Drop in venture capital funding puts squeeze on Israel’s tech sector

TEL AVIV (JTA) — The Facebook page of PlayArt Labs, an Israeli gaming startup, looks more like the homepage of an art museum than the profile of an emerging technology company.

It features an article about Johannes Vermeer’s “Girl with a Pearl Earring,” an animation of Vincent van Gogh’s “Starry Night” and a link to a Twitter feed, @FrescoJesus, about a century-old Spanish fresco. The goal of the startup is to integrate art and cultural education into iPad games — to create “some added value from playing,” according to Adir Wanono, who launched PlayArt Labs 10 months ago.

But now Wanono, 34, who successfully funded another startup two years ago, has encountered an unfamiliar obstacle.

After eight months of working with barely any money, he has had trouble securing necessary funding from investors who like his idea but are hesitant to invest. He has secured $55,000 in investments from family and friends, but with four people working at the company, even that shoestring budget will run out in six months, Wanono estimates.

Wanono says the market in Israel has become tougher since his last startup.

“People say, ‘Go to the market, gain traction and we’ll invest,’ but this lowers the chances of most startups to succeed,” he said. “We need money now to maximize our chances to succeed. Without money now, we won’t be able to maximize the benefit from a good launch.”

PlayArt Labs is far from alone in encountering this problem. Recently, Israel’s famously booming startup scene has seen funding from large venture capital firms decline. That means there’s less money available than there used to be for startups — a key engine of the Israeli economy — to get off the ground.

This drop in funding has come as Israel’s technology sector, which includes startups and larger established companies, has experienced dramatic layoffs.

According to an August article in Haaretz, 16,000 of Israel’s 80,000 tech workers have lost their jobs. Government funding of the tech sector also has dropped 40 percent over the past decade, to $400 million in 2011.

While the number of new startups has not declined from previous years, industry investors and entrepreneurs say that venture capital firms have been less willing to take risks on those companies as they seek to expand.

“The entire venture capital model is broken,” said Yesha Sivan, president of the Israel Internet Association. “It used to be that a fund would get $100 million, it would invest in 10 companies and it would get two or three big winners that would make 10 times more on their money. Today the return on VCs is relatively lower, so people are looking for other avenues.”

Into that void have stepped individual “angel” investors, as well as several dozen companies called startup accelerators or incubators that provide funding, space, equipment and professional guidance to startups.

One such accelerator is Tel Aviv-based Rad BioMed, which focuses on biomedical startups. At the end of its central hallway, above a smooth beige table surrounded by beakers, microscopes and computers, Dan Frumkin holds a test tube in his latex gloves. Frumkin, 40, hopes to improve diagnoses of bladder cancer by analyzing DNA. He is the vice president for biochemistry of Nucleix, a startup focusing on DNA analysis that he co-founded four years ago.

Nucleix rents space from Rad BioMed, though it does not receive funding from the lab.

“It’s cheaper and easier” to work at Rad BioMed’s offices, Frumkin said. “Instead of creating a laboratory, we entered an existing one. It helps that we have a little in common with other companies.”

Incubators and accelerators have less money to invest than venture capital firms — typically in the hundreds of thousands rather than the millions. But Yoav Chelouche, managing partner of Israel’s Aviv Venture Capital, says “the cost of building a new company is dramatically lower than it’s been” in the past.

“You don’t need to buy software and an operating system,” he said. “You can use a lot of open source code,” programs that are available for free on the Internet.

According to Chelouche’s research, venture capital firms in Israel provided about $3 billion of funding to startups in Israel from 2008 to 2012, versus $3.6 billion from 2004 to 2008 and $6.5 billion from 1999 to 2004. He also found, however, that Israel is on track to see about 600 new companies created in 2012, a similar number to 1999 and 2000. Chelouche says this could be a positive development for Israel’s tech sector, as it will create “a situation where companies have to do more with less, which is not necessarily a bad thing — being more frugal.”

But another investor, Roni Einav, the founder of New Dimension Software, which he sold for a record $675 million in 1999, says that companies may hit a roadblock as they seek to expand overseas.

“If the company is successful in developing and having the first three, four or five customers in Israel, they can try to go abroad, but then they need more money,” he said.

The drop in funding actually could help people like Wanono, however, as they will own a greater percentage of their own companies and thus make larger profits should they sell their companies or go public on the stock market, Einav said.

“The question is how much time the founders are ready to sacrifice with minimal salaries, or whether they successfully convince the employees to work with reasonable salaries for a year or two,” he said. “If you’re an entrepreneur and you’re not ready to sacrifice a part of your salary, it’s like you have a dream but you want someone else to finance it.”

Einav also noted that the percentage of venture capital funding of Israeli companies from the United States is growing, which he says is “good because the biggest challenge is to cross the ocean, so an American investor will give credibility to the company.”

While some areas of the startup industry are hot targets for investment, like biomedical companies, Sivan says it’s harder now than in previous years to get major investments as a startup. Still, he has confidence that no matter how the industry changes, startups will always be an attractive career option for enterprising Israelis.

“This will always be something people do,” he said. “People like to create things, to take a chance.”