The Israeli tech eco-system ponders a slowdown in startup creation
Gil Dibner

Despite the recent market downturn, the Israeli tech ecosystem continues to bask in the glory of 2021. Big rounds seem to be happening every day, unicorns are born seemingly every week, and even big exits (like Siemplify, Epsagon, and Granulate) continue to take place with a comforting frequency. The Israeli tech ecosystem — like the European tech ecosystem — has never known a better time than right now.

Cause for concern? Under the surface, however, data is emerging that is causing concern and hand-wringing among some: the rate of new company formation in Israel seems to have dropped precipitously in recent years. According to new detailed data published jointly by the Startup Nation Policy Institute and the Israel Innovation Authority, the number of new startups formed in the country dropped from well over 1000 per year in 2014–2016 to under 600 in 2020. The report, which is worth a glance, was published in Hebrew, but is readily Google-translatable.

Why is this happening? The authors put forward three theses that could explain this dramatic drop-off: (1) fewer startups are being created, but they are of higher quality; (2) a change in the mix of sectors is affecting the rate of startup creation; or (3) competition for talent and resources is making it harder to start companies.

Shifting sectors. The report provides some strong evidence for the second thesis, finding that a decline in the number of “social media and advertising” startups accounts for 70% of the decline in new startup formation. As someone who has participated in the Israeli startup scene since 2003, this observation fits neatly with what I’ve observed on the ground. Between 2000 and 2015, Israeli startup activity was dominated by three sectors: security, semiconductors, and adtech/media. Of these, only the first continues to see high levels of activity. For a time, Israel was a globally dominant player in both the semiconductor and advertising/media industries — but no amount of local expertise can counterbalance an industry that is in structural decline. As we witness the continued explosion of activity in “AI” and “SaaS” it is worth pausing to remember that no sector stays strong forever…

Templatization is raising the bar. To my mind, the report doesn’t provide compelling evidence for or against the other two theses. Empirically, however, I am convinced they are both contributing to the decline in new company formation that we are seeing. In recent years, the startup journey has become industrialized. Enthusiastic venture money has powered ever larger “seed” rounds, and founders have become adept at leveraging both their networks and online resources to construct businesses that are fundable. While this industrialization (or templatization) of the early-stage startup journey has made it easier for many quality teams to raise capital, it has also clarified the delta between the “haves” and the “have nots.” In the 2000s, when I started in the Israeli VC industry, we’d see a lot of “hail Mary” business plans and decks — companies that, for a variety of reasons, really had no realistic chance to raise capital. Today, we see far fewer of those. My hypothesis is that as the market matures and it becomes clearer to more people “what it takes” to build a startup, more and more people are self-selecting out of the process before they even get started. Overall, this is probably a healthy thing for the ecosystem — and the effect has been a dramatic rise in the average quality of the business plans we are encountering.

The war for talent. No startup in Israel can find anyone to hire. The local tech economy in Israel is probably at over 100% employment (if such a thing is economically possible). Salaries at both well-funded startups and at tech giants with local offices are high. Tel Aviv’s fancy restaurants are full, and the occasional sports car sometimes passes by (still a bit of a shocking occurrence in this land of mandatory military service and Kibbutzim). I’ve always believed that lack of lucrative local career options in Israel was always a driver of entrepreneurial activity — and I think that this has begun to change. Israeli software engineers do not need to found a company in order to have a chance at economic independence, owning a home, or having a rewarding international career. This development has, I think, both fundamentally changed the nature of Israeli society and driven up the average quality of startups that get formed. Today, most Israelis face far greater opportunity costs to choosing an entrepreneurial path than ever before. That’s a good sign for the local economy, and a good filter for committed mission-driven founders.

Quality over quantity. While it’s true that fewer startups are being formed in the Startup Nation, it’s not entirely clear why this is the case. From my vantage point — which is typically meeting a killer founding team over coffee in Tel Aviv — the Israeli tech eco-system has never been stronger despite the reduced rate of startup formation. I suspect that the market slowdown we are witnessing right now will — in the short term — drive company formation rates lower still (both in Europe and in Israel). Over time, however, the rate of new startup formation will probably remain roughly where it is today: around 500–700 per year. Ultimately, it is the quality of those startups that matters — and on that front I remain extremely bullish about what we are seeing in the Israeli market.

If you are one of those 500–700 teams in Israel that has decided to start something new this year — please reach out. And if anyone has seen a similar study of startup formation rates across Europe (or in other, specific, European countries) please let me know!

Gil

EVENTS

Apr 28 / Funding your Growth with Venture Capital
David Peterson, Partner, Angular Ventures

Jun 1 / The Importance of Culture and Values As You Scale a Business
Oren Kaniel, Co-Founder & CEO, AppsFlyer

FROM THE BLOG

Success Can be About Less Than You Think
Don’t fall victim to unfocused ambition.

Why Building a “Compound Startup” Might be the Next, Great, Non-Obvious SaaS Play
Or why “just focus” might be bad advice.

Enterprise & Deep Tech VC in Europe & Israel 2021
A data-driven look at a record-setting year.

Shifting Left, Shifting Right
Are we on the cusp of a new era of empowered non-engineers?

EUROPE & ISRAEL FUNDING NEWS

Switzerland/Climate Systems. Climeworks raised $650M for its ‘direct air capture’ to capture carbon dioxide directly from the air.
France/Climate. Sweep raised $73M for its carbon emissions management platform for large corporates.
UK/Fintech API. Fidel closed $65M for its global financial infrastructure platform, providing tools to build powerful, real-time products on top of payment cards.
Israel/Security. Coro closed $60M for its threat detection & prevention over wifi & cellular networks.
Germany/Healthcare SaaS. Avi Medical raised $54.5M for its provider of practice management and appointment booking solutions for doctors and patients.
Spain/Data Tooling. Tinybird raised $37M for its API to help data teams build real-time Data Products at scale through SQL-based API endpoints.
Spain/Travel SaaS. Amenitiz raised $30M for its platform for streamlining the administration of independent hotels and B&Bs which it shorthands as ‘Shopify for hotels’.
Israel/IT Infrastructure. Appwrite raised $27M for its open-source backend-as-a-service (BaaS) platform that enables companies to forget about infrastructure and focus squarely on the front end.

WORTH READING

ENTERPRISE/TECH NEWS

EU unicorn drain. While European tech is growing — with a total investment in European startups hitting €33B in 2022 Q1, surpassing 2021 Q1’s total by €10B — the continent is still losing many unicorns to US relocation. Most startups relocate to the US due to the draw of customers and investors — for most, it’s simply fundamentally easier to build a large company in America than in Europe. Algolia’s CTO expanded on why they relocated: “the flip helped us significantly develop the business and accelerate our growth. It accelerated our growth in two ways: to raise money at better terms and attract more customers to our service.” American culture is also often far more conducive for startup growth, Adwanted’s founder, Emmanuel Debuyck, shares: “as an entrepreneur, you want to feel everything is possible. In France people always tell you that you won’t succeed and you should think twice. In the US, they say just do it and if it works you’re successful, if you fail you can do something else. If you fail in France that would be a red mark.” At Angular, a US market focus from our European and Israeli portfolio companies is core to our thesis. Gil even wrote a helpful post on why European and Israeli startups should incorporate in the US.

A fast demise. After many startups raised astronomical rounds last year, some are now facing the harsh reality that their previous ~100x ARR rounds have left them in an… undesirable position. From layoffs to valuation cuts and down rounds, to potential shut downs. Fast’s implosion has quickly become the early cautionary tale of 2022. And so now we must wait and see how many unicorns “will be able to avoid what happened to Fast — and instead hunker down and survive? To avoid going Fast, in other words, they might have to go slow.”

HOW TO STARTUP

Pilot purgatory. Champ Suthipongchai from Creative Ventures wrote a terrific piece on how deep tech founders can climb out of pilot purgatory. His three recommendations for founders were to:
1. Define your conversion metric. As many customers don’t know what success exactly looks like when using new tech, but this is so vitally important to move to the next stage, founders should engage their stakeholders to define success as a metric to remove any possible post-pilot ambiguity.
2. Know what your pilot proves. “As a deep tech company, your pilot is not about how many dollars you have already raked in; it’s about proving that you have achieved a critical milestone and created a well-oiled engine that can turn dimes into dollars.”
3. Choose the right customer. “The first mistake founders make at this point is talking to anyone who is willing to talk to them. But a wrong customer is just that: wrong. At best, talking to the wrong customer is a massive waste of resources. They’re often harder to convert, have smaller contract sizes, will be resistant to speak with potential investors and often won’t represent the best market fit. At worst, these faux customers are surreptitious. They pretend to be your customer by having a “pilot budget” to learn about your technology but won’t have an intent to buy at all. The right customer, on the other hand, is a resource you can tap for honest feedback on your not-so-great-yet product. They allow you to test your product and your business model, are willing to debate what makes sense for them and help you refine what you will ultimately bring to the correct, broader market.”

Humble leadership. Employees don’t leave jobs, they leave managers. Thus, it’s imperative that managers not lead with outdated top-down leadership approaches where they are “overly obsessed with outcomes and control, and, therefore, treat their employees as means to an end”. Instead managers should focus on how they can best help their employees — and one of the best ways to do so is to adopt a servant leader mind-set. “Servant-leaders have the humility, courage, and insight to admit that they can benefit from the expertise of others who have less power than them. They actively seek the ideas and unique contributions of the employees that they serve. This is how servant leaders create a culture of learning, and an atmosphere that encourages followers to become the very best they can.”

HOW TO VENTURE

State of Venture 2022 Q1. CB Insights has released their State of Venture Q1’22 report. The entire report is worth checking out, but here are the highlights:

• Global startup funding reached $143.9B in Q1’22 (19% drop compared to Q4’21)

• US-based startups received 49% of global funding in Q1’22, with a quarterly total of $71.2B

• Q1'22 saw the birth of 113 new unicorns globally (5-quarter low)

• So far in 2022, companies raising new financing have gained a median valuation increase of 2.6x compared to their prior financing rounds

• The number of exits via SPACs and IPOs decreased by 45% QoQ in Q1’22

PORTFOLIO NEWS

Vault Platform’s CEO, Neta Meidav, shared how data is making whistleblowing more effective. “According to Vault’s co-founder and CEO, Neta Meidav, adopters of her firm’s tech are reporting a 70% average increase in the number of internal complaints received, while the time taken to resolve them has fallen by half. This, she says, points to a new era in employee-generated data that, when acted on correctly, can not only save companies the costs of litigation and all the associated reputational damage; it can also prompt them to engineer turnarounds in problematic areas.”

CruxOCM’s Head of People, Joanna Woo, recently spoke to Forbes about hiring tech talent within the remote work environment. “COVID/Remote work hasn’t changed our hiring process much. What we believe really helps set us apart is our strong belief in transparency. We are extremely clear on how much candidates can expect to make in salary and we use data to determine what the best salary bands are. We are able to “sell” potential candidates on our mission and the grandness of what we are building. There is a strong mental health aspect of caring about what one does at work so at CruxOCM we want to hire people who genuinely care about the infrastructure that we are building.

Firebolt vs Snowflake: comparing data warehousing platforms. “Firebolt’s strengths lie in performance and flexibility. Independent reviews such as Hevodata.com have confirmed that Firebolt’s speed is superior to other providers including Snowflake. Snowflake does not use indexing, whereas Firebolt does so, along with a higher octane blend of query performance. Firebolt lets you tune individual node types, whereas Snowflake limits you to tuning warehouses only.”

Snyk acquired developer cloud security platform Fugue.