The coronavirus pandemic has left Israel’s high-tech industry perplexed. While some sectors of the economy, such as tourism, have been hurt badly and others, such as retail, have profited, high-tech has yet to decide what to make of the crisis and where it will lead. The confusion lies partly in differing appraisals as to the short, medium and long-term implications as well as differences between different segments of the industry.
In the short term, everything appears fine, even good, at first glance. According to IVC, which tracks Israel’s tech industry, in the first half of the year startups raised $5.25 billion, a 40% increase over the same time in 2019. The number of high-tech investment deals grew as well, to 312 in the first six months from 258 the same time last year.
“Even the optimists among us were surprised for the good,” says Shmulik Zysman, the founder and managing director of the Tel Aviv law firm ZAG-S&W. Even though the level of foreign capital invested in Israeli tech companies was lower than it had been in previous quarters, it was still higher than it has traditionally been.
Venture capital funds are also faring well. Since February they have raised $1.5 billion in new funds to invest in startups, including impressive fundraisers by Team8 Capital ($104 million announced in June), Cyberstarts ($100 million in May), S Capital ($120 million in April) and Amiti Ventures ($110 million in July).
Many in the industry feared that air travel restrictions would create an insurmountable barrier to deals because investors usually want to meet the heads of the startups in person before they commit money. Instead, they have shown an unexpected willingness to close deals over Zoom and in some cases even start them over the video-conferencing service. The global tech industry has even come up with a term for the phenomenon, “Born in the Zoom.”
Omers Ventures, a Canadian VC manager, surveyed 150 VCs in June and found that 69% were ready to do remote deals and that 40% had already done some.
Doing their homework
The tech industry has another advantage over other industries that are contending with lockdown in that it is already set up to enable workers to work from home. A survey by the Israeli Advanced Technology Industries trade group found that among 50 multinational companies operating in Israel half were considering letting their staff work remotely after the lockdowns are over for at least two days a week.
Employees are willing partners to the world of remote work. “That’s what we’re hearing from most of our workers,” says Alona Eyal-Fried, vice president for human resources for Intel Israel. “In the office, people will do things that require joint activity, like brainstorming, while at home they can do other tasks.”
What that means in the short term is that Israeli high-tech has the fuel to keep moving forward. More than other industries, it is quick to size up new situations and adapt to them, including the new, more remote era that the coronavirus has created.
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Nevertheless, the coronavirus has also taken a toll on the industry. The Bank of Israel says that as of May, 4.2% of the high-tech workforce had been laid off while pay was cut an average of 6% from March to April. A lot of workers took much bigger cuts than that.
“Companies are raising money, even if they don’t need to, so that they’ll have a runway of 24 months,” says Irit Kahan, managing director and head of Israel for DTCP, a VC backed by Deutsche Telekom and other institutional investors. “The two most important things now are to preserve your customer base and to operate efficiently,” she says, which explains why some startups have been cutting their payrolls.
On the other hand, those who were laid off were likely to find other jobs quickly because the Israeli industry suffers a chronic labor shortage of software developers. Even taking into account the reductions in salary, the average monthly wage in the industry is 25,000 shekels ($7,200) a month, about two-and-a-half times the average salary in Israel.
In the medium term, the picture is more worrying. Even if the flow of new capital is expected to remain strong, the business side of startups faces major challenges. Without normal air travel, companies will have a hard time making sales and an even harder time supervising installations.
Globally, there is a move toward local sourcing of products and services as the coronavirus has exposed the vulnerabilities of the global supply chain. Worst of all, corporate America, Israeli high-tech’s paramount market, has put a break on purchases of everything except for essentials.
Bracing for a bad second half
“While the first-half figures were strong, in the current environment there’s no assurance that it will be the same in the second half of the year,” IVC researchers wrote when they released their fundraising data. “The impact of the [global] economy will only be felt in the third and fourth quarters and could have a devastating effect on a large number of Israeli high-tech companies.”
Tal Morgenstern, a partner in Lightspeed Venture Partners shares that concern. “Enterprise software companies that sell in the United States accounts for most of the Israel industry. Startups are only now feeling the slowdown in the sales process. The third quarter is the first in which most companies are starting with a smaller orders backlog and fewer leads than they expected.”
For early-stage companies, which have few if any sales, times are much better, Morgenstern said. “It’s a great time to be a seed stage company because there’s been almost no let up in fundraising. Its less good for later-stage companies that are burning a lot of cash,” he says.
Investors are more cautious right now and are opting for less risky options. “More money is chasing after fewer deals and in my opinion that trend will continue for some time,” Morgenstern predicted.
DTCP’s Kahan says that not only is the second half of the year likely to be harder but that a full recovery is years away.
“In contrast to [the global financial crisis of] 2008, when there was a big explosion and the recovery process was gradual, the crisis today is both a health and economic crisis and it will take time,” she says. “I don’t believe the recovery will be this year or next year but only in 2022.”
For that reason, Sarit Firon, managing partner at Team8, is advising her portfolio companies to hunker down.
“If I had to give advice to entrepreneurs in their place I wouldn’t rush to assume that things will return to what they were so quickly because they don’t yet fully understand their value chain. Suddenly, they’ll discover that their customers are in trouble. The crisis will reverberate until it winds down. If I were the CEO of a company, I would continue to act cautiously.”
That said, Firon predicted it would take another year to 18 months before we will see a world free of the coronavirus.
And long term? Some investors express confidence that in another two years a new crop of entrepreneurs who are now under the radar screen will emerge with innovations for the new age. “From a crisis, you can emerge stronger. A company that knows how to adapt will emerge from the coronavirus [crisis] stronger,” says Kahan. “This is a good time to be building, to create new companies.”