“We are experiencing a ‘bull run’ in a ‘bear’ market”

“We believe that the global economic challenges will persist into early next year. We are experiencing a ‘bull run’ in a ‘bear’ market, driven in no small part by VC’s needing to spend funds on one hand and starting to now prop up their portfolio which is running out of cash and cannot raise, and an irrational AI hype cycle on the other. In each case, it does not end well,” assesses Avi Eyal, Managing Partner of venture capital fund Entrée Capital.

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“I don’t think ‘crisis’ is an appropriate word. We are in a pullback or a recession. Is it a crisis? Or just the natural order of things?” responded Eyal when asked whether the Israeli tech sector will continue from the point where the crisis started once the local turmoil (political and financial) ends. “As one overeats over a period, one has to then diet or abstain for the next period. It’s healthy (albeit unpleasant for many) for the ecosystem that it ‘resets’ and finds its new normal. I say this in the full knowledge that Entrée Capital will also inevitably suffer some losses, but I remain hopeful that our portfolio companies, founders and staff have and will continue to implement our ‘lean and mean’ strategy to emerge on the other side of this with a fighting chance.”

Avi Eyal.

Over recent months, we have witnessed one of the most serious crises to hit Israeli high-tech in recent decades: on the one hand, a global economic slowdown, and on the other hand, local political turmoil that sent the industry into deep stagnation. Since the general assumption is that the situation will not change in the near future, the question hovering over the industry is what can still be done to minimize the damage to the Israeli high-tech industry and how should we act so that when the crisis passes - all those involved can take a leap forward. Therefore, as part of this on-going project, we spoke with senior executives from the local venture capital industry to try and understand from them what needs to be done now to justify the reputation Israeli high-tech has earned as being creative, adaptive, innovative, agile and cunning.

Name of fund/funds: Entrée Capital

Total sum of fund: Over $1B under management

Partners: Avi Eyal, Ran Achituv, Eran Bielski, Adi Gozes

Notable/select portfolio companies: monday.com, Riskified, Breezometer, Rapyd, HiBob, Snapchat, Classiq, SWAPP, Glovo, Coupang, PillPack, SeatGeek, Stash, Gusto.

"AI has its place, but over exuberance by VCs and founders is taking us down a road that can only result in massive losses"

Does the fact that major international funds have generally slowed down the pace of their investments - play to the benefit of the local Israeli funds and to the benefit of the local ecosystem?

“International funds have reduced investment from the 2021 highs but evidently have now increased their pace significantly in the pre-seed and seed stages - this does not affect the local ecosystem substantially. What has happened though is that founders in Israel are trying to skip the pre-seed and still raise significant seed rounds ($6m+) - and this does not fit with what’s happening internationally, where a greater focus on capital efficiency has driven good founders and deals into pre-seed stages.

“At the Series A and B (and later stages) the market is down 75%-90% down and that’s not changing this year. Hence the local ecosystem hoping to extend their portfolio company cash out into 2024 in the hope of bridging this chasm.”

Do you see a significant decrease in the number of new startups in the sectors you cover?

“Generally speaking there is a reduction across all sectors. Generative AI is an exception due to a hype cycle. Particularly hard hit areas in Israel include FoodTech, Deeptech, FinTech and DevOps.”

Are there positive sides to this crisis?

“As in any slowdown, there are green shoots. The key is to find these and invest with an understanding of what happens to these opportunities over time, and if funding is required down the line, that there is a reasonable chance that it will be available. For the first time, we are seeing a better quality of human resource skill starting to come to the market, yet competition over these folks is intense. Unfortunately, we are seeing too many making the same mistakes as before i.e. valuations too high, chasing features vs products, building ‘good time’ budgets. Very few are making the leap in understanding how much the market has changed, and what will get Series A and Series B funding. And unfortunately, as Israelis we are misreading the market - our technological gap from the past 20 years has been reduced substantially. We need to find a new way forward to remain a competitive market for investment and innovation.”

Which investment strategies or financial tools have entered your tool-kit of solutions? Are there any that are no longer suitable to offer to startups?

“We have always maintained that venture debt is a two-edged sword. You cannot build your company on debt that you can have the next investor settle. Those days are gone. While MRR-related lines of credit do make sense in some cases, as a founder you need to understand your cash flows and what happens down the line when you go raise again. As a rule of thumb, we recommend that startups that take venture debt, limit it to less than 15% of the size of the next capital raised (and be conservative in assuming how much you raise next). Entrée itself has built some tremendous businesses with founders on small amounts of capital and on “milestone-based” funding solutions. This has worked really well especially in deep tech companies, and we hope to keep doing that.”

What are the critical points in which Israeli high-tech was damaged?

“The challenges we have in Israel are on a few fronts: (a) There are political and economic (cost of living) factors - these are weighing on the minds of many, forcing founders and CEOs to ask the question of which location they should base themselves to optimize their chances of success. And whilst we are all committed Zionists, is the short term period the right time to (i) start something and (ii) start here.

“(b) our education system has not kept up with the world (and OECD) - we are now far behind on a median basis. No longer can we rely on the 8200 etc. gap. We need a step change - something that will launch the nation into a new cycle of hyper-innovation. At the same time there needs to be a serious investment in high quality teachers and subjects like math, physics, biology, computer science, and English.

“(c) We need a social contract. We are so diverse as a nation across ethnic, religious, and other lines, and we need true, ethical, and moral leadership to emerge that binds us - a Mandela of sorts. Until this happens, we will continue to battle each other instead of winning together.

“I am hopeful we can overcome these challenges.

“On the economic side, we will go the way the U.S. etc goes. Investor interest remains, Good companies get funded. That doesn’t change.”

How can you take advantage of this interim period (until the crisis passes) to prepare better for the reawakening when it arrives?

“We continue to do what we have done for over twenty plus years. Look for exceptional teams to back solving unique problems. We are generalists and contrarians - we hope to keep that approach. We don’t play the valuation game - we focus on a value game, where founders also appreciate our company building experience.”

Do you support the general assumption that AI can rescue the industry from the current crisis?

“Personally, I don't believe AI is the solution for getting out of the current period. AI has its place, and indeed *everything* will be affected by it, but over exuberance by VCs and founders is taking us down a road that can only result in massive losses. We’ve seen this before in mobile, in search, in social media. When companies are doing Seed rounds raising $50m+ in capital, with most of the capital expenditure going on compute costs and GPUs, it’s an accident waiting to happen. In 2-3 years time, you’ll achieve the same at one tenth of the cost. Rather focus on building niche verticals where you emerge with a moat and a winner, than fight it out with the FAANGs.

“I also don’t believe in remote work and believe that it’s actually been a contributor to the situation we all find ourselves in today. Remote work by and large does not work - it promotes bad behavioral practices and breaks team dynamics. The lowest contributors get to dictate the pace of the team.”