Stability in times of upheaval – A challenge Israel's high-tech industry can meet

If the doomsday prophecies become a reality and the high-tech industry also enters a prolonged crisis, we might be able to take a look at past crises in order to try to predict what kind of action this industry might take.

As a general rule, in times of crisis the "power" shifts to the financing partners – the funds and investors. As many of us recognize, the past decade gave a significant power to entrepreneurs and innovators, among other things due to low interest rates in the markets and a perception that young, growing technology companies proposed a good alternative investment in a world going through decades of technological revolution. Now, investors will reassess the chances for success of existing portfolio companies, as well as of those first approaching them, and they will need to be conservative in managing the money placed in their hands. It can be expected that, except for companies with significant positive cash-flows, initial fundraising rounds will drop significantly, and young companies will need to plan use of funds for extended periods of time. Downrounds, fundraising rounds at the post-money value of a previous fundraising round despite significant progress (flat rounds) and harsher investment conditions will occur in quite a few cases. Companies that have recently raised significant amounts may replan the use of the capital and refrain from continued fundraising for as long as the crisis continues. These are not doomsday prophecies, as we will immediately explain, but it would be impossible to expect that small companies might be spared from a return to the practice of assessing companies based on performance, which had been widespread until not so long ago. The value of quite a few public technology companies was cut by dozens of percentage points within a short period of time, and it is only natural that start-ups will also encounter a drop in value.

Gil Brandes.

However, it appears that the shift to "money is king" will not be as complete as in the past. Today, Israel's high-tech industry is substantially more mature and learns from past mistakes. The value of many companies, certainly the veteran companies, relies on real performance and sales, not just on presentations and ideas. At present, quite a few of the entrepreneurs have already been through the crises of the 2000s, they are more experienced and understand the importance of immediately reassessing the situation. We can already see many companies tightening their belts in preparation for the future. Should it turn out that the instability is temporary and short-lived, it will always be possible to accelerate. But continuing as usual and hoping for the best is not a real possibility.

As in past crises – today the identities of funds that have already invested in companies is of great significance. The past teaches that during times of crises funds attribute great significance to maintaining their existing portfolio of investments, while feeding capital into companies with the best chance of weathering the crisis. Usually, this is done at the expense of new investments, but not necessarily. Either way, in the immediate term, all companies will have a harder time raising funds. If in the past, a successful company would receive several offers for investment (multiple term sheets) and would be able to choose between them, today good companies will receive fewer offers, and less appealing companies will have difficulty raising amounts that will enable them to continue the pace of growth and development they had been accustomed to in the past. The entrepreneurs and founders' experience will play a decisive role in investment decisions. The maneuvering range for mistakes naturally shrinks.

And in business? Companies are expected to become more aggressive in their attempts to generate high volume of sales, and by doing that to support the previous company value based on which funds were raised. Companies that planned long development times will attempt to shorten the "time to revenue" in order to reduce dependency on additional fundraising rounds. At the same time, the more the cashflow problems of companies unable to raise new capital increase, one can expect consolidations and a sharp rise in the number of mergers and acquisitions ("exits") by those companies unable to find enough capital to continue their activity and which decide to sell, mostly for modest amounts. During the period of instability Israeli entrepreneurs might tone down their desire to build a company for the longer run and "go all the way" as an independent company – and we may again see multiple smaller exits in the range of tens of millions and less in the hundreds of millions. Concurrently, in an industry that has greatly matured, Israeli high-tech will also continue to produce new unicorns, not as a target, but as a result.

Finally, one can also expect more conservative human resources management than we have been used to over the past few years - from cutting expenses to halting recruitment for positions that are not essential. As a result, the aggressive salary race of the past few years is also expected to subside. Should the crisis last a long time, we may even witness a drop in salary levels for some positions.

Gil Brandes, Partner and Head of Hi-Tech Practice, at Naschitz Brandes Amir.

Gil Somech, Partner, Hi-Tech Practice, at Naschitz Brandes Amir.