State of the *Israeli Early Stage Funding* Union

It is the best of times, it is the worst of times

Exhilarating. Perplexing. Inspring. Depressing.

All are words that accurately describe my mood on a day to day basis as an early stage investor in Israel during Q1 2024.

What’s Going On

It’s well documented that 2023 was a slow year when it comes to total $’s deployed into Israeli companies, and that makes a lot of sense! The year started off with a global market correction in startup land, unprecedented local civil unrest and ended with the horrific October 7th attacks and all that has followed.

At TLV Partners, we saw a 50% decrease in net new deals compared to 2022, 2021 and 2020 (we’re usually quite consistent), and a 40% decrease in overall deal flow. The 40% decrease can be explained purely based on the fact that the entirety of Q4 was lost to the war whereas the decrease in net new deals can be explained by a combination of the war as well as a subconscious decreased appetite to focus on new deals due to the events mentioned above (btw, this subconscious decreased appetite refers both to investors and entrepreneurs).

Many doom and gloom style articles, including the one I linked to above, were posted in late 2023 and there was genuine concern that the events of 2023 would lead to a more sustained slowdown in the local ecosystem. But the opposite seems to have occurred.

So far, 2024 has been the most active market I can remember during my ten years in venture. Anecdotally, not only has our deal flow quantity increased dramatically compared to 2023, but our deal flow quality is off the charts relative to the past several years.

And let me tell you - competition has never been stiffer. Every VC I know seems to be “working on multiple deals” (we’ve already done three this year), two of the most well respected global funds established new local offices by hiring full time Israeli Partners, there have been at least five seed deals that have surpassed $20m in round size and received multiple term sheets, and I’ve literally witnessed founders “holding office hours” at various Sarona cafes.

So - to quote the 4 Non Blondes - what’s going on?

Release the River

The first and most basic explanation is that there was a backlog of companies waiting to begin fundraising but the macro environment simply never allowed them to do so.

Most founders chose not to fundraise during the summer months as it’s perceived as a time when most VCs are on vacation (I can neither confirm nor deny the accuracy of that sentiment) and due to the way the calendar fell out last year, fundraising plans were further delayed by the local holidays. And of course, the holiday season led directly into the war which put both a practical pause (due to reserve duty) and an emotional pause on most new fundraising activity.

Many reservists began to be released from reserves in early December and while it’s impossible to say that we’ve emotionally recovered, a new war-time routine started to take form in the final days of 2023.

This led to a “release the river” moment in Q1 2024.

This explanation alone though, would indicate that there hasn’t been any structural shift to the early stage fundraising environment but rather we’re experiencing a period of deal compression due to a few “lost” quarters.

I don’t think it’s that straightforward though.

The New Reality

There are four major shifts that I’ve witnessed.

1. The impact of the global slowdown in A and B rounds has led to more dollars being allocated to early stage opportunities from global funds. IPOs and growth rounds will return at some point, but until then many large international firms seem to be focusing their attention on seed rounds so as to “punt” the need to raise a growth round for a few years. It’s important to note that I’m not referring to large growth funds/crossover funds (i.e. Tiger). Those types of funds allocating significant capital to the earliest of stages was a 2021 phenomenon that hasn’t returned and rightly so. I am, however, referring to global Tier-1 early stage (seed-series B) firms who have traditionally been more conservative when it comes to investing in seed stage Israeli companies but have now squarely focused their Israeli efforts on seed rounds.

2. There is a renewed sense of purpose and patriotism from local funds post October 7th. While the country came together to contribute in any and every way possible, VCs view investing in a new cohort of Israeli companies not only as their fiduciary responsibility to their LPs but also as an expression of patriotic duty to their country. And rightly so.

3. There is increased fomo on the heels of the acquisition spree in the cyber security market. Israel has always been a cyber security powerhouse, but over the last few years (and specifically over the last 12-24 months) it has cemented itself as a consistent producer of cyber security M&A targets. But perhaps more specifically, everyone wants to invest in the next Wiz. What this means practically is that:

   1. If you’re a second time founder operating in the cyber security domain you can raise $15m+ before finishing to complete the introduction slide to your seed deck.

   2. If you’re a first time founder who held a senior position at a successful cyber security company, you can raise $8m halfway through your seed presentation

4. The promise as GenAI as the next platform shift has driven investors to inundate founders with capital so as not to miss the “next big thing”. It’s interesting to note though, that Israel has not had many (any?) “piping hot” AI deals. Not on the foundation model side, not on the application layer nor on the infrastructure layer. I expect this to change specifically on the infrastructure layer. So while there have been a plethora of AI related seed deals (every company has an AI angle today), it’s a market that’s operating in a slightly more conservative manner than the security market.

The fact of the matter is that there’s actually more dollars available to seed stage founders than ever before. This paired with the “release the river” phenomenon mentioned above has led to increased competition, increased round sizes and (naturally) increased valuations at the seed stage.

Conclusion

Is 2021 back? No.

• First of all, that shouldn’t be the goal. 2021 represented a perfect storm of irrationality and the market is operating in a much more conservative manner nowadays for every round beyond seed.

• Secondly, portfolio maturity/liquidity isn’t looking as rosy as it did during 2021 and as funds who weren’t already able to do so struggle to convert TVPI (on-paper markups) to DPI (actual cash returned to LPs), they will have a harder time raising additional funds and the capital will begin to dry out. But this will take time. (**Tip for founders - it’s more important now than ever before to ask potential investors where they are in their fund’s deployment cycle.**)

Our country is at war. There are still 134 hostages held in Gaza. As a nation we have not even started to think about what “recovery” from this time period looks like. Finding reasons to be optimistic is possible, but difficult.

The early stage startup environment is the exact opposite. I don’t think there has ever been a better time to raise seed capital. To be clear, it’s not that it’s easier to raise a seed round today than it was previously, but if you have a good narrative with a strong team there are more dollars available than ever before.

Weaving in and out of these two conflicting realities is simultaneously exhilarating, perplexing, inspiring and depressing. But as Haviv Rettig Gur said in the interview below - that may just be our super power.

Random Nuggets

• Average seed round sizes:

  • Cyber: $7m-$10m round size

  • Non cyber: $4m-$6m

  • Second time founders: $8m-$12m

• Is pre-seed back? This might be worth a dedicated post. TLDR - sort of, but it shouldn’t be.

• Growth rounds are happening. The best companies are still able to raise at relatively high (compared to the public markets) revenue multiples. Down rounds have been taking place as well - but predominantly healthy down rounds in solid companies, not predatory down rounds in challenged companies.

• What sectors are hot?

  • Cyber

  • Security

  • Cyber

  • Security

  • Cyber Security

• What other sectors are hot? AI infrastructure, co-pilot for x, service as software, defense tech