Venture capital firms continue plowing cash into promising sectors

June 15, 2006, 1:14 a.m. |
Venture capital firms continue to seek fresh opportunities in Ukraine’s burgeoning economy, which could amount to hundreds of millions of dollars worth of capital injections by private equity investment companies nies into new businesses here over the next several years, as investment risks fall and foreign-investor interest in the country continues to rise.

Pavlo Kazymirov, an associate with the Kyiv-based law firm DLA Piper, a member of the London-based global legal services organization DLA Piper Rudnick Gray Cary, said that the volume of venture capital investments in Ukraine has grown significantly in the last several years, largely due to tax benefits provided by Ukrainian legislation. He said that venture capital investments are regulated by the Ukrainian law on joint investment institutes, or JIIs, which went into effect in 2001.

“In particular, profits received by JIIs as a result of operations with their assets are exempt from corporate profit tax,” Kazymirov said, referring to the legislation.

“This is one of the reasons why large Ukrainian industrial groups are channeling their investments in Ukraine through JIIs.”

Equity and venture capital funds invest in small start-up companies and risky turnaround ventures, whose fortunes they believe they can reverse.

Such funds typically acquire stakes in companies at a relatively early stage and work with the management of those companies until they can be sold to other investors, or listed on a stock exchange through initial public offerings.

Venture-capital investing also often entails risks, but offers investors the potential for above-average future profits.

According to DLA Piper’s Kazymirov, venture capital firms have become increasing willing to take on those risks in the Ukrainian market.

“Looking at the risks facing venture capital investors in Ukraine, we believe they would be the same as for all other foreign or domestic investors. These may include, for instance, general political instability and corruption of state authorities at various levels,” Kazymirov said.

“However, as these symptoms decline, we are observing an increasing number of foreign investors prepared to do business in Ukraine.”

Those words would probably sound familiar to Timothy C. Draper, co-founder and managing partner of Draper Fisher Jurvestson (DFJ), Silicon Valley’s leading venture capital firm, which announced big investment plans for Ukraine’s high-tech sector last July.

“The recent political upheaval known as the Orange Revolution provides the opportunity for a business revolution in Ukraine,” DFJ quoted Draper as saying in a statement last July 21.

The DFJ Network currently includes 20 affiliated venture capital firms with over $3 billion under management, consisting of operations in major technology research and innovation centers throughout the world.

At the time of Draper’s announcement, DFJ said it had plans to attract between $50 and 80 million to finance Ukrainian and Russian high-tech companies through DFJ-Nexus, a venture capital outfit launched by DFJ in partnership with Techinvest, a privately funded, Ukrainian hi-tech venture capital firm.

Techninvest was spun off in 2004 from the Kyiv-based venture group Aventures, which manages one of Ukraine’s largest computer hardware and telecommunications equipment retailers, Unitrade.

Serhiy Loboyko, the founder and managing director of Techinvest, said that the earlier announced DFJ Nexus venture capital fund will concentrate on investments in Russia, while a new venture capital fund being set up between the U.S. and Ukrainian venture capital firms, DFJ Techinvest, will focus on the early and growth stages of venture investments into Ukrainian high-tech projects that are competitive on the global market.

“The decision to form a separate technology fund focused primarily on Ukraine was taken by DFJ to acknowledge the high-tech potential of Ukraine, its scientific and engineering talent, as well as the competence of Techinvest on the Ukrainian high-tech market and its successful pioneering experience in the venture capital business,” Loboyko said.

He said that DFJ Techinvest’s target size is $50 million, with the fund’s initial closing to be $10 million.

Techinvest has already established what Loboyko called a “corporate VC ecosystem”, which involves identifying the best Ukrainian technology projects for venture capital investments through the fund-established Ukrainian High-Tech Competition, the “incubation of technology start-ups” that the fund believes are competitive on the global market and management of the fund’s venture capital investments.

“On the basis of this ecosystem, it [Techinvest] has done successful investments in several IT and nanotechnology companies, competing on the global market,” Loboyko said. Nanotechnology is the development of technology at the atomic and molecular levels.

He said that Techinvest has already pre-selected three projects for DFJ Techinvest out of 130 submitted to the Techinvest high-tech competition, with two being IT projects, and one a nanotechnology project.

“The investment [in these projects] is planned for three to seven years,” Loboyko said. He did not name the companies.

Timothy Draper told the Post in a July 2005 interview that the fund envisioned by DFJ and Techinvest at the time would probably invest around $40 million into Ukrainian high-tech firms in the near future.

“Because the venture capital business is one where you make 10 investments, and then one or two might make 10 or 100 times the money,” Draper had said.

“Since that’s the case, we would want investors to be well diversified. It [the fund] will make investments that are relatively small to start with and we’ll see how the company will grow.”

Loboyko said that the venture capital industry in Ukraine is still “very undeveloped,” with the main problem for Ukraine’s high-tech sector being the absence of a venture capital ecosystem “necessary for nurturing technology products attractive for commercialization and VC investments.”

“The prerequisites for creating such an ecosystem – a so-called Ukrainian Silicon Valley – are a critical mass of businessmen and entrepreneurs who believe in the potential of high-tech technologies and are ready to invest in them. Government support – for example, in establishing technology centers in major Ukrainian cities – can dramatically speed up the process of developing an ecosystem,” he said.

As for the investment possibilities and the ‘business revolution’ opened up by the Orange Revolution, Loboyko called it “tremendous international PR for Ukraine,” and nothing more.

“The expectations of investors were not fulfilled after the revolution,” he said.

“Political instability and the lack of a clear strategy for the development of the country harmed the investment climate in Ukraine.”

Making headway in other sectors, such as financial institutions and fast-moving consumer goods, is Horizon Capital, a private equity manager formed earlier this year from Western NIS Enterprise Fund (WNISEF) employees.

Horizon Capital currently manages two funds – WNISEF, with $150 million funded by the U.S. government via USAID, and Emerging Europe Growth Fund (EEGF), a $150 million target fund.

“Our investment strategy is to identify companies with potential to grow quickly, secure market leading positions and deliver above-average returns, and to provide them capital and know-how to meet those goals,” said Horizon Capital Managing Partner Natalie Jaresko.

Jaresko said that typically Horizon Capital invests $13-15 million, taking equity positions in mid-cap companies in sectors that will benefit from the region’s growing purchasing power, focusing on the consumer goods, financial, retail and light manufacturing sectors.

With regard to EEGF, Jaresko said that Horizon Capital had their “first close in February [of this year] at $45 million,” and that the fund currently has four investments in its portfolio. These include IMB Group (combined entities of International Mortgage Bank and Favorit Capital, a consumer lending intermediary); Ergopack, a kitchen disposables manufacturer; Moldovan vegetable and fruit processor Natur Bravo; and Shostka, a cheese manufacturer.

“We have a full pipeline of additional deals at various stages of negotiation in the sectors of our primary interest: fast moving consumer goods (FMCG), financial institutions, retail, media and manufacturing,” she said.Horizon Capital’s other fund, WNISEF, has invested in small and medium-sized businesses in a number of industries, including FMCG, industrial goods, retail and distribution, and financial services, and invested over $114 million in 29 companies since its inception in 1995.