Tech industry leaders are gloomy about the future as they contend with a world starting to worry more about the environment than cybersecurity

David Rosenberg. June 6, 2023

These are not happy times for Israel’s Startup Nation. The global tech slump is entering its second year with no sign of relief in sight. The government’s proposed judicial overhaul has upset entrepreneurs and investors, who fear it will destroy the liberal-democratic underpinnings of the tech ecosystem. The state budget for 2023-24 cuts funding for high-tech research and development while giving billions of shekels more to Haredi schools that don’t trouble to teach math and science.

But there’s a growing worry inside the industry that Israeli tech’s troubles aren’t going to end when the global tech industry rebounds and venture capital starts to flow again, even if Prime Minister Benjamin Netanyahu decides to kill off the judicial overhaul. A boost to government R&D assistance or forcing Haredi schools to teach the core curriculum would help, but only on the margins.

The fact is the entire Startup Nation phenomenon is at risk due to much deeper problems than industry cycles or the priorities of the current government. That gloomy mood was palpable last week at the Israel Democracy Institute’s Eli Hurvitz Conference on Economics and Society roundtable on “The Future of Israeli High Tech.”

“For the first time in the last 30 years that I’ve been involved in high-tech, I’m afraid that we could destroy everything we have here,” Tal Barnoach, a general partner in the Disruptive VC fund, told the conference. “If people think that as soon as things change, foreign investors will return at the push of a button, you can forget about it. If we don’t come to our senses quickly, the State of Israel is heading into a dangerous place.”

Hurting more in Israel

The pessimism goes beyond general malaise. There are, unfortunately, a host of facts and figures that testify to the industry’s ailments, most of them presented in a talk by Alan Feld, the founder and managing partner of Vintage Investment Partners, a VC managing $3.6 billion in assets.

The sharp drop in tech investing that began in the middle of last year is conventionally attributed to the global tech downturn, with the effects of the judicial overhaul perhaps making things a little worse. 

In fact, as Feld showed, the downturn in start-up fundraising has been much steeper in Israel than it has been in the United States or Europe. 

This year Israeli tech fundraising is down 60 percent from the same time in 2022, compared with 40 percent in the U.S. and 50 percent in Europe. That could be due to the struggle over the judicial overhaul. But last year, too (long before most Israelis had ever heard of the judicial appointments committee), the decline was steeper as well – 34 percent in Israel, versus 29 percent in the U.S. and 16 percent in Europe.

Why is Israeli tech suffering a steeper downturn than anyone else?

Feld points to a few negative trends, one being the rise of environmental, social, and governance, or ESG, investing, which takes into consideration social responsibility concerns when evaluating a company, rather than just seeking to maximize returns.

ESG has become a bugbear of the U.S. right, but it is a growing phenomenon that Israel can’t easily avoid. As a joint survey by Bain and the Institutional Limited Partners Association found, 70 percent of investors take an “ESG approach” in weighing investments. Only 7 percent said they would never walk away from an investment that failed ESG standards. ESG presents Israeli tech with two problems. 

One is the judicial overhaul, which by ESG standards could be seen as undermining democracy and the independence of courts. “I have heard personally from big foreign investors that they look at political developments in the State of Israel through an ESG lens. That may explain part of the decline in fundraising in the first quarter of 2023, and it is likely to affect fundraising going forward,” Feld said.

The other is more fundamental. Israel has failed to join the world’s rapidly increasing interest in climate-tech, which means ESG investors looking for green investments end up looking elsewhere. 

Yesterday’s game

Israeli climate-tech companies raised $4.1 billion in capital in 2020-2022, compared with $13.1 billion raised by cybersecurity startups, according to figures compiled by Feld.

The question of why Israel isn’t doing more in climate-tech reaches down to an even more fundamental problem the tech industry faces, namely the lack of basic research.

Israel spends more on R&D as a percentage of GDP than anyone else in the world, but it’s nearly all private sector research and much of that R&D is done by multinational companies with offices in Israel. Government spending, on the other hand, is miserly and skewed heavily towards defense.

The Israel Defense Forces spends generously on cybersecurity R&D, hence Israeli startups founded by army veterans are world leaders in the segment. But when it comes to civilian R&D spending, money is scarce: The Israel Innovation Authority estimates that the government share of total civilian R&D spending in Israel is just 9 percent, less than half the 23.8 percent average for countries belonging to the Organization for Economic Cooperation and Development. 

The result is that cybersecurity, whose best days as a growth industry may well be over, is heavily over-represented in Israel while there isn’t enough university and hospital research for climate-, health and ed-tech startups to build on even as these segments are emerging as the new growth sectors. 

In short, Feld says, Israel is “playing yesterday’s game.”

There are other fundamental problems. The number of new tech companies formed every year – the lifeblood of Startup Nation – has fallen by more than half since 2015 to about 630 last year, according to IVC estimates. Israeli university rankings have dropped in recent years and, in the latest rankings by U.S. News & World Report, not a single one makes it to the top 100. Huge numbers of Israeli degree-holders, especially those with PhDs, have decamped to the U.S.

High-tech entrepreneurs and investors are well aware of the problems, but their ability to cope with them is limited. The government does have the power, but there is little sign it has either the interest or the desire. In the fight over the judicial overhaul, tech has come to be regarded as part of the “post-Zionist” left because of its high-profile role in the protests. It’s now seen more as the enemy than the engine of the economy.