JERUSALEM: After weathering recession and military conflicts, Israel’s high-tech sector could be facing its biggest test yet as the collapse of Silicon Valley Bank (SVB) removes a key funding source and a proposed judicial overhaul threatens the bedrock of corporate law.

Nicknamed “Startup Nation”, Israel’s economy has ridden a wave of tech success with a sector that employs just 10% of the country’s workforce accounting for around 15% of economic output, more than half of exports and a quarter of tax income.

But proposals by Prime Minister Benjamin Netanyahu’s hard-right coalition to give the government greater say in the selection of judges while limiting the Supreme Court’s power to strike down legislation have worried current and potential investors.

“The high tech sector needs stability, needs the rules of the game to be clear, needs a certainty that…they will have the court to go to,” said Karnit Flug, a former Bank of Israel Governor who is now a vice president at the Israel Democracy Institute, adding that otherwise investors would be reluctant to commit funds.

There is also the risk of accelerating a brain drain. An estimated 100,000 Israelis already live and work in California’s Silicon Valley and many others have moved to Europe. In an industry of around 400,000 there are currently around 6,000 vacant tech jobs, according to government data.

“This sector…would take their brains…their ideas, their entrepreneurship, and there will be a red carpet laid out for them in some countries,” Flug told the Israel Council on Foreign Relations.

Parliament has given preliminary approval to the proposed legislation, hailed by proponents as necessary to curb what they deem an activist judiciary that interferes in politics while opponents call it a threat to democracy, but final approval has been delayed for a month after widespread protests.

A number of high tech firms such as U.S.-Israeli cyber security startup Wiz have said they would pull money from Israel and keep funds from entering the country if the reforms pass, while the head of cloud-based software provider NICE (NICE.TA) said major investors were carefully watching the situation.

Meanwhile, the shekel has dropped to a three-year low versus the U.S. dollar on expectations of a drop in foreign direct investment from $15 billion last year and a record $27 billion in 2021.

According to the IVC Research Center and LeumiTech, Israeli high tech firms raised $1.7 billion in the first quarter, down 70% from the $5.8 billion in the first three months of 2022 and its lowest quarterly fundraising level in four years.

THE GO-TO BANK Adding to the tech sector’s worries is the collapse of U.S. lender SVB, which Jon Medved, chief executive of investment firm OurCrowd, called “the go-to bank” for Israeli startups - a 7000 strong group including “unicorns” with a valuation of at least $1 billion and smaller companies with no more than 50 employees.

More than half of the country’s startups held an account with SVB, companies and venture capital investors said, in some cases their only U.S. banking facility although the amounts involved are not fully known.

Mickey Balter, chief executive of indoor navigation startup Oriient, said SVB was the firm’s only U.S. bank and it was fortunate to transfer 70% of the millions of dollars it had there back to Israel, leaving the rest at SVB.

Initially, Balter thought the remaining 30% was lost but he regained access once regulators took over. “It would have been very painful,” he said. “Before (the regulators took over) I foresaw a scenario where we lost most of our operating cash.”

Israel’s Bank Leumi (LUMI.TA) said it was able to move $1 billion back to local accounts before U.S. regulators took control, about half the amount estimated to have been returned, according to the investors.

Tech companies and investors alike said SVB was a rarity in the banking industry, familiar with Israel’s tech ecosystem and offering loan terms unmatched by other banks.

“These guys were very professional and lovely to work with…Banks today can be a pain…These guys weren’t,” said Medved.

Citing the judicial reforms, Adam Fisher, a partner at investment firm Bessemer Venture Partners, said fewer American banks may be willing to lend to Israeli companies, which means less competition and more onerous terms.

“Locals will step in to a certain extent but they can’t grow their loan books overnight,” he said.

A top executive at an Israeli bank also said that while he saw an opportunity to boost lending to startups, local banks alone would not be able to fill the vacuum left by SVB.

“We don’t have the ambition of billions of dollars but we certainly have the ambition to double or triple the portfolio,” he said.

Israel’s tech companies are therefore likely to flock to register as U.S. companies, while keeping R&D back home, said Yaron Samid, managing partner of the TechAviv Founder Partners fund.

A handful of large U.S. banks have offered deposit accounts to those affected by SVB’s failure, Samid said, while fintech firm Brex said it had too. Others have offered emergency liquidity but at higher rates.

“No doubt there’s a bunch of companies that only survived because of SVB’s credit facilities,” Samid said. “There’s going to be some pruning. It was already happening because of the macro dynamics and private equity markets, but this is only going to accelerate it.”

Declining to name specific companies at their own requests, Samid said some Israeli startup founders had been in the “advanced stages” of negotiating investments, only for potential funders to pull out or ask for more time due to the proposed reforms.

“Good companies are going to survive,” he added. “But companies that are not as healthy are not going to survive.”