In recent years, there has been an alarming decline in the number of new start-ups and in the amount of funding rounds by seed-stage start-ups. The Israel Innovation Authority analyzes the causes of this decline and is taking action to reverse the trend and to relaunch Israeli entrepreneurship

Israeli high-tech entrepreneurship continues to stand out globally, with the highest number of start-ups per capita¹2019 Startup Genome Report and a third place global ranking in venture capital investments.²Global Innovation Index 2019 In 2019, Israeli high-tech companies raised an all-time high in capital, reaching a total of roughly 9 billion dollars, a 15% increase since 2018.³IVC data processed by the Israel Innovation Authority In the past decade, exit value grew eightfold, from 2.6 billion dollars in 2010 to 21.7 billion dollars in 2019.⁴IVC Exits Report

Israel excels in entrepreneurship and in launching new ventures. Israeli entrepreneurs have shown remarkable ability in identifying technology trends at the forefront of global innovation before the new fields become overly competitive and crowded, and that ability is an essential asset for Israeli industry.

Yet despite the sustained success of Israeli entrepreneurs, an analysis performed by the Israel Innovation Authority found some troubling trends. In recent years, the number of seed-stage funding rounds for start-ups dropped and the amount of new start-ups established declined, so much so that in 2019, the number of new start-ups launched was the lowest seen in a decade. The Israel Innovation Authority believes that these worrying trends are a call for action.

Decline in the Number of Start-Up Companies

Analysis conducted by the Israel Innovation Authority indicates that recent years have shown a decline in the number of start-ups added to the Israeli innovation ecosystem. Figure 4.1 demonstrates that from 2012 to 2017, 1,000 new start-ups were established per year, with a net of 500 companies added to the high-tech industry per year (the sum of new start-ups after deducting those that closed). However, since 2015, there has been a decline in the number of new start-ups, with 800 new start-ups registered in Israel in 2019, a net addition of just 360 companies – the lowest number seen in a decade.

Source: IVC data processed by the Israel Innovation Authority

The reduction in today’s new companies is not merely a problem of quantity. The decline in the number of new companies also means a decline in the diverse technologies and new fields of innovation developed by Israeli high-tech. This drop could hinder Israeli high-tech’s dynamism and flexibility, as well as its ability to continue to maintain its position as a world leader in up and coming technology trends.

Knowledge Transfer from Academia to Start- Ups Increases – Slightly

Academia plays a key role in the creation of innovative knowledge and groundbreaking ideas, and in developing concepts to the point they can be used to establish start-up companies. Consequently, mechanisms that support the transfer of knowledge and collaborations between academia and industry play a crucial role in the creation of new start-ups. In recent years, there has been a moderate uptick in the number of license agreements signed by research institutions with Israeli companies, and in the number of start-ups established by the institutions’ knowledge commercialization companies.

The Authority believes that despite the moderate increase, academia’s contribution to innovation has huge untapped potential, and that the number of companies and license agreements that originate from research institutes can and should be substantially higher. The Council of Higher Education’s Planning and Budgeting Committee (Vatat) and the Israel Innovation Authority, in collaboration with the Ministry of Finance, are working together on a proposal aimed at increasing the transfer of knowledge from research to marketable products.

Source: Data from the Central Bureau of Statistics’ Survey of Knowledge Commercialization, 2018, processed by the Israel Innovation Authority. The data includes the activity of all knowledge commercialization companies in Israel – universities, colleges, research institutes, and hospitals

Declining Investments in the Early Stages of Start-Up Companies

The Israel Innovation Authority’s analysis of the Israeli high-tech industry shows an alarming a decline in funding rounds and in the total amount of capital raised by seed-stage start-ups.

As indicated in Figure 4.3, the total investment in seed-stage companies has remained constant in recent years, with a decline in 2019. At the same time, there was a gradual decline in the number of funding stages of seed-stage start-ups, dropping from roughly 570 funding rounds in 2015 to 410 in 2019.

Source: IVC data processed by the Israel Innovation Authority

Reasons for Deceleration in the Early Stages of Start-Up Companies

In order to discern the reason for the slowdown in the creation and investment in new start- ups, the Israel Innovation Authority analyzed a variety of sources, including roundtable sessions with investors and a survey of 270 Israeli angel investors, and discovered several potential causes for the decline:

• Maturation of the Israeli ecosystem } More attractive investment alternatives
• Global technology and funding trends } More attractive investment alternatives
• Fewer active early investors
• An overall shortage of groundbreaking research, along with large companies performing more innovation in-house (instead of acquiring start-ups).

Maturation of the Israeli Ecosystem

One of the primary reasons for the decline in the number of seed-stage companies with access to capital is that Israel’s innovation ecosystem has matured significantly in the past few years. The growth of the ecosystem has two effects of the opening of new ventures:

• Quality, not quantity: One widely held belief is that Israeli seed-stage investors and entrepreneurs, 20% of whom are serial entrepreneurs,5 are currently capable of better identifying the more successful, high-quality companies, essentially separating the wheat from the chaff. Their accumulated experience enables higher precision in selecting quality investments and in avoiding the opening of a large number of low-quality start- ups and investing in them.
• Sufficient deal flow of growth-stage companies: The increasing number of growth- stage companies in Israel offers investors a broad selection of investment opportunities. Investors usually prefer to invest in more mature companies. While the amount needed to invest in these companies is higher, the risk level is generally lower and the payback period is shorter.

While the first claim, of quality replacing quantity, points to a positive trend and a more efficient allocation of resources, the second claim, diverting investments to growth-stage companies, is not as beneficial for the Israeli innovation ecosystem, as it shows that are less resources available for seed-stage start-ups.

Figure 4.4 also shows that more and more investments are being diverted from seed companies to growth-stage companies. The amount of investments in Israeli start-ups valued at up to five million dollars has decreased both absolutely (from 853 million dollars in 2018 to 509 million dollars in 2019) and as a percentage of total investments in Israeli start-ups (from 11% to 6%, respectively).

Source: IVC data processed by the Israel Innovation Authority

Global Technology and Funding Trends

Notable trends in Israeli seed-stage companies are also evident in the US ecosystem and in other places around the world. The lower number of fundraising rounds, the higher median amount of the funding round, and the longer it takes, on average, for a company to reach initial funding,⁵Venture Pulse, Q3 2019 KPMG can all be seen in global markets, along with Israel.

Figure 4.5 demonstrates that in 2009-2015, the number of funding rounds conducted by Israeli seed-stage companies grew at an average rate of 15% per year, which is similar to the growth rate of several start-ups that raised initial funding in the US. In 2015-2018, there was a decline in the number of funding rounds in Israel at an average rate of 4% per year, while in the US there was an even more rapid decline averaging 9% per year.

Source: PitchBook and IVC data processed by the Israel Innovation Authority

Other trends observed both in Israel and the US are growth in the median sum raised in seed rounds and an increase in the age of the company at the time of the round. In 2014, the median sum of a seed-stage funding round in Israel was 750,000 dollars and 700,000 dollars in the US, while in 2019, the median sum raised in seed rounds was 2 million dollars in Israel⁶SNC data and 2.2 million dollars in the US.⁷Venture Pulse, Q3 2019 KPMG Furthermore, as demonstrated in Figure 4.6, companies took longer to begin to raise seed funding, with the average time between a company’s founding and its seed round growing from 10 months in 2014 to 29 months in 2019.⁸SNC and IVC data processed by the Israel Innovation Authority This trend was evident in the US, where the average age of companies raising seed capital increased from 29 months in 2017 to 36 months in 2018.⁹PitchBook data processed by the Israel Innovation Authority

Source: SNC data processed by the Israel Innovation Authority

There are several possible explanations for these global phenomena. One explanation for the decline in the number of funding rounds is that today, investors have a range of attractive investment alternatives at more advanced stages in the private market, or even in the capital market. For example, in 2019, Nasdaq 100 saw gains of roughly 38%.¹⁰Nasdaq 2019 Review

The decline is also the result of a global trend of giant tech companies (such as Google, Facebook, Apple, Amazon and Microsoft) shifting to intensive in-house innovation, and creating new ventures within organizations instead of acquiring or establishing new start-ups.

The higher amounts raised in the seed rounds¹¹In 2014, the global median amount of a seed funding round was 500 thousand dollars while in 2019, the global median amount of a seed funding round was 1.9 million dollars stems from the fact that the global low- interest rate environment increased the supply of capital available for private investors, allowing entrepreneurs in initial stages to find private, “under the radar” funding solutions. As such, their need for a public seed-raising round was postponed to a later stage in the maturation of the company, when the sums required are greater and the risk level is lower.

An additional explanation is the revolution of cloud computing, which makes the world even more global, and the ever-growing geographic distribution of accelerators and hubs for fledgling entrepreneurs. The combination of cloud computing and easy access to early guidance led to a substantial decline in the ongoing costs of start-ups in their early stages (especially in software). Cutting early stage costs allows some fledgling entrepreneurs to reach more advanced stage in the maturation of the company using only personal capital.

The Israel Innovation Authority believes that despite the low-interest rate environment and the lower costs stemming from cloud computing and accelerators, the decline in seed-stage funding sources and the increase in the amount of time it takes, on average, to raise seed funding, indicate that for a growing number of quality seed- stage ventures, it is harder than it was in the past to raise investments and to reach funding milestones.

Decline in Available Funding and in the Number of Seed-Stage Investors

There is a discernible decline in the number of seed-stage investors in Israeli high-tech. This translates into fewer smart money opportunities for seed-stage companies – investors who provide experience, connections, and management guidance along with capital.

The Authority’s analysis indicates than while in 2014-2017, the number of seed-stage investors remained steady at approximately 675, in 2018 and 2019, this number dropped by 17% to roughly 560. Among the various types of investors, the largest apparent decline is in angel investors. Figure 4.7 describes the involvement of various types of investors in seed-rounds and shows that the percent of angel investors dropped 19%, from roughly 400 angel investors in 2014 to 230 in 2019.

Source: IVC data 20 processed by the Israel Innovation Authority

Angel investors play a key role in the growth of new companies during their seed stages. These investors, many of whom were once entrepreneurs themselves, bring important business and management experience to the fledgling start-ups. Moreover, these investors usually focus on investing in start-ups at the earliest stages of their life-cycle, when the risk is high but investment amounts are lower. The investments and experience that these investors bring can help companies reach a significant milestone in their R&D, enabling them to raise larger sums of capital from additional investors.¹²Diamanto Politis, “Business Angels as Smart Investors: A Systematic Review of Evidence”. Handbook of Research on Business Angels, page 147

Figure 4.8 presents the results of a survey performed by the Israel Innovation Authority of 275 Israeli angel investors. It indicates that the large majority of angel-investors invest up to one million dollars, and that 65% of them invest up to 500,000 dollars. Although these are lower sums in comparison to advanced rounds, however, in early stages, even small investments are the oxygen that allows young companies to grow.

Because of the decline in investments by Israeli angel investors (Figure 4.7), new start- ups, which require relatively low sums of money (up to one million dollars) in order to reach a milestone to facilitate the raising of larger sums of money, currently have fewer smart money funding sources at their disposal in a critical stage.

Figure 4.8 also demonstrates the distribution of angel investors’ responses to the question: “Do you think that in recent years, it has been difficult for pre-seed and seed-stage start- ups to raise funds?” Responses show that the angels’ views on this are divided. Half of the respondents described recent circumstances as difficult, whereas the other half expressed that there is no such difficulty.

This discrepancy of views on a general lack of seed-stage funding was also articulated in interviews and roundtable sessions that the Authority held with various investors and entrepreneurs in seed stages, yet there was consensus that there is currently less smart money and fewer angel investors available in Israel.¹³Roundtable sessions were conducted in October 2019

Source: Israel Innovation Authority survey data

Human Capital

As covered extensively in earlier Israel Innovation Authority reports, there is fierce competition for skilled professionals in the Israeli high-tech industry. According to a survey conducted by the Central Bureau of Statistics,¹⁴Central Bureau of Statistics, “Employees, available positions, and the ratio between supply and demand” classified by occupation (2011 classification) in select groups, 9.33 Israeli high-tech is in need of an additional 12,500 tech professionals. A survey conducted by the Startup Nation Central (SNC) and the Israel Innovation Authority estimates this number to be even higher, reaching approximately 18,500.¹⁵Human Capital Survey Report 2019, Israel Innovation Authority and Start-Up Nation Central, work version

The growing number of multinational high-tech companies operating in Israel has also increased the demand for highly skilled and talented workers, which in turn has increased their pay. For example, in 2017, multinational companies offered an average annual salary of 500,000 shekels, in comparison to an average annual salary in start-ups of up to 336,000 shekels.¹⁶CBS, “R&D Activity in Startups and Multinational R&D Centers”, 2017

The fierce competition for skilled professionals and the abundant supply of attractive, high-paying positions in growth companies and in multinational companies operating in Israel make it difficult for fledgling entrepreneurs to recruit the core team they need to establish a new start-up.

Israel Innovation Authority’s Support of Seed- Stage Companies

The Israel Innovation Authority believes that the decrease in the establishment of new start-ups in Israel (dropping to the lowest rate seen in a decade), alongside a concurrent decline in the volume of seed-stage investments, are worrying phenomena that require a response. Israeli entrepreneurship, and especially the establishment and growth of new start-ups, is essential to the preservation of a dynamic, advanced ecosystem of innovation and for its lasting prosperity.

In an effort to support Israeli entrepreneurship and the establishment and growth of innovative, groundbreaking companies, the Authority operates in a myriad of ways to remove the obstacles standing in the way of these companies and to help them raise the capital that they need. The Authority believes that these efforts should be expanded and accelerated in order to “relaunch” Israeli entrepreneurship.

The primary method employed by the Authority to help new start-ups raise the capital they need in seed stages is by providing grants for R&D projects. As delineated in the second chapter of this report, the Authority focuses on fields with a market failure in regards to available capital – innovative, less prominent fields that usually carry high risk and offer long-term returns, and thus are less likely to attract private capital. Notable examples of these include:

• Seed-stage companies led by first-time entrepreneurs, especially founders from sectors underrepresented in high-tech (such as women, ultra-orthodox Jews and minorities).
• Seed-stage companies with high-risk tech solutions and long development times before reaching market, such as companies in silicone, clean-tech, pharma or agriculture sectors.

In addition to providing grants for R&D funding, the Authority aids in the formation of new start-ups by establishing innovation labs and incubators, which provide tech infrastructure and auxiliary knowledge. For more information on these and other tools, see chapter 7 on the Start-Up Sub-Market.

Furthermore, the Israel Innovation Authority is also working with the Ministry of Finance and the Tax Authority to look into ways to diversify sources of smart money, such as exploring ways to amend and improve the Angels’ Law.¹⁷The Angels’ Law refers to Section 20 of the 2011-2012 Economic Policy Law (legislation provisions), which legislates tax incentives in order to encourage private investment in seed-stage start-ups

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Alan Feld / Managing Partner, Vintage Investment Partners¹⁸Vintage Investment Partners is an Israeli venture capital fund that invests in venture capital funds (a fund of funds), in secondary funds, and in advanced-stage growth companies. The fund manages roughly 1.8 billion dollars, and follows over 500 venture capital funds and roughly 6,000 private high-tech companies

“I am not troubled by the number of startups created; this number increases and decreases continually. What makes me optimistic is that the quality of the entrepreneurs keeps improving, which to me is the most important point. Having said that, most of the companies being created lately seem to be focused on three areas: Cyber Security, Cloud Infrastructure and FinTech. Going forward, I think it will be very important to see far more startups created in other important areas in which Israel has an advantage, such as AgTech, Foodtech, Digital Health, Semiconductors and even selected areas in Energy and Water. As a country, we cannot have our eggs in too few baskets.

“Israeli companies tend do a great job when there is a complex, multi-disciplinary technology challenge. Examples of this are computational biology, where advanced hardware, data science and biology meet. Remote patient care is another example, taking advantage of Israel’s skills in sensor and communications technologies.”

“I see the Innovation Authority as a bridge between innovative academic research and the creation of new companies and industries emerging from this research. The Authority helps to reduce the financial risk of investments in the emerging sectors I noted previously, serving as a catalyst for the success and growth of sectors.”