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Business Intifada, Global Downturn Harm Investment in Israeli High-tech

March 14, 2003
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With the intifada continuing and the international high-tech economy still in the doldrums, private Israeli high-tech companies in 2002 raised their lowest amount from domestic and foreign venture capital firms in three years.

The $1.14 billion figure also marks the first time since 1999 that investment fell below $2 billion.

According to the annual survey conducted by the IVC Research Center, a division of Giza Venture Capital, venture capital investment in Israel decreased by 43 percent in 2002 from 2001.

IVC polled 159 venture investors, of which 91 were Israeli VC funds and 68 were other — mostly foreign — investment entities.

Not surprisingly, both the number of companies raising investment capital and the average company financing round were down in 2002. A bump in the final quarter of 2001 signaled a possible rebound, but investment in the first quarter of 2002 plummeted by nearly $100 million from the previous quarter, to $376 million.

Each successive quarter in 2002 saw VC investment fall further. The low reached in the fourth quarter — only $205 million, the lowest fourth quarter figure since 1998 — was the lowest quarterly total since the first quarter of 1999.

“The decrease in fund-raising by Israeli start-ups reflects global trends,” said Ze’ev Holtzman, chairman and CEO of Giza. “However, Israeli companies experienced a smaller decline than U.S. or European firms, indicating that there is still substantial interest in Israeli companies.”

On the other hand, “Funds at the disposal of Israeli VC firms are limited, and foreign investors are hesitant to invest. This points to 2003 being another year of reduced investment in Israeli start-ups,” Holtzman said. “The high-tech sector is of prime national importance, and the negative trend will therefore be another blow to Israel’s economy.”

Israel’s high-tech industry is critical to the country’s economic well-being. High-tech exports in 2002 amounted to $4.6 billion, or 25 percent of the nation’s total industrial exports. Due to a general decrease in global demand, this translates to a drop in blue-and-white high-tech exports of nearly 11 percent from 2001.

Meanwhile, investments made by Israeli venture capital firms totaled $481 million last year — a drop of 40 percent – – and represented less than half the total amount invested in Israeli companies.

In addition, foreign investment without Israeli VC participation declined by 49 percent from the previous year, to $156 million.

At the same time, the proportion of total investment without Israeli VC participation remained roughly constant in both years, at about 15 percent. This undiminished interest by foreign investors is a consistent bright spot in an otherwise grim picture.

“Despite the global tech downturn and Palestinian terrorist attacks, Israel’s high-tech scene is still flourishing,” said Jon Medved, general partner of Jerusalem venture capital firm Israel Seed Partners. “In fact, there are still exits. Just a few weeks ago, Precise was bought by Veritas for over $500 million.

“The future bodes well because Tier 1 venture firms around the world are actually stepping up their activities in Israel,” he continued. “Funds such as Benchmark, Sequoia, Accel and Lightspeed are now making more investments and focusing more investment professionals’ time in Israel than ever before.”

The second bit of good news is the decision by Moody’s Investor Service to continue its A2 rating and stable rating outlook on foreign and local currency bonds issued by the State of Israel.

Moody’s move reflects the international community’s respect for the core strength of Israel’s technological competence, as well as for the country’s ability to withstand its persistent security problems.

The IVC survey divided high-tech companies into four categories: seed, early stage, mid-stage and late-stage. During the past two years, early and mid-stage companies raised the largest amounts of capital.

Mid-stage companies attracted 54 percent of total investments in 2002, with $614 million, while early-stage companies garnered 29 percent of the total, a 40 percent slide.

Seed companies are hardly being supported at all by the investment community: They received only 2 percent, or $23 million, of total financing in 2002, and only 19 seed-stage start-ups received any VC backing.

Considering that seed companies were already down to 5 percent of total financing in 2001 — and seed and early- stage companies together attracted less than one-third of investment in 2002 — the figures are likely to discourage entrepreneurs from going out on their own.

“The continuing decline in investments in 2002 especially impacted seed companies,” Holtzman said. “This decrease is likely to affect the number of start-ups as well as the scope of Israeli high-tech in the coming years.”

Nearly all sectors of the high-tech industry suffered in 2002 as compared with 2001, though the communications sector fared best, attracting 37 percent of total investment.

Software companies were also popular in 2002, with a 20 percent share of total financing. The Internet sector, on the other hand, collapsed to a new low, attracting only 4 percent of total investment.

Semiconductor firms ran counter to this trend — raising 12 percent of the total, triple the previous year’s 4 percent — as investors handed Israel’s innovative microchip industry a vote of confidence.

In fact, Intel’s latest chip, the Centrino — which is scheduled to be unveiled next week to great fanfare — was developed in Israel.

In what might be a harbinger of the future, however, the fourth quarter of 2002 saw life science companies — especially those developing medical devices — more than doubling the financing they raised in the third quarter. Life sciences companies ended the year with a 15 percent share of total financing.

With universally respected research powerhouses such as the Weizmann Institute of Science, the Technion and the Hebrew University — all of which have spawned government-supported biotech incubators or spun off for-profit commercialization arms — plus the renowned Rehovot Science Park, Israel is at the forefront of the emerging frontier of advanced life sciences, which offer the prospect of better medical treatment and drug therapies.

Riding this trend — Forbes Magazine reports that 20 percent of VC investment worldwide went to life sciences companies last year, up dramatically from 8 percent in 2000 — is likely to be healthy for Israel’s economy, as well as for patients everywhere.

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