Venture capitalists are seeking investment opportunities in Ukraine’s growing economy but the domestic venture capital market remains seriously underdeveloped, mainly due to the lack of Western-style venture firms on the market and foreign investors’ unfamiliarity with investment opportunities in the growing high-technology sector.
As international investors become more interested in Ukraine, venture capital firms are slowly beginning to make inroads into the economy, mainly in real estate and via private equity investments, but also in the high-tech sector, albeit on a smaller scale. The venture capital market in Ukraine remains compact with only several major players and a relatively small market turnover.
Industry insiders admit that since real estate and private equity investments are considered high-risk businesses in Ukraine, these investments are referred to as “venture capital.” Although venture-capital investments entail risk they also offer investors an opportunity to reap higher returns.
Equity and venture capital funds typically invest in small start-up companies and risky turnaround ventures, whose fortunes they believe are reversible.
Such funds typically acquire stakes in companies at a relatively early stage and work with management until a company can be sold to other investors or listed on a stock exchange through initial public offerings.
“In the last two years we have witnessed the arrival of a new type of investor, such as large Western investment funds that have been taking part in a number of private placements of highly developed Ukrainian companies. Such placements, organized by a few leading investment banks in Ukraine, are viewed by Ukrainian entrepreneurs as an alternative source of financing,” said Valeriy Schekaturov, co-managing partner of Euroventures Ukraine, a private equity firm.
He added that these investors do not necessarily set up a local presence in Ukraine. Instead they operate through local investment banks. A number of private placements have been marketed as pre-IPO type financing so the sustainability of this type of private equity will depend on the ability of Ukrainian companies to keep their promises.
Euroventures Ukraine Management Ltd. is an equity fund manager making direct investments into companies based primarily in Ukraine. The fund aims to maximize capital appreciation through investments in companies that have a high growth potential by assisting them in establishing “best practices” and transforming the business into a desirable target for acquisition. The company was established in 1999 as a European Bank for Reconstruction and Development (EBRD) initiative and the Dutch government.
The underdevelopment of the venture capital market is partly due to the fact that the private equity market is quite new in Ukraine, with investment having actively begun only around three years ago when the economy began to stabilize with higher GDP and increased foreign investments.
“Private equity is quite new to Ukraine, although there are more and more companies familiar with private equity investments. Only in the last two to three – after the Orange Revolution put Ukraine on the map – have private equity players started to demonstrate successful exit strategies, building their track record which is important for fundraising. New players were able to demonstrate that not only could they make investments but also profitably exit them [by spinning them off or placing them on a stock exchange],” said Schekaturov.
He added that despite a population of 47 million, the Ukrainian market began attracting traders and private equity players only recently, when GDP per capita reached $2,500-3,000.
“It is pointless to speak about the size of the Ukrainian venture capital market because it is still undeveloped,” said Serhiy Loboyko, founder and managing director of TECHINVEST Venture capital firm. Nevertheless, he said, the Ukrainian Investment Business Association unites hundreds of so-called “venture funds” with more than Hr 25 billion for investment in real estate and private equity.
Based in Kyiv, TECHINVEST is part of TECHINVEST Business Group, which has a portfolio of companies and a tech-business incubator called Center for Innovations Development. The Company specializes in seed and early-stage investments and builds competitive global technology companies on the basis of Ukrainian innovations and engineering talent.
According to the Ukrainian Investment Business Association, there are 745 investment funds currently operating in Ukraine, 591 of which are considered “venture funds.” However, according to Loboyko, all of these funds cannot be considered classical or traditional venture funds, in the way they are perceived in the West. In Ukraine these funds are mainly focused on real estate projects with large profits, and on buying out shares in Ukrainian companies; these funds do not invest in high-tech, start-up companies like American venture capital firms which operate, for example, in California’s Silicon Valley.
According to Loboyko, the Ukrainian private equity market is focused on consumer-related industries from retail to banking to real estate development because these industries will show much higher growth in the next five years and will exceed the general GDP growth two or threefold.
“Now it is time to build the Ukrainian Venture Capital Association, which will bring together professionals in private equity and venture capital investment, like EVCA, the European Venture Capital Association,” said Loboyko.
The value of venture investments in the country remains fairly low; according to Schekaturov of Euroventures Ukraine, venture investments in Ukraine over the last ten years have equaled roughly $1.5-2 billion.
Loboyko points out that the Ukrainian government and large financial groups are showing an increased interest in Ukrainian high-tech and venture capital firms.
At the same time, despite the high potential of the high-tech sector, the Ukrainian venture capital industry is underdeveloped and misunderstood by both the government and business sectors.
“The high-tech sector’s potential is still hidden from international technology centers and foreign businessmen know very little about Ukrainian successes in computer science and the aerospace industry. Ukraine is perceived mainly as an agricultural country in the world,” said Loboyko.
The other problem, according to Loboyko, is that international venture funds are not willing to work directly with Ukrainian technology projects because Ukrainian projects place a focus on the technology itself and not on the business aspect.
“USA’s Silicon Valley venture capital companies don’t bother looking for projects from Ukraine, they are bombarded with hundreds of start-up presentations, which adhere to international standards. The Silicon Valley start-ups, besides the technological aspect, normally have an entrepreneur capable of leading an international company, who conducts comprehensive market surveys, creates professional business plans and oversees company strategy,” said Loboyko.
Industry insiders admit that in order to foster the development of the venture capital industry in Ukraine, the Ukrainian government and businesses should start thinking of Ukraine as an integral part of the global economy, eliminate Soviet-style stereotypes regarding scientific development and obsolete models of applying scientific achievements to production methods.
“Industry should believe in the potential of the Ukrainian high-tech sector, stop looking for tax relief from the government, and get rid of the poor habit of imposing big business management models to venture start-ups,” said Loboyko. He advised that the government should follow a scheme that has proven itself worldwide: create special funds that will co-invest together with private venture capital firms in technology venture projects. According to Loboyko, this model has been successful in the US, Finland, Israel, and more recently, in Russia.
Meanwhile, the topic of venture capital investment in the high-tech sector still evokes skepticism among industry insiders.
“In any business, model marketing and sales play a major role and we do not believe there is enough demand for investing in high-tech products in Ukraine,” said Schekaturov, adding that the only success formula for high-tech investments would be to combine product development in Ukraine with strong marketing and sales in the West. Another reason behind such skepticism, said Schekaturov, is the fact that almost no resources have been invested into innovative technologies, whether high-tech or biotech, since the mid-1980s.
“Unless more attention is paid by the government to this area we do not expect any major improvements in this area for the next five to ten years,” said Shekaturov.
“The private equity market in Ukraine will likely repeat the experience of our more advanced neighbors. We should expect more leveraged buyout (LBO) and management buyout (MBO) deals due to consolidations in different industries,” said Schekaturov, giving his short-term forecast of venture capital development in Ukraine.
Many of the new rules related to the coming into force of the Civil Code of Ukraine as of 1 January 2004 are considered positive and create fair and favorable conditions for the development of real estate market in Ukraine. Foreign citizens or legal entities have the right to buy and own property in Ukraine. These property rights are set forth in the Constitution of Ukraine and Law of Ukraine On Property. The law permits owners of property not only to own property but also to use such property for commercial purposes, lease property, keep the revenues, profits, and production derived from its use.
The two sectors of the commercial property market that offer an investor the best potential for growth and leasing yields are grade A office and retail.