Israel may have a new record low of startup companies, data recently obtained by Haaretz indicates. A chart made by the IVC Research Center has – seemingly – worrying data: The chart highlights the long-term and continued drop in the number of technological startups founded in Israel.
This trend is not new. It has been underway for six years. Until 2014, the peak for the high tech sector, the Israeli entrepreneurship arena was growing and expanding – in part thanks to the founding of cloud computing and advanced development tools – and reached its high of just over new 1,400 startups a year.
But since then, fewer and fewer startups have been born in Israel every year. The steepest drop, 18 percent, was seen from 2017 to 2018. The figures for 2020 are lower than the numbers for 2010. And all this is happening at a time when more money than ever is flowing into the industry, exits are at record levels and venture capital investments have reached a new peak of $10 billion.
Even though the trend is clear, no orderly and comprehensive research has been done to find the cause – and we are left for now with just a few hypotheses and one unsolved question. Here they are:
1. The venture capital community is taking fewer risks
The clearest theories as to the cause of the drop in the number of new startups are those that can be easily identified: and they are based mostly on structural changes in the venture capital investment community.
In recent years, enormous sums have flowed into the industry, in part because of almost zero interest rates. The money comes through venture capital funds, which are raising larger sums than in the past – but the money is also flowing directly to the startups through relatively “new” players in the industry, such as family offices, private equity firms, hedge funds and investment banks.
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The big money has changed the patterns of thinking and decision making in the venture capital industry, and has affected its view of risk management. The well-known rule is that the VC that provides the first funding takes a greater risk – because the entrepreneurs are only at the idea stage, without a product or even a business model.
Such an investment requires much more attention and input from the VC’s partners – so it is not possible to invest in too large a number of young companies, and their attractiveness is based on the fact that they provide their investors with a much larger share of the company in return for a relatively low investment.
Today, VC’s operate a bit differently. The companies stay private for a long time, the investors can enter later and reduce their risk, and even though in percentage terms the return is lower – the high valuations in recent years enable them to have a higher return in absolute terms on their investment over a shorter time.
2. The new path of innovation
Another line of thinking argues that in fact there is not really any deterioration in the spirit of entrepreneurship in Israel – the entrepreneurs have simply moved somewhere else.
Ronen Nir, a veteran investor and a general partner in Viola Ventures investment fund, says that in the past the rule of the international startup industry was that big corporations were too slow to develop innovation, unlike small and nimble startups, that it is possible – and even desirable – to buy out.
“This axiom has been broken,” Nir says without any doubt. “The large companies have undergone a cultural change, which allows small and fast teams to work for them too, and skip over the organizational bureaucracy. Add to this a lot of cash and an unlimited amount of data collected thanks to their products and services – and now we have a completely different picture.”
Employees who have the opportunity to experience entrepreneurship inside big companies with a reputation for innovation – such as Facebook, Google, Amazon and Microsoft – are given access to resources, workers and a huge group of users, compared to any alternative they could set up independently. In such a situation, it seems they have no real incentive to take the financial and psychological risk required for technological entrepreneurship.
3. Headhunting for the brains of multinational corporations.
Another leading hypothesis concerns the increasing competition for high tech workers, which stems mostly from the entry of the development centers of multinational corporations into Israel.
These development centers do not arrive in Israel with their own staff of foreign workers – but have to make do with the existing local supply.
Because the supply of engineers in Israel is limited, the demand is expressed mostly in “brain drain,” which raises salaries and leads people to postpone their path to entrepreneurship – at the very least.
An article published in March 2020 in the journal American Economic Review showed that the average age of the founders of a startup – that reaches the stage of high growth – at the founding is 42.
4. The illusion of success is shattered early
Dr. Shai Harel from Tel Aviv University recently started to examine another theory, according to which entrepreneurs today face a much greater abundance of feedback mechanisms, such as accelerators and entrepreneurship centers in academia and cities. Today, according to IVC, there are some 390 such centers scattered all over Israel.
“These programs allow entrepreneurs to go through a short process, during which they meet investors, consultants, lawyers and professionals from the technology innovation sector, and can evaluate quite well what is their chance of raising money and advancing their initiative,” said Harel.
“In the past, entrepreneurs did not enjoy such help, and it is possible that this is support for fewer startups that choose to incorporate. This is a positive reason, because it means that startups that reach the market have higher chances of success – and greater resources will be invested in them,” added Harel.
5. Is this a good thing – or not?
The debate over the falling numbers of new startups has been a major issue in the industry for a number of years, with a lot of speculation and it will take more time before it will be possible to reach conclusions. But a major question is whether this trend is something good or bad is already relevant – and has drawn a wide range of opinions.
Harel is worried about the situation, because the drop in numbers could well mean that in the future the engine pulling the Israeli economy will be much weaker.
“Fewer startups today means fewer successful companies in the future. We of course need to qualify this and say that we still don’t know if in order to create 20 large Israeli companies we need to start with 1,400 startups and aim for 1.5 percent success, or 750 startups and aim for 3 percent success,” he says.
Harel is also worried about the tendency of venture capital funds to invest less in inexperienced founders, something that he says will reduce the legitimacy of failure – which many entrepreneurs benefited from.
“The new entrepreneurs are those who failed or succeeded in a minor way – but when the day comes will become experienced entrepreneurs. We must not skip over them,” said Harel.
Nir adds that in the peak years of the number of new startups, 2014 and 2015, there were many inappropriate companies, and “natural selection” is a positive thing, he says.
Everything depends on the target we want the industry to aim for: “Is the target function the number of startups? The number of employees in the industry? The contribution to GDP?” he asks. “If we are talking about diversity and competition – then the answer is that the drop in the number of companies is a bad thing. But if we are talking about GDP – the answer is different.”
If we look at the data from the perspective of technological innovation, then it is not declining at all, but accelerating – even though the phenomenon of the fall in the number of new startups is global, says Nir.
“The coronavirus vaccine, the massive adoption of video calls as a means of communication, the rise in online commerce, the switch to digital payments – all these are occurring at a more rapid pace than ever. But the innovation is no longer solely the property of startups, it is the property of every organization that knows how to read the changing conditions in the market, to adapt its organizational culture accordingly, invest the necessary resources and take the appropriate risks,” said Nir.