Start-Up Nation seeks to emerge unscathed from coronavirus crisis

While economic downturns are a fact of life for markets, investors and entrepreneurs, the impact of the coronavirus outbreak has shaken the Israeli and global innovation ecosystem to the core.

A nighttime view of Tel Aviv from the municipality building (photo credit: TEL AVIV-JAFFA MUNICIPALITY)
A nighttime view of Tel Aviv from the municipality building
(photo credit: TEL AVIV-JAFFA MUNICIPALITY)
Blissfully unaware of the approaching coronavirus storm, Israel – the so-called Start-Up Nation – celebrated another record-breaking year of hi-tech success in 2019.
Champagne corks were popping regularly in Silicon Wadi last year as Israeli start-ups secured a total of 138 “exits” worth $21.7 billion, some 522 fundraising deals amounting to $8.3b. in new investment while enjoying the most prolific year for venture capital-backed deals to date.
As is natural, threats of varying severity still loomed over the hi-tech sector. Most notably among them, a worrying shortage of skilled human capital that highlights the lack of diversity in Israel’s key economic growth engine.
While economic downturns are a fact of life for markets, investors and entrepreneurs, the instant impact and unpredictable nature of the coronavirus outbreak has shaken the Israeli and global innovation ecosystem to the core.
When the vast majority of investments – some 90-95% – in Israeli hi-tech come from abroad and Israeli companies are focused on lucrative foreign markets from the get-go, the Start-Up Nation is inseparable from the rest of the world.
The well-known fruits of its success are not geographically-limited, but it equally cannot shy away from global troubles, even as Israel emerges from lockdown earlier than most developed nations and markets.
“When the majority of money comes from abroad, the success of Israeli start-ups is not just about Israel bouncing back, but if the world bounces back,” said Uri Gabai, vice-president of strategy at Start-Up Nation Central, a Tel Aviv-based nonprofit connecting Israeli innovators to global partners.
Start-Up Nation Central vice-president of strategy Uri Gabai (Credit: Start-Up Nation Central)Start-Up Nation Central vice-president of strategy Uri Gabai (Credit: Start-Up Nation Central)
“All the markets are abroad and customers are struggling, whether they are private customers or institutions. Right now, some places are in lockdown and others are entering a recession. Start-ups are really under threat, because global investments are shaky. We’ll only return to normal when our clients return to normal.”
Gabai emphasizes that encouraging investments announced by start-ups in recent weeks should not disguise the tough reality, with venture capital funds currently relying on money raised prior to the virus outbreak. Maintaining hi-tech activity is no less than critical for the Israeli economy as almost half of its exports in 2019 were services, primarily hi-tech exports.
“If you’re driving on the highway at 100 km/h and the engine cuts out, you’ll keep on driving fast for a period of time. So what’s the problem? The engine has stopped working and at some point will slow down,” Gabai said.
“We don’t have many engines here in Israel, so we need to make sure there is continuity in investments and that start-ups should have sufficient resources for research and development. If we do not build technologies now, we will not be competitive next year.”
The state has an important role to play, Gabai says, referring to a vibrant industry-wide debate regarding whether the government ought to intervene directly in the hi-tech sector.
Prof. Eugene Kandel, the CEO of Start-Up Nation Central and former head of the National Economic Council, has advocated “modest government support” for the tech sector, including by offering incentives to local institutional investors to take a more active role in the local ecosystem rather than investing almost solely abroad. Doing so, Gabai says, will ensure greater financial roots are planted for sustaining Israeli innovation now and in the future.
There is a general industry consensus that Israeli hi-tech is well-positioned to take advantage of the emerging post-coronavirus world, should its start-ups emerge from the current period more or less unscathed.
Demand for digital health and life-sciences innovation will certainly increase to meet the clear challenges posed by the outbreak for healthcare systems. As workplaces and manufacturing become increasingly digital and automated, accelerating the Fourth Industrial Revolution (Industry 4.0), cybersecurity solutions will need to protect more and more systems. These are all technology verticals where Israelis have excelled in recent years, and could enjoy a significant boost in the years to come.
For investors seeking deals, now is certainly the time to take advantage of more modest – maybe sensible – company valuations.
For veteran investor Zeev Holtzman, the founder and chairman of Giza Venture Capital and IVC Research Center, 2020 is likely to be a year characterized by many acquisitions but a sharp decrease in fundraising, especially for early-stage start-ups.
Zeev Holtzman, the founder and chairman of Giza Venture Capital and IVC Research Center (Credit: IVC)Zeev Holtzman, the founder and chairman of Giza Venture Capital and IVC Research Center (Credit: IVC)
As global tech giants sit on surplus finances and US venture capital funds seek to spend more than $100b. in funds raised last year, Holtzman believes they will “take advantage of the opportunity to acquire Israeli start-ups at a reduced cost.” They have the cash and will use it, he said.
If investors and entrepreneurs were previously able to jump on a plane and shuttle between Tel Aviv and Silicon Valley or New York to secure investments, current restrictions on travel and movement are likely to have a negative impact on deal flow.
“When it comes to investments in start-ups or exits, there is a process of due diligence and meetings with key persons in the companies,” said Holtzman. “Surprisingly, we have seen some big acquisitions completed during the coronavirus outbreak, with hardly any physical meetings, but these are rare.”
The $1.15b. acquisition of the cybersecurity firm Checkmarx by global equity firm Hellman & Friedman and $900m. purchase of Moovit by Intel are likely to be exceptions to the rule, with the latter likely assisted by the strong presence of Intel Capital in Israel and Prof. Amnon Shashua’s existing role on the Moovit board.
“At some point, travel will return. Even if it was possible to travel, of course, there would still be significant damage to the scope of investments as a result of the global financial crisis,” Holtzman said.
While the true extent of the investment slowdown in Israeli hi-tech will only be witnessed once second quarter statistics are published, with Holtzman predicting almost a 50% drop in seed and Round A investments, he also highlights Israel’s reliance on the American hi-tech sector.
“Our experience shows that Israel usually piggybacks and is influenced by American hi-tech, with a two quarter delay,” Holtzman said. “Once the United States returns to normal investing, Israel will return to enjoying normal investments about half a year later. Including that delay, I expect that it may take one to one-and-a-half years to return to 2019 investment levels.”
Holtzman also favors government intervention to enable hi-tech firms to emerge quickly from the crisis, but in the form of direct assistance to start-ups rather than institutional investors or venture capitalists.
“Intervention is also important to retain Israeli entrepreneurs, intellectual property and knowledge, and prevent brain-drain,” he said.
Investments in Israeli hi-tech from Asian countries, notably China, have increased significantly in recent years, with a 2018 IVC report showing that Chinese investors were involved in approximately one in every eight fundraising deals – primarily in software and life-science technologies.
While the scope of the investments from the Asian continent remains massively overshadowed by the United States, the quick recovery of Asian countries could offer opportunities for Israeli start-ups seeking funds.
Echoing Holtzman’s comments, Brilliance Ventures managing partner Keren Maimon also forecasts an increase in acquisitions – especially from Asia – as the buyer’s market takes hold. Brilliance Ventures was established in cooperation with Tel Aviv Capital in 2018 to focus on investments in mid- to late-stage companies with high growth potential in Asia-Pacific.
Brilliance Ventures managing partners Keren Maimon (L) and Ron Sadeh (Credit: Brilliance Ventures)Brilliance Ventures managing partners Keren Maimon (L) and Ron Sadeh (Credit: Brilliance Ventures)
“From 2020, we will see that Israeli companies are increasingly welcomed by Asia-based venture capital, where recovery has been the best worldwide,” said Maimon, named by Forbes Israel among the 30 Under 30 young leaders of 2018.
“Although the decision-making process might be slowed down and constrained by international travel, we can see that Asian investors are very actively looking for deal flow in Israel with a mindset of cooperation and helping them scale in Asia.”
Importantly, she added, the outbreak has led to an awakening among Israeli start-ups regarding the importance of healthy cash flow. Companies in Israel will only survive if their operations are based on sustainable growth and cash flow, or strong financial and strategic backers.
Israeli start-ups with disruptive technologies will still be able to raise funds despite the investment slowdown, said Media Ventures founder Shay Arad, who offers fundraising and scouting services for technology companies. Yet even with potentially game-changing solutions, companies will need to know how to read the markets and understand what investors are now looking for.
Media Ventures founder Shay Arad (Credit: Courtesy)Media Ventures founder Shay Arad (Credit: Courtesy)
“Venture capital funds are very selective in regular times,” said Arad. “Now they will think twice when money in the funds comes from limited partners – institutional investors hit hard in the stock exchanges worldwide.”
Negotiating power, Arad said, has switched from the start-ups to the investors. Just as property investors are currently seeking to buy property at low prices, venture capital funds are also looking for mature companies at a lower value, and preferably with an existing product.
“There are still funds that are sitting on cash, built up over the past few years. Foreign funds are turning to me, especially now, and looking to invest. Now, they know they can receive good valuations on the companies,” Arad said.
For entrepreneurs, Arad cites a number of key principles for fundraising in times of recession. These include enhanced public relations efforts, presenting a detailed use of proceeds, showing ways to reduce burn rate and costs while specifying paths to quickly accrue revenues, and compromising on valuation and dilution.
Ultimately, as long as the coronavirus pandemic continues to rage in some of Israel’s key markets, accurate forecasts regarding its impact on the Start-Up Nation will prove problematic. Waiting to see what the post-coronavirus world heralds, however, is not feasible, and easing off the innovation gas pedal is simply not an option.
The pandemic has certainly upset the innovation status quo, to the advantage of some and detriment of others. If Israeli entrepreneurs, known for their agility, manage to navigate the current storm – possibly with a helping hand from the government – they are likely to find themselves well-placed to take advantage of new opportunities offered in a post-coronavirus world.