Why Israeli tech needs to look beyond fundraising as the sole measure of success

The numbers emerging from Israel’s high-tech sector appear somewhat paradoxical. In 2023, total capital raised fell for the second consecutive year: in 2021, a record $25 billion was raised by Israeli companies, in 2022 it fell to $15 billion, and in 2023 it was only $7.5 billion. However, an opposite trend has been observed in the number of new employees, with 350,000 people working in tech in 2021, 385,000 in 2022, and a record 400,000 in 2023. Meanwhile, the contribution of high-tech to GDP, taxes, and exports has not changed significantly during these years.

When Ronen Nir looks at these numbers, his message is clear: stop focusing on fundraising. Nir is a veteran of Israeli tech, a graduate of the IDF’s Unit 8200, a former General Partner at Viola Ventures, and is currently a Managing Director at American fund PSG, which manages $20 billion and in the past two years invested half a billion dollars in Israeli companies. He is also a board member of the Aaron Institute for Economic Policy at Reichman University.

Ronen Nir.

So what's wrong with fundraising?

"We all look at it as a measure of the state of the industry because it's easy, it's an accessible and understandable source of data, unlike more complex data on human resources and productivity. Academic research on high-tech in Israel is limited (though, you might expect deeper research on an industry that accounts for almost a fifth of GDP) so we rely on reports on capital raising, press releases from companies, and some reports from the Israel Innovation Authority. And, we got used to there being a link between fundraising and employment levels because there was a time when there was a correlation. You received funding and you proceeded to hire employees. But that connection ended about ten years ago and it has dramatic implications for the future of the sector."

Are you saying that we need to stop looking at fundraising?

“I’m calling on the entire high-tech community to think differently. It's a parameter that generates a lot of headlines and is good for the ego, but we've become addicted to a measure that no longer represents the industry. The fact that a certain company hasn't raised money in three years can indicate a problem but it can also indicate great success."

Fundraising is also used as a measure abroad.

"The rest of the world is also mistaken."

What led to the breakdown of the connection between fundraising and hiring?

"First of all, the accumulation of money. After COVID-19, flows of capital into tech companies in general and Israeli ones in particular reached a historic level, but the workforce did not grow at the same rate. Then there was a rapid crash, and companies weren’t able to spend their funds, and now they don't want to spend it. Many companies still have a lot of money in their coffers - as someone who sees the industry from the inside, I can tell you that some of them have hundreds of millions of dollars on their balance sheets even two years after the last fundraising. And that's good, we've been smart. In the years of plenty we knew how to accumulate money and now we're managing it responsibly.

"That's the second reason for the disconnect between the amount of capital raised and number of employees: maturation. Companies are managed as mature companies and not as small startups. Many companies are breaking even or are close to it and no longer burn through money. And when they reach this point, they are no longer dependent on fundraising, and fundraising no longer has a direct correlation with an increase in manpower or performance. That's also good, because it means we've reached a stage of success, but these are characteristics of a mature industry, and that also has drawbacks."

This is significantly different from previous crises, in which we saw a dramatic decrease in the number of employees. So, could it be that the number of employees should be the measure for the state of the industry?

"A central measure, definitely. In 2014, for example, the sector employed 250,000 people - it has almost doubled since then. Raising capital doesn't reflect what's happening in the industry - which includes not only startups but also an amazing ecosystem, with a delicate balance between startups, large international companies, universities, and even the military and defense industries. The number of employees at a company reflects all of this and normalizes the industry's behavior because it's less volatile than raising capital."

What exactly is the problem with using raised capital as a measure?

"About half of the workforce today is employed in established and large companies like Wix or Monday, another 17% work in international companies - Google, Microsoft, Amazon, Intel, etc. - and this is another large amount of money coming into Israel on a regular basis that isn't published or counted. Also 12% of the workforce is in the defense industry and they're not counted either. So, especially in a period of turmoil like now, examining fundraising actually measures only one specific area, which in the near future may not necessarily be the fastest-growing one. What reflects the Googles and Amazons? What shows us how these companies are affected by events? And what about the defense industries, which are further influenced by the war in Ukraine? Where do we take into account the fact that the number of employees in the aerospace field increased by 17% last year? No one pays attention to that."

What other relevant metrics are there to understand the state of the industry?

"Business output - the total revenue of Israeli companies. This is a figure published by the Central Bureau of Statistics, and it shows whether we are able to turn large investments in research and development into business successes, into real revenues. The disadvantage of this metric is that it doesn’t reflect startups that aren’t yet recognized, even though they are a significant part of the sector's future. Another drawback is that companies don't always disclose their revenues, and international companies don't report what portion of their revenues comes from activities in Israel. There are also several objective data points that can be measured, such as exports, tax revenues, and the contribution to GDP, without relying solely on companies' reports of fundraising."

This is a dramatic change in how the industry is viewed.

"True, but we are in the midst of massive technological change, which requires a new strategy for the State of Israel. We're not working enough on that. The government needs to devote more thought to the industry, to think about how it sees it in the future, and not let it stagnate, so that other countries which are already starting to outpace us with large investments in research and development won't overtake us. It's not just a matter of measurement; the decline in the number of startups established each year is a serious issue that has been happening for several years, and it needs to be understood. We need academic research to understand all of this."

Are there any research initiatives on this topic?

"Later this year, Dr. Sergei Sumkin from the Aaron Institute will publish a study analyzing various metrics and their connections. It's common to rely on companies' reports, but many of the reports are inaccurate, and some are even incorrect. There are companies that can't complete a funding round and resort to raising SAFE investments - fundraising that's more akin to credit, without a fixed valuation, allowing companies and investors to avoid a devaluation at the investment stage. So more money is entering the industry, but it's not reported or counted. The same goes for secondary transactions, which are part of funding rounds and channel money to angels and funds specializing in early-stage investments. The money doesn't go to companies, but to new investments."

What other trends should we focus on in understanding the industry?

"The war. It's a major technological event that we still don't fully understand, whose impact will be felt for many years in the development of startups and the defense industry. It's not shown in the news, but AR/VR helmets, for example, are an amazing technological event. I see in this field the main growth engine of Israel: dual-use technologies, born in military contexts but with civilian applications. Given Imaging also developed a PillCam (a pill that is also a camera) for the small intestine based on a missile camera."

When you talk to people about the need for change, how do they react?

"Everyone tells me, 'You're being pessimistic, it's just another cycle. Like in all previous crises, we'll recover from this too.' I say: that's true, but there's a big but. In terms of NASDAQ’s metrics we've recovered, but the tech industry that comes out of this crisis will be a different industry, with different types of companies."

What types of companies will not survive this time?

"There are companies that are waiting for a recovery in the industry and, as a result, aren’t raising capital; they’re wrong, because high-tech will recover in a different place that won’t include them. We’re a little too preoccupied as an industry and as a country to know yet what this other place is."

It is quite clear that when the world comes out of the current crisis, AI will be on the other side.

"Maybe, but I’m not sure. We have to think about whether we have a relative advantage there. I’m optimistic that we’ll see prosperity again, not in two or three years, but in ten years."