there are 676 active cybersecurity companies in Israel.
“2021 really showed the appetite of investors and cyber was leading the pack, and as things cool up, you see cyber moving down,” said Hasson.
Investments and number of funding rounds across all of the tech sectors covered in the report declined in 2022, except for the agri and food tech sector which saw deal count rising to 87 from 84 in 2021, while the total investment amount remained stable between the two years.
“This suggests that the agri & food tech sector may have been more resilient to external factors such as economic downturns,” according to the SNC report. “This sector is relatively small but has been experiencing rapid growth in recent years with 624 active startups.”
According to the SNC report, the most active VC foreign investor in Israeli companies in 2022 was Insight Partners, a New York-based private equity and investment firm that participated in 40 rounds in 2022, down from 49 in 2021.
Tiger Global, which only began operating in Israel in 2019, was the second most active and invested in 26 startups. During its first years of activity in Israel, Tiger focused on more mature companies ready for IPO or unicorn valuation. In 2022, its investment strategy shifted to earlier stage companies, which included 13 A-round funding deals and three seed-round deals. In 2021, the fund made 75% of its investments in Israel in C+ rounds, and the rest in B rounds.
By far, the most active Israeli VC company was OurCrowd, investing in 84 startups in 2022, followed by Viola (all funds) with 47 rounds, and Pitango, which invested in 21 different start-ups.
IPOs and M&A activity
2022 marked a return to the “normal” numbers of 10 to 20 new initial public offerings (IPOs) annually characterizing the Israeli high-tech industry in recent years after the phenomenal record number of 77 IPOs (including special purpose acquisition companies, or SPACs) that took place in 2021, according to the SNC report. Last year, only 14 Israeli companies went public, with an additional four companies doing so via SPACs versus the 22 IPOs registered in 2020.
The number of mergers and acquisitions fell 45% in 2022, year-on-year, with the aggregate sum of deals dropping 40%. A total of 89 tech firms were sold for a total sum of $5.3 billion. M&A activity dried up in the second half of 2022, with the aggregate sum of the deals ranked as the fourth lowest recorded by the SNC database.
One of the most prominent deals of 2022 was US semiconductor giant Intel buying Israeli computing tech startup Granulate for $650 million, marking the chip multinational’s seventh acquisition of an Israeli company in just over five years. Another was Israeli fintech startup Finaro, formerly known as Credorax, being snapped up by integrated payments and commerce tech firm Shift4 for $575 million.
Looking ahead to what is coming in 2023, Hasson sees a year of slow economic activity, with investments and exits continuing but in a much more “prudent and measured manner.” Some difficulty in VC funding that might have an impact on the available capital for investments in 2024 and 2025.
“We are going to see a huge reduction in exits, much less than we are used to seeing, and that by itself will have an implication on the ability of funds to raise capital,” said Hasson. “While everybody is slowing down in terms of their investment base, funds are going to have a hard time raising money, which means that we are going to see capital shortage in companies in 2024.
“The good news is that the Israeli high tech industry is going into this situation with full pockets, as both companies and funds entered the current crisis with more cash raised in 2020 and 2021, so they can weather the storm for the first six to 12 months,” he continued. “But at some point in time next year, startups are going to need more money and when that happens, we are going to see down rounds and a lot of consolidation, because right now, it’s very convenient for everybody to delay the discussion, and not make the valuation adjustments unless needed.”
A down round is when a private company raises capital at a lower price or lower valuation than in a previous financing round. Last month, US-based cybersecurity startup Snyk, founded by Israeli entrepreneurs, raised $196.5 million in funds from investors at a company valuation of $7.4 billion valuation, down from its $8.5 billion valuation in a previous funding round.
“So there’s a lot of dry powder and private equity funds, which have their pockets full, are going to find really interesting opportunities in the market, because we are going to have less liquidity, less M&A and less IPOs materializing,” said Hasson. “We are also going see more secondary deals happenings where VCs sell their shares in companies to private equity funds.”