By Steven Scheer

JERUSALEM The spiralling conflict with the Palestinians is set to derail a fragile recovery in Israel's all-important tech sector, say investors and analysts, after a global slowdown and the government's divisive judicial reforms saw funding drop sharply this year.

Israel, one of the world’s most innovative high-tech economies, relies on the sector for 14% of its workforce and nearly a fifth of its overall economic output. It has weathered decades of turmoil and is ultimately expected to see investment return once the conflict ends and fundraising globally recovers, they added.

"Overseas investment will slow for the next couple of weeks and months, especially to the extent that there are still hostilities going on," said Jon Medved, Chief Executive of OurCrowd, one of Israel's largest venture capital firms.

"This is not a particularly easy time to get investment," he added, noting the number of flights to Israel that have been cancelled.

Israel declared war on the Palestinian militant group Hamas after gunmen on Saturday burst across the fence from Gaza in the deadliest incursion into Israeli territory since Egypt and Syria's attacks in the Yom Kippur war 50 years ago.

Israeli media said deaths from the attacks had reached 900, mostly civilians gunned down in homes, while scores of Israelis and some foreigners were taken to Gaza as hostages. Israel has responded with fierce air strikes into the Hamas-ruled Gaza Strip.

Before the conflict, investment in Israel's high-tech startups had dropped as the global economy slowed, the collapse of Silicon Valley Bank (SVB) removed a key funding source and a proposed judicial overhaul threatened the bedrock of corporate law and intellectual property rights.

According to the IVC Research Center and LeumiTech, Israeli high tech firms saw a 70% fall in fundraising in the first half of the year, but added that the rate had stabilised to a drop of 14% in the third quarter compared with the second.

LeumiTech CEO Maya Eisen Zafrir said the figures were "the first signs of stabilisation in the amount and scope of fundraising, data that bring us back to the levels of 2018-19."

In all, startups have raised some $5 billion so far in 2023, versus $16 billion last year and a record $26 billion in 2021. It was $10.4 billion in 2019. Investment has been broad-based but led by cybersecurity and artificial intelligence (AI) companies.

"Certainly, while we are in the midst of the war, it's hard to imagine major deals happening," said Avi Hasson, CEO of Startup Nation Central and a former venture capitalist.

CONFIDENCE EARNED

That said, Hasson and others expect Israel's tech sector to rebound in the same way it has in past conflicts with Palestinian and Hezbollah militants.

"Israeli tech has earned the confidence of investors in terms of being able to function during conflict and also recover from it," Hasson said. "So, I don't see investors losing faith in Israel so quickly."

Medved said that he believes that Israel will prevail as an tech investment destination.

"Historically, every time Israel has gone to war, long term has been a buy side," he said.

With much of the country reeling from the attacks, tech firms have been using their offices to collect supplies for soldiers since many of the 300,000 reservists Israel has called up are tech employees.

U.S. venture capital fund Insight Partners said it would match up to $1 million in donations to a pre-approved list of charitable organisations in Israel, saying it was a "critical opportunity to stand with our Israeli friends and partners."

Gem Security, a cloud security startup that just raised its Series A funding of $23 million from U.S. investors, has 30 staff split between Israel and New York. It was expanding the team when the conflict broke and some staff in Israel had to report for reserve duty.

"What's happening in Israel, in my perspective, won't change anything with our plans to stay within Israel when it comes to technology," said Arie Zilberstein, Gem's co-founder and CEO.

Ariel Efergan, vice-president of growth at startup MDI Health, estimated that about a fifth of its 40 employees in Tel Aviv, had been put on reserve duty. The rest are now working remotely.

Startup marketing adviser Hillel Fuld was ultimately optimistic about the industry, pointing to a wave of support from the global venture capital community and a shift in world opinion in Israel's favour.

"That shift may even help push those investors who might have been reluctant (to invest in Israel)," he said. "I don't see this situation affecting Israel in a negative way."

(Reporting by Steven Scheer in Jerusalem; Additional reporting by Krystal Hu in New York; Editing by Louise Heavens)