Israeli tech startups flock to US amid uncertainty at home

By Steven Scheer and Emily Rose

JERUSALEM (Reuters) – A growing number of Israel’s tech startups are incorporating in the United States, attracted by deep pocketed U.S. funds and pro-business policies, and with an extra push from a planned judicial overhaul at home that has rattled investors.

That marks a reversal, as Israel had managed in the past decade to persuade more of its startups to set up their legal identity domestically.

It may not mean jobs shifting overseas en masse – the tech sector accounts for 14% of Israeli jobs – but registering companies or intellectual property (IP) abroad can affect where taxes are paid and so impact government revenue.

Entrepreneurs and investors told Reuters there were good business reasons for incorporating in the United States, and particularly Delaware, which is considered pro-business and a tax haven as it has low corporate and no state sales taxes.

But some also cited Israeli Prime Minister Benjamin Netanyahu’s judicial overhaul, which his right-wing government says is needed to tackle over-reach by the courts but which critics view as an assault on democracy.

Though the overhaul does not directly affect the tech sector, Ian Amit, a former Israeli military officer, frets about its impact and is taking his startup across the Atlantic.

“It’s just a very high level of uncertainty,” said Amit, who is registering his artificial intelligence-based cloud security firm Gomboc in Delaware.

“It mainly really revolves around corruption and uncertainty of what system is there to protect me as a business, from a tax perspective, from a legal perspective or an intellectual property perspective,” he said.

The economic risk for Israel’s government is that its plans, which have sparked unprecedented nationwide protests, scare a tech industry that accounts for almost a fifth of the country’s gross domestic product and about 30% of tax income. Some entrepreneurs already appear to be voting with their feet.

As many as 80% of new Israeli tech startups in 2023 have so far chosen to incorporate in Delaware, up from 20% in 2022, according to an Israel Innovation Authority (IIA) survey that also showed companies intend to register future IP overseas. IIA did not give the number of companies surveyed.

“The fact that you are shaking up the judicial system puts Israel in a very high level of uncertainty and investors don’t like uncertainty,” said IIA Chairman Ami Applebaum, who is also chief scientist at the Ministry of Innovation, Science and Technology.

Yair Geva, a partner who runs the tech group at law firm Herzog, Fox and Neeman, said that not only were new Israeli companies incorporating in Delaware, but some existing ones were expanding research and other operations outside of Israel.

“So, it’s somewhat of a bigger issue than just the incorporation aspect of it,” he said.

A survey of 615 firms by Startup Nation Central showed that 8% of Israeli startup/tech companies had started moving their headquarters abroad, and 29% intended to do so soon.

STARTUP NATION

Some entrepreneurs and investors said the decision to register in the United States was business, not political.

After all, Israel’s tech sector relies heavily on foreign investment, and a drop in funding to startups following interest rate rises and the collapse of major tech investor Silicon Valley Bank may be encouraging firms to go where the money is.

“If you want to operate in a global world and you want American investors … then that’s the way it is,” said Ronen Feldman, founder and CEO of ProntoNLP.ai. “It’s pure business.”

Tomer Tzach, CEO and co-founder of agri-tech company CropX, is considering switching incorporation to Delaware.

“At the end of the day as a CEO I need to do what’s right for my shareholders, my investors, my company and I feel terrible about it,” said Tzach.

Michael Fertik, founder of Heroic Ventures, a Silicon Valley-based early-stage venture investor, has invested in more than a dozen Israeli startups since 2015. He insists on Delaware incorporation and existing Israeli startups seeking a new funding round from him must switch.

“It’s better to have a Delaware C Corp from the beginning. It’s true in all cases, without exception,” he said.

But the Israeli government’s judicial overhaul is casting a shadow for some.

Adam Fisher, a partner at Bessemer Venture Partners and long-time investor in Israeli startups, has been happy to invest in Israeli-based tech firms over the past decade. He isn’t forcing existing portfolio firms to switch but now recommends entrepreneurs incorporate in Delaware and open an Israeli unit.

“I don’t view it as ‘Israel’s not good anymore’. We don’t know what’s going to happen. Nobody knows. It is just uncertainty versus certainty,” said Fisher.

Setting up shop in Delaware is mostly psychological, according to Ayal Shenhav, head of hi-tech and venture capital at law firm Gross & Co.

“It’s not something concrete that you can say ‘judges in Israel are corrupt’. No one is saying that,” he said. “It’s just a feeling that it is not as stable as it used to be and a lot of people follow the crowd.”

Yaron Samid, managing partner of the TechAviv Founder Partners fund, said that for U.S. investors incorporating in Delaware removes “one variant in a highly uncertain business of a startup”, but investment in Israeli startups would continue.

“Israel tech is not going anywhere,” he said, “because we have a an incredible bunch of talent that is producing more and more great companies, so whether they are structured as U.S. or Israeli corporations is really not significant for the tech ecosystem.”