Israel’s venture ecosystem to weather global crunch

To:

Al-Monitor Pro Members

From:

Daniel Frankenstein 

Co-Founder & Partner – Joule Ventures LLC 

Date:

Aug. 5, 2022

Bottom Line: 

The private markets have seen a similar boon to the public markets over the past decade with low interest rates leading to more risk appetite and yield beyond more traditional products. The inflow of cash into venture funds, combined with more private equity and later stage players increasingly making earlier stage investments, has significantly grown the pools of capital searching for compelling private company investments. The increase in capital supply has driven up round sizes, valuations and the required exit multiples betting on a continued public bull market. With the cost of capital increasing and more scrutiny on valuations, there will be a global “reset” of valuations and a flight to quality businesses. Ecosystems like the United States where we saw the greatest amount of valuation inflation will be hurt most dramatically.  Ecosystems like Israel will have a softer yet dramatic correction

Background Facts:
  • In 2021, US-based companies raised $341 billion. Israeli companies raised $26 billion in the same period.
  • Declines for both ecosystems are evident already in the first half of 2022. US-based companies raised $144.2 billion in the first half of 2022. Israeli companies raised $9.8 billion in the same period.
  • These drops follow years of steady increases. 
  • The inflation rate in Israel for the 12-month period between July of 2021 to June of 2022 was 4.4% compared with 9.1% in the United States and 9.4% in the UK during the same time period. 
  • The Bank of Israel has raised interest rates by over 100 basis points since the beginning of 2022. 
  • The United States Federal Reserve has raised interest rates approximately 50 basis points since January 2022.
Alternative Scenarios:

Scenario 1: Lower capital investment disproportionately impacts non-US ecosystems, negatively affecting Israel. Despite conflicting data, many investors view non-US opportunities as riskier than those in the United States. As fewer dollars are invested in private companies, there is the chance that such a retrench could disproportionally affect ecosystems outside the United States. 

  • Why is this less likely to happen than your primary scenario? Technology companies are less loyal to a particular geography. Many have employees all over the world, outsourced development centers and remote employees. The integration of global tech talent centers over the past five years has changed attitudes related to geographic risk. 

Scenario 2: Aggressive monetary policy in Israel tempers the local venture ecosystem limiting the supply of growth stage companies. The Bank of Israel has been far more aggressive than the Federal Reserve increasing rates to tamp down inflation. The results are largely positive as Israel is seeing a far lower rate of inflation than the United States. The consequence of managing inflation has dramatically increased the cost of capital. That means fewer dollars going to companies by local players that are more early stage operators – getting these start-ups ready for the bright lights of the global, growth stage investment community. 

  • Why is this less likely to happen than your primary scenario? Despite the dramatic percentage rises in rates, they are still near historic lows. Most early stage venture funds don’t borrow money and are therefore not as exposed to cost of capital fluctuations.  
Conclusion - most likely scenario:

Israel’s tech ecosystem will generally track the global trends, seeing a drop-off in number of deals, investment dollars, M&A transactions and IPOs. These downward trends are likely to be less exaggerated in places like Israel that didn’t see as much valuation and deal velocity. Much of the private market capital are captive pools that legally need to be deployed during fund commitment periods. This ensures that while investors may be slower to deploy, they will not stop deployment. A retreat to quality and increased pricing discipline will favor quality opportunity from known ecosystems solving existing market inefficiencies.   

Contributor Background:  

Daniel Frankenstein is a co-founder and Partner at Joule Ventures with over a decade of experience in North America and Israel working with both C-suite executives and start-up entrepreneurs developing advanced technologies.

As a corporate expert turned venture investor, Daniel has a deep understanding for the value early stage technology businesses gain by partnering with multi-national enterprises at an early stage, which he leverages on behalf of the fund's portfolio investments.

Prior to Joule, Daniel spent eight years at the Corporate Executive Board (NYSE: CEB) in Washington, D.C. advising Fortune 1000 Chief Financial Officers on industry best practices. In 2009, he led CEB’s market entry into Israel where he worked with some of the country’s leading corporations.

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