Call it an economic virtual reality.
Over the last three years, while the rest of the Ukrainian economy struggled due to the turmoil generated by Russia’s war in the Donbas, the information technology sector, as if in a world apart, has been continuing to power up.
Just last year, at least 86 investment agreements were struck between backers and Ukrainian tech companies — the highest number since Ukraine became independent in 1991.
Most of these investment agreements — 73 out of the 86 — were made with startups at the seed stage, meaning those that have prototype products and are just starting operations on a market. There was only one deal involving a tech company at the Series B, or post-development stage, while the agreement details of the other 12 deals remain undisclosed.
At the same time, the total amount invested in Ukrainian startups in 2016 ($88 million) was 33 percent less than in 2015, even though 22 more deals were closed. The average investment in deals dropped to $1 million.
According to Andrey Kolodyuk, a managing partner at venture firm AVentures Capital, the sector attracted less money in 2016 than in previous year because there were several one-off, large-growth stage deals back in 2015, including the acquisition of Odesa facial recognition app developer
Looksery by U.S. messenger company Snap Inc. for a record $150 million.
Overregulation
Not all of the investment in the sector came from abroad: AVentures Capital, TA Ventures, TMT Investments and Digital Future are among the most active Ukrainian investment companies, according to online tech journal AIN.ua. In total, the country has five incubators and accelerators, one corporate fund, 17 venture capital funds and eight private equity funds.
Still, around 60 percent of all the deals closed were with foreign partners, while foreign capital accounted for 80 percent of the total investment volume in 2016 (not counting undisclosed agreements), according to Kolodyuk.
“(Such a share of foreign capital) is the best indicator that the business climate in Ukraine is improving,” the investor says. “It’s a signal to the whole world that it’s possible and necessary to invest in Ukraine.”
Denis Dovgopoliy, the managing partner of GrowthUP Group, a tech sector development company, agrees that Ukraine’s IT sector is on the up, but cautions that compared to Europe and the United States, growth is modest.
“And we still have an overregulated economy,” Dovgopoliy said.
“Thank goodness that the number of searches (at the offices of) IT companies has gone down,” he went on, referring mainly to the period in late 2015 when Ukrainian law enforcement launched numerous surprise raids on tech companies, saying they were looking for “suspicious data.”
The heavy-handed way law enforcement conducted those searches either partially paralyzed some tech companies or brought them to a complete halt.
And while the companies were publically accused of spreading pirated content, tax evasion, hacking and even terrorism, none of the searches is known to have led to any criminal charges, or even a criminal investigation.
However, the searches did spark a damaging conflict between the managers of top Ukrainian tech firms on one side, and the Ukrainian Interior
Ministry and the Security Service of Ukraine, known as the SBU, on the other. Some tech companies even moved their offices abroad as a result of the raids.
Legal bugs
Apart from harassment by law enforcement, the tech sector also has to deal with an out-of-date legal and regulatory environment — Dovgopoliy points out that Ukrainians still can’t legally incorporate a company abroad, and that much of the Ukrainian legislation on companies dates back to the times of the Soviet Union.
“(The legislation) was revised (when adopted after independence), but in a minor way,” he says.
A radical legal upgrade is needed, Dovgopoliy believes — the government should either completely rewrite all of the laws, or copy English company law, he says.
“Unless (the legislation) is in order, I don’t believe there will be any (great) investments in our local market.”
The figures bear him out — in almost all cases when investors put money into Ukrainian startups, they expect the tech firms to operate globally, focusing on markets much bigger than the Ukrainian one. That’s true for all of the big names: Sixa, Mobalitycs, Concepter, Kwambio, Petcube, People.ai, Allset and many others.
“The local market’s dead,” Dovgopoliy said, adding that Ukrainian startups tend to target the vast and non-fragmented market of the United States.
“I don’t know a single serious startup that would be a (purely) Ukrainian company.”
And while Ukraine is a great place to hire talent, it’s at a disadvantage compared to other tech hotbeds in the region, such as Estonia, because of its poor international image and reputation for pervasive corruption, which tends to scare off potential investors, Dovgopoliy said.
“Regarding the pool of talent and the cost of labor, Ukraine is a good place to develop a tech company,” he says. “(But the negative image) puts people off. That’s why most startups try to conceal their Ukrainian roots.”
According to Dovgopoliy, this is unlikely to change within the next five years. Until then, Ukrainian companies will continue to base their development operations in Ukraine, while headquartering abroad.
Meanwhile, the talent pool in Ukraine keeps on growing. One of the leading Ukrainian freelancing platforms, Freelancehunt.com, had 165,000 registered users by the end of 2016 — three times more than it had in 2015.
Vladyslav Kryveshko, the founder and CEO of another popular freelance platform, Proffstore, thinks the amount of freelancers will continue to grow.
“Above all, this is because of the economic situation in our country,” Kryveshko said. “Prices are going up, wages are not.”
As a result, Kryveshko said, more Ukrainians have started to earn money on the side — by freelancing.
At the same time, top outsourcing firms are continuing to take advantage of Ukraine’s skilled yet inexpensive IT workforce. As of the end of February,
Ukraine’s 50 biggest software outsourcers together employed almost 43,000 people, according to the report by software developer community DOU.ua.
The largest employer within the industry is EPAM, which has 4,600 staffers in five Ukrainian cities. The second and the third are SoftServe and Luxoft — with 4,491 and 3,700 workers respectively. All three are firms with global brand recognition.
Meanwhile, at the beginning of 2017 some 13 Ukrainian outsourcing companies won places on the International Association of Outsourcing Professionals (IAOP) annual list of top tech firms — the Global Outsourcing 100.
Those listed are either subsidiaries of international tech companies that have research and development, or R&D offices in Ukraine, or are purely local IT firms.
The ranking included EPAM, Luxoft, Ciklum, Intetics, TEAM International Services, and Softjourn, all of which have R&D centers in Ukraine. The six local Ukrainian firms are N-iX, SoftServe, Program-Ace, Eleks, Miratech, Softengi and Sigma Software.
According to PWC, the Ukrainian market of IT outsourcing has every chance of growing to be worth $5–7 billion in the near future.
However, AVenture Capital’s Kolodyuk still thinks tech startups will be the main driver for future investment in Ukraine’s IT sector. He reckons there are at present about 3,000 startups in Ukraine working in a range of areas and at various stages.
“We believe not only that the number of projects will grow, but that their quality will evolve as well, attracting more investors to do deals with our entrepreneurs,” Kolodyuk said.
