Fewer, but better than ever
The Israeli tech eco-system ponders a slowdown in startup creation
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 the 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 start 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 have decided to start something new this year — please reach out.
