In war's aftermath, startup boom expected to pop in Israel

Upon the release of the Startup Nation Central annual report on the Israeli tech sector, The Media Line spoke to its CEO Avi Hasson, who shared his insights and lessons learned from 2023 and his expectations for 2024.

The Media Line: The report you just released states that Israel’s tech sector has remained robust despite the judicial reforms and the October 7 massacre. What were the findings and why do you think the tech sector’s private funding withstood the impact from politics and the war with Hamas?

Avi Hasson: We must remember that, besides the two Israel-specific shockwaves that you talked about, the most important factor for the health of the tech sector every year, and in 2023 as well, is the global macroeconomics. And 2023 was a rough year for tech companies and venture capital firms, not just in Israel, but everywhere else, obviously a continuation of the second half of 2022 as a reflection of the high interest rate and the economic downturn. That was the most important component of such.

Having said that, when we look at the overall funding numbers, we are in very similar numbers to 2019, just before COVID and everything else, with a high level of investment for Israeli startups. We estimate that almost $10 billion will be invested. I’m saying “will be” because part of the rounds are yet undisclosed, but we have our own methodology for estimating those numbers.

To take a broader look, let’s say in the past five or six years, we really see in Israel very similar trends to the US, Europe, or Asia, all leading global innovation tech hubs. We have seen a dramatic rise towards 2021 and then a sharp decline towards 2023. Israel went higher than all of these places and then lower than all of these places. But if we just take a baseline, we see that we have very similar trends to other places, which was surprising, because we’ve also had our share of local events that left their mark on the ecosystem.

The Media Line: How is Israel faring on a global scale? I mean, if you dive deeper into 2024, and what the outlook is?

Avi Hasson: If we try to compare 2023, I think maybe the main difference is that in Silicon Valley, as the leading innovation hub, we are already seeing in the past two quarters, definitely last quarter, Silicon Valley is coming, coming back to life, both in terms of new companies creation as well as in terms of level of investment, and we’re not seeing that in Israel yet.

Now, we have to say that historically we know that Israel tends to have a shift of a quarter or two after Silicon Valley. I can personally testify, for the last 25 years that has always been the trend. We also had our local issues to consider. But I think 2024 is going to be a relatively good year for Israeli investment. Let me just maybe give some examples of why I think that is the case.

One example is the very large amount of capital that is currently in the hands of Israeli venture capital firms, what we call dry powder. This is, these are funds that were raised during 2021 or the first half of 2022. Most if not all of them were very, very cautious during 2023, and really shied away from making new investments, both because of their uncertainty in their own funding cycle, and the desire to protect their own portfolio.

Maybe the last factor, which I think is going to change, was really the fact that a lot of the companies in Israel raised a lot of money in very high valuations during the party time and there was not sort of a meeting of the sellers and buyers with regards to the prices. So even good companies were still living in the 2021 valuations, whereas the investors were looking at a totally different world in terms of the price they were willing to pay.

I’ve been personally a venture capitalist for over a decade. You can say, “I’m not investing this year,” but you cannot continue saying that for more than 12 months. That’s the nature of the game. You have to deploy capital. That’s your profession. So I think funds are just going to go out there and make the investments.

I think, equally important, companies are going to realize mostly because they will have no choice, just running out of cash, that we’re living in a totally different world in terms of prices, and we’re going to see many more deals, maybe not done in favorable valuations from the eyes of the entrepreneurs, but certainly will infuse capital into the market.

To that, I would add one last item. I do expect the baby boom of startups after the war. I think this is an Israel-specific issue. The judicial reform, politics “balagan,” and the war, they all had a cooling effect on the formation of new companies. And I think hopefully the judicial is off the table, and again, assuming the war, we can talk about that, everything I’m saying is based on a scenario that we are not going now into a five-front war that will intensify and continue for the next 12 months. But I think after that, we are going to see a baby boom of new companies. I see a lot of innovators and innovation waiting on the sidelines.

The Media Line: Can you give an example please of some of the sideline startups?

Avi Hasson: Examples could be with regards to the sectors, but I think what I talked about was not necessarily about sectors. I think a lot of people, forget from October, that’s obvious, but even in June, were not in the mood to start a new company, which is really like having a new baby. You do that in times of optimism and so on. And I think, and I’m going to answer your question in a minute, but I think one of the good things that I’m seeing as a result of the war is that unlike the judicial legislation, which brought somewhat a spirit of despair, and I was starting to feel concerned about the talent that might leave, the spirit that we are seeing right now is exactly the opposite, is the spirit of determination: “We are staying put. We are fighting it out. We are rebuilding the country.” That is the most important fuel for an entrepreneur to start a new company.

Now if you ask me about specific sectors, not all of them are going to be impacted by the war, but some are. I’m expecting and seeing a lot of new ideas and technology in the health area, in rehabilitation, in mental health. Defense tech is starting to emerge as a sector by the way, not just in Israel, also in the US.

That’s something new. We are used to thinking about the large security contractors and manufacturers, the Raytheons or Rafaels, but I’m talking about startups. Cybersecurity is showing very strong resilience both throughout 2023 and I believe, also going into 2024. It’s one of the few sectors that remains attractive and relevant, even as we have moved from one innovation cycle to the other, the other being the AI. That is going to drive pretty much everything we are going to see next year. I think we’re going to see a lot of a lot of things around drones and sensors. Not just defense. Sometimes it could be vertical applications, from agriculture to logistics, but we’re seeing a lot of innovation around that and Israel has unique capabilities there.

The Media Line: Are there any positive outcomes that you expect to see in the tech sector coming from the war concerning the geopolitical front?

Avi Hasson: It is really hard to try to guess how things will play out from the geopolitical diplomatic front. At Startup Nation Central, we have been involved a lot in what we call innovation diplomacy. I’ve been actively collaborating on the innovation fronts with a lot of the countries you mentioned (UAE, Bahrain, Jordan, Saudi Arabia). A lot of that activity is now, I don’t want to say cooled off because the channels are open, and the motivation is there. They are equally interested in collaboration and Israeli innovation, but it’s hard to do things in the public nature that we did.

Funny enough, sometimes it’s easier to maintain the same level of activity, let’s say with the Saudis, simply because it was under the radar. Whereas with Bahrain things were extremely public, and now it’s much more difficult to do that, and yet the motivations are there. So I’m pretty certain that we’re going to see that activity going down. That’s on the geopolitical front.

I have talked about another positive element of the war with regard to the innovation that it ignites, and I gave, I think, examples in my previous answer. A third one, which I think is important is just because of the war, I think if we take both the political instability and the high-tech protest and war, we’ve seen a change in the level of activism and mobilization, involvement, and interest of the high-tech leaders in broader national and social agendas. I think that’s going to remain after the war, and I think that’s extremely positive both from a country’s perspective and also from the high-tech perspective. I think that high-tech understood, not necessarily through great circumstances, how much it is for them to be involved in more than just their own micro business.

The Media Line: You mentioned Bahrain and you used the words “going down.” Can you elaborate?

Avi Hasson: I think the same would go for Morocco or the Emirates. It was just an example of a country where we had a lot going on, and it’s harder to do a lot of things right now. It did not stop in the sense that the channels of communication are still open and discussions are taking place, but the level of activity went down and the public nature of that activity extremely went down.

We tend to group those countries as one, which of course is wrong to do. Each of them is very different in its composition of population, in the social contract between the regime and industry, in the role of the media, and so on. You need to analyze them one by one if you want to understand the challenges. But if I try to keep it general, I will that a lot of the things that were done very loudly and publicly are harder to do right now.

I am optimistic, not necessarily in the short term, but I’m optimistic in the long term because I’ve personally been involved in dozens of hours of discussion with people from those countries analyzing the motivations for signing the Abraham Accords and increasing the collaboration on all fronts between our countries. That didn’t go away, and it’s going to stay relevant. It will wait for the right time to go back to the level of activities that we witnessed before October 7.

The Media Line: You said that private funding declined from the 2021 peak, reaching 7.9 billion to date. What is the current investment sentiment for 2024?

Avi Hasson: From our survey, and also we talk to the ecosystem all the time, I think there is a mixed picture. On the one hand, it is quite optimistic with regard to the capabilities of the local ecosystem. I’m reminding you that since there is a lot of dry powder in the pockets of Israeli investors, which I think will have to be deployed next year, that gives you a good robustness kind of metric. But I’m hearing interestingly enough, this is anecdotal, I cannot share the names, but I’m talking about multiple foreign investors, who told me something that might sound surprising. They said, “In 2021, we stopped investing in Israel, because the prices were so high, and the place was so crowded, that it just didn’t make sense. Right now, what we are seeing in Israel makes it much more interesting for us, both in terms of the type of innovation and the valuations in the marketplace.”

It is kind of counterintuitive. You would expect investors to shy away and I’m sure some will, some will at least wait to see how these things play out, but we’re hearing from multiple investors, saying, “We think now is the time to come to Israel, because the type of innovation combined with the price level, makes it extremely attractive for us to participate in it now.”

That is why I think the key for me is, and always has been, the human capital. I’m sure that if we spoke around the judicial legislation, I told you, that’s my biggest concern. That’s the biggest asset, and people acknowledge that the international community, both multinational companies and investors, appreciate the talent that exists in Israel, both from a technical level, technological level as well, and from an entrepreneurial level.

I always give the example of the Russia-Ukraine war. CEOs’ first concern was how to take the teams outside of Ukraine, and in Israel, 300,000 Israelis were hopping on a plane and coming to Israel during the war. Very different dynamics. You see a lot of, “We have a responsibility to rebuild the country,” and so on.

The only thing I would say, I think, is a key component, is the government or the public sector’s activities, because I’m a true believer and not just because I was the chief scientist of Israel, that the government played an important role in building this ecosystem, mostly by sending a very clear signal to the international investors and multinational companies that there is a deep public-private partnership and that high-tech is strategic and important to Israel. I think that’s a very important message to keep sending across the international community that was somewhat lost, throughout the judicial legislation.

The Media Line: Avi, Israel has many sectors that sort of fall under the category of tech. Israel is known as the startup nation and your organization is the Startup Nation Central. The bottom line is, if you looked at the different categories, AI, cybersecurity, defense, and others such as health care, climate tech, and agritech, what is the one that you would bank the most on in terms of investments in the coming year?

Avi Hasson: I think cybersecurity has shown amazing resilience both in 2023 and I expect it to continue going back into 2024. I just think that Israel really acquired a well-deserved leadership position in that sector. If you’re investing in cybersecurity, if you’re looking to acquire cybersecurity companies, if you want to set up a cybersecurity center of excellence as a large company, you have to come to Israel. And I think that’s going to stay.

The second reason for that resilience is the fact that cybersecurity, unlike other sectors, which may become less relevant as they mature, certainly from a startup perspective, cybersecurity remains super important also, as we go into the AI age. We can all imagine that in an AI-driven world, there are frightening threats. I think cybersecurity will continue to evolve. Cybersecurity is an entire universe, it has a lot of sub-sectors.

I think that’s one which is super strong and is going to stay high in health. Let’s remember, that there are almost three times more health tech startups than cybersecurity startups in Israel. Obviously, they are much smaller, and most of them are young companies. Most of them are still in their clinical trial, or product development state. But I think that’s also something that is going to remain strong, both in terms of company creation, development, and funding.

I think, and I talked about that earlier, that we’re going to see some sub-sectors within health becoming interesting because of the war. And there is amazing innovation happening in the battlefield and in the hospitals as we speak. I also sit on the board of Sheba Medical Center, and I know for a fact that things have been applied definitely for the first time in Israel, many times for the first time in the world, both on the battlefield and also in the hospitals or rehabilitation. Unfortunately, so many new rehabilitation words have been set up almost overnight.

I think, just in general, most of the trends are going to reflect the global trends. So really, if you want to look into what’s going to happen in Israel in certain sectors, you have to look into what’s happening in the world. A notable example is fintech. Fintech, in which Israel is very strong, went down globally significantly in the past year, and also in Israel. I don’t want to say 100% but almost the majority of the reason for the further decline in Israel was just a decline in the world, which again, was driven by the high interest rate, the demise of crypto, and so on.

The Media Line: Where is most of the investment in Israel coming from, local or foreign, and can you please break that down?

Avi Hasson: Traditionally, and that has not changed, the vast majority of investment in Israeli technology companies is foreign capital. And that is directly from foreign investment vehicles. You can see in our report the exact composition of rounds where there are only foreign investors or there’s a co-investment of foreign and local investors or only local investment. You will see that the share of foreign investors has gone up and not down. And if you add to that, where do venture capitalists raise their money, you get to the point where understanding that 95% of the capital funding Israeli startups is foreign. It is a very strong positive representing the attractiveness of Israeli innovation to the global investment community.

I also think that it’s from a national perspective. It’s not balanced. I’ve been saying that for 16 years, I would love to see Israeli institutional investors taking a bigger part within that investment in Israeli high tech, not just startups.

The Media Line: Avi, before we let you go, what was the most interesting thing in terms of the report that you as chief scientist of Israel and now of course CEO of Startup Nation Central, what surprised you the most?

Avi Hasson: I just want to say that it’s hard to be surprised when you are part of the ecosystem. I mean, all year long, we monitor the data every day, and we talk to the ecosystem every day. So, we have a good feeling about what’s happening.

But if I need to go back and look at it from a broader perspective, I will say, I think the resilience of the sector in 2023 has been remarkable. I look at both the numbers and sentiment, and they are quite very powerful. I think Israel is very stable, on a quarter-by-quarter basis, if you look at it, very stable.

It’s always dangerous to give forecasts about whether we have reached the bottom or not, but to me, it looks like this is sort of a baseline that we can grow from. Then I think also seeing the survey results was somewhat surprising to the positive. To see the optimism with regard to the resilience, the multinational companies’ support, and not only the public support. I’m not talking about Patrick Gelsinger, CEO of Intel, who has very strong support for Israel, but just hearing from the people that they are either going to maintain or expand their activities in Israel, to me that was a big positive because I see them as an important component of the Israeli ecosystem.

So I felt all along a good picture. If you’re looking for some warning signs, then I would choose one which we highlighted also last year. It’s not new to this year, but it remains an issue: new company creation, the formation of new companies. We just need more new companies because it’s a funnel. If we want to have the 10 next unicorns, we need to have 500 companies.