For Israel’s Startup Nation, the clouds have been gathering on Wall Street for months. The Nasdaq Composite Index – home to the world’s tech giants and the barometer for the state of the industry – has fallen by more than a quarter since its historic high last November.
The storm hasn’t blown in yet, but industry figures remain nervous. In the first half of the year, new investment in Israeli startup companies plunged to $9.8 billion, down nearly 30 percent from its peak in the second half of 2021, according to Israel Venture Capital Research.
But everyone in the industry agrees that the final half of 2021 saw huge and unsustainable amounts of capital flooding into startups in Israel and around the world. There was bound to be a comedown, they say.
“What we don’t know is how things will develop in the global economy: is the United States going into a long recession? If it is, it could be the beginning of a real downturn for Israeli high-tech,” says Uri Gabai, CEO of Start-Up Nation Central’s Start-Up Nation Policy Institute. “It’s too early to call this a crisis. Hopefully, it won’t become one.”
The rest of Israel should hope as well. Israel has already felt in a small way the slowdown in global economic growth stemming from supply chain disruptions, the war in Ukraine, accelerating inflation and rising interest rates. The Bank of Israel said earlier this month that the Israeli economy would grow 5 percent this year – a healthy rate of expansion, but down from a previous forecast of 5.5 percent.
A global high-tech downturn – much less something like the burst dot-com bubble of 2000 – would hit Israel especially hard. Two decades ago, high-tech was a major driver of the economy; today, its role is much, much bigger.
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Technology accounted for 16 percent of Israel’s gross domestic product last year, up from 12 percent five years earlier, making it among the highest in the world. But that headline figure understates how important tech is to the Israeli economy.
High-tech accounts for just over half of Israel’s exports of goods and services. Tech workers comprise only 10 percent of the labor force, but because salaries are on average 2.2 times the national average, their contribution to consumer spending and government tax revenues is much greater.
A big slump in high-tech would reverberate across the economy: stores and restaurants would lose customers; real estate companies would be left with empty office towers; and the government would be short tens of billions of shekels in tax revenues – not only from lower tech employment, but the windfalls it gets from taxes collected on mergers and acquisitions deals.
To someone unfamiliar with the world of high-tech, it might seem that the ups and downs on Wall Street should have little impact on a team of startup entrepreneurs and engineers in Tel Aviv or Herzliya. But there is a direct connection that already played out in big terms – once after the 2000 tech bubble and again after the 2008 financial crisis.
Startups depend on a steady flow of capital to finance their research and development, and to bring their first products and services to the market. The last decade has been unusually favorable to them: Low interest rates not only fueled a booming stock market, raising the valuations of publicly traded companies, but forced investors to look for other places to put their money where they could get higher returns. Startups were one such place.
The result was rising valuations on Wall Street for tech giants like Apple and Amazon, which fed down to startups in Silicon Valley and Israel. Meantime, the coronavirus pandemic proved to be a boon for the tech industry by boosting demand for remote services.
In 2021, Israeli startups raised $26 billion, six times what they had raised five years earlier, according to IVC data. Unicorns – companies that are valued at more than $1 billion before they have gone public – were once as rare as their name implies. But Israel saw no fewer than 52 emerge as startup valuations skyrocketed in 2021.
Rising inflation, and the interest rate hikes being ordered by central banks around the world to combat it, have suddenly made the fundraising environment much less easy. But, industry figures note, Israeli startups still raised more money in the first half of this year than they ever had before (not counting the blowout year of 2021). IVC figures show that 20 new unicorns were born in the first half of 2022.
Beyond the flow of finance, things are also looking rocky for Israeli tech exports, which have also shown a moderate decline.
On the one hand, exports of technology services were down by close to 13 percent in the first four months of this year compared with the final four months of 2021, according to government figures. On the other hand, they were up by nearly 24 percent from the same time in 2021.
“People are talking about a 2008 scenario – a global financial meltdown and the world going into another recession where everything is affected,” says Gabai. “But there’s no sign right now that that’s where we’re headed. If this is a normal recession – and macroeconomists know there’s a recession every few years – Israeli companies will come out of it stronger.”
One way companies become stronger is by cutting expenses by laying off employees, which already seems to be happening based on the evidence of media headlines.
On Sunday, the Israel-based Soluto unit of U.S. company Asurion said it was shutting down and firing its 120 staff. Last week, U.S.-based Zencity said it was laying off 20 Israeli employees, D-Fend and Lusha each said they were letting go 30 workers, and Intuition Robotics gave notice to 20 staff.
Nevertheless, Eyal Solomon, CEO of the high-tech employment firm Ethosia, says he hasn’t seen a huge wave of layoffs so far. Even if the numbers do rise, he notes, it will only help ease Israel’s chronic shortage of engineers and other key personnel. He doesn’t see tens of thousands of jobless engineers.
“We’ve had something like 20,000 positions that remain open from both before and after the financial crisis,” Solomon says. “The startups that are cutting back are those without any real business or value to offer investors. The market is getting healthier in economic terms. But we’re still seeing a shortage of talent and employees.”
Where there have been layoffs, they have occurred outside companies’ core research and development operations, he says. The employees getting pink-slipped are junior staff and recent hires, and underperformers. “What we’re seeing is something that is very natural after a bubble [in 2021] that was unreal and not sustainable.”
The Central Bureau of Statistics reported last week that job vacancies for software engineers were down 7 percent in April-June from the previous two months. The decline comes as vacancies all across the Israeli economy have come down a little after running at record highs, with tech vacancies leading the decline.
“If we compare it to 2021, [hiring] decisions are being taken more slowly. Companies are more cautious, they are moving slower than in the past – but they are hiring and they are fighting for talent,” Solomon says.
Due to the combination of a persistent labor shortage and rising inflation, wages in the tech sector will probably rise, he predicts.
“The year 2022 will end with around a 5 to 8 percent increase in terms of salaries for software engineers. I can say that around 3 or 4 percentage points of that will be due to inflation, not the market,” he says. “Engineers are still holding the best cards in salary negotiations. They see prices are going up, and naturally they’ll ask for higher salaries.”