Israel is seeking to encourage investments in high-tech firms as the ongoing political turmoil and continued uncertainty around the contested judicial overhaul is fueling fears that tech entrepreneurs are fleeing the country.
The Knesset last week approved a law dubbed “Angels Law,” which grants some tax benefits to investors in Israeli hi-tech companies, as well as incentives for acquiring or merging with startups if the intellectual property is registered in Israel and they have operations in the country.
The government said that the purpose of the law is to preserve Israel as an attractive hub for investment in tech companies and to support the development of the industry. The law has been advanced over the past couple of years and was passed in an initial reading in 2022.
The final approval of the law came a day after the coalition put into law its reasonableness limitation bill, despite mass public protest and as efforts to reach broad consensus on the controversial judicial overhaul collapsed. Following the passage of the first bill in a series of legal changes advanced by the government, global credit rating agencies, Moody’s Investors Service, and Standard & Poor’s last week issued warnings that the continued political turmoil around the widely contested judicial overhaul is posing risks to economic growth and social stability in Israel.
Moody’s raised concerns about the slump in venture capital investments into local tech firms during the first half of the year since the judicial plan was presented and cited data showing that 80% of new Israeli startups chose to register overseas during the same period.
“This is particularly concerning given that the country’s high-tech sector has become the key engine of economic growth, accounting for half of total exports and generating around 15% of GDP in 2022,” Moody’s noted.
Adding to this, Tel Aviv Stock Exchange chief executive Ittai Ben-Zeev cautioned that any plan to strengthen the Israeli economy will become irrelevant should the agencies cut the country’s favorable credit rating. Ben-Zeev urged Prime Minister Benjamin Netanyahu and Finance Minister Bezalel Smotrich to act to restore trust or Israel will be facing a “UK-style financial crisis.”
“In such a tough time, where investors are shunning away from investing in Israel because of domestic uncertainty, any tax benefit marks a little improvement of the current atmosphere and mood and some hope for angel investing in startups that are already operating in the country,” Ofer Ben-Noon, angel investor and co-founder of Talon Cyber Security told The Times of Israel. “The benefits are good, but the challenge is that currently startups are not founded in Israel.”
“I wouldn’t recommend to any entrepreneur to found a company in Israel right now because the level of local risk is much higher in view of establishing in Delaware,” said Ben-Noon, who is also the co-founder of Argus Cyber Security, sold to Germany’ Continental AG, a car manufacturer, in 2018.
Prime Minister Benjamin Netanyahu hailed the passage of the Angels Law as a catalyzer “designed to jumpstart the Israeli high-tech industry.”
“It will allow for a series of benefits, including postponing payment of capital gains taxes, tax credits for private investors, recognizing investments in stocks as recognized expenses and providing tax exemptions on interest for foreign investors,” Netanyahu said on Sunday.
Specifically, the purpose of the tax benefits is to attract investment early-stage startups that are in the initial stages of research and development, and which generally carry a higher risk for investors. Early-stage startups often seek strategic investors who have experience in the technology market, and can support development and growth of the company, especially in the initial stages.
Among the benefits included in the law is a tax benefit for private investors who make investments in seed and pre-seed startups that have some R&D operations. The tax credit will be limited to an investment of up to NIS 4 million per investor and per company.
Another benefit in the law grants a postponement of capital gains tax generated for shareholders who sell a tech company and use part of the proceeds reinvest in startups.
To encourage mergers and acquisitions, companies that acquire local tech firms will be able to get some tax relief over a period of five years.
“It means that it will effectively become cheaper to acquire startups and is geared to motivate potential buyers, especially foreign ones,” said Ben-Noon.
The law also grants foreign financial institutions, including banks, a tax exemption on their income from interest, fees or linkage differences for loans they offer to Israeli tech firms. The purpose of the exemption is to lower the costs for Israeli startups in raising credit from foreign banks.
Meanwhile, local startups find themselves starved for funds as capital raising in the first half of the year plunged 73% to $3.2 billion versus $12 billion during the first half of 2022, data by venture capital firm Viola published this month showed. The figure marked the lowest reading since at least 2018.
Tech investments have continued to slump globally, albeit at a slower pace. In the first six months of the year, global funding activity dropped 50% to $168 billion from the $333 billion raised during the same period in 2022 and $348 billion in the first half of 2021.
“Against the background of the global crisis, you can already see a recovery in high-tech investments and the Israeli government is taking an important and significant step to continue strengthening and developing Israeli high-tech,” said Smotrich. “I will continue to stand on the side of Israeli startups and high-tech firms to find the channels and paths to continue strengthening this important area.”
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. Meanwhile, the changes to the judiciary proposed by Israel’s government early this year have been triggering mass protests across the country for the past six months.
Tech executives and employees have been taking part in the protests amid concerns that the plan undermines Israel’s system of checks and balances and threatens its democratic character, which in turn, it is feared drives away foreign investment.
“As long as the outer perception persists that Israel is becoming less of a democracy than it was a coupled of months ago and decisions are being taken without wide consensus, investors will think five times before investing in the country,” said Ben-Noon. “As a founder of a cybersecurity firm, I am considering relocation, as I need to weigh the pros and cons, and for now, the instability is not adding to the pros.”
“Israel needs to restore stability and regain trust.”