Is the Decline in the Number of New Startups Creating a Problem for the Israeli Economy?

The introduction of the iPhone in 2007, the lower prices of cloud services, and further technological and economic changes, brought about a global growth in the rate at which new startups have been opened. Until approximately 2015, there was a surge in the number of new startups opened every year both in Israel and in other prominent hubs. Since then, the number of new companies opened in most of the hubs has declined. Why did this happen and does this trend constitute a problem for the continued growth of the Israeli innovation hub?

In 2014, the number of new startups established in Israel stood at 1,400 companies, a figure that has steadily declined ever since. According to an Innovation Authority estimate, only 600-700 companies were opened in 2022.  The Innovation Authority’s estimation is based on estimates of IVC and SNC publications. The figure relating to the number of new startups established during the past two years is still expected to rise due to the occasional delay in the reporting of data on the establishment of new companies. It is nevertheless clear that there has been a decline in the number of new companies established since the record years. As of 2015, Israel was the second largest innovation hub in terms of the number of new companies established that year. The other large hubs experienced a similar phenomenon of fewer new companies opened after the record years of 2014-2015, including those in San Francisco (the largest hub) and New York. In other hubs, such as London and Boston, the decline was more moderate than that recorded in Israel.

The Innovation Authority and SNPI conducted a joint study to examine the reasons that led to the decline in entrepreneurial activity in Israel. A decline in the number of new startups: a worrying sign or natural maturation? (Hebrew). The study revealed that since 2017, the number of new startups established each year dropped by 12%. According to a calculation that refers to an estimated figure from 2022.

One of the assumptions examined in the study is whether the decline in the number of new startups was accompanied by a rise in the quality of the companies opened. However, in terms of capital raised by early-stage companies, there was no increase in the ratio of companies that successfully raise capital each year. Nevertheless, the study reveals that despite the decline in the number of new companies, the number of active investors and the average number of investors who participated in each funding round actually increased.

Two central questions arise from the decline in the number of new companies: first – what caused this decline and why did it occur? Second – does this situation constitute a problem in terms of the Israeli economy?

An in-depth analysis of the decline in the number of new startups established reveals that in recent years, this trend stems primarily from a downturn in the field of social media and advertising that had flourished and prospered a decade earlier. The entry barriers to establishing startups in these fields decreased because of the introduction of cloud technology and accessibility of the social platforms, including Facebook and Twitter, and the transformation of mobile devices into major computer products. Now however, only a limited number of entrepreneurs establish companies in this field. In practice, a comparison of the new companies established in 2019 with the companies established in 2014 reveals that the decline in the companies established in the social media and advertising sector explains approximately 70% of the drop in the number of new startups established.   

Another explanation for the decline in the establishment of new startups is the shortage of quality personnel and startups’ difficulty in competing with the large established companies in paying high salaries. With the increase in salaries paid by high-tech companies in Israel, led by multinational technology companies, startups encountered increased difficulty, certainly those in their initial stages which have yet to raise significant capital, in recruiting experienced employees who demand high salaries. This presents a significant obstacle to establishing startups. Furthermore, there is low incentive for entrepreneurs to take a risk and establish a startup in an environment characterized by high salaries, safe jobs, and well-established companies.

Although the decline in the number of companies stemmed mainly from fewer new companies in the social media and advertising field, this is a worrisome trend. The significance of the decline in number of new companies is that it results in a drop in the number of growth companies because it hasn’t been proved that the companies established in recent years succeed more. In other words, there is a need to increase the pace of establishing new technology companies in Israel to create the next generation of growth companies, that will become significant employers in the market. The Innovation Authority closely monitors the entrepreneurial situation in Israel and employs various tools to promote it.

This worrisome trend joins a new phenomenon indicated in a position paper published by the Innovation Authority in May 2023: new Israeli startups, some of which are expected to become growth companies, choose to incorporate outside Israel in a way that could limit the future number of jobs that will be available to Israelis.