If you worked in the high-tech industry last year, your chances of getting rich were pretty high. Beyond the rise in the average salary in the industry, which exceeded the NIS 30,000 mark last February (and has since dropped to about NIS 26,000), Israeli high-tech workers benefited from an influx of several sources of wealth.
According to a review of Israel's tax revenue published by the Tax Authority, the year 2021 was particularly prosperous for hundreds of Israelis who became millionaires overnight. The data show that the number of Israelis with an income of over NIS 3.5 million last year more than doubled to 562. For the sake of comparison, Israel had more millionaires in 2021 than in the two previous years combined (484).
However, the year of plenty today seems like a sweet, receding dream, and the number of newly rich is reverting to previous levels. While in the first quarter of 2022, there were 133 millionaires, up from 120 in the corresponding period last year, in the second quarter their number it dropped to 95 - 25% fewer than in the corresponding quarter of 2021. Accordingly, capital gains for the newly wealthy also decreased, from NIS 2.62 billion in the first half of 2021 to only NIS 1.3 billion in the first half of this year - a decrease of about 50%. In other words, the market has done an about-face, and profitability seems to have reverted to its former dimensions.
An unusual year for high-tech
2021 was exceptional. In previous years, the number of reported millionaires was less than half than what it was last year.
Up until a year ago, companies going public on Wall Street allowed their employees to convert options to shares at the time of the issue and sell them all at once. The global development centers in Israel, such as those of Microsoft, Apple and Amazon, provided employees with restricted shares - shares given free of charge after a period of one or two years, at values that, at the time, only increased. Start-ups and unicorns enabled their founders and senior employees to earn millions through participation in secondary rounds. In exchange for heaping money into the pockets of company managers and existing investors, new venture capital funds could obtain stakes in the company.
Entrepreneurs and employees were inundated with billions of dollars, turning Israel's "Silicon Wadi" into a cornucopia for at least a year. According to an investigation conducted by "Globes" in April of this year, employees of Israeli companies traded on Wall Street, among them Sentinel One, Monday and Iron Source, exercised options worth $2.65 billion in 2021.
"It was an unusual year," said Tal Dori, CEO of IBI Capital , which manages options for most of the Israeli high-tech companies traded on Wall Street. "The party began to become disconnected from reality, as clearly it wasn’t going last forever. Since then, things have calmed down a bit: interest rates started to rise, the market switched from growth stocks to value stocks, and stock prices. Of course, this had an effect on the capital flow to employees, but all in all, things have gone back to reality."
Elyor Zitalni, Chief Valuations Officer at Altshare, says, "In many cases, the employees didn't have to wait for the IPO to get money in their pockets. Many companies accelerated their share exercise dates to just before the offering, so they could convert options to shares along with a pre-IPO fund raising round in which they could sell shares even before the IPO."
In 2022, especially in the past few months since the capital market began turning bearish, and interest rates began to rise, several wealth conduits have run relatively dry. "At the public companies, employees’ earnings have been cut," Dori says. "When a share that was once worth $300 is now worth $70, the employee is 'out of the money', that is, the exercise price of their options is higher than the share price, so they don't benefit.
"Meanwhile, in cases where it's still worthwhile for employees to exercise options, we see fewer of them doing so. This indicates that employees aren’t running away, because many of them believe it's worth waiting to see if growth returns. We’re seeing a similar phenomenon among those employees who received locked-up shares. After all, they can't lose, because the shares were given to them for free, but they still understand the share price has fallen too far. Overall, we’re seeing a lower volume of options being exercised compared with last year, but not commensurate with the market decline."
Secondary rounds delayed
Another revenue stream that has almost disappeared in recent months is secondary rounds - venture capital funds that purchase shares from entrepreneurs, senior managers and veteran employees for millions of dollars as part of a larger round of investment in a company. Last year, this activity represented up to a third of the capital invested in privately-held companies, but it has declined significantly this year. In the past, secondary rounds were made as part of investors’ efforts to buy shares in unicorns or growth companies at any price, a maneuver that many investors avoid today. For their part, entrepreneurs prefer to put every outside investment dollar towards their company's survival, rather than towards for personal enrichment.
"For both investors and entrepreneurs, there's currently no moral environment to do secondary rounds the way there was in 2021," said Eran Goren, managing partner at Fidelis Family Office. "Suddenly, money has significance, and when the companies re-plan their budgets so that there will be enough for a longer period of time, they suddenly realize the purpose of money has changed - and that a company needs certainty and long-term planning."
The same is noted by Nir Yeshaya local managing director of the Israel Representative Office of Lombard Odier Group, which manages the wealth of high net worth individuals, including techies whose massive new earnings have made Israel a strategic market. "There’s no doubt that there's a slowdown, and that secondary rounds released a great deal of money into the market," he said. "In recent funding rounds, you barely saw secondary rounds, and those that did happen were at lower volumes than before. Income that in the past came from capital raised in SPAC mergers and IPOs has given way to mergers and acquisitions of start-ups - but those acquisitions are also made at low multiples."
According to Tal Dori of IBI Capital, the total of share sales in secondary rounds or exits has fallen by at least 30% in 2022 in comparison with last year."Last year's taxable income was NIS 30 billion," he says. "In the first half of this year, we have seen revenue of about NIS 10 billion - an annual rate of NIS 20 billion."
Trying to buck the trend
The tectonic shift in wealth distribution also affects demographics. If last year thousands of employees benefited from converting options to shares during an IPO, SPAC merger, or secondary round, today’s beneficiaries consist of a small group of founders and senior executives.
"Many people who were worth hundreds of thousands of dollars or several million dollars on paper are worth far less today," adds Yeshaya. "Shares of the companies that issued them have fallen by tens of percentage points, and an employee's options that were worth, let's say, $2 million in 2021, are worth a few hundred thousand today, and are often worthless. However, I assume the market will rebalance, and companies will distribute new options to retain their workforces."
Dori says Israeli public companies have several ways of dealing with the decline in share value: granting additional restricted shares, repricing options, meaning, lowering the strike price to artificially create a profit for employees when options are exercised, and issuing new options at a more favorable strike price. However, companies that do this pay a price by diluting their existing shareholders or recognizing additional capital expenditure, which may increase expenses, and reduce profitability.
"Asking for more help"
Pioneer Wealth Management is a family office that only accepts clients with a minimum of NIS 50 million. The firm has grown in the last two years especially thanks to the tech sector. "In the past it was difficult to find clients with capital like this, and suddenly you were meeting lots of them," Shmuel Ben-Arie, chief investment officer for the Israel market at Pioneer, tells Globes. "They come to us after gaining tens of millions of shekels in cash, with several tens of millions more in restricted shares to their credit, usually worth 5 or 10 times the liquid assets. However, in the meantime, the market has changed - share prices have dropped, entrepreneurs have had to cut expenses, maybe even lay off workers, and the value of their shares has shrunk. Some of them are beginning to feel stressed because they sense that no one is invulnerable , and they understand that with big money comes great responsibility.
"After they've tasted wealth - bought plot of land in Savyon, a house in Ramat Hasharon or an apartment in Tel Aviv - they discover that after paying tax and commissions they don't have as much as they thought; certainly not enough to make all their dreams come true," says Ben-Arie. "Some have to get out of commitments, others have invested considerable sums in friends' start-ups that are less successful than hoped, maybe they also purchased real estate abroad without doing enough research, and many come back to consult us on how to manage their assets.
"Now, they understand that what's important is not getting rich, but maintaining purchasing power for themselves and future generations. Suddenly, what’s important is not just making an exit but being professional about conducting yourself in the capital market. Before, the promise of a 5% or 6% return was of no interest to technology people. Now, they're coming back to us, ready to listen. For example, whereas entrepreneurs bought residential apartments in luxury areas like Rothschild Boulevard last year, this year investment in income-producing real estate, whether commercial or residential, has become a higher priority," says Ben-Arie.
"The entrepreneurs that come to us are highly exposed to their own sector," says Eran Goren of Fidelis Family Office . "Everyone who made a secondary round is left with a large risk component - they still have unsold shares in the high-tech company where they work, they've invested liquid assets in a high-tech venture capital fund they knew about, or in a friend's high-tech startup. Today, they understand that this exposure generates risk for them, and they want exposure to more stable industries - insurance, finance, retail, income-producing real estate abroad, and if you do want to invest in private equity, there are more traditional funds that invest in growth enterprises, but not necessarily high-tech."
Published by Globes, Israel business news - en.globes.co.il - on August 29, 2022.
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