As Israel’s war rages on, questions bubble about its long-term tech talent

“The startup ecosystem in the country remains strong and attractive for global investors, as evidenced by the billions invested here through funding rounds and acquisitions since October 7 while the country is at war,” said Yonatan Sela, Partner at Square Peg. “However, if the country doesn’t get back on a more stable path, we’ll have a long-term problem.”

For investors and young companies, long-term questions about Israel’s tech future depend on where talent will end up when this is all over and Israel enters a more peaceful era. “If Israel is able to maintain itself as a place where brilliant developers and entrepreneurs see a future and business can be safely conducted, companies will continue to form, capital will continue to flow in and the startup ecosystem will prevail,” he added. “If the top talent leaves, reversing the trend will prove difficult, severely impacting the sector and the country’s economy as a whole.”

Yonatan Sela, Partner at Square Peg

You can learn more in the interview below.

VC fund ID
Name of the fund/funds: Square Peg. Currently investing out of our fifth generation of funds 2022 Vintage, $550m).
Total assets: Nearing $3 billion across our early stage and growth stage funds.
Leading partners: In Israel: Yonatan Sela, Philippe Schwartz. The fund's co-founders include Tony Holt and Paul Bassat (founder of the $6 billion online employment marketplace SEEK).
Latest investments in Israel: Exodigo’s most recent $105 million Series A Round, SPIRITT’s US$13.5M Seed Round, and three other unannounced investments.
Selected portfolio companies: In Israel - Fiverr, Aidoc, Tomorrow.io, Exodigo, Deci.AI (acquisition by Nvidia was just reported); Outside of Israel - Canva, Stripe, and Airwallex.

From your perspective, was 2023 a ‘lost year’, or can the events that happened during it be seen as a springboard for opportunities in 2024?

2023 has been an extremely challenging year in Israel and a rollercoaster for startups, but not a 'lost year':

This was a breakout year for AI. The rapid advancements in AI have kicked off what could turn out to be the most impactful era of innovation we've seen, with big challenges and even bigger opportunities.

The war in Israel has really put local startups to the test, challenging their teams not only on a personal level, dealing with various types of trauma, but also in terms of the need to continue delivering and growing the business in the face of unprecedented circumstances. Companies had to quickly adapt, focusing more than ever on business continuity and employee well-being. Each of our Israeli portfolio companies has been impacted, but the founders and teams were proven unequivocally resilient, and in many cases literally inspiring. They’ve taken their companies to new highs and their best quarters to date, in spite of the circumstances, in some cases even to a successful exit. In the aftermath, going through these hardships makes the teams more cohesive, efficient, confident in their abilities and stronger.

New opportunities in defense tech have emerged in Israel, and may open up a new category for local founders and investors.

What do you believe is more crucial to the state of Israeli tech: the influence of global processes and the global economy, or the local events ranging from the political protest to the war state?

Both dimensions are crucial. At the beginning of the downturn in 2022, it was certainly the global economic parameters that impacted the ecosystem more than anything else. But since then, the world has recovered at a healthy pace, whereas Israel lagged behind due to the internal turmoil of the judicial reform and then October 7 and the war.

The startup ecosystem in the country remains strong and attractive for global investors, as evidenced by the billions invested here through funding rounds and acquisitions since October 7 while the country is at war.

However, if the country doesn’t get back on a more stable path, we’ll have a long-term problem. At the end of the day, the long-term question for the ecosystem remains this: where will the talent be? If Israel is able to maintain itself as a place where brilliant developers and entrepreneurs see a future and business can be safely conducted, companies will continue to form, capital will continue to flow in and the startup ecosystem will prevail (through the highs and lows) and drag the economy up with it.

If the top talent (who also happen to be the people with the most compelling options outside of Israel) leaves, reversing the trend will prove difficult, severely impacting the sector and the country’s economy as a whole.

How much effort was required of you to maintain the fund's status with your investors in 2023? What were their primary concerns and how did you address them?

We are grateful to our investors for all their continued support throughout 2023. We have great investors who have continued to back us over multiple vintages including leading Australian pension funds as well as university endowments, family offices, and our team.

How are you preparing for the most pessimistic scenarios, such as the continuation of the war in Gaza deep into 2024, the opening of another front in the north, or further reduction of government support for high-tech?

Our approach is grounded not in pessimism but in a realistic approach to building toward long-term success. In fact, one of our core values at Square Peg is “Anchor to Optimism,” which is the only way you can stay sane in the VC job (and the founder’s job…).

Specifically at this time, in the face of great geopolitical uncertainty, we advise companies to preserve cash cushions and have plans for how they would operate in those described scenarios. Unfortunately, most of them have already had to develop such “best practices” since October 7 and during the war, reinforcing the need for resilience and adaptability. However, this is not the focus of most of our conversations with founders.

Did you raise fund money in 2023 for an existing fund or a new one? What are your expectations regarding this matter for 2024?

We are actively deploying our fifth fund (2022 vintage), and we’ll be launching our next fundraiser for our sixth vintage of funds in the second half of 2024.

How many investments did you make in 2023, and how does it compare to 2022?

We’ve made several investments, totaling tens of millions in Israel in 2023 across all of our funds (three of these investments are unannounced). We had a slightly slower investing cadence in 2023 compared to previous years (probably a healthy thing), however, we made new investments and a number of follow-on investments in existing portfolio companies across our Venture and Opportunities funds.

Our investing activity in new companies is an entirely bottom-up exercise and we do not target a given level of activity in a year, we invest when we meet extraordinary founders with a big vision at the right point in their journey. The number of opportunities gathered pace towards the end of last year, and we’re seeing this trend continue in 2024.

In your view, will the amounts and/or the number of deals in 2024 be more like those of 2023 or 2021-22?

Overall, we’re witnessing a return to healthy investment activity, steering away from the exaggerated caution seen in the market in 2023. 2024 started with us meeting fresh opportunities and several groups of brilliant, exceptional founders. There is an exciting wave of innovation in AI that opens up a big opportunity set (as well as incredible momentum in cyber, though we are less focused on the sector). This is a long-term game, and there’s a wave of renewed optimism and transformative potential in the coming year across most of the geos we operate in.

While the general pace of investing has slowed across the venture capital industry when you compare the data to the period of late 2020 and 2021, if you compare the data to the 2016-2019 period, both funding levels and valuations look very normal. In fact, seed valuations are quite similar to 2021 levels...

Which high-tech sectors will you focus on in the upcoming year? Which areas will maintain their prominence, and which ones appear less attractive?

We focus on SaaS, AI, Fintech, climate and health. Our multi-geo approach means we’re not limited by the knowledge available in one geography or theme. Most of our investments in Israel in recent years have been into AI companies, and we expect that trend to continue. We also see more opportunities in the market in defense tech, which makes sense given the market dynamics.

Which type of companies stand a better chance of garnering increased attention from VC funds this year - early-stage or advanced rounds?

Seed rounds are back at full force, in some cases with the same FOMO and high valuations of the 2021-2022 days. Founders building in AI and Cyber are also seeing incredible interest from investors, and in some cases are hyped and valued at a premium. Late stage investors, however, have returned to much greater discipline following the 2021-2022 hangover, and the late stage market has picked back up at a slower pace.

We’re early-stage investors so we’re focused on starting our journey with entrepreneurs at the seed-Series A stage, and continuing to invest in our portfolio founders heavily throughout their journey.

What changes will you implement in your approach to evaluating investments in startups in the coming year, compared to the previous two years? What practices will you abandon, and what criteria will you now demand from founders?

No big changes. We continue to pursue the same investment strategy in 2024 as we have in the last few years - to identify the best early-stage opportunities across Australia, Israel, and Southeast Asia and help them make it big in the US and globally, with a particular emphasis on founders building businesses in the areas of SaaS, Fintech, and AI.

We have a high level of confidence that our current strategy and team can deliver strong outcomes. These three thematic focus areas will typically represent about three-quarters of our investing activity, with the balance looking at emerging themes such as climatetech, crypto, and others.

Provide an example of an intriguing investment you made in 2023. What sets this company apart, or what is distinctive about its sector?

In 2023, we invested in Exodigo, a standout in the construction and energy sectors with their innovative technology for underground mapping. Exodigo's use of non-intrusive, AI-powered methods to create accurate 3D maps significantly reduces the need for disruptive excavation, addressing major cost and delay issues in urban projects. Their ability to innovate within traditionally rigid industries positions them uniquely for substantial growth.

Practical and current tips for founders planning upcoming money-raising efforts

1. As an Israeli, at this time in particular, having as your partner a VC that is global, but is present with you in your corner of the world and understands Israel deeply, is important. Israel may seem very different to those looking at it from the outside vs. inside, and having both perspectives is highly valuable at this time.
2. Vet the VC - Fundraising is a two-way process. Given that it can be a decade-long relationship that both sides are entering into, take the time to get to know each other properly. Find partners, not just investors. Look for individuals who will provide honest feedback, support you during challenges, and share a mutual respect and vision for your business.

Name two portfolio companies that you think will thrive in 2024:

Voyantis
Sector + description of the product/service: For most companies that sell online, marketing is both a critical revenue driver and one of the largest expenses. Voyantis built an AI-based product that predicts customer lifetime value and helps organizations stop overpaying for low-value customers, and start paying more to get high-value customers.
Investment amount + total: Invested $9 million out of $19 million, and then continued to double down on the company.
Founders + year of establishment: By Ido Wiesenberg and Eran Friendinger in 2020.

Reasoning why this is their year: Great tailwinds are playing in favor of the company - increased focus on profitability in the current macro environment, industry-wide privacy changes reducing marketing effectiveness, a push by Google and Meta in the direction Voyantis offers customers, maturing of Voyantis’ product to a point of incredible and repeatable results for customers. The company is quickly scaling its business in the US and globally, with an exceptional team.

SPIRITT
Sector + description of the product/service: SPIRITT democratizes the creation of complex, fully functional apps through simple descriptions. Imagine having a tech co-founder who doesn't require equity. SPIRITT's AI platform is designed specifically for entrepreneurs with minimal or no coding experience, enabling them to bring their innovative ideas to life quickly and efficiently.
Investment amount + total: $8 million, and the company raised a total of $13.5 million
Founders + year of establishment: By Tamir Magen and Or Kliger in 2021.

Reasoning why this is their year: This is undoubtedly SPIRITT's year to shine. The AI sector continues to experience significant growth, largely fueled by foundational work from major tech companies. Public awareness and understanding of GenAI's potential, particularly in coding, have just begun to surge. Most offerings seen in the market to date have been limited to showcasing semi-functional demos. However, SPIRITT stands out with its groundbreaking technology and a unique model focused on automated development of modern applications.