“If the crisis extends longer, it will take us years to reverse the damage”

"We are now six months into the local crisis and it’s naive to think that once the local issue is resolved we will just see everything bounce back to normal. I think that this is the last moment when we can still turn things around with a reasonable ‘price’ to pay,” said Gigi Levy-Weiss, General Partner at NFX, in a special interview with CTech. “If the crisis extends longer, I fear it will take us years to reverse the damage. Not only because we are losing the opportunity to create category leading companies in the field of AI, Synthetic Biology and Quantum, but also because we will be left with less people who are the foundation of our industry. The government must act now!"

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Levy-Weiss spoke with CTech as part of the project “Where do we go from here?”, which aims to examine how the Israeli VC industry is dealing with the crisis in the sector. According to Levy-Weiss, while the global tech industry is starting to show some rebound indicators, this is not the pattern being seen in the Israeli tech sector. “It does seem that globally we are starting to see the tech industry rebound. This is apparent all the way from consumer spending on tech, through B2B tech spend, the growth in venture investing, and the rebound of tech stocks,” he said.

Gigi Levy-Weiss

“While it’s unclear whether the slowdown is over – especially since interest rates are still not declining – it’s clear that the mountains of VC dry powder are now finally being put to use and that the AI revolution is reenergizing the industry. So we are not out of the woods yet – but definitely some positive signs globally. Sadly, this is not the pattern we are seeing in Israel. Until mid-Q1 2023 we saw similar patterns in Silicon Valley and Israel, but we started seeing a gap opening mid-Q1 and it just seems to be widening in Q2 and early Q3. This gap is clearly the impact of the aggressive attempts to push through a very extreme judiciary ‘reform’ (or ‘revolution’ as many of us call it) without a wide public consent,” said Levy-Weiss.

Name of fund/funds: NFX

Total sum of fund: $1.1B

Partners: Gigi Levy-Weiss, James Currier, Pete Flint, Omri Amirav-Drory, Morgan Beller

Notable/select portfolio companies: C2i Genomics, Mammoth Biosciences, Walnut, Yo-Egg, Triple Whale, Firefly, Moov, Papaya Gaming, Komondor, superplay, Imagen AI

“We are all about finding amazing, hungry founders who wish to disrupt huge markets with a good idea”

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

“Generally speaking, around 90% of the capital invested in Israel comes from international sources, either directly (global funds) or indirectly (global LPs). Clearly the slowdown in international VC investments – generally because of the slowdown and specifically because of the Israeli political situation and instability – is hurting Israeli startups which have dramatically less sources of funding. Similarly, the slowdown in the investments of global LPs in Israeli funds – again, generally because of the slowdown and specifically because of Israel’s instability – dries the local VCs and therefore hurts Israeli startups even further.

“One could assume that Israeli-focused VCs that have dry powder (like NFX) are likely to perform well, and indeed we are seeing dramatically less competition on new deals. But this also hurts us as the situation is similar for follow-on funding for startups. Hence, while some Israeli VCs may enjoy a short-term benefit, overall, this is very bad for the ecosystem and for Israeli VCs. I would love to see the situation change, money flow in and competition rise again!”

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

“The answer is, sadly, a very steep decline. In 2019 Israel benefited from more than 1,400 funded pre-Seed and Seed-stage startups. This is an amazing number. We have seen a steady decline since 2019, and looking at the data of the first half of 2023, we are at a pace of only 400 funded Seed stage startups. This is an unbelievable decline, which brings us back exactly 20 years ago, as these were the numbers in 2003. That’s unbelievable and very risky. It is important to say that while the decline started as part of the global downturn, it clearly accelerated with the launch of the judiciary revolution, and we see the numbers continue to decline as instability grows and people are more preoccupied with the state of the country. How can you think about building a new company when you are out protesting at least once a week, feel your country is falling apart and are worried about the future? Founding a startup requires crazy focus, and the current turmoil just takes away entrepreneurs’ energy.

“What we need to remember is that – statistically – every 100 funded Seed startups will create one ‘unicorn’ (company with a $1 billion valuation). And each such unicorn ends up employing an average 1,000 people. So if we now have 1,000 less companies a year – that’s 10 less unicorns or 10,000 less jobs. And if we assume the rest of the 99 companies employ another 1,000 together – that’s another 10,000 jobs potential. Even if we put a significant discount on these figures, that’s tens of thousands of lost jobs, not to mention taxes paid, secondary impact (cars, food etc) and the amazing impact of each new unicorn on the specific field (each unicorn fuels innovation and new startups in its field). The damage of going down to 400 new funded startups a year is truly huge.”

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

“The industry needed a few drivers in order to start growing again. Clearly the fact that consumer spending and B2B spending weren’t hit as hard as we all feared plays a big role in the potential rebound. Similarly, VCs starting to invest again after an almost stand-still period, alongside tech stocks soaring in Q1, had a major impact. But it’s excitement around AI (or specifically LLMs) that drove a lot of the Q1 and Q2 excitement. It’s been a few years since we saw a new technology that clearly has so much potential to impact any field and any product. I think it is fair to say that the excitement around AI is as high as the excitement around the initial smartphones, with AI having an even faster immediate impact on everyone globally (users don’t need to buy hardware which makes it super-fast to adopt). It’s clear that almost no product will be the same in a few years, and as such the opportunities are endless. We should say that it’s not 100% clear where the value will accrue in the generation of AI-infused products – it could be new startups or the incumbents – but it’s times of quick changes in the market – which are generally good for startups and therefore for VCs.

“Having said that, AI is not the only exciting field. We are super excited about synthetic biology and are very actively investing in the field. Also quantum computing is set to change the world. So overall – despite the difficulties – a super exciting period!”

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?

“As an early-stage Seed VC, we mostly use SAFEs as our method of investing (Simple Agreement for Future Equity), and try to be super-fast – so that from decision to invest to actual funding it’s less than a week. We actually measure our own speed… Some investors are using this downturn period to go back to cumbersome priced rounds with lots of terms – including mechanisms we disapprove of like participating preference and staggered investments – but we believe our very simple and founder-friendly terms are good for the company and hence good for us, so nothing changed in our documents between the super hype period and now.

“One thing we are more careful about is venture lending. We don’t believe startups should fund operations based on debt and try to limit the use of debt for growth initiatives, where it’s easier to see the direct link between the spent capital and revenues, ensuring positive return on investment. This was true in the hype period – but it even more so in a downturn.”

How should the venture capital industry conduct itself in the immediate and medium term?

“I believe that the business of being a good investor doesn’t change if it’s a good or bad period in the market. We are all about finding amazing, hungry founders who wish to disrupt huge markets with a good idea (that most likely will change through the startup’s life). We believe that when we find them we want to fund them fast with decent terms and then support them as much as we can in their entrepreneurial journey. This is true for every period… And while in the peak period we gave up on deals which we felt were not priced right, we are now not trying to leverage the period to force founders to take unreasonably low valuations. So the business is the same and we always try to be at our peak performance as a partner to the founders we work with.”

How do you work with your investors these days, following the internal political crisis in Israel?

“We have many top LPs, mainly from the U.S., and while – as a fund focusing both on the Silicon Valley and Israel the pressure on us may be a bit lower than Israeli-only funds, this is definitely an issue. It’s not that LPs don’t believe in the Israeli ecosystem anymore – the Startup Nation brand is still strong – but investors like stability.

“We need to remember that the Israeli tech success story is a miracle – generally we don’t see investors rushing to conflict areas, and we can all see how the entire tech industry left Ukraine when the war started. Similarly, the Israeli security situation should have made Startup Nation impossible… But with the hard work of many great entrepreneurs, the contribution of the IDF, good government policies over the years and our amazing level of talent, Israel became one of the top startup ecosystems in the world. And this is not per capital – where we clearly lead – but in absolute terms. This is truly unbelievable. But for this to continue, we need to provide stability. Instability is the only real risk to Startup Nation – and over the last six months the government has done everything possible to destabilize the country. It’s unbelievable how bad the situation has become and how damaging this is to the Startup Nation brand. This truly has to change if we are to save our amazing industry.”

And regarding entrepreneurs from your portfolio companies?

“As I mentioned before, I believe that our business with entrepreneurs doesn’t change in a downturn. If anything, it’s our role to support them even better, as everything is harder in this period – from fundraising to closing deals with customers (the only thing slightly easier is recruiting, but top talent is still hard to find). So generally there is no difference in how we work with founders.”

Do you have any interaction with the government?

“In normal periods, we have very little interaction with the government as a fund… Occasionally trying to ensure the best regulatory environment for companies, but not beyond. However, in the last six months we have put a lot of effort into communicating the risks we see from the outcome of the judiciary revolution and expressing our demand for stability. This was part of what is now called the ‘High-tech protest’. We generally believe that these are decisive times for the industry and that if Israel doesn’t regain stability – which can only happen if any constitutional legislation is done only with a country-wide agreement – we will lose our unique position in the market, lose the opportunity to build the next wave of unicorns in the AI boom, and eventually severely damage Israel’s economy.”

Are there positive sides to this crisis?

“Overall, the crisis is not good… But we are seeing companies go back to the basic rules of building companies, which was not always the case in the peak of the hype. These include a strong focus on burn and cash management; an aim to reach profitability; ensuring every employee in the company is a top performer, and many other principles which should always be top of mind for entrepreneurs.

“We also see how valuations came down to be more reasonable – this clearly is good when you invest and not as good when the next fund invests, and the valuation is lower than what you want it to be… But generally speaking, we are happy to see Seed valuations back at levels we feel we can invest in.

“In the longer term, many companies that never had a good business model but just lived off more and more investments will fail. This is a net positive as these companies would have eventually failed anyhow and the talent that will be released to the market will support the good companies.”

What are the critical points in which the Israeli venture capital industry was hit - if at all?

“While the industry was hit on all fronts from the combination of the global downturn and the Israeli-specific political crisis and instability, if I had to choose one area that was hit the most, I would point at the ability of Israeli VCs to raise capital. While top Israeli startups will continue to raise money – even if global VCs invest less in Israel, it’s the foreign LPs which are the most severe risk. This is because they don’t choose a specific company but need to decide to invest in a region. And as Israel is currently an unstable country, why would an LP (which is not a VC getting excited about a top performing company) risk investing in Israel right now? I personally think that LPs should continue investing – and tell them so – but hear from them that they prefer to wait and see the country regaining stability. This is why Israeli funds are having a tough time raising new capital and why I truly believe we must stop the legislation and turn our focus back to the more important issues at hand.”

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

“Further to the risks and impact I mentioned already, the worst thing I am seeing is the talent drain. At the end of the day, the Israeli tech industry comprises only 300,000 people, of which around 10% - so only 30,000 people – drive most of the innovation and success. These are the top entrepreneurs, the top product people, the top technologists – they are 10% of the industry. Now, sadly these are also the people who have the most alternatives. They can get a passport anywhere; they can get jobs in any country. Some countries would even offer them bonuses to move over… And what we are starting to see is a dual phenomenon where on the one hand some of them are starting to plan their move outside of Israel while others – usually living in the Silicon Valley or New York – are delaying their return to Israel. This is the biggest risk to Israel’s tech ecosystem, and if we don’t reverse it quickly – we will pay the price for many years to come. This is solely the outcome of the political instability and it’s the government’s responsibility to overcome the political fights and provide a stable environment where these amazing contributors will want to live and raise their kids. This is sadly not limited to the tech industry – I am hearing similar concerns in academia and the major hospitals. The country just can’t accept losing our core talent.”