Cover Story (#10 October 2019)

The Next Level

Private equity investments have for a long time been playing an important role in developing Ukrainian businesses and taking them to the next level, while venture capital is on the rise with some landmark Ukrainian companies becoming global players in the high-tech sector. In fact, both private equity and venture capital have reached the level where each can be defined as a separate industry.

In order to discuss the development of these industries in Ukraine and their perspectives, we met with the Ukrainian team of the CEE legal powerhouse, Wolf Theiss, and its Ukrainian team headed by Taras Dumych, managing partner of the firm's Ukraine office, along with senior associates Oksana Volynets and Sergii Zheka.

UJBL: What is the strategic vision of venture capital (VC) and private equity (PE) funds for Ukraine?

Taras Dumych: The strategy vision of both VC and PE funds is to actively look for and be ready for all sorts of opportunities. It relates to potential new investments, developing and creating synergies for existing investments as well as for exits from investments. While Ukraine continues to be among high risk countries, this concern is mitigated either by the expected return on investments, when the cost of entering the country is reasonably low, or by the synergies factor when investments in Ukraine are made with the view of combining Ukrainian operations with operations in other countries. The latter is pretty much part of the globalization process in VC and PE investments, and the good news is that Ukraine is not out of the process. At the same time, the funds are closely watching reforms in Ukraine, as the implementation of real reforms will be a win-win situation for both Ukraine and investors.

UJBL: What avenues are available for VC funds to invest in Ukraine? Are there any specific acquisition issues?

Oksana Volynets: Traditionally, venture investments come as participation in the equity, investment loan or convertible loan. While often, or even traditionally, financing of venture investments in Ukrainian projects is structured at the offshore level, these forms of investments are now gradually becoming available onshore in Ukraine. The adoption of the law introducing shareholders agreements, or as they are called in Ukraine corporate agreements will be a helpful tool to make these avenues work better in Ukraine. The new corporate legislation provides, among other things, for more flexible corporate governance rules, better protection for minority shareholders and standard corporate instruments, such as options, irrevocable power of attorneys, etc. The recent reform of Ukrainian currency control regime and relaxation of various currency control restrictions should create more incentives for cross-border deals.

However, as in most cases, the focus of VC investments is internationalizing the investment target and its business, the effective use of multinational corporate structures and their combination with Ukrainian operations will be an important factor for both the founders of businesses and VC funds.

UJBL: What impact is expected from PE investors, and how is it balanced with the PE investors own expectations?

T.D.: Quite often PE investors, in addition to acting as investors, also act as joint venture partners for the founders of businesses. Thus, the founders naturally expect PE investors to help increase the value of the portfolio company and its business. This could be done by bringing new technologies, gaining the ability to enter new markets, improving the bankability of the company and attracting debt financing and by bringing onboard executives and managers whose contribution to valuation increase would be essential.

Nowadays, PE investors are also expected to make a contribution to society and not to disregard corporate social responsibility. For a company that has a PE investment, being a good corporate citizen will pay off for society, the company and its shareholders.

As to the PE investors expectation, they expect the founders and the management of the portfolio company to stay engaged and committed to implementing the business plan and developing the business as well as to running the affairs of the company in such a way that it will pass due diligence of financiers or other investors. Finally, PE investors expect founders to stick to their commitments and obligations at all stages of the investment cycle as agreed in the shareholders agreements, including to jointly exit from the company by selling it to another investor.

UJBL: How can a company become an attractive investment target for VC funds? Quite often there are legal tips that founders of target businesses need to follow, arent there?

Sergii Zheka: Of course, the companys financials, its products and services, business plan and the team behind a business play by far a major role when it comes to investment decisions by VC funds. When it comes to products and services, these should obviously be far beyond the stage of an idea and be at least implemented as a testing-stage product. However, the legal aspects of the targets activities are also important (or sometimes even crucial), especially if we are talking not about a startup, but an established company that wishes to attract VC money.

The better the founders of businesses are prepared to either pass the due diligence standards of VC funds or cooperate with them with the purpose of implementation of the VC funds expectations, the higher will be the chance for a VC fund to make an investment and for the founders to justify the higher value of the target at the actual VC investment stage.

Depending on the purpose of the investment, VC funds expect the target to clear upfront all important legal questions relating to future investments in the research and development of products as well as marketing (e.g. any licensing requirements, permits for import of equipment, etc.).

When it comes to investments, the expectation of VC funds is that most, if not all of the investments, will be spent on further development of the product and business rather than the founders cashing out.

Last but not least, the target should have its rights to key assets, especially intellectual property, properly secured and should not be subject to any challenges from other parties that could jeopardize the product and business.

UJBL: What economic sectors are specifically on the radar of VC funds, and why? Do you observe any shifts in their investment targets?

O.V.: VC funds naturally focus on high-tech and IT sectors, which relate to both B2B and B2C areas. Quite often the main factor that stands behind the decision to invest in a business or a product is the prospect of taking the product beyond the boundaries of Ukraine or even beyond the regional boundaries in Europe. This corresponds to the same principle that US VC funds follow in their investment decisions.

We note that the continuing trend of recent years is its focus on innovative technology projects. According to the report by the Ukrainian Venture Capital and Private Equity Association, the most attractive sectors in terms of deal numbers in 2018 were online services, software, and hardware. Depending on the economic situation in Ukraine and globally, this trend is most likely to continue with e-commerce, artificial intelligence, machine learning, biotech and med-tech attracting further interest from VC funds.

UJBL: Perhaps you could share with us a VC and PE investment success story in Ukraine/CEE?

T.D.: Absolutely. In my view, the factors to be used to evaluate the successfulness of VC or PE funds are return on investments that the funds make at the time of their exit; valuation of a portfolio company at the time of additional investment rounds; the investment in a portfolio company, particularly if it is done in the course of competition with other VC and PE funds; and the amount of funds or investor commitments that VC and PE funds raise from their investors.

Let me start with the last point. In current conditions it shows not only the trust of investors in a particular fund, but also investors trust in a country. The news about Horizon Capital raising USD 200 million for their new fund in the beginning of this year is an absolute success, as it is the largest Ukraine-focused fund, and is a definite sign of investors confidence in both Horizon Capital and Ukraine.

As to the most recent exits, which are at the same time successful investments for new investors, the transactions of Dragon Capitals private equity arm may serve as a really good example of investments and success stories for Ukraine. Dragon Capital recently exited its investment in Chumak, one of Ukraines landmark food production companies, to Delta Wilmar CIS, which is a great example of a sale to a strategic investor. In a different transaction, Dragon Capital acquired the Aladdin Shopping Mall from Meyer Bergman, an international private equity firm. That was a landmark transaction as it was the first real estate investment in Ukraine that secured warranty and indemnity insurance from a major international insurance company, and Wolf Theiss was pleased to act for the insurer and help all the parties involved to successfully close the transaction.

On the VC investments that have a Ukrainian nexus, I would particularly mention two VC funds and their investments. The first one is the investments made by AVentures Capital (together with other VC funds) into now internationally renowned start-ups like Petcube, depositphotos, DivanTV and others. The other is SMRK VC Fund, which was the pioneer investor into AJAX a wireless security system producer and Allset a restaurant reservation and pre-ordering service which, at later investment rounds, also attracted investments from the Silicon Valley legendary fund Andreessen Horowitz.

UJBL: How do VC funds and PE investors raise money for their investments in Ukraine, and what is the impact of Ukrainian law on this process?

O.V.: When it comes to the funds that PE and VC firms manage, they are all structured abroad in jurisdictions that have the necessary regulatory framework for the funds. These include various UK jurisdictions, Cayman Islands, BVI, Luxemburg and various US states. The investments into those funds come from a variety of investors, including pension funds, endowments, high net worth individuals, institutional investors, family officers and other investors, acting in those funds as their limited partners.

In addition to using raised money, PE funds (rarely VC funds) turn to various lending institutions. In this case, debt is usually provided directly to portfolio companies either as bank loans or as bonds placed and traded on international public markets.

As to the impact of Ukrainian law on these processes, first of all, investments in Ukraine or Ukraine-based businesses need to be referred to in the prospectuses of funds, or at least Ukraine must not be excluded from the countries where investments may be made. I believe that further implementation of reforms in Ukraine should prompt more and more PE and VC funds to include Ukraine on their investment radar screens (and, therefore, prospectuses).

Ukrainian law also plays a crucial role when it comes to raising debt financing, as it should create comfort for lenders concerning security and safety of their loans and help lenders meet bankability criteria.

UJBL: What other legal issues affect VC and PE investments?

S.Z.: New issues and relevant regulations in the area of compliance, data protection, anti-money laundering, anti-corruption measures have started playing a more significant role in the business and investments of VC and PE funds. It concerns both the level of the funds and the level of their portfolio and investment companies.

Not only are these matters implemented once the investments in the portfolio companies are made, but also PE and VE have started examining these matters and the related risk at pre-investment due diligences.

In addition to pure legal issues, investors are also increasingly wary of cyber attacks which can inflict significant damages on businesses that become more and more IT-dependent, including even agricultural producers who have increased applying modern technology for land cultivation. However, these concerns open an opportunity for companies working in the area of cyber security and standing to benefit from the increase of their customer base. As a result, such companies have become an attractive target for VC and PE investors.

UJBL: Is Ukrainian law and the business community, in general, well prepared for these types of investments?

T.D.: Not only is the Ukrainian business community well prepared for VC and PE investments, but Ukrainian PE funds have also become major players in Ukraine, while Ukrainian VC funds have already reached the level of international players. Though Ukrainian VC funds are, so far, certainly much smaller than their peers, say, in the US, their investments have already started attracting the attention of funds in the US. As a result, one could see US VC funds partnering with Ukrainian VC funds at later investment rounds.

Another example is when Ukrainian subsidiaries of larger international groups play their role in the investments relating to these groups. Many international high-tech and IT companies have important operations in Ukraine and sometimes even depend on their Ukrainian operations. Thus, the success of such Ukrainian outposts and their ability to pass due diligence often impact investment transactions on the group level outside of Ukraine.

The Ukrainian VC and PE community is also active in developing business standards and best practices in Ukraine, as well as promoting investment opportunities in Ukraine. There are a number of business associations that are active in this area. I would like to particularly mention the Ukrainian Venture Capital and Private Equity Association (UVCA) founded by leading Ukrainian VC and PE players and other businesses. Wolf Theiss has the privilege of being one of the co-founders of UVCA.

As to Ukrainian law, both VC and PE funds, together with their legal counsels, have found a way of working in the existing legal framework and combining it with the law of other countries, such as English law, so that significant investments are possible. I am optimistic that the current overhaul of Ukrainian law will improve the attractiveness of our legal system and investment opportunities in the country.

UJBL: Based on your experience, what drives the decisions of VC and PE funds in their selection of legal counsels?

T.D.: VC and PE funds, like any other client, take into account various factors when deciding on legal counsel to handle their investment transactions. Particularly, these types of clients tend to focus less on the features of law firms and more on the benefits and value added that they can receive from the work with a particular legal counsel. By this I mean a clear understanding by lawyers of the business side (and not just the legal side) of the transaction, the ability to minimize or eliminate risks, to work closely and intensively in helping VC or PE funds to efficiently negotiate, structure and implement their transactions.

I was pleasantly surprised when an executive of a PE firm that we work with shared with us that one of the factors that influenced their decision to work with Wolf Theiss was client feedback in a leading international legal directory stating that Taras Dumych is a reputable guy. According to this executive, working with a Ukrainian lawyer described as a reputable person was a decisive factor for the PE firm to start a relationship with our law firm.


Key Facts
Wolf Theiss

Year of establishment: 1957

Office in Ukraine since: 2009

Number of offices in CEE and SEE: 13

Number of partners/lawyers: 73/340

Number of partners/lawyers in Ukraine: 1/6

Core practice areas:

  • Corporate and M&A
  • Banking & Finance
  • Private Equity
  • Venture Capital
  • Dispute Resolution
  • Real Estate
  • Competition & Antitrust
  • Energy
  • Employment
  • IP/IT
  • Tax
  • Compliance
  • Corporate Investigation
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