Fear factor: Israeli startups registering abroad due to judicial coup

After the warnings of senior economists, the Bank of Israel, and countless high-tech executives against the profound impact of the judicial coup on the Israeli economy in general and the high-tech industry in particular, on Sunday, a government body provided its own dire warning.

According to the report, there are two alarming phenomena. Firstly, in recent months there has been a significant negative gap between the technological stock index return on the Tel Aviv Stock Exchange and that of Nasdaq. The position paper indicates that this gap is increasing the fear that we are on the verge of a situation in which there will be a "splitting" between the global and Israeli markets. If this is the case, many Israeli high-tech companies will find it very hard to raise investment and will be forced to close or move to other countries.

Until now, the Authority, which is the support arm of the Israeli government, charged with fostering the development of industrial research and development, has kept silent regarding the judicial coup. But recently, its experts have gathered a lot of information from a variety of sources and the result is a very worrying report that was sent to the Minister of Innovation, Science and Technology Ofir Akunis.

The Authority warns that the continuation of the uncertainty generated by the judicial coup, along with the global crisis, will mean a severe blow to Israeli high-tech and a splitting from the global industry. Israel is completely dependent on the global industry and the funds that come from it, on the multinational companies that buy companies or set up centers here, and on the fact that most of the Israeli companies' business is overseas. Such a splitting would be the end of the high-tech industry in Israel, the report clarifies. "The government must be active, reduce uncertainty and take economic action," CEO of the Innovation Authority Dror Bin told Calcalist.

According to the paper, the first worrying indication is the number of Israeli companies being registered abroad. If in the 2000s most Israeli companies began their journey by registering in Delaware in the United States, then the high-tech boom in Israel in recent years brought most companies back to Israel, and that is where they registered their intellectual property. According to the report, by January 2023, 80% of the newly established companies were registered in Israel, while in the first quarter of this year, 50%-80% of new companies were registered overseas. The authors of the report even estimate that soon more than 80% of the new companies that will be established by Israeli entrepreneurs will be registered abroad.

The trend of the change in the location of the incorporation of the companies is disturbing mainly due to the potential future damage to the growth of local high-tech and the Israeli economy. This is because the high-tech industry is characterized both by a higher than average rate of increase in employees and by high productivity rates of its employees. This aspect may also be reflected in the future erosion of the government tax base, to which the high-tech industry, whose volume is close to a quarter of the business output in Israel, is one of the main contributors.

Another worrying sign is the local stock market. Nasdaq is the best predictor of the state of high-tech. When it rises, industry flourishes and vice versa. A position paper issued by the Ministry of Finance in the past stated that there is an almost perfect correlation between the growth of Nasdaq and the volume of investments in Israel. However, the Tel Aviv tech indices and Nasdaq have displayed very different behavior during 2023. Since the beginning of the year, the TA technology index has provided zero return, while the Nasdaq 100 index rose by about 20%, the report states.

Moreover, the level of correlation is so high that the number of vacancies in high-tech is correlated with the performance of the Nasdaq index and venture capital investments, with a lag of one quarter. In light of this, one could expect to see a return to growth and an increase in vacancies in Israeli high-tech in the coming months. But in recent months in Israel there has been an alarming increase in the number of people being laid off, as well as in the closing of significant development centers. The continuation of this trend will testify to the gap that is beginning to widen.

"In the last few weeks, following conversations with funds, entrepreneurs and companies, we have seen very worrying signs. As soon as we collected the data, we published a report to wake up the government. We see that many investment funds are starting to run out of money and it is going to be difficult for entrepreneurs as well,” said Bin. “It is difficult to know which has greater influence - the global crisis or the local crisis. The situation is not clear. There is no data that demonstrates Israel's splitting from the world, but when you see the stock performance in Israel and the establishment of Israeli companies abroad, it is clear that we are at the threshold of a possible crisis."

The IIA listed five different steps it recommends in order to limit the damage.

“Our report will not change the political map, but we must lower the uncertainty. It is possible as a first step to pass the high-tech law passed by the previous government which has very relevant tax incentives for this crisis. There are incentives for growing companies to make acquisitions, gain support form angel investors etc,” said Bin.

Other steps include: An updating and implementation of the Innovation Authority tracks in a way that meets the growing funding needs of Israeli startups; Examining the need to update the regulatory environment, including incentives to encourage investments in Israeli technological companies, including increasing the level of Israeli investment in these companies; Assessing the need to update incentives for startups to register intellectual property in Israel; and accelerating the implementation of multi-year government programs for technological infrastructure (such as the national programs).

Why is a government body issuing a report that is all about challenging the government?

Bin: "It's a snapshot of what's happening here and it's our duty to get it out. We're not part of the protest but part of the government and want to reduce the damage."

If the reform passes, will Israeli high-tech survive?

"There is a difference between risk and uncertainty. Investors know how to price risk, but they don't know how to price uncertainty. In a time of wars, they invested here. The situation with us right now is one of uncertainty, which creates a very uncomfortable situation for investors."

Minister of Innovation, Science and Technology Ofir Akunis said: "The findings of the study by the Israel Innovation Authority require the government to take rapid action in order to reverse the worrying trends it highlights. The fact that the deceleration in human capital investment in hi-tech is an international trend and has continued for a year does not prevent the Finance, Innovation, and Economy ministries from taking action that will preserve and strengthen hi-tech as the jewel in the crown of the Israeli economy."