Is Israel's tech industry bouncing back?

Unicorn illustration: Gil Gibli
Unicorn illustration: Gil Gibli

Investments, mergers and acquisitions, and salaries are rising despite the war but industry experts warn that the latest recovery may not be sustainable.

Two years ago, in May 2022, trouble began brewing for Israel's tech sector. The prestigious and flourishing industry that had been producing a new unicorn almost every week and hundreds of new millionaires every month, began to creak. Six months after stock markets began falling, and two months after the US Federal Reserve raised interest rates for the first time in years, investors in privately-held companies also began cutting company valuations and closing the funding pipeline, which until then had flowed almost uncontrolled.

The first to be hit were the companies built on dreams - startups whose revenue model was shaky, while expenses skyrocketed. This is how, for example, the grocery delivery company Avo, founded by former Israeli tennis champion Dekel Valtzer, and which had symbolized the tech opportunities of the Covid era, collapsed. Other promising unicorns at the same time, like Cybereason, Elementor, Fabrik, eToro, laid off significant percentages of their employees, and later Israeli companies traded on Wall Street and the tech giants also started making similar cuts.

Between May and July 2022, 3,000 tech employees were laid off at Israeli and foreign companies in Israel, according to the "Lestartup" website. Funding also decreased, from $5 billion dollars in the second quarter of 2022 to about $2 billion dollars in the corresponding period a year later. Since the beginning of 2024, some 2,000 tech employees in Israel have lost their jobs.

However, it seems that in recent weeks there has been a turning point. 11 Israeli companies have been acquired since the beginning of the year for $2.1 billion, of which seven companies are from the cybersecurity industry. Nvidia alone spent $1 billion on two Israeli acquisitions: Run:AI and Desi. In May, Blackstone announced its first major investment in Israel - the acquisition of veteran software company Priority for $800 million. In addition, Wiz announced the largest ever financing round for any Israeli startup ever - $1 billion - and the average salary in Israeli tech reached an all-time high, according to the Central Bureau of Statistics. Does all this mean that the tech crisis is over?

"We are seeing more AI acquisitions"

As someone who sees financing and acquisition deals from their inception, Adv. Yair Geva, who heads the startups and emerging companies group at law firm Herzog Fox & Neeman, believes that the answer is yes. He says, "After January, which was completely dry, we began seeing a few more acquisitions in the field of AI and more private equity investments with checks of $50 and 100 million."

He adds that many of the gloomy predictions that were made have not materialized. "Meanwhile, it looks like the IPO window has opened and many Israeli companies are making preparations to take advantage of it this year, and this in turn is increasing the pace of mergers and acquisitions in the industry. Investments in companies in defense - arms and security - are also increasing from mainstream investors who until now were afraid to do so. The AI revolution allows Israeli software companies to take part in drug development - the hot investment trend in the US - a task that until now was reserved for pharmaceutical companies that raised hundreds of millions of dollars."

Rising investments with a caveat

Judging by the total capital raised by privately-held companies, there has been a certain improvement in the situation of Israel's tech industry. The amount being raised, which has become a barometer for the strength of the local tech industry, is higher than in recent quarters. According to research firm RISE Israel, which was founded by former head of the National Economic Council Prof. Eugene Kandel, total investment in the second quarter of 2024 is expected amount to between $2.5 and $3 billion - higher than last year's quarterly average of $1.7 billion.

However, RISE Israel CEO Uri Gabai explains that there are worrying signs behind the figures. "We have entered a market that is driven by huge financing rounds that take up a significant portion of the total fundraising in each of the quarters, and in fact skew the results upwards," he says. Since the second quarter that began at the beginning of April, four companies - Weka, Cyera, Island and Wiz - have raised a combined $1.6 billion.

"On the one hand, it is encouraging that there are companies in Israeli tech that are 'superstars' in their field. Despite the geopolitics, this is a statement from Israeli and foreign investors that there are good companies here with talent. But on the other hand, most of the capital is concentrated in a single-digit number of companies each quarter. In practice, all the other companies that are not part of this small group of companies raised $600 million combined. This is worrying, because the number of companies in the 'rest' group, which includes companies that are not bad at all, is declining."

The first quarter figure was the lowest in recent years, and the much more encouraging second quarter has not yet ended. Excluding mega rounds, in the first quarter Israeli high-tech raised $864 million, $1.1 billion was raised in the fourth quarter of last year, and $1.7 billion in the corresponding quarter last year.

Gabay says, "Two separate economies are being created here, one of 'industry stars', and the other of everyone else, who are fighting each other for the leftovers. Although, many companies are still living on the fuel vapors of the large funding they raised in 2020 or 2021, at some point this funding will run out for them, if not in the near future, then down the road."

Israel: No difference from the global trend

While stock markets resumed rising in the first half of 2023, the private market has not yet narrowed the gap. Investment in privately-held tech companies worldwide, and in Israel in particular, remains low compared with recent years. According to the RISE Institute, the fall in investment in Israel in the last two quarters was 31% higher (from the preceding two quarters) than in the US and Europe. In Europe there was a 22% decrease in investment during these periods, and in the US even a slight increase of 3%.

In the second quarter of 2024, in which the amount of funds raised and the number of acquisitions has been surprising, Gabbay does not see a different trend in Israel from the one prevailing in the US and Europe. "Investment remains low in the global tech industry, although it has stabilized. One of the reasons for this is the huge investment required for the AI revolution," he says. "Training the models requires huge investment from the tech giants, so the value of the large companies increases, as you can see on the Nasdaq or the S&P 500. Meanwhile, startups are struggling to raise capital, unless they are applying AI or developing technology that improves its creation and consumption."

Asaf Horesh, managing partner at Vintage Investment Partners, which has a database of the latest information on the entire start-up industry in Israel, as well as information on venture capital funds worldwide, explains that the steep fall in investment in Israeli tech in 2022-2023 was a consequence of the big rise experienced in the local market in relation to other markets - partly because of its small scale and its dependence on investors who have already disappeared from the landscape. He means venture capital funds such as Tiger Global, which has disappeared from the Israeli investment landscape, and Insight Partners, which has reduced investments. However, Horesh claims that since the start of 2024, the rate of investment in Israel is reasonable compared with before the Covid bubble of 2020-2021. "Companies that focus on AI are growing nicely not only in value, but also in revenue, and attract investors."

Horesh adds that the improvement in tech company mergers and acquisitions has been even higher in Israel than in the US and Europe, due in part to Nvidia's acquisition of Run: AI for $700 million. Total acquisitions in the first quarter amounted to $2.1 billion about 50% of the total income from exits in the US market, and higher than the amount recorded in all of Europe. In these markets the amount of exits is getting smaller, while in Israel it has been growing for three quarters in a row.

Are high-tech salaries really rising?

Data published by the Central Bureau of Statistics earlier this month showed that the average salary in Israel's tech industry has jumped to an all-time high. In February, the most recent reported month, it was close to NIS 34,000 per month. This is a nominal increase of more than 13% within one difficult year, which included the judicial reform and a war. For comparison, the nominal increase in the average salary in the economy was only 3.5% over the last year.

But are salaries in high-tech really rising? RISE Institute chief economist Dr. Assaf Patir says, "The salary data received from the National Insurance Institute is partial, and their sampling error is relatively large, so it creates the illusion of a more fluctuating change than actually exists."

Dr. Patir also claims that the Central Bureau of Statistics did not take into account the seasonality component, which has a significant potential for bias, because in February and March, bonuses are given at the big companies for performance in the previous year, which can abnormally skew the results upwards. At Intel, for example, 11,000 employees in Israel receive a bonus worth 2-3 salaries.

"Sometimes most of the bonuses are received in February, and sometimes in March," says Patir, "so a comparison between the last February and the previous February is not necessarily symmetrical. Therefore, discounting seasonality, the nominal salary is increasing essentially at the same rate as it did before the Covid bubble, while the real salary in general is eroding because of inflationary pressures." Thus, if in the previous decade the real wage rose at an average rate of about 3.5% per year, in 2022 and 2023 the real wage rose by about 0.9% and 1.7% respectively - that is, by only 1.2% on average.

"We are at a crossroads"

Despite the campaign against Israel in academia and social media,  economic sanctions imposed on Israel by direct and indirect investors due to the war have remained mostly behind the scenes and limited in extent, as far as we know. Since the start of the war, the major development centers have increased their activity in Israel, especially Nvidia, which has made two acquisitions.

Only one venture capital fund has closed down in Israel - Samsung Next. Even though it has been one of the most active funds in Israel in terms of the number of companies, it has invested small amounts relative to other funds. On the other hand, Sequoia has resumed investing large sums in Israel, and the fund has re-established its offices in Israel, which were closed with the departure of Shmil Levy and Haim Sadger. Globes has learned that at least one more large fund is on its way to Israel, and that two more are conducting preliminary enquiries about setting up Israel operations.

At the same time, many Israeli venture capital funds are struggling to raise capital due to the dwindling number of investors in the funds, low returns, and fear of investing in Israel. According to the RISE Institute, there was a 25% fall in the number of foreign investment entities in the fourth quarter of last year and the first quarter of 2024, compared with the preceding six months. The number of Israeli funds also decreased by the same rate.

"Whether we end this quarter with $2 billion in investments in Israeli tech or with $3 billion, is unimportant in the long run," says Gabai. "If a year ago they had talked to us about international sanctions, the danger of arrest warrants, the decisions of the two tribunals in The Hague against Israel, we would have said that all of this was imaginary. We are in a situation in which if we see economic isolation here and investors afraid to touch the Israeli economy, it will not happen all at once, but gradually. 47% of all investment in Israeli tech comes from foreign investors, a higher rate than in any other country in the OECD, where the average capital from foreign investors stands at only 10%. One can only imagine Israeli tech at a time when foreign funding is declining. It will be much less successful than what we are used to."

On the other hand, Horesh says he does not see such a trend. The calls of anti-Israeli students to investment bodies at US universities to boycott Israel have not been answered, and he still does not see immediate danger in the field. "We're not there yet, but the direction we're going in is definitely not good," he says. "Instability is not good for the industry or for investors. Last year, foreign investors asked questions about the judicial reform. The war does not make it easier for them. In Israel, many venture capital funds are still having difficulty raising capital. and with the instability, combined with Israel's credit rating cut, the direction we are going in is not positive. But I don't see a catastrophe here."

"We are at a crossroads that will determine whether Israel is on its way to becoming a leper country in the international community, or we can choose the right path and grow from there," concludes Geva. "You have to be naive not to think that the tech industry is defending itself against future damage. Entrepreneurs are not only founding their companies abroad, they are also moving the R&D departments there. I have just returned from several meetings in the UAE - the investment flow from there is still large - but I see the sentiment towards us changing in places like Singapore, and in northern and western Europe, where it is enough for one large fund to give an order to stop investing in Israel and we will find ourselves in an avalanche that will lead to a more difficult situation."

Published by Globes, Israel business news - - on May 31, 2024.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2024.

Unicorn illustration: Gil Gibli
Unicorn illustration: Gil Gibli
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