Foreign investors active in Israeli tech plummet by 23%: Troubling trend or temporary setback?

Is Israeli tech about to return to 2015? Too much data has been published and accumulated about Israeli high-tech in recent months, pointing to the fact that the industry has been set back a decade. It's not just a decade, but the golden age of the Israeli technology sector, during which it managed to break away from being branded as a start-up nation on its way to becoming a scale-up nation. An entire avenue of start-up companies matured and became companies that sell in hundreds of millions of dollars, are issued on Wall Street, and have a market cap of billions of dollars.

The generation of companies that were established from 2015 onwards is also the one that brought here most of the large and important foreign investment bodies, starting with large venture capital funds such as Insight Partners and Tiger Global, as well as private investment funds that opened a permanent representation here, led by Blackstone and General Atlantic.

The main danger and test for the Israeli ecosystem today is not measured in one or two quarters of weakness, but in its ability to maintain its image as a ceaseless center of innovation that produces start-ups and ideas on a regular basis. To produce what investors call Deal Flow - a large enough pool of attractive companies. Israel's great promise is today unfortunately on the battlefield and in reservists who will return home with new ventures in mind, but until that happens, there needs to be enough money and foreign interest left here to finance the next generation of startups.

Not a single investment by Qumra

In this context, it is possible that the relatively reassuring picture of the high-tech sector that emerges from capital raising for startups in the last six months is only due to an irrelevant view in the rearview mirror. Recent reports that reviewed the state of Israeli startups showed a certain stabilization in the first quarter of 2024 compared to the last quarter of 2023 when the war broke out. Local tech apparently transmits resilience and a feeling that a catastrophe was avoided. But this is in retrospect, when some deals were actually closed even before the outbreak of the war, and the question is what will happen next? A number of currents, which for the time being can be said to remain underground, signal that the danger of the crisis to the central and most important sector for the recovery and future growth of the economy has not yet passed.

An analysis by the RISE Institute (the research institute that operates alongside the Startup Nation Central organization) reveals the sharp decrease in the number of high-tech investors active in Israel. These are both local bodies, but mainly the foreign investment bodies that are responsible for more than 80% of the capital that flows into "Startup Nation". "The continuous decrease in the number of active investors is very worrying and it has worsened because of the war," write the authors of the report Dr. Assaf Patir, Danny Biran and Almog Grisariu.

According to RISE data, in the six months of the war, there was a 23% drop in the number of foreign investment entities that were active in Israel compared to the previous six months. This figure is interesting because it includes a comparison to the half during which Israel was engulfed by the turmoil of the judicial reform, which had started the process of the abandonment of the foreign investors. Among the Israeli entities, the decline in activity was even sharper and reached 30% compared to the previous half year, i.e. the second and third quarter of 2023. Investment entities include venture capital funds, corporate venture capital funds (CVC) and institutional investors.

The flight of institutional investors from the high-tech sector in 2023 was already known and is not necessarily related to the war, but mainly to the declines recorded in the stock markets. However, even looking at venture capital funds alone, the trend remains the same. The number of foreign venture capital funds operating in Israel in the last six months fell by 20% and the number of Israeli funds shrank by 25%. For example, in 2021 the number of foreign investment entities operating in Israel reached a record of 761, while in the first quarter of this year their number was only 406. Although in 2021 it was clear that some investors were so-called "hitchhikers", who do not really specialize in high-tech but want to catch the wave, this is not nearly half of the entities that worked here.

Who stopped operating in Israel? Contrary to excited statements about entering the local market, no one announces the exit, but simply reduces activity. For example, the large Israeli venture capital fund Qumra, which specializes in investing in growth companies, did not make any new investments in 2023, but only supported its portfolio companies. Insight lowered its profile and lessened investments as well, Tiger Global was busy licking the wounds of investments with inflated values and mainly tried to sell its shares in its portfolio companies, Blackstone continued to wait for the next big opportunity. Alongside the big names, there are also dozens of small funds that raised money in 2021, but it is clear to both them and their investors that this was a one-time event that ended as soon as the money stopped being free. This phenomenon is evident in the decrease in the number of active Israeli venture capital funds, which dropped from 157 in 2021 to only 105 at the beginning of 2024.

The good news is that the decrease in investor activity is not only related to Israel, but to the difficulty of most funds in raising new capital. The bad news is that the less money they have, the more they'll prefer to invest it closer to home rather than overseas adventures. And if it is difficult for the giant entities that were the most active investors in the good years to raise new funds, what will the Israeli funds say? Last week, it was revealed that Tiger Global, one of the symbols of the bubble of 2021, tried to raise $6 billion for a new fund for more than a year, but has now finally given up and closed the fund with "only" $2.2 billion in commitments. This after receiving commitments from investors for only $200 million over the past nine months.

Insight Partners, the best-known fund in Israel, also reduced the target for its new fund from $20 billion to $15 billion, and according to reports abroad, it is still very far from even the narrowed target. These difficulties are part of the global trend of decreasing appetite for risk capital on the part of the institutional bodies in the U.S. and Europe, as well as on the part of the wealthy investors who used to invest through their family offices. Another significant player whose presence has greatly decreased are the Chinese investors who lowered their profile following the rise of geopolitical tensions both with the U.S. and with Israel. In Israel, only 21 venture capital funds managed to raise an aggregate amount of $1.5 billion last year, a 73% collapse to the levels of 2015.

The quarterly level of fundraising, which stabilized at $1.6-1.7 billion, is also the lowest it has been since 2015, if the numbers are adjusted according to the dollar inflation rate. At RISE, beyond the decrease in investor activity, they are also disturbed by the fact that the stable numbers of capital raising in the first quarter of 2024 were distorted by several factors. The first of these is mega-rounds, those capital raisings of $100 million or more for the largest and most promising companies that were responsible for almost half of the money raised in the past quarter, masking the less glamorous picture that emerges from the small fundraisings.

In addition to this, RISE found that nine companies actually raised money from emergency funds established since October 7 and therefore did not necessarily receive investment for purely business reasons. Some 22 companies out of those that raised in the first three months of 2024 did not receive investment from foreign or local venture capital funds, but from private investors, technology incubators or companies. Therefore, only 80 companies raised capital in the traditional way from venture capital funds in the first quarter.

Although a drop in the activity of investment entities in Israel is not solely related to the complex situation of the country, this is a worrying event mainly because it will be very difficult to bring back a foreign investor who has stopped operating in Israel. The Israeli high-tech sector depends on foreign money in all three of its main legs - the development centers of huge companies depend on the budgets set in the U.S., Israeli high-tech companies that trade abroad depend mainly on the ability to raise capital from Wall Street investors, and startup companies depend on both foreign and Israeli funds, who also raise their money from foreign investors.

At the beginning of the war, the Innovation Authority recognized the expected decrease in the activity of investors, so they are trying to start a program that will bring the institutional funds, that is, our pension funds, to invest in venture capital funds. But the program is still ping-ponging between the Authority and the institutions that want a series of changes within the definitions of the program. One of the disputes, for example, is in itself a warning sign for the local industry: the Innovation Authority allows venture capital funds that receive money from the institutions to invest only in companies that are registered in Israel.

For their part, the institutions say that because since the judicial reform most of the startups that have been founded have been registered in the U.S., they would like to see a different definition of the degree of Israeliness of the company and not necessarily the place of its registration. According to estimates by the Innovation Authority, its plan may pour about a billion dollars into the local funds over a period of two years, but even in the most optimistic scenario, this is not enough to bring the industry back to the pace of 2019 and beyond. The road to bringing foreign investors back to activity here also naturally goes through a recovery in the global technology sector, which is already showing such signs after sharp rises in the Nasdaq, but also in sentiment towards Israel. RISE presents preliminary data from the analysis of sentiment towards Israel in the global technology sector, which jumped sharply in October, but began to decline two months later. One can draw some optimism from the fact that precisely from the beginning of 2024 it stabilized at a higher level than before October 7 and this despite the fact that the war continues.