Analysis
The inflation of unicorns is not all bad for the Israeli economy
Capital invested is far more significant than lofty valuations. The new millionaires will reignite the economy, but also widen socio-economic gaps
1. Massive funding rounds will jumpstart the economy
One Billion dollars. That is the amount that Israeli tech companies, mostly cyber companies, raised in the first 10 days of March. These are only the sums raised by companies valued at over a billion dollars, ie. unicorns, which were augmented by dozens of smaller rounds.
These figures mark a continued rally by Israeli tech, which was felt throughout the pandemic, but accelerated since the start of 2021. January and February also saw huge funding rounds for Israeli tech companies, chiefly in the fields of fintech and cyber, taking the sum total past the $2 billion mark.
The headlines tend to focus on the high valuations that the rounds were carried out at instead of the amounts that were raised because they are in the millions and not billions. But what matters more to the Israeli economy is not the valuation, but the capital that actually lands in the companies’ coffers, and in many cases also into the bank accounts of the Israeli founders and employees through secondary share sales.
The more than $2 billion that has flowed, and will continue to flow, for the most part into the Israeli economy, will be what leads to the rise in housing prices and the import of vehicles, increase in the cost of living and expand the salary gaps between tech industry workers and those in other fields. But in the long run, they will increase local productions and exports and eventually contribute to the Israeli economy.
2. Valuation estimates have no real meaning
Why do the tech company valuations carry little meaning beyond the prestige factor? Enterprise valuations determined for the purpose of funding rounds are a vague concept that is only truly important to the founder — for whom it determines the dilution level of his or her holdings— and for the investors, who use the valuation amount to signal to the entrepreneur and to other investors what they expect from the company. This differs from valuation determinations in the public market, which are derived from crowd wisdom and the sophisticated market mechanisms that also determine the cost of the company’s traded shares.
When it comes to private companies, valuations are little more than a temporary anchor point that was reached in negotiations between a small group of investors and an entrepreneur or team of entrepreneurs. Because of that, and regardless of how sexy it may sound that a company likeSnyk or Next Insurance secures each funding round at a valuation that doubles what it was in the previous one, with each now valued at around $4 billion, the valuation figure is not that significant until the companies enter the public capital market. As a founder of one of the unicorns recently told Calcalist: “The valuation was reasonable in the last month or two prior to closing the round. After the round was over, it was a gift, and now it’s history.”
What needs to happen at a company for it to be worth more than a billion dollars less than a year after its founding, like WIZ or Orca Security? What major breakthroughs took place in Snyk or Next that enabled them to double their valuation in less than six months? Mostly it’s a matter of demand by giant organizations who are investing more and more capital in tech and have discovered the Israeli market.
While the Startup Nation ethos has been around for well over a decade, in practice, until recently, Israeli companies that completed an exit for a few hundreds of millions of dollars were considered too small and tended to fly under the radar of many investment bodies, such as the funds belonging to giant corporations, insurance companies, and private investment funds.
3. The world discovered Startup Nation
Over recent years, the stars have aligned for the Israeli tech industry and huge organizations have come running. It’s not only American investors, either. Japanese companies entered the market in a big way this past year as well as European banks and insurance companies, mostly those that are active in the fintech sphere. The latter has also seen a growing presence of local Israeli insurance companies and investment houses, who compete against each other for investments in a limited number of companies, artificially inflating their value. The moment the capital funding market became an entrepreneurs market, spurred ahead by other, more experienced entrepreneurs with a proven track record, such as WIZ, whose founders had sold their previous company to Microsoft — it only makes sense that the valuations will skyrocket.
At the end of the day, enterprise valuations reflect the level of demand for shares of a given company and the founders’ willingness to have their shares diluted. The higher the valuation is, the more funding the founders can secure without losing out on their shares in the company.
4. The millionaires are multiplying
There’s no escaping the feeling that the valuations in the private market, largely as a result of what’s taking place on Wall Street, represent a bubble. Even the entrepreneurs are realizing that the markets may be reaching their boiling point, definitely after the recent weeks of increased volatility in tech stocks, which is why they are accelerating their funding processes to ensure they have the capital to see them through the lean times that may be ahead. It is precisely that, that the public needs to be aware of. The capital that goes into the tech companies will enable them to recruit more employees in order to expedite their product development and increase marketing activities, which will in most cases lead to an increase in revenues. Not all the companies that are raising capital these days are based in Israel, but they all have development centers here and in most cases, their increased revenues will contribute to the Israeli economy.
Personnel recruitment in Israel will lead to more participants in the national workforce and expand beyond the tech sector to adjacent industries, such as the restaurant sector, which suffered a severe blow as a result of the pandemic. It’s no coincidence that over the past year, celebrity chefs have signed deals to launch restaurants within tech companies.
In most late-stage funding rounds there is also a large secondary share component, in which the founders and veteran employees sell their shares as part of the agreement. In the case of Snyk, the secondary component reached $125 million, nearly half of the entire round. In the case of fintech company Rapyd, $100 million went to the purchase of shares from employees.
In most cases, even if the majority of employees are based outside of Israel, their core teams are located locally since they tend to be the ones who accompanied the founders since their time in the military or at a former company. In such a way, every funding round grows the Israeli millionaire echelon.
5. Growing discrepancies between two economies
While it may be true that there is a bubble in the making, after all, valuations doubling every few months do not stand to reason, there are ways in which the Israeli economy can benefit from the current craze. Of course, just as with too much of anything, there are disadvantages to the massive capital flows into the Israeli market. If the salaries of Israeli engineers rise too high, it may eventually harm Israel’s relative advantage in drawing giant multinationals. Already tech company managers are saying that Israeli engineers are among the most expensive in the world. This is a result of salaries being inflated following a surge in funding that hit a peak of $10 billion in 2020 and because of tech giants like Amazon, Google, and Facebook who expanded their activities in Israel and have no issue paying talented employees salaries of NIS 80,000-100,000 a month.
Such salaries may not discourage the tech companies, since Israeli employees are considered top quality. But it does intensify the discrepancies between two emerging economies in Israel, with salaries in the tech sector doubling the average market salary.
Tech workers, who make up nearly 10% of the total workforce, and especially those that become wealthy due to their sale of secondary options, drive up demands and as a result the prices of assets, primarily for housing and for basic goods and services, such as tourism. The steady increase in real-estate prices makes it harder for the rest of the population, that isn’t a direct beneficiary of the bonanza, to purchase housing. The Covid-19 crisis only made matters worse since unlike the tech industry, other traditional sectors couldn’t shift as seamlessly to work from home and generate the same returns.
These, however, are generally good problems — ‘rich people’s problems.’ The fact that the Israeli economy shrunk by only 2.5% during the Covid-19 crisis is in large part due to the tech sector’s performance, which bucked the overall trend. So for example, while total services exports dropped by 3.8%. Export of software and research services climbed by 11.6%, which contributed to the overall 0.7% increase in export of goods and services, despite predictions that it would decrease in 2020 and despite the strengthening of the Israeli shekel that harmed exporters. The massive funding rounds may have some ill side effects, but they are issues that a government with a serious strategic plan and a determined central bank can cope with if they only choose to do so.
