Judicial reform could push hi-tech out of Israel - opinion

When a glacier begins to melt, it does so in a way that is imperceptible to the onlooker because the warming water melts it from beneath the surface. By the time the glacier’s retreat is irreversible, it’s shrinking at its fastest rate. Only then do giant cracks become visible and make headlines.

If the radical proposed changes to the Israeli judicial system pass, business will appear to continue as usual. Investments will still flow to Israeli startups and acquisition offers will still be received. But that will be highly misleading. 

The overhaul that subordinates the courts to politicians won’t do as much harm as every subsequent piece of illiberal legislation the government will probably then proceed to pass. Like a glacier that melts from underneath, each contentious decision will gradually warm the waters around Israeli hi-tech, until it is severed from its mainland. 

I am an Israeli venture capitalist who brought one of the leading American funds to Israel 17 years ago, and which has since invested approximately $1.5 billion across more than 75 Israeli startups. I’ve been asked repeatedly what will really happen if these misguided “reforms” come to pass.

People are asking the wrong question when they wonder whether foreign investors will abandon Israel. Investors in fact won’t need to leave Israel: The entrepreneurs will do so first. 

Hi-tech entrepreneurs will leave Israel due to judicial reform

Entrepreneurs are the heart of the Israeli hi-tech economy, and investors will follow them wherever they go. As entrepreneurs recognize the slide toward authoritarian rule – and the uncertainty that presents for their business and personal lives – they will increasingly choose to start their companies outside of Israel. And they will be welcomed by many countries with open arms. The imperceptible retreat of Israeli hi-tech will begin with individual, personal decisions like these. 

If you consider the recent past, you’ll see that such an entrepreneurial brain drain is not far-fetched. Israeli entrepreneurs have often established their companies abroad, closer to the market and to sources of capital. Some have done so with Israeli R&D centers, while others ignore their home base altogether. 

Consider this: The most valuable tech company in the world that was founded by an Israeli is Palo Alto Networks, currently valued at $45 billion. This cybersecurity company only bothered to create an Israeli office 13 years after its founding. To understand the impending loss to Israel a decade from now, multiply the case of Palo Alto Networks by twenty. This is not an anecdote. There are dozens of additional examples. 

Other Israeli entrepreneurs will start their business in Israel, but incorporate in the US or UK. This was once standard practice due to tax uncertainties in Israel for founders and their shareholders. These founders will correctly reason that as Israel enters a new illiberal era, it is hard to anticipate how Israeli-domiciled companies will be received in global markets and by global investors.

It will be the prudent thing to do, and foreign investors will eventually demand it of them. Businesses and investors don’t like uncertainty, and that is what the judicial transformation represents. 

Existing Israeli startups are unlikely to leave Israel, but some will be compelled to “flip” the company into a US parent to dissociate themselves from their country of origin. Others will open secondary R&D centers in Europe and North America to lessen their dependence on the Israeli office and to accommodate those Israelis wishing to relocate.

THIS TOO is not far-fetched and happens regularly. Our country is too small and distant to accommodate so much talent, so there has always been an Israeli brain drain. But the slippery slope towards illiberalism will take it to depths never imagined. 

Like itinerant merchants from another era, Israeli startups are some of the nimblest, most fluid businesses in existence. They will go where there is opportunity and leave where there is a liability. Criticize this all you want on ideological grounds, but it’s their business and their lives. Israeli startups, like their products, are remote and virtual. Unlike a manufacturing site in Hungary, they don’t need special trade agreements, economic incentives or access to railroads. 

Twenty years ago, Israeli startups struggled to attract the attention of American investors and multinationals. We intentionally obscured the fact that we were Israeli, hired foreign CEOs, flew to meet them and agreed to conference calls in the middle of the night. We also accepted an “Israeli discount” on our valuations. One of the most remarkable accomplishments over the last five years has been that an “Israeli premium” replaced this unfair “Israeli discount.” 

Investors and buyers may not leave Israel so soon, but they will once again demand a discount to reflect the uncertainty and the damaged Israeli brand. They will demand this discount until the Israeli brand is so toxic to the point that no discount will suffice. The Israeli tech brand that took decades to build will gradually become a liability.

The final blow to Israeli hi-tech will be the most silent of all. That will be the opportunity cost – missing out on the continued upward trajectory of Israeli hi-tech had we not taken this precarious path. 

Bad news in business is often manifest solely in terms of what can’t be hidden from the public: A company lays off employees, shuts down an office or pulls out of a previously announced deal. But worse news comes when plans to open and expand a local office are shelved in favor of a European office; or when a Silicon Valley CEO refuses to even bid on an Israeli acquisition due to perceived difficulties with shareholders and employees; or when a large venture capitalist (VC) with a third of its capital from Persian Gulf countries becomes wary of building too large a portfolio in Israel.

One less investor may not seem important but can be the difference between a company’s ability to negotiate a great outcome and having to accept inferior terms from the only bidder. These are things that will not make headlines, because few will know how things might have been different.

The absence of declarations from foreign investors and multinationals should not be seen as evidence of business as usual. Investors have nothing to gain by public statements, so stop looking.

The legacy of today’s government will not only be the gutting of Israeli democracy, but the stunting of the hi-tech economy. That hi-tech is resilient, but not invincible. Like an iceberg, Israeli hi-tech will slowly retreat in the warm waters of illiberalism, unnoticed by those relying solely on headlines and declarations. It will happen gradually, then suddenly. 

Politicians can ignore the warnings from the entrepreneurs themselves, but the future of Israeli hi-tech hangs in the balance. Those of us working at the level of the individual decision-maker can already feel the otherwise imperceptible change in temperature. It will only be with hindsight that the cracks will become visible and the cumulative impact makes headlines. Or we can stop, reflect and reconsider.

The writer is a partner at Bessemer Venture Partners and the head of the firm’s Israel office.