In early 2016, many pundits predicted a more tepid investment environment, characterized by a slowing venture capital market, a more rational valuation environment, and potential correction in the public markets.  There was a feeling that we were due for a bit of a “hangover” from the 2014-15 startup investing frenzy – which had been driven largely by walls of new capital from the likes of sovereign wealth funds, increased corporate venture money, and family offices. (For more on that, see our thoughts from early 2016 here.)

And, indeed, the end-of-year data for 2016 has exposed what everyone pretty much knew: In 2016, venture capital funding in the US was down year-over-year, following five years of consistent growth in funding. According to data provided by Pitchbook, VC funding dropped roughly 14% – from the impressive $79.2 billion funneled into US-based startups in 2015, to a more modest sum of $68.3 billion in 2016. Perhaps even more telling is the decrease in the number of deals done in 2016 vs. 2015: 10,486 in 2015, compared to 7,966 in 2016. And exit activity was also lower, with 935 exits compared to just 719 in 2016 – representing a 25% drop.

The reasons for the slowdown in the US are varied, ranging from a sense that valuations had potentially run ahead of themselves in 2014-2015, hindering later stage rounds in 2016, to uncertainty around public markets and the presidential elections. While the US stock market ended the year on a high note, the fact is that for the 20 months leading up to November 2016, the US markets were basically flat, trading in a wide range. (Remember the periods of high volatility around such events as Brexit, the first Fed interest rate hike in many years, and the US election.)

Yet – while this somewhat sobering description may accurately portray 2016’s investment story in the US – in Israel, the investing environment was different, demonstrating continued momentum, and a more positive atmosphere. Indeed, the growth trend in both dollars invested and number of deals done continued apace in Israel in 2016.

The Israeli experience was different

In 2016, Israeli VC investing showed growth in almost all key metrics – a continuation of what has been a very strong growth trend (some might ask if it is too strong?) over the past five years. According to the recently released report, Summary of Israeli High-Tech Company Capital Raising (IVC and ZAG Report), 2016 actually saw a record high of $4.8 billion of capital raised, which is 11% above 2015 levels, and up from $1.8 billion in 2012.   In addition, while the number of deals fell a modest 7% from 2015 levels, the average deal size rose to a record $7.2 million, up 19% from 2015 levels.

The reasons for this? I believe there were four distinct drivers:

  • The relatively less inflated valuations of Israeli companies compared to their Silicon Valley peers;
  • Israel’s focus on and frontier technologies – those areas where global dollars are flowing;
  • the growth in Israel of late stage funding rounds;
  • and a new influx of Asian capital.

Below, I take a closer look at each.

No bloated valuations

During 2014-2015, startups in Silicon Valley saw record amounts of investment. Much of this came from new sources of capital, such as sovereign wealth funds, hedge funds, a new trend towards corporate venture capital and strategic corporate investment, and large family offices. And as pointed out in PitchBook’s analysis, this sudden increase in available capital drove up valuations across the industry. It generated a plethora of new unicorns (private companies valued at over $1 billion).  This led to somewhat of a “hangover” in 2016,  when companies found it harder to complete next funding rounds as founders’ valuation expectations were often different than what the market was willing to pay.

In the 2016 climate, some US-focused VCs were worried about where the follow-on investment would come from for later stage companies – and in many cases, they opted to reinvest in their own companies as opposed to launching new investments. As a result, overall deal activity slowed. Indeed, according to Crunchbase, in 2016 there 14 new unicorns created, down from 48 in 2015.

In contrast, this dynamic did not play out in the same way within the Israeli ecosystem. While valuations have been rising at a healthy rate in Israel – and in some cases, and some sectors, I would argue have gone too far — in general, valuations in Israel did not go up nearly as much during 2015, compared to Silicon Valley. Instead, most valuations stayed pretty much in-line with business fundamentals.

As a result, when it came to the ‘next round’, Israeli companies found there were eager and interested funders available. In fact, later stage rounds – the area where valuations became more extended in the US – saw the greatest growth in Israel (more on this below).

Where global dollars flow: Frontier technology generating interest

“Skate to where the puck is going, not where it has been,” said Wayne Gretzky, but that’s only part of the story.

When it comes to growth in investment dollars, it is often very important not to look at venture capital as one uniform sector (though it is of course an asset class), but rather to look at the areas of technology that are attracting the most interest from global investors.

Even when investing slows down, as it did in the US this year, the slowdown is not uniform across different sectors. Specific areas of technology development and innovation will continue to attract interest and funding.

According to a recent year-end 2016 report  by Crunchbase, key frontier technology sectors, such as transportation (autonomous vehicles, drones, logistics), artificial intelligence,  and AR and VR,  all saw significant growth in investment across the globe, with investment in each of these sectors up between 70% and 150% in 2016. This reality played in Israel’s favor in 2016, as the Israeli high-tech sector is well positioned in key areas of technology that have continued to attract interest. These include AI (artificial intelligence), machine learning, drones, autonomous automotive technologies, Big Data analytics, robotics, digital health, and cutting edge areas of cybersecurity.

These are spheres of excellence where Israeli has historically been strong, and where the country’s best companies have been – and continue to be – created. As a result, Israeli entrepreneurs have been incredibly active in these technology areas and global capital continues to flow.

Cybersecurity is a prime example of an Israeli field that has historically been very strong, producing some of Israel’s largest companies (CheckPoint, CyberArk), and global investing interest remain strong. According to data gathered from CB Insights and CrunchBase, there was a 23% increase in funding for cybersecurity companies across all stages in Israel —from $560 million in 2015 to $689 million in 2016 (even as funding in this sector dropped roughly 20% in the US.

Newer areas of innovation such as AI, VR/AR and mobility (drones and autonomous vehicles), play right into Israel’s core strengths and are becoming key areas of growth, attracting large amounts of new investment. Israeli -founded Mobileye – now traded for over $9 billion – was at the forefront of many of the technologies that now enable autonomous driving.  Israeli entrepreneurs and engineers are attracting rapidly growing amounts of capital in this area.

Interestingly, we are seeing Israeli companies excel at the convergence points of key technology trends.  For example, a number of Israeli startups are emerging as leaders in cybersecurity for automobiles, while others are using expertise in big data analytics to move the autonomous driving industry forward.

According to a recent report by automotive industry consultants Roland Berger (Israel’s Automotive and Smart Mobility Industry):

Israel has recently become active in the automotive and smart mobility industry. Technology companies like Mobileye and Valens or mobility service providers like Waze and Gett have their roots in Israel and foster growth of this sector in the region… the digitization of mobility has required new competences – such as object recognition and tracking for advanced driver assistant systems, or mobility behavior projections for shared ride services. These are precisely the fields where Israel has developed competences in the past, often targeting military defense applications or Big Data applications for intelligence services. A growing awareness for the availability of these competences is reflected by the increasing investments and activities of automotive players like GM, VW, Daimler, Ford, Renault-Nissan, Bosch, Samsung (Harman), and many others.

Larger and late-stage rounds

Large funding rounds providing later stage “growth” capital for startups ready for expansion have been a part of the VC/startup scene in Silicon Valley and New York City for many years. However, in Israel, startups have generally built more capital-efficient businesses, and have often exited earlier — through either an IPO or M&A. Therefore, larger, later stage funding rounds have historically been less prevalent in Israel.

In 2016, that started to change as founders and investors realized that in order to scale their businesses faster, and better compete on a global basis, larger amounts of capital were necessary.  Larger rounds at later stages of growth have also become more important in a capital markets environment, in which it has become more challenging, and less desirable to IPO.

While it is true that companies are staying private longer all around the world, in Israel there’s a new phenomenon in which larger, later funding rounds are becoming more normative. Five years ago, when a company reached a certain stage and needed to raise $30-50 million for a round D, they would either sell or go public.  Generally, such amounts of growth capital were not available in Israel. Now, there’s late stage capital available and investors who are searching for those bigger, late stage growth companies.  This is combined with serial entrepreneurs looking to build large companies with global scale.

In 2016, there was a clear acceleration in later stage growth rounds in Israel. According to IVC, there were 76 large deals (defined as above $20 million), up over 25% from 2015.

Moreover, the amount of money invested in growth rounds (above $20 million) in Israel in 2016 was as high as $2.7 billion, up from around $2 billion in 2015. Notable large, later stage growth rounds in the Israeli ecosystem over the past year include:

  • VIA ($70mm series C)
  • Payoneer ($180mm)
  • Claroty ($32mm, Series B)
  • Airobotics ($28mm, Series B)
  • Sisense ($50mm, Series )
  • Formlabs ($35mmm, Series B)
  • Celeno ($38mm, Series F)
  • Lemonade ($33mm, Series B)
  • Enverid ($21mm, Series C)

It is a testament to the strength and breadth of the Israeli startup ecosystem that these companies represent a wide range of sectors, including cybersecurity, fintech, clean tech, digital printing, mobility and semiconductors.

Funding from the East

Until relatively recently, the vast majority of foreign capital investing in startups in Israel came from the West – North America and Europe.    Over the past five years, we have seen a major shift, with increasing interest from Asian investors, primarily from China, Hong Kong and Singapore.

In 2016, this trend accelerated dramatically, and while accurate data is hard to pinpoint, Asian investment activity – especially from China—has grown dramatically.   According to one estimate (IVC), Chinese investment in Israel has grown roughly 50% year over year since 2011.  I believe that growth rate may have been higher in 2016.  Anecdotally, I can say that in well over 50% of the investments we look at seriously (those in which we would consider investing), we note that there are Asian investors either looking at the deal or who have put forward a term sheet.  One data point worth noting is that the amount of capital deployed by Israeli VCs in 2016 was roughly flat with 2015.  Thus, the $400 million of growth in capital deployed in 2016 was almost all driven by foreign VC and strategic investors.  I believe that a very high percentage of that came from the East.

The surge in capital coming from Asia is a response to the fact that Israeli high-tech has generally matured and offers highly innovative and proprietary technologies to the Asian markets.  Chinese investors in particular have woken up to the significance of Israeli technology and the opportunities inherent in developing Chinese-Israeli business partnerships.  Bringing great products and solutions to the huge markets of Asia can be a win-win proposition for all.

Working more closely with Israeli companies also means getting Israeli attention in terms of the direction of product development, i.e., Asian money is pulling Israel’s tech attention toward Asian markets, in contrast to more US-centric companies.

And the Asian interest in Israeli companies is not just about passive investment:  According to PwC’s 2016 Israel M&A Report, investors from the Far East were involved in nine acquisitions of Israeli companies in 2016, totaling no less than $6.38 billion, representing a 3.5-fold increase from the previous year. Six of those deals specifically involved investors from China.

At a recent event in Tel Aviv, the China-Israel Forum hosted by the Chinese media group Caixin, the growing role of China in Israel and cooperation between the two countries was explored. The forum highlighted the fact that China is one of Israel’s largest trading partners (I believe it is #2 after the US), and both sides are highly motivated to build on the growing relationship. At the event, dozens of entrepreneurs from China and Israel gathered to discuss tech links between the countries, and Caixin Editor-in-Chief Hu Shuli was quoted as saying that China is especially interested in Israel’s tech innovation and talent in the areas of cybersecurity, agriculture, AI, and the Internet of Things.

Well-positioned for continued momentum (then again, it’s a small world)

I remain very enthusiastic about the trends I am seeing as we’ve entered 2017.  Israel is well positioned in some of the most important emerging areas of technology.  The core competencies of Israel’s technology ecosystem are well suited to benefit from “where the puck is going” – and global investment dollars are flowing.

Nonetheless, while Israel sidestepped the modest slowdown experienced by the US VC industry in 2016, we need to be cognizant of the global nature of the technology industry. Both business and investment trends are international, and the cycles in one geography are highly intertwined with the rest of the globe.

The Israeli startup and investment scene continued to thrive in 2016 and overall trends feel solid going into 2017. However, we’d be wise to remember that we’re just a small—if important — part of a highly interconnected, global community. The future development of the Israeli high-tech sector will be driven by many of the same unique attributes on which the ecosystem has been built, but is also likely to reflect, in one way or another, what’s happening elsewhere in other parts of world.

Thanks to David Stark and Liz Cohen for contributing to this thought piece.

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