Analysis by the Bank of Israel’s Research Department:Financing Characteristics of High-Tech Companies in Israel
- Relative to its size, Israel's share of the global venture capital funds market is substantial, with Israeli high-tech companies accounting for approximately 4 percent of global venture capital investment—ten times Israel's share of global output and of business credit.
- In recent years, the total amount of venture capital investment in late-stage companies has grown in Israel, as it has across the world. These companies naturally require relatively large investments. In 2019, venture capital funds invested a total of approximately $9 billion in Israeli high-tech companies.
- Venture capital activity brings foreign currency into Israel. The Israeli economy sells the future returns of the high-tech sector abroad, but at the same time eliminates the risk embodied in it. The coronavirus crisis highlights how the reliance of a key sector in the Israeli GDP on a single source of financing—which is correlated with global activity—can make it difficult for Israeli high-tech companies to continue to obtain financing during a global recession.
- Indeed, as a result of the coronavirus crisis, there are indications that the activity of the high-tech sector has been adversely impacted, as has been the ability of the sector to raise capital. The greatest difficulties are currently experienced by early-stage companies.
Due to the increasing importance of the high-tech (high technology) sector, we will discuss the unique characteristics of this sector’s financing. First, we will briefly review how high-tech companies fund their operations; we will then present the scope of these companies’ financing in the Israeli economy and discuss the unique characteristics of the sector’s financing and their impact on the economy; finally, we will discuss the impact of the coronavirus crisis on the sector’s financing.
A. Background - Financing of the High-Tech Industry around the World
In broad terms, there are 3 life stages in the high-tech sector: (1) Early stage companies (also called start-ups) are companies that are at the initial stage of developing a product or service, and even if they already have initial revenues, are still in the early stages of developing their business model. (2) Mid-stage (also known as expansion-stage) companies are companies that already have a relatively well-formed product or service, which they are already selling, and are working to expand their business activity in order to attain profitability or obtain a significant market share. (3) Late-stage companies are companies that produce or offer a proven product or service, which are already profitable or are well on their way to profitability.
In the various life stages - especially in the first and second stages -
investment in high-tech companies is characterized by significant uncertainty
and asymmetric information between entrepreneurs and investors regarding the
quality of the company; in addition, the incentives of the entrepreneur and
those of the funding entity are difficult to match. These difficulties are
resolved, inter alia, by staging investments and through non-standard contracts
between the entrepreneur and the investor, which enable both sides to obtain
non-monotonous returns. High-tech companies are mostly funded by
venture capital funds and private investors (also known as "angels").
Venture capital funds (VCs) are a partnership of professional investors
who manage and invest the funds of institutional entities (such as pension
funds, insurance companies and endowment funds of US universities).
There are also corporate venture capital funds (CVCs), which are managed
and funded by large corporations (such as Google and Samsung). Private
investors, in contrast, are people who invest their own funds directly or as
part of a group of investors. They tend to invest in early-stage companies,
while later-stage companies are mostly funded by venture capital funds.