The Israel Innovation Authority, in charge of setting out the nation’s policies for the tech sector and fostering the startup ecosystem, has set up a new NIS 80 million ($25 million) fund to encourage investments in early-stage companies that are facing a funding squeeze, in a bid to boost the number of new startups.
Grants from the fund will be given to startups that team up with veteran investors, the authority said in a statement on Wednesday.
Since 2017, there has been an average annual decrease of about 25% in the number of startups being formed in Israel, a negative trend that has intensified against the backdrop of the coronavirus crisis, the authority said in the statement. The objective of this new program is to help seed-stage startups in high-risk fields attract investors and grow.
“In recent years, the volume of seed investments in Israel has been stagnant. Conversely, investment in later-stage rounds is on the rise. We have also seen a significant decline in the number of new startups established each year – a decline that has been highlighted and exacerbated by the coronavirus pandemic,” said Ami Appelbaum, chairman of the Israel Innovation Authority, in a statement. “New startups are the future of the Israeli innovation ecosystem, and supporting them during their early stages is critical for their progress.“
The new Hybrid Seed Incentive Program will increase the success rate of Israeli startups, will stimulate the creation of new seed-stage startups that are “so critical for the innovation ecosystem, and will encourage experienced investors to invest in early-stage startups,” he added.
Companies that take part in the program will receive a grant worth 40% of investment rounds of up to NIS 3.5 million, and 50% of the investment round for those that are located in Israel’s geographical periphery or whose founders come from populations under-represented in the high-tech industry, such as Arab Israelis, women and ultra-Orthodox populations.
The program reduces the risk for potential investors, the statement said. To apply for a grant, startups must provide a signed term sheet with a potential investor regarding the capital investment. A term sheet is a nonbinding agreement that shows the basic terms and conditions of an investment. The grant in practice gives investors a 40% guarantee on their investment. As part of the program, the investors get a three-year option to acquire shares in the company vis a vis their investment. If and when the investor realizes the option, the Israel Innovation Authority will be reimbursed for the grant amount it initially provided, the statement said.
Early stage or seed stage startups are those with the highest perceived risk.
Even before the start of the pandemic these startups were suffering from a shortage of investment as VC funds and private equity and institutional investors globally have switched to investing in less-risky, later stage firms that have a proven record of sales.
Investments in Israeli startups valued at up to five million dollars has decreased both absolutely (to $509 million in 2019 from $853 million in 2018) and as a percentage of total investments in Israeli startups (to 6% from 11%).
In addition, large tech firms have starting setting up their own, in-house startup hubs, which won’t become part of Israel’s startup ecosystem.
Analysis conducted by the Israel Innovation Authority indicates that recent years have shown a decline in the number of startups added to the Israeli innovation ecosystem.
From 2012 to 2017, 1,000 new startups were established per year, with a net of 500 companies added per year (the number of new startups after deducting those that closed). However, since 2015, there has been a decline in the number of new startups, with 800 registered in Israel in 2019, a net addition of just 360 companies — the lowest number seen in a decade. In 2020, that net number has declined to 325, with just 224 new startups joining the fray last year, according to data provided by the Authority.
The decline in the number of new companies also means a decline in the diversity of technologies and new fields of innovation developed by Israeli high-tech. This drop could hinder the sector’s dynamism and flexibility, as well as its ability to continue to maintain its position as a world leader in up-and-coming technology trends, the Authority said in its 2019 annual report.
The total investment in seed-stage companies has remained constant in recent years, with a decline in 2019.
“The new program is a great opportunity for numerous investors, even those who generally invest in later-stage companies, to invest in these high-risk early-stages, while reducing the risk factor,” said Anya Eldan, VP and head of the Startup Division at the authority. “The ongoing stagnation in seed-stage fund raising in Israel, combined with the fact that the long-term effects of the coronavirus pandemic remain uncertain, requires immediate action.”
The Authority estimates that 64% of the companies that take part in the new program will carry out another funding round within three years, which will allow VC investors to realize their options while also refunding the grant money to the Israel Innovation Authority.