Startups Face Roadblocks Despite Record Fundraising

Survey finds that clauses favoring investors remain much more common in Israel than in Silicon Valley

FILE Photo: 'High-tech park' in Ra'anana, Israel.
Tomer Appelbaum

It’s a good time to be an Israeli startup entrepreneur. Israeli tech companies are raising record amounts of capital and investors are tripping over each other trying to put money into the most promising businesses.

Even so, Israeli startups still face stiffer terms from investors than their counterparts in Silicon Valley do, according to a survey released this week and conducted by the U.S. law firm Fenwick & West and Israel’s Shibolet & Co.

>> Read more: Debunking the 'Startup Nation' myth: How Israel's economy cut itself off from the world | Analysis 

The comparisons come in the form of an alphabet soup of obscure business terms that appear in fundraising contracts, many of which have disappeared from the U.S. fundraising scene in recent years but have remained in force in Israel.

The results of the survey, which encompassed all startups that raised $500,000 or more last year, show that even as Israeli startups often compete head-to-head with American companies, they are handicapped by more onerous fundraising conditions.

One is the Participation in Liquidation clause, which appeared in about 30% of all fundraising deals between investors and Israeli startups last year, according to the survey. This number is down from 60% of all deal in 2013 and 40% in 2016, but is still nearly three times the rate that it appears in Silicon Valley deals.

The clause, which is popularly known as “double dipping,” requires that when the startup is sold to another company, the investors gets their full investment back. The rest of the proceeds from the exit are then split according to all the shareholders’ equity stakes.

Another one – Cumulative Dividends/Interest Accruals – and appeared in 47% of Israeli fundraising deals last year, compared with just 5% of those in Silicon Valley. That percentage hasn’t changed in recent years.

This clause not only guarantees that the investors are repaid the amount they invested, but that they will get it with interest. The rate typically demanded of Israeli startups is a steep 6% to 8%, far higher than the investor could ever expect to get these days from a normal financial investment.

On the other hand, one positive development is a clause known as Senior Liquidation Preference – one that appears in more than half of Israeli fundraising deals, compared with just 24% of those in Silicon Valley. In 2017, the clause appeared in 73% of all contracts.

The clause grants preference in terms of allocating returns from an exit to newer investors over older ones. Lior Peled, a Shibolet partner and a co-author of the study said the decline in the number of Senior Liquidation Preference clauses is a vote of confidence in Israeli high-tech.

“In the past, new money was considered to be better and new investors sought protection, which reflected their fears that they might never see their money again,” said Peled. “The sharp decline in the use of this clause testifies to the increasingly optimistic investment environment.”

In fact, the survey documents the rosier environment for startups and their investors. Last year, 89% of all fundraising in Israel was done in so-called up rounds, where the fundraising company’s valuation was higher than in its previous round. The figure has stood at about 89% since 2015 and marks a big improvement over just half of all rounds in 2008-10.

The figures also testify to the growing maturity of the Israel startup sector: More companies are opting not to sell themselves but to keep raising money and remain independent. Moreover, they are raising less and less money in down rounds.

The Fenwick-Shibolet survey found that last year, only 6% were down rounds in D rounds or higher, and the figure was only 21% in E rounds or higher.

As Lior Aviram, who heads Shibolet’s high-tech practice, explained it, in the past, when a startup was raising money after its D round, it often signaled that it wasn’t yet good enough to seek an exit.

“That means these investments were often done at lower valuations,” he said. “Today there’s more capital available to fund growth, so we’re seeing later rounds in the tens of millions of dollars and companies are getting valuations that in the past were quite rare in Israel. They can now remain independent, grow and generate more revenue and jobs.”