In Israel's new 2024 state budget that was approved on Monday, the cabinet decided not to increase the higher education budget but to increase assistance to Israel's tech industry through the Israel Innovation Authority, an independent statutory authority under the Ministry of Innovation, Science and Technology.
The annual budget was meant to be cut to NIS 1.4 billion to its lowest in many years. But instead, the Innovation Authority, with the support of the Ministry of Finance Budget Department, passed reforms that transform its structure, adapting it to the hardships encountered by startups since the outbreak of the tech financing crisis in May 2022 - a crisis that is still ongoing.
A marginal organization on Israel's investment landscape
The Ministry of Finance is proud of the fact that the Innovation Authority will receive an extra NIS 1 billion in 2024 with an annual budget of about NIS 2.3-2.4 billion. However, market sources believe that ultimately the Innovation Authority will only receive about NIS 1.7 billion this year.
Interest rate rises, which resulted in financing sources for tech companies drying up combined with the political and security instability in Israel, have brought about a significant decline in the number of new startups founded in Israel and a fall in investments, which has seen Israel's tech scene go back to the previous decade in terms of the scale of financing.
The Ministry of Finance believes that 90,000 employees could leave the industry in the coming year and a record number of companies will close after so many employees have been in the army for three months of reserve duty so far.
Despite everything the Innovation Authority has remained a marginal organization on the overall investment landscape of Israel's tech industry while it could help navigate its progress in desired directions.
The Innovation Authority's budget has not been substantially raised for more than a decade and even an extra several hundred million shekels will still keep it as a very small organization on the investment landscape in Israel - about an annual average of 4% of investment funds.
The proposal to tie the size of the Innovation Authority's budget to a fixed percentage of the budget was not accepted, and in any case, most unicorns and companies that go public on Wall Street are privately-held companies without any government funding. On top of that, its influence on applied research in Israel and its ability to influence budgets for higher education is low, despite the crucial role played by academia in promoting Israeli high-tech.
Canceling the fund set up in the 1980s
The Innovation Authority's R&D Fund, the main instrument for helping startups, which is worth about NIS 600 million, will be gradually phased out in the coming years, and instead a new fund will be established called the Startup Fund, which will be designed for investment in companies similar to venture capital funds, the main investors in startups, and more suitable for the tech companies' needs.
The R&D fund is an archaic relic of the period when the Innovation Authority (originally called the Chief Scientist's Office) was founded in the 1980s. Back then, the Chief Scientist would subsidize not only early stage companies, but also R&D projects in big companies. The Chief Scientist would help subsidize companies like Osem, Strauss and the Israel Electric Corp.
The Innovation Authority stopped supporting large companies about a decade ago, but provided support to startups in an archaic manner and seemingly disconnected from the financing environment that exists for them. In order to raise a grant from the R&D fund, entrepreneurs had to file a new application every year, without knowing whether the Authority would continue to support them in the future. The new Startup Fund will invest together with venture capital funds and from now on will also allow long-term investment.
The Startup Fund will only invest in early stage companies, from the concept stage through seed funding through until the third financing round (Series A). The maximum investment in any startup will be NIS 15 million. The Innovation Authority will be able to take a significantly higher percentage of any round - up to 60% - a higher rate than the Authority used to take previously. The Innovation Authority will not purchase shares in the company, but will receive rights to royalties, if and when the company produces revenue.
As part of the transition from the R&D Fund to the Startup Fund, NIS 160 million will be added each year to allow for financing rounds that will be approved in the coming year to support companies for the next two or three years, and not just one year as with the R&D Fund. In the coming years, the fund will be worth about NIS 500 million and after the budgets promised have been used for companies on the R&D track, more and more funds will be added to the new Startup Fund.
The new fund has already been criticized in the industry for its lack of focus. The Innovation Authority says that it will invest in deep tech, which includes areas that Israeli investors do not like to invest in like life sciences, climate change technologies, advanced materials and robotics, which is code for companies that struggle to raise funds because they require much bigger initial funding.
What about AI labs and bringing back scientists from abroad?
The technological incubators program was founded in the 1990s as a response to the lack of jobs for the massive immigration from the former Soviet Union. It succeeded in this, but the technological incubators did not produce many sustainable companies and along the way most of them failed. The state spent a lot of money that did not produce a significant return, and the bodies chosen to manage the incubators often did not see a profit either.
The demands on entrepreneurs and funds were also not viable. They were required to open offices in the periphery, but usually worked most of the week in central Israel. The government authorities used to divide the research centers in the periphery into niche content areas, but it was difficult to find enough entrepreneurs in those areas to meet the requirements.
Instead of the incubator program, an alternative program will be opened that will encourage venture capital funds and investment companies to establish laboratories or ventures for partnership between academia and industry, and these will be able to request a grant of up to $10 million each in order to cover these expenses.
The aim is to encourage foundations to open research laboratories in scientific fields and allow portfolio companies to conduct research in them. If in the past startups in the incubator could access a dedicated fund that was promised to them to request additional capital, then this program has been canceled. Now the companies belonging to the new program will have to compete with other startup for money from the Startup Fund.
In addition, a fund has been founded that will leverage investments by insurance and pension companies in venture capital funds with an overall budget of NIS 850 million to which the Innovation Authority will add NIS 580 million in 2024. A further NIS 270 million will be injected in the first quarter of 2026.
The Innovation Authority has received an additional NIS 1 billion in the Israeli tech industry's most difficult year - this is welcome and demonstrates the seriousness of the Ministry of Finance in assisting the sector. The new programs will enhance and improve, but the budget still does not address the major problems of Israeli high-tech: promoting technological education, promoting higher education, building AI laboratories and integrating populations such as Haredim and Arabs into the tech industry. The Ministry of Finance had promised to form a fund to bring home scientists from abroad as well as an applied research fund, each with a budget of NIS 200 million, but this was not put into the budget in the end.
The Authority is undergoing a facelift, but it is still spread among the same activities it engaged in before and operates in an already well covered field. It would be better for the limited capital it has to be dedicated to one or two strategic goals that it sets for itself.
Published by Globes, Israel business news - en.globes.co.il - on January 17, 2024.
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