A decline in the number of new startups

Introduction

In April 2022, together with the Israel Innovation Authority, we published a study on the decline in the number of new start-ups launched in Israel. The study focused on the period 2014–2020 and indicated an average annual decline of 9.4% since 2017 [1]. Since receiving data on the establishment of new start-ups can be delayed by months to years, we did not include 2021 in the original analysis. Now, following a further six months of measurement, the accumulated data has enabled us to estimate the pace of launching new companies over the past year. In light of this new data and, specifically, in view of the worrying downward trend, we have chosen to publish an update to the original study.

According to Start-up Nation Finder data [2], only 417 start-ups were founded in 2021. Even taking into account that some of the new companies founded have yet to be discovered, this still represents a decline of 23% compared to 2020. The average annual rate of decline since 2017 stands at 11.3%. Consequently, last year’s decline marks a further deterioration in this trend.

Figure 1: New startups (with forecast for late discovery)

As noted, there is a lag in the arrival of data on the establishment of new start-ups. The Start-up Nation Finder database locates new companies by monitoring a broad variety of sources. However, many companies prefer to remain “in stealth mode” during their early stages, so that historically, only 37% of companies are discovered during their founding year, and a further 35% during the following year. In order to contend with this problem, we developed a model that estimates the number of companies yet to be discovered at any point in time [3].

Now, drawing on the 2022 data, we can compare the forecast of the original model with the actual measured data. As can be seen in Table 1, the model succeeded in providing an extremely precise forecast of the rate of discovery. This result serves to reinforce the model’s reliability, along with our confidence in the fact that the number of new companies launched in 2021 is, indeed, extremely low.

Table 1: Model for forecasting the number of new start-ups

Key hypotheses for the decline: Revisiting the assumptions

In the original report, we presented a number of potential hypotheses to explain this phenomenon of decline and we offered evidence to support or refute them. We now seek to revisit those hypotheses and to examine how the new data affects the analysis.

An increase in quality

One of the hypotheses examined is the possibility that the decline in the number of start-ups signifies an improved capability of investors and entrepreneurs to estimate in advance the chances of success of high-tech ventures. According to this hypothesis, while we would expect to see fewer start-ups per year, those would have greater chances of success.

As an approximate measure of start-up quality, we measure the number of companies that succeeded in raising initial investment (seed rounds and beyond) within a given period. In the original report, we showed that according to this metric, we find no substantial or methodical difference in the quality of the start-ups according to their founding year. In each period we selected, the percentage of companies that succeeded in raising funds remained similar over the years. After updating the data for the companies founded (and which have raised funds) in recent years, the picture remains largely unchanged. Just as in the original report, we still find no evidence to support the claim of an increase in quality.

Figure 2: Time to seed round accourding to founding year

Technological developments create a scale bias

An additional explanation we examined was the possibility that the technological advancements of recent years have caused the start-ups currently being launched to be larger upon founding. We found support for this hypothesis in our analysis of the decline in the period 2014–2020 according to sector. According to our findings, 70% of the decline occurred in the SMA (Social Media & Advertising) sector, one that is characterized by projects that fall completely in the realm of pure software and require only scarce resources during the initial stages, in terms of both personnel and equipment. In contrast, we saw no similar declines in sectors such as AgriTech and DigitalHealth, where ventures frequently require various professionals (agronomists, physicians, laboratory technicians), together with expensive equipment.

However, the pattern whereby the decline tends to mainly occur in the software-intensive sectors did not continue in 2021. The updated data indicate a decline in almost all sectors (Figure 3), with sectors such as Life Sciences & HealthTech showing decline at even higher-than-average rates.

Figure 3: Launching of new startups, selected sectors (log-cale)

Additionally, based on new data we collected from social media, which represent a large sample of high-tech employees [4], we are now able to examine this hypothesis in relation to the number of employees. For all the companies in the sample that were founded in a specific year, we measured the number of workers in the sample who worked at the company one year after its foundation, and we created an index representing the change in the number of workers per start-up by founding year. The results appear in Figure 4. We found that for companies founded in 2020–2021, the number of workers employed one year after their establishment was 27% higher than the figure for companies founded in 2014.

This result supports the hypothesis regarding technological changes creating a scale bias. However, we should point out that the increase in the number of workers is still low in comparison to the decline in the number of start-ups. Figure 4 shows the total number of workers in start-ups one year after their initial establishment (the product of the number of workers in the average start-up and the number of start-ups) and shows that this statistic has been on the decline since 2014 (apart from 2020), and that from 2014 to 2021, it declined by a total of approximately 30%.

Figure 4: Average number of workers in a start-up one year after its establishment (2014=100).

On the whole, we find support for the hypothesis that technological developments create a scale bias, but this process only partially explains the decline.

Competing with larger companies for resources

In recent years, we have witnessed a significant increase in the number of large companies operating in Israel. Whether these are R&D centers of multinational corporations, or Israeli growth companies, the Israeli high-tech market is replete with large, established companies competing with the younger start-ups for the same human capital resources. In the original report, we noted that this competition raises both entrepreneurs’ opportunity costs and a start-up’s founding costs due to the high wages of the R&D workers and others.

Figure 5 depicts the wage spikes in the high-tech sectors between 2014 and 2021. According to the Central Bureau of Statistics (CBS), during this period there was a 4.5% annual rise in wages, creating a total rise of 36% since 2014. In 2021 there was a 6.3% rise in wages. We should note that the CBS definitions for high-tech are different than those of the SNPI, and therefore we estimate that the actual rise in relevant wages was even higher.

Figure 5: Wages in the high-tech industry (CBS, 2014=100).

Figure 6 depicts the wages in the high-tech industry (again, according to the CBS definitions) compared to the number of new start-ups. The correlation certainly does not imply any causality, but it is difficult to ignore the almost linear connection between these two variables (R-squared coefficient of 93%). It is difficult to avoid the conclusion that some process is simultaneously driving the increase in wages and the decline in the number of start-ups, and that this process is connected to the intensifying competition over relevant human resources.

Figure 6: The number of new start-ups compared with the wages in the high-tech industry (2014=100).

Changes in investor preferences

Is the decline in the number of start-ups the result of a decline in the scope of investment or in the number of investors? Figure 7 shows that this is not the case, and that, in practice, the number of investors investing in pre-seed or seed rounds has been on the rise in recent years. This data, alongside a record figure of $27 billion in investments in Israeli start-up companies in 2021, show that it is difficult to point to a problem in relation to investments.

How can we reconcile these opposing trends? Figure 7 shows that in recent years, the average number of investors participating in each pre-seed and seed round reached a record of 2.65, an increase of 40% since 2014.

Alongside this data, the increase in the external investment amounts over the years may, among other things, indicate an excess supply, or an increase in the investment amounts required for the establishment of start-ups (due to the wage spikes, the cost of inputs, etc.).

Changes in investor preferences

International comparison

Before completing this report, we would like to provide an update on the comparison of the decline phenomenon in Israel with that of the high-tech centers in Silicon Valley and London. In Figure 8, we present data from the Pitchbook database regarding these centers. In contrast to the data presented above, this data does not contain corrections for the time lag in locating the start-ups, so the decline trend is surely overstated and will apparently be mitigated in the future. Nevertheless, comparison of these centers shows that the decline in the number of new start-ups remains an international phenomenon, and the timing of the declines is also similar among these three centers.

Figure 8: Number of new start-ups, an international comparison
(without correction for late discovery, 2014=100)

How will the global recession affect the trend of decline?

The Israeli high-tech industry, like the global high-tech industry and the global economy, has been forced to contend with tremendous uncertainty and plummeting stock markets in recent months. How will this change of direction affect entrepreneurs, and especially, is the trend of start-up decline will come to a halt? It is very difficult to predict this, as a number of different economic forces could have an impact on entrepreneurship in Israel:

double_arrow
The increase in layoffs and the cooling off in the high-tech labor market might lead to a rise in the number of entrepreneurs (those who have been dismissed) and make it easier for new start-ups to recruit skilled workers. Many workers who have already succeeded in realizing options and restricted shares, and who underwent secondary rounds in the months preceding the crisis, may be more likely to turn to entrepreneurship.
double_arrow
The slowdown in the establishment of R&D centers by multinational corporations might also contribute to the growth in the tendency to turn to entrepreneurship (assuming that this slowdown will also lead to a concomitant slowdown in the recruitment of new staff by these companies).
double_arrow
On the other hand, potential entrepreneurs might be risk averse at this time of market instability and may prefer the safer option of working as salaried employees. This is all the more possible in light of the waning level of investments and the growing concern of the investors.

Conclusions & recommendations

We believe that the continued decline in the number of start-ups is a problem that Israel can no longer afford to ignore. While we still believe that there is no “correct number” of new start-ups per year, an average decline of 20% for four consecutive years is jeopardizing the future of the Israeli high-tech industry. Furthermore, the expansion of the trend of decline into numerous sectors is a clear indication that there is an industry-wide decline in entrepreneurship in the Israeli high-tech industry.

The decline we have described here is largely “going unnoticed” as the economic impact of start-ups is relatively limited in the short term. They do not employ a large number of workers and they are usually yet to generate large revenues; and thus, do not pay much in taxes. However, start-ups are the basis of the Israeli high-tech industry, the seeds from which the growth companies and the “whole companies” will develop in the years to come [5].

In contrast to the study published in April, in which we stated that there is no room at this juncture for a change in government policy, the new data have caused us to update our recommendation. In particular, we believe that the government must prepare and implement an incentive plan as soon as possible to boost technological entrepreneurship by examining the following steps, among others:

Increasing the Israel Innovation Authority’s budgeting of support plans for start-ups, and especially the Ideation (Tnufa) Incentive Program, and the Early-Stage Companies Incentive Program.

The Authority’s policy must adapt itself to the problems affecting the ecosystem, especially as the decline in entrepreneurship appears to be an ongoing problem. Accordingly, eyes toward the 2023 budget, we recommend prioritizing the start-ups’ share within the total amount of grants awarded by the Authority.

Increasing the budget ceiling per worker in the Israel Innovation Authority’s grants for technological employees in high-tech companies.

The current wage ceiling for support awarded by the Israel Innovation Authority stands at NIS 30,000 (wage costs). We believe that this ceiling should be raised to at least NIS 40,000 for start-ups.

Encouraging and increasing budgeting for the entrepreneurship programs run by the universities and colleges.

Many entrepreneurs start their entrepreneurial journey during their academic studies. Some of the most legendary global tech companies were founded by young students (Facebook and Google are the most notable examples of recent decades). Increasing the number of start-ups founded through academic entrepreneurship programs can be a valuable tool in reigniting the entrepreneurial fire of the start-up nation.

Increasing the grant ceiling in the Ideation (Tnufa) Incentive Program to NIS 300,000 per year (currently NIS 100,000 per year).

The Ideation (Tnufa) Incentive Program is designed to support fledgling entrepreneurs as they start out. We believe that increasing the ceiling should provide a better incentive to promising entrepreneurs while concomitantly filtering out less serious entrepreneurs.

Increasing the Israel Innovation Authority’s budgeting of support plans for start-ups, and especially the Ideation (Tnufa) Incentive Program, and the Early-Stage Companies Incentive Program.

Increasing the budget ceiling per worker in the Israel Innovation Authority’s grants for technological employees in high-tech companies.

The current wage ceiling for support awarded by the Israel Innovation Authority stands at NIS 30,000 (wage costs). We believe that this ceiling should be raised to at least NIS 40,000 for start-ups.

Encouraging and increasing budgeting for the entrepreneurship programs run by the universities and colleges.

Increasing the grant ceiling in the Ideation (Tnufa) Incentive Program to NIS 300,000 per year (currently NIS 100,000 per year).

Annotations 🔽

Annotations 🔼

A decline in the number of new startups:
Update with 2021 data

Introduction

Key hypotheses for the decline: Revisiting the assumptions

An increase in quality

Insert subtitle here

Insert subtitle here

Insert subtitle here

Insert subtitle here

Insert subtitle here

Insert subtitle here

Insert subtitle here

Insert subtitle here

Insert subtitle here

Technological developments create a scale bias

Insert subtitle here

Insert subtitle here

Insert subtitle here

Insert subtitle here

Insert subtitle here

Insert subtitle here

Competing with larger companies for resources

Changes in investor preferences

Changes in investor preferences

International comparison

How will the global recession affect the trend of decline?

Conclusions & recommendations