The spread of coronavirus is giving way to talk in Israel’s high-tech industry about the risk of a crisis. The prevailing view remains cautiously optimistic, but fears are growing of declining sales, difficulties for startups to raise capital and a slowdown in hiring, or perhaps even layoffs.
Sequoia Capital, the giant U.S. venture capital fund, set off those concerns last week when it wrote to its portfolio companies to prepare for a difficult period ahead. Among other problems, it warned them to expect lower sales and a tough environment for raising money, as happened in the previous two industry crises in 2001 and 2009.
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This time around, Sequoia said, “It will take even longer for the global economy to recover its footing” and called the coronavirus “Coronavirus: The Black Swan of 2020.”
Sequoia urged entrepreneurs to get by with less and increase productivity.
Avi Eyal, cofounder and managing partner of Entrée Capital, with offices in Silicon Valley, London and Tel Aviv, expressed similar concerns in a letter he wrote to his portfolio companies CEOs entitled “Winter is Coming.”
In his view, the decline in the financial markets will last about three months before a recovery begin. However, because that could bring a drop in revenues for tech companies, Eyal is urging his companies to assess their spending and impose tighter costs controls. “Our recommendation is to cease hiring sales and marketing personnel and only take on critical research and development hires,” he added.
Paule Tzuker, CEO of the high-tech placement firm Nisha Group, said she didn’t yet detect any signs of a slowdown in hiring and certainly not of layoffs. But she added: “If [the epidemic] continues, we’ll feel it within two or three weeks. Even if there are layoffs or hiring freezes, we don’t see blow coming to the entire sector. There’s a shortage of 15,000 workers in the industry and there are enough opening to absorb all the new workers.”
Some startups could use the crisis as an excuse to impose layoffs, said one investors recently. “Companies are afraid about broadcasting negative vibes to their teams, but now they have a legitimate excuse,” said the investor, who asked not to be identified.
Another key worry facing startups in Israel is the ability to raise money from VC funds. Eyal of Entrée warns: “If you’re raising money now, close [the round] quickly, even if it means settling for less.”
High-tech is a people-oriented business where investors want to get to know the teams they are investing in personally, a process that usually involved lengthy in-depth meetings. But the epidemic may make fundraising more difficult is because people are flying less and businesses are conducting fewer face-to-face meetings.
“We don’t plan to slow down. But it has to be said that it’s very difficult to invest without face-to-face meetings, without having lunch together, to really get to know people, especially at the seed stage,” said Shahar Tzafrir, managing partner of the VC investor TLV Partners, referring to the youngest startups.
That’s exactly what happened in China, where the startup sector has been hit hard by the lockdowns ordered by the authorities to fight the coronavirus. The Financial Times reported that the number of venture capital deals dropped 64% in January and February through the 24th of the month, compared with January-February last year. The amount of capital raised fell by two thirds.
In Israel, the industry is counting on a recent surge of capital-raising by local funds to help tide over the industry. In recent months, aMoon, Grove Venture, Aleph, 83North, TLV Partners, Angular Ventures and others have marshalled new money to invest in local startups.
According to IVC Research, which tracks the Israeli venture capital industry, in 2018-19, 55 Israeli VC funds raised a combined $4.7 billion. Israeli tech startups last year raised a record $8.3 billion in 522 deals.
Tzafrir said the real fear is the panic that has taken hold. “Venture capital is like a flock of sheep. Everyone is starting to think that all the others are starting to suffer hysteria and no longer investing, so they also stop investing in order to protect their existing [portfolio of] companies,” he explained.
“Most of the funds are going to take shelter without justification. This is a great time to keep investing. New funds don’t suffer the same worries about preserving their capital for [follow-on investing] in previous investments,” he said.
Tal Morgenstern from Lightspeed Venture Partners said the reaction to the coronavirus was overblown, but that’s to be expected in a market that is built on psychology.
“The [coronavirus] event is coming after an almost unprecedented 11-year rally in the private and public markets, in fundraising and exit amounts,” Morgenstern said. “It’s premature to say whether we’re talking about a correction that will continue for some time like in 2000-01, or a spot event and relatively fast correction like in 2008.”
He said is that the epidemic would likely to serve as a catalyst for trends that had already been beforehand – more working from home and more online shopping. Enterprise software startups will switch their marketing and sales focus to a more consumer-like strategy (as there are fewer industry conferences and the ability to travel to reach business customers will be constrained).
Startups will focus more on profitability and cash flow, rather than allow losses to grow as they seek to build revenues and market share. “As always, it’s great for companies that have enough cash to cope with the crisis, because it will clear away a lot of competitors,” Morgenstern said.