“Dickens said ‘It was the best of times, it was the worst of times.’ We’re living in a complicated reality for Israeli high-tech,” said Jon Medved, who’s behind the crowdfunding platform OurCrowd, the biggest tech investor in Israel these days based on number of investments.
Like it has the rest of the Israeli economy, the coronavirus pandemic has hit Israel’s flagship industry, but not everyone has been hit equally.
On the one hand, the list of startups putting staff on unpaid leave is growing. Others are cutting salaries and even firing employees outright. On the other hand, there are companies like the ride-sharing startup Via that raised $400 million at a $2.25 billion valuation.
Israeli high-tech entered the coronavirus crisis armed with a lot of capital. The last half of 2019 saw funds like PICO Partners raise $80 million, 83North take in $300 million, Vintage Investment Partners round up $133 million and Aleph take in $200 million. Even as the pandemic was now in the news, TLV Partners raised $210 million and Grove Ventures $120 million. Last month, Pitango pulled in $250 million.
“A lot of venture capital funds have money, which was not the situation in 2008,” said Yossi Vinitski, who heads the high-tech business of Bank Hapoalim. He has better insight than many into the industry because the bank has invested in a “double-digit” number of VC funds.
“Last week I did a round of 27 meetings with different funds to get a handle on the situation. Their teams are pretty experienced and have gone through at least one crisis before – that of the 2008 [global financial crisis] and for some the dot.com crisis of 2000.”
Most of that new money was slated for new startups, but VC funds traditionally give priority to existing portfolio companies, a priority that has taken on new urgency amid the coronavirus lockdown. Legally it’s not so easy for the fund manager to move money from one to another, but as Avihai Michaeli, a long-time adviser to the industry, said it can be done.
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“You come to a meeting of the board and say, ‘Yes, the money was supposed to go to innovation, but if we’re going to save our existing investments we must make an allocation.’ The board will probably approve the change,” he explained.
The epidemic, meanwhile, has aroused the interest of so-called secondary funds, like Vintage, which buy out existing stakes of other VCs in startups. The pressure exerted by the lockdown is likely to prompt many VCs to look for positions they can divest, even if it means selling at a loss.
“It’s already happening,” said Michaeli. “Entrepreneurs are coming to me in search of a secondary to whom they can sell their shares. They need money for household expenses and realize that the horizon for cashing out is growing more distant.”
The money doesn’t have to come from inside Israel. According to research by IVC, a research house that tracks the local tech industry, on average only about a fifth of the VC invested in Israel startups comes from Israeli funds, and in the first quarter of this year only 8% did.
Money from America
The rest comes from overseas, mainly the United States. In that context, two American funds active in Israel recently announced major fundraisers – General Catalyst said it had raised $2.3 billion and Insight Partners no less than $9.5 billion.
Whether from Israel or from abroad, the funds will continue to invest in high-tech even in these troubled times, said Dan Shamgar of the Tel Aviv law firm Meitar.
“The DNA of a venture capital fund is new investments – it’s their life’s work. What is true is that they may say, ‘Let’s wait a little, look at the direction things are taking, there are whole industries undergoing change,’” he said.
Aya Peterburg, a partner in the fund S Capital, explained: “Crisis creates opportunities. Also the background noise disappears in a crisis. Those who are here for a visit leave. The entrepreneurs who are less strong opt to do other things and become employees. That helps eliminate a lot of the noise and opens a lot of opportunities for a VC investor, especially early stage, when the [startups’] teams are small and number only relevant people.”
As for the companies themselves, most of them can operate with their employees working from home, especially in the software segment. Most companies use cloud computing and staff are used to working on laptops and taking work home with them.
“I thought that because we’re staying at home we wouldn’t be working that hard because of the constraints from being at home,” said OurCrowd’s Medved. “But it was the complete opposite – work was going well and even taking away from private life. At night I would work till 3 A.M.”
The problem is that working at home creates the illusion of business as usual. The reality is that there are a lot of things that are difficult to do from home, one of them connected with marketing. Conferences and conventions, one of the main ways tech companies do their selling, have all been canceled. In addition, most contracts are sealed in face-to-face meetings.
Another function that’s been disrupted is installations. Many startups need to come to the customer’s premises to put their software or hardware into place and help the running-in process. Another problem is raising capital: Few investors will sign off on an investment without meeting the startup’s team in person.
There have been occasional reports of startups raising money in the midst of the pandemic, but Shamgar said that is not indicative of the real situation.
“Most of the deals you see [in the media] were already in the pipeline. They are at the implementation stage and close to completion, so in most cases they were simply winding up the last details,” he said. “It’s simply regarded as unethical in the industry to back out on a deal underway.
“As to new deals, it’s pretty clear there’s a slowdown. That’s coming from both sides, by the way: Investors are more cautious and companies don’t want to conduct negotiations right now because their valuations are lower,” Shamgar said.
Data from IVC show that the pace of deals has slowed. In January this year there were 35 investments by VC funds; in March the number had more than halved to 17.
In a survey of 286 entrepreneurs and 114 VC investors from around the world, the U.S. market research firm NFX found that the coronavirus pandemic had caused 51% of companies to cut overhead, 39% to reduce marketing, 38% to impose a hiring freeze, 23% to cut pay; and 18% to lay off workers.
If those results apply to Israel as well, a large number of tech workers will be losing their jobs, including many of those who have been put as of now on unpaid leave.
However, the Israeli industry pre-crisis was desperately short of manpower – by some accounts some 18,500 workers short – so it is reasonable to assume there won’t be widespread unemployment. Jobs will be available at other startups or at one of the more than 300 multinational research and development centers in Israel.
Not all startups are feeling the same effect of the pandemic. Those in the sectors knocked lowest by the lockdowns, namely tourism and aviation, have fared the worst. Real estate, it seems, is also a casualty, as is auto-tech and logistics as supply chains have ground to a halt.
Those engaged in tech-related delivery or remote services (for instance, the U.S. company Zoom) are thriving, as are cybersecurity companies riding a surge of hacking attacks. Some of these companies have even reported a rise in demand for their products and services.
But the sector most likely to succeed is tele-medicine and digital health. Even after the pandemic has crested, the memory of its impact will continue and not only give a boost to existing startups but encourage a host of new ones.
Across all sectors, there is the understanding that the pandemic will bring about change. The NFX survey found that no less than 84% of surveyed companies said they expected to undertake changes in their products, in many cases fundamental ones.
“If you want to stay relevant, you have to have an angle,” said Medved. In that respect, Israelis have an edge in their proven ability to adapt quickly to change – not just altering their product but even repositioning the whole company.
Another variable discussed in not what sector a company is in but at what stage of its evolution. So-called growth companies are seen by many to be vulnerable because they are burning cash and sales will be harder to come by for the foreseeable future. That’s what the NFX survey showed: Startups that have raised their first round of capital raising were more likely (32.5%) to be laying off staff than those before (24%).
At the Israeli office of the accounting firm Baker Tilly, they take the opposite view. “In Israel there are more strong and established startups. Mature companies are a winning horse for investors and their odds of surviving a crisis greater, compared to small startups,” it said in a recent note to investors.
First-quarter figures from IVC bear that out: Seed-stage startups completed only four fundraising deals in February and March, down from 17 in January. On the other hand, big investment deals flourished: There were 11 of more than $50 million, six of them for more than $100 million.
The final question lies with the United States. With its struggling healthcare system and mercurial president, the American economy may take longer to recover than others. Since the U.S. is the major source of Israeli tech capital and the industry’s main (and sometimes only) market, this could have a direct impact on Israel. America is also the source of most mergers and acquisitions deals.
The NFX survey found that 39% of respondents didn’t believe the U.S. would return to normal economic activity before April 2021 and 12% thought it wouldn’t happen until after April 2022. Peterburg of S Capital is among those who are pessimistic.
“In 2008, it took the markets two-and-a-half years to recover. Right now we’re at the peak of the crisis and it will take time to develop a vaccine and bring it to the clinical stage and then to commercial distribution. I think we won’t return to normal air travel for another year and a half and even then our exit from the crisis will be gradual,” she said.
“I believe it will take three-and-a-half years until we exit the crisis completely,” she predicted. “And then we will be in a new reality.”