Start-up Nation

These negative developments happened about as rapidly and simultaneously as their positive counterparts had just a few years earlier. And yet the new state of affairs didn’t bring an end to the boom that was only about five years old. From 1996 to 2000, Israeli technology exports more than doubled, from $5.5 billion to $13 billion. When the tech bubble burst, exports dropped slightly, to a low of less than $11 billion in 2002 and 2003, but then surged again to almost $18.1 billion in 2008. In other words, Israel’s technology engine was barely slowed by the multiple hits it took between 2000 and 2004 and managed not just to recover but to exceed the 2000 boom level of exports by almost 40 percent in 2008.

A similar picture can be seen in venture capital funding. When the VC bubble burst in 2000, investments in Israel dropped dramatically. But Israel’s market share of the global VC flow increased from 15 to 30 percent over the next three years, even as the Israeli economy came under increasing stress.

Israel may not, however, fare as well in the current global economic slowdown, which, unlike that of 2000, is not limited to international tech stocks and venture capital funding but is being dramatically felt in the global banking system as well.

That said, the breakdown in international finance has infected almost every nation’s banking system, with two notable exceptions: neither Canada nor Israel has faced a single bank failure. Since Israel’s hyperinflation and banking crisis of the early 1980s—which culminated in 1985 with the trilateral intervention of the Israeli and U.S. governments and the IMF—tight restrictions have been in place. Israel’s financial institutions adhere to conservative lending policies, typically leveraged 5 to 1. U.S. banks, on the other hand—precrisis—were leveraged at 26 to 1, and some European banks at a staggering 61 to 1. There were no subprime mortgages in Israel, and a secondary mortgage market never came into existence. If anything, a shortage of financing—even before the crisis—for small businesses in Israel drove even more people into the technology sector, where taxes and regulations were more friendly and venture capital was available.

As Israeli financial analyst Eytan Avriel put it, “Israeli banks were horse-drawn carts and U.S. banks were racing cars. But those racing cars crashed badly whereas the carts traveled more slowly and stayed on course.”¹

This is the good news for Israel. Yet while Israel’s economy was not exposed to bad lending practices or complex credit products, it may be overexposed to venture finance, which could soon be in scarce supply. Venture capital firms are funded largely by institutional investors such as pension funds, endowments, and sovereign wealth funds. These investors set aside a specific allocation for what are called alternative investments (venture capital, private equity, hedge funds), typically in the range of 3 to 5 percent of their overall portfolios. But as the dollar value of their public equity (stock market) allocations has shrunk—due in large measure to crashing markets globally—it has shrunk the absolute dollar amount available for alternative investments. The overall pie has been downsized, reducing available funds for venture capital investments.

A diminished supply of venture capital dollars could mean less “innovation finance” for Israel’s economy. Thousands of workers in Israel’s tech scene have already lost their jobs, and many tech companies have shifted to four-day workweeks to avoid further layoffs.² In the absence of new financing, many Israeli start-ups have been forced to close.

In addition to an overdependence on global venture capital, Israeli companies are also overdependent on export markets. Over half of Israel’s GDP comes from exports to Europe, North America, and Asia. When those economies slow down or collapse, Israeli start-ups have fewer customers. Because of the Arab boycott, Israel does not have access to most regional markets. And the domestic market is far too small to serve as a substitute.

Israeli companies will also find it harder to negotiate exits—like Given Imaging’s IPO on the NASDAQ or Fraud Sciences’ sale to PayPal—which are often the means by which Israeli entrepreneurs and investors ultimately make their money. A global slowdown will coincide with fewer IPOs and acquisitions.