Higher investment reflects new Israeli startup mindset

Startups Photo: Shutterstock
Startups Photo: Shutterstock

Investors understand that more Israeli companies have the potential and desire to become large companies, observes 83North partner Erez Ofer.

High-Tech investments in Israel have shown a strong first quarter in 2016 according to the latest IVC statistics released in April. Total capital invested was $1.09 billion for the quarter, a run-rate of more than $4 billion a year, and the sixth straight quarter with over a billion dollars invested. This pace of investment has been reached only in recent years.

From an average of just about $2 billion invested per year in 2006-2012 (excluding 2009-2010 following the financial crisis), the industry has now more than doubled to $4.4 billion invested in 2015. The number of deals has also grown, going from an average of 490 deals per year (again excluding 2009-2010), to an average of over 680 over the last 3 years, a 40% increase.

The growth in capital invested is driven by two main forces, first, new company formation reached record levels in the last 3 years as evident by the 40% increase in number of deals, the majority of them being early-stage financing rounds. Many of these early deals are funded by angels and smaller VC funds who have emerged over the last couple of years. This trend in Israel follows closely the increased early stage activity also observed in the US in recent years.

The second, more substantial, phenomena driving the increased capital raising is the increase in the number of larger financing deals, many of them supporting growth stage, mature companies. Funding rounds larger than $20 million were a rare event in the Israeli market prior to 2013, but Israeli late-stage companies are now able to raise larger financing rounds and are willing to take the longer term view and swing for the fences, much more than in past years. There were 17 financing rounds larger than $20 million in 2013, 39 in 2014 and 65 in 2015.

The increase in late stage financing is driven mostly by later stage investors who have picked up on the fact that more Israeli companies have the potential and the desire to become independent companies. Late-stage and crossover investors that have not been in this market before, as well as a few new growth-stage local funds are busy identifying companies that have not just the potential to become large enterprises, but also the right management teams, mindset, and existing investor base to do so.

The current state of the market would not be complete without also mentioning an increased activity of corporate strategic investors, some who have been active in Israel for a while such as EMC, Cisco and Intel, but also a growing number that are new to the scene such as Microsoft, Disney, Lenovo and Qualcomm. The overall growing interest and increase in venture investing globally, coupled with Israel having a special spot as an innovation center, has also attracted new investors and crowd-funding to the local scene. Specifically, the last 2-3 years have seen an increased activity by Chinese investors directly investing in companies or as LPs in local funds.

Will the rate of investment continue at this accelerated pace of more than a billion dollars per quarter for the long run? Probably not. The slow-down evident earlier in the year in the US market is felt in the Israeli market as well. However, with the shift of a healthy number of companies to the Scale-up phase, Israeli investment levels will unlikely go back to a $500 million-per-quarter level any time soon. Valuations of Israeli companies have not skyrocketed similar to the Unicorn herd in the US (Israeli Unicorns can be counted on one hand) and as the Unicorns of Silicon Valley are cooling off, investors are further digging into the Scale-up opportunities in Israel.

With this new phase of the local high-tech scene, we should continue to see large growth financing rounds for businesses that have a proven model and good trajectory. Early stage companies will also continue to get funded in promising technology areas going after large markets such as Cloud, mobile and FinTech. However, we are now getting back to a more normal financing environment and the companies caught up in a soft spot of financing will be those in the middle stages of their development. The sentiment reflected by Bill Reichert of Garage Technology Ventures in a recent study by USF on US VC sentiment, holds also true for Israel: The proliferation of incubators, accelerators, co-working spaces and funding groups has generated an ocean of startups that cannot be sustained. And the tide of capital that flowed in from non-venture sources will ebb with the downturn in valuations at the unicorn level.

The increased investment activity in Israel did not develop in a vacuum. This trend is encouraged and supported by two factors: Israeli companies have come back to the public markets in recent years after a long drought, and M&A deal sizes have increased as well. Looking again at IVC data (excluding life science companies) there were an average of 7 acquisitions larger than $100 million per year in the years 2010-2012. That number has grown to an average of 12 such transactions per year in 2013-2015. These last three years also saw three transactions larger than $500 million, up from just one transaction in the previous three years.

Israeli venture investing used to be considered a game of Singles and Doubles. That is not the case anymore. Looking at the list of companies that have raised substantial growth financing rounds over the last 24 months, one finds an impressive group of high-flyers that share the potential of becoming independent, substantial companies. Investors are taking notice.

The author is a partner at 83North Venture Capital (formerly Greylock IL)

Published by Globes [online], Israel business news - www.globes-online.com - on June 21, 2016

Copyright of Globes Publisher Itonut (1983) Ltd. 2016

Startups Photo: Shutterstock
Startups Photo: Shutterstock
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