With the Israeli government this week passing the first in a series of significant changes to its judicial system, the country’s startups and investors are bracing themselves for turbulence.

Why it matters: Israel may have less than a quarter of California’s population, but its tech industry has been punching above its weight for a long time.

• In June 2022, Israel had 92 "unicorn" startups — that is, private companies valued at above $1 billion. (The number has dropped since the market downturn, of course.)

Catch up quick: On Monday, Israel's parliament passed the controversial bill spearheaded by Prime Minister Benjamin Netanyahu's coalition that will significantly limit the Supreme Court's ability to review government decisions.

What they’re saying: “Both in the short and in the long term, it introduces a lot of uncertainty,” Yuval Ariav, founder and managing partner of VC firm Symbol, tells Axios.

• “A big part of why it’s difficult to talk about is that nobody knows what’s going to happen,” he adds. Startups are already risky business, and the battle over the judiciary adds a whole new dimension.

Zooming in: In addition to the broader market forces that have depressed startup investing, Pangea Biomed CEO Tuvik Beker fears the judicial reforms have further affected already falling startup investments.

• Israeli high-tech companies raised $3.7 billion in the first half of this year. But that was a 31% drop from the second half of 2022, and an 68% decrease from the first half of 2022, according to data from the Start-Up Nation Policy Institute.
• Within that period, they raised about $2 billion in the first quarter of 2023, and $1.7 billion in the second.
• “The level of activity is down this year. The first few months, that was attributed to the global slowdown, but as the U.S. market has become more active, that’s becoming less true,” Target Global founder and executive chairman Shmuel Chafets tells Axios.

Zooming out: More broadly, in the Israeli markets, the Tel Aviv Stock Exchange indices are already diverging downward from the S&P 500.

• Credit rating agencies have also warned of downgrades for the country.

Between the lines: “I personally fear that the power grab by the Netanyahu government will make it much more difficult for Pangea and other Israeli companies to raise VC funding in the near future,” says Beker.

• “In the long run, if this dangerous trend isn't curbed and reversed, I fear it will cause ‘brain drain’ and emigration among the most capable individuals and stymie the innovation that Israel is so famous for,” he adds.
• It's also unclear how the legal system could change the business environment — "what is the future of property laws?" Ariav asked.

State of play: While tech companies have long been setting up offices and even incorporating abroad, this trend is greatly accelerating because of the judicial overhaul, Israeli investors and entrepreneurs say.

• In a recent survey by Start-Up Nation Central, 68% of startups said they're taking active legal and financial steps, such as withdrawing cash reserves, moving their headquarters outside of Israel, relocating employees and laying off staff.

The bottom line: Israel startups are steeling themselves for uncertain times.

Here's what some tech entrepreneurs and investors had to say about the judicial overhaul, as told to Axios Pro's George Moriarty and Lucinda Shen:

Shmuel Chafets, Target Global executive chairman:

"People talk about [environmental and social governance]. The venture industry in Israel is taking a stand and have become activists and community leaders. That is ESG."

"[NFX general partner ] Gigi Levy-Weiss, two weeks ago, I saw him in a protest walking down the street with a flag. They are in the street, in the protests.... They are totally doing it out of a sense of civil mindedness. [It's a] testament to the strength of Israel as a country, where the elite really does care and serve."

Eynat Guez, Papaya Global CEO:

"If you need to imagine the worst-case scenario, if all of a sudden the Israel currency drops sharply, the government can take a very, very proactive approach of blocking you from taking funds outside of the country." (In January, the company moved most of its cash into overseas institutions in anticipation of the judicial reforms and the Israeli shekel's volatility.)

"We respect every decision, and unfortunately, a lot of people are looking to relocate either temporarily or permanently outside of Israel because the level of tension, stress and uncertainty that they currently feel in Israel is quite high." (Papaya Global, however, is not planning on relocating or forcing employees to move.)

Dima Gutzeit, LeapXpert CEO:

"We are not relocating employees, since we don't have many key people there, but we for sure are not growing there as a decision. I wanted to grow the team there — partially because there are good people, but partially because of ideological reasons (being Israeli)."

• What to know about Israel’s contentious judicial overhaul plan (Axios)
• White House calls Israeli Knesset's passage of judicial overhaul bill "unfortunate" (Axios)
• Record 26 Israeli-founded unicorns now headquarter in NYC (CTech)

In lieu of trivia, send me your thoughts and insights on how this is going to shape the Israeli startup market.