One Sector That Doesn't Need a Bailout Now
(Bloomberg Opinion) -- Since mid-March Israelis have experienced a similar, if not stricter, lockdown to most Western nations. Unemployment has skyrocketed to over 25%, and the Bank of Israel estimates the effects of Covid-19 to be costing the economy over 1.5 billion shekels ($420 million) per day.
Many in Israel’s vaunted tech sector are concerned that the country should do more to protect a flagship industry that accounts for 40% of Israeli exports. Past lessons in government funding suggest that is exactly the wrong approach.
The Israeli government had come up with an 80 billion-shekel aid package for the entire private sector, though details have been scant. The finance ministry has also promised the tech sector 1.5 billion shekels in financial support, to be distributed through the Israel Innovation Authority, a governmental agency whose task is supporting start-ups and R&D-related activities. Some venture capitalists and industry associations, however, have been calling for more direct investments into companies and venture funds, similar to the plans put out by some European governments.
The coronavirus may be new, but Israel’s tech sector has been through rough patches before, and those experiences taught us all about adaptability. In 2009, it had barely recovered from the crippling effects of the dot-com bubble, which was aggravated by the second Intifada and the war in Lebanon. The financial crisis hit the Israeli market early in its recovery. The sector had raised $3 billion between 2006 and 2008 (venture capital funds usually run in three-year cycles) and a negligible $1.1 billion was raised over the next three years.
While the government was involved in seeding the tech sector in the 1990s, since those early days support has been limited to some R&D grants and seed funding. At 4.4% of gross domestic product, Israel’s R&D spending is ranked among the highest of any advanced nation, but comes directly from the state.
The past decade has seen phenomenal growth in the sector just the same, including $40 billion of venture funding and high levels of value creation from companies such as Mobileye, which develops systems for driverless cars and which Intel Corp acquired for more than $15 billion, or Wix, a software company, which has become a $6 billion public company.
Israeli venture capital funds have raised more than $6 billion over the past few years, and significant funds have even been dedicated to the local market in the first quarter of 2020. U.S. and other international ventures are now highly committed to the local market. Start-ups also find themselves well funded with more than $8 billion invested into Israeli companies in 2019 alone.
But while the Israeli tech sector is impressive, it’s also small. There is a limit to how much capital it can absorb and create returns on. Many local investors (including myself) have felt uneasy for some time with the amount of capital coming into the market, with some early signs of a bubble beginning to form. Overcapitalization has also led to inflation in salaries which could eventually erode the competitive advantage of Israeli companies.
A somewhat lower level of investment would provide the impetus for the kind of “creative destruction” that all changing markets need, freeing up resources and manpower to be better allocated for the future. Moreover, the industry is in good shape to navigate the current storm.
It’s also worth noting that Israeli tech companies are much less affected from the crisis than some other sectors. Most were multinational almost from the start, and are geared toward remote work; some industries, such as e-commerce, gaming and telehealth, have even benefited from the crisis.
The government should refuse calls to invest or support venture funds and companies beyond the existing framework. Such support is unnecessary and would only delay the inevitable collapse of some companies. It would also lead to significantly more irregularities, with part of the money inevitably going into the pockets of wealthy money managers, when it should go to the unemployed and small business owners.
But it’s not just the Israeli government that should resist these handouts. The tech sector generally is expected to weather the storm well, with the Nasdaq back to its December 2019 level and major tech companies such as Amazon.com Inc., Microsoft Corp. and Netflix Inc., as well as smaller companies such as Zoom, showing strong performance in public markets.
The U.K. has just announced a 250 million-pound ($308.8 million) “future fund” to match venture capital firms investing in British start-ups. As in the Israeli case, this will likely have only a limited impact and raises the issue of moral hazard. Governments worldwide, and particularly in Europe, would be wise to allow market liquidity to drop slightly, and to focus on reducing regulations that could lead to friction.
This is not to say that there will be no impact on start-ups and funds. There is no way to anticipate their long term impact on the market, and particularly the changes to the funding environment down the line. Israeli start-ups may find that U.S.-based investors are less likely to venture abroad and that strategic acquirers, burdened by debt and in the face of a challenging business cycle, would be less inclined to pay the same multiples for technology. But there is no way to anticipate future impact, and public investments made today would not serve to solve any future need.
While handouts aren’t needed, Israel’s government could support the tech sector by creating more clarity around its mid-term exit strategy from the crisis, and more specifically, try to help companies understand how they would be able to resume international travel since the tech industry is highly reliant on travel to meet customers, partners and investors.
The government should also use this moment to clarify some long-running questions around taxation of employee options, and other issues where industry associations have been pressing the country’s treasury for action. A deal in which the tech industry does not burden the national coffers during the crisis but receives long-term benefits and regulatory clarity can be a fair trade. The German model of “Kurzarbeitergeld” (“short work”), allowing companies some flexibility in reinstating furloughed employees on a part-time basis, might also be useful for Israel’s economy.
Overall, the most important thing Israel’s government can do right now is to equitably distribute aid to those who truly need it. The tech sector will sort itself out.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Shmuel Chafets is vice chairman and general partner at Target Global in Tel Aviv.
©2020 Bloomberg L.P.