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вторник, 7 октября 2014 г.

Changes in the Ukrainian venture market during the first 9 months of 2014. A blessing in disguise?

(версия на русском http://dennydov.blogspot.com/2014/09/9-2014.html)

The current situation is that there is a war in Ukraine. Taking this into consideration, we can observe several factors which influence the economy: 2 rounds of elections make it impossible to make any forecast, as it is not yet known what will happen in the Verkhovna Rada after the elections. The main point is that the climate for consumers has worsened as:

· The amount of money in the economy is insufficient
· People are spending far less on nonessential items. Their needs fall low on Maslow’s pyramid, which has reduced the demand for innovative products.
· The public has borne responsibility for maintaining the army, which has resulted in a reduction of retail turnover totaling 800 million to 1.5 billion hrivnas (according to estimates from specialists) in favor of purchases connected with supporting the military. Many people spend their time volunteering, which is not profitable for them and impairs payable demand.
· Dependence on imports and a weaker hrivna (relative to the U.S. dollar) negatively influence the retail index, particularly e-commerce. The volume of sales has also decreased, while the rest of cash flow actually fell by 50%.
· A lot of companies have begun to reduce expenditures on wages (most of them even did not revise wages in hrivnas) or to dismiss employees, including those who are highly-paid.
· The majority of startups are founded by men of military age and, in the event of an expansion of the war, their employees could be conscripted to the front, which can, at a minimum, cease project development.

In view of the aforementioned information, we will observe the changes that have occurred during the first 9 months of 2014

Startup Market

· During a crisis, the quantity of startups traditionally increases, which we observed in 2008. The current situation is similar. The idea is that, if enough of a certain type of people lose their jobs, they will decide to launch a new project instead of seeking new work in an adverse market. This effect has nearly doubled the quantity of startups created in Ukraine.
· Resources have become cheaper, which enables businesses
to do more with the same amount of money during times of crisis (excluding trends seriously impacted by the exchange rate of the hrivna).
· There has been a change of proportions in the market. If there were 9 locally-oriented startups for one globally-oriented startup from 2007-2013, then the Ukrainian economic crisis shifted this ratio towards 1:1 (for startups created in 2014). Many startups changed their focus from the Ukrainian to European market or refrained from expansion to Russia, in favor of Europe.
· The share of B2b and b2b2c startups has increased. It is connected with the corporate sector, which has started to reduce work positions. Those who lost their jobs or have seen decreases in pay have begun to create startups in high-profile industries. We have witnessed a number of enterprise-oriented startups emerge.
· The share of startups on hardware has also increased, but this is not connected with the crisis. Rather, this is connected to the global trend which also spread for Ukrainian engineers in hardware industry, consumers’ hardware industry and this potential of engineers which we have in our country now begins to generate startups.
· Startups on conversion. Due to the difficult economic situation, the share of startups in conversion industry in e-commerce has increased. Any startup which can increase conversion for online retailers is able to increase its turnover and income accordingly. There is a certain demand for the services of such startups, which encourages people to create startups in this industry. The friendliest situation for such startups is in the European market, where e-commerce is very fragmented and competition between local companies is very high, as they are stressed by large American and Asian players (Amazon, E-bay, Alibaba, Deal Extreme).
· On average, the rate of startups created has decreased. As a result of the crisis, risks have increased and the rate of startups created has thus been affected. However, the rate of quality projects created has increased as a result of a large amount of investors entering the market. In a startup market with low risks and quality projects, there is competition between investors for the opportunity to make an investment.

Angel Market

· The quantity of angels always rises during a crisis. This is connected with risks in traditional economics, which also rise relative to risks in the technology sector. Herewith small investors lose objects for potential investments. During a crisis, private investors do not invest in real estate, which is why people who have between $50,000-200,000 have nowhere to invest. Some of them save their money, while others travel or spend on their family. However, the quantity of people who begin to invest this money in startups also greatly increases and we now witness 300% growth.
· Some experienced lead-investors have joined angels within the past year and deals are being initiated. On one hand, this practice contributes to a decrease in the risks borne by lead-investors, as well as inexperienced angels (they rely on the expertise of others). On the other hand, it allows for sharing experience and access to interesting projects for investors who are new to this field.
· The practice of syndication does not scare people off and we have observed that 70% of deals have been made by two or more angels. In the market, convertible debt has become the standard instrument of investment into startups over the past year. As apotheosis of the aforementioned, the association of UAngels has entered the market within recent weeks. This association unites those angels who plan to invest or already invest in technology companies.

Accelerator and incubator market

Accelerator and incubator markets have also changed within the past 6 months.

· Under the new circumstances, several accelerators and incubators have left, while others have changed their models (sometimes dramatically).
· New accelerators and incubators with specialized expertise have entered the market and there are plans to open several more. Accelerators from Europe and USA have increased their presence in this market. It is connected with the growth in value of expertise in international and local markets, which could be helpful for the creation of startups with limited experience in the global market. Therefore, our startups are going to go to Europe and America to get such experience. Within the past 9 months, more than 10 Ukrainian companies have completed or are in the process of completing incubation and acceleration programs in Europe, the United States, or Asia.

Russian money

Before the crisis, Russian investment significantly impacted the Ukrainian market, but political circumstances have caused this funding to flee.
· Excess offers. But presently part of Russian money arose in Ukraine due to changes in the Russian market and Russian internet projects which have become very unattractive. We have received excess offers, which are partly unclaimed from startups attracting seed or round A funding.
· Unacceptable for international projects. Russian money has come to be considered toxic globally, which may prevent further rounds from being raised when it applies to new global projects.
· Nevertheless, together with our partners from Europe and the United States, we have found 7 funds from Russia. Their money can still be invested in and have value for startups, while not preventing them from attracting further rounds of investment.

Corporate investors

Corporate projects I have observed in the Ukrainian market (there is also a separate post about this):
· FIG (financial and industrial group) observes the industry and searches for investments starting from $20 million. There are no such investments in the local market, so they are searching globally.
· Ukrainian FIGs are searching for possibility of investing with venture funds from Europe and the United States. They do not have expertise, so they are interested in investing with venture funds so that they have the possibility of a definite yield. They have very high requirements to these funds and such deals are not structured but I know about several negotiations.
· FIGs invest in global, pre-IPO startups. There was a precedent when one of Ukrainian FIGs invested in the Alibaba IPO and was very happy with the result.
· Corporate incubators appear and try to develop the projects. They are frequently specialized and do not function as accelerators. They will also likely undergo changes in the near future.
· The main purpose of these investments is the investments in the projects with independent from countries legislation infrastructure. The war influenced that very much. Many domestic oligarchs realized that, during times of trouble, they have no opportunity to secure their assets, for example, in factories, which could be invaded or destroyed during hostilities. Therefore, they are searching for projects where such risks are minimal and it was revealed that virtual economics and internet projects, including e-commerce, have such characteristics.

European money

The main problem of European money is that it could be invested neither in Russia, nor in Ukraine, and most often invested in the regions.
· Search for alternatives for Russians. They have no mandate in Russia, as they observe the CIS (former USSR) and Western European regions. As a result of sanctions imposed on Russia as a result of its role in the conflict with Ukraine, they became toxic.
· Considering the possibility of falling under further sanctions, almost all Russian FIGs have nearly ended deals with Russian projects in technology sector. Accordingly, part of this money searches for applications in its region. As Russia has withdrawn from a pool of countries which also consisted of Ukraine, Belarus, Moldova, Uzbekistan and Kazakhstan, the most developed technological market becomes Ukraine. That is why the part of this money with high tolerance to the risk is ready to be invested into technological projects with traditionally high country risks which do not really scare the investors coming to our country to invest. Here, investors have split into two groups: the first expects uncertainty connected with the indefinite length of the armed conflict and its impact on economies.
· The second group is now gradually getting into the projects. There are several deals which already structured in the market, one of which has already been completed, but not announced. This is connected to the fact that investors can get the minimal rating of the project in crisis and get into the project on the most comfortable conditions. Therefore, those investors who are open to the risk keep investing and, nearly every week, the representatives of European venture funds negotiate actively or observe the projects in our market.
· Also, funds which widely observe the technology sector, including infrastructure projects, have been created. I am aware of the creation of 3 funds, at minimum, with pools of investment totaling $1,5 billion. They are focused on purchasing distressed assets in the field of IT-infrastructure. They also look for later-stage startups and for major E-commerce players. At the same time, there is a political will from the side of EU leaders, who have strongly recommended to private and state venture funds to actively work with Ukrainian companies.

American money.

The position of American investors has hardly changed.
· American investors always consider Ukraine a distant country and Ukrainian projects promising only in the event that they relocate to the US. In this respect, the situation remains the same. The only change is that increased risks stemming from the political crisis affect ratings and such projects with R&D departments in Ukraine, especially in the regions close to ongoing hostilities, could be revised downward. I am currently aware of only 3 such deals. The details of how the rating was revised downward will only be revealed in the upcoming 3-4 months.

Local seed funds

Finally, we arrived at a point in time when local seed funds have begun to spring up like mushrooms overnight.
· At the moment, we have 8 structures which make investments connected to projects acceleration or incubation including corporate or strategic.
· At the same time, 8 corporate or private seed funds have appeared in the past 6 months. They invest from $100,000-500,000 in startups.
· Currently only 22 such structures operate in this market.
· The main problem seed funds face is a lack of qualified staff capable of providing a selection of projects, forming deal flow, conducting due diligence, and conducting deals. Thus, the demand for such specialists will rise, but currently a majority of seed-funds unfortunately do not realize that attracting employees from their present business without experience of rating or investment into the projects will lead to elaborations in the near future and there is a possibility that the elaborations will last for 3-5 years.

Local funds

· New local funds, meaning funds which invest from $1-2 million, have not been created. There are only a few existing national funds and we work closely with 2 of them.
· Provisional family offices look for the possibility of deals. Anyway, these deals can be referred to corporate ones because, while they are created by private money from specific individuals, they are made within FIG.

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