Mykola Minchenko raised $5 million for his promising tech startup and fled.
Minchenko’s investors had enjoyed frequent communication with him for several years, received regular financial reports and thought they were about to hit a jackpot with Minchenko’s startup Sixa, which was projected to be worth millions of dollars.
Six months ago, however, Minchenko fell off the radar and no one knows where he is.
Oleksii Vitchenko was one of the Minchenko’s investors. He gave $400,000 to the Ukrainian Houdini. For Vitchenko’s fund Digital Future, which has invested a total of $6 million in different startups over six years, the investment was significant.
“At some point, something went wrong. The founder stopped answering and vanished,” Vitchenko says.
Although he was taken aback by such brazen deceit, he’s not going to be deterred from investing in Ukrainian startups.
“This isn’t the first money I lost. Being a venture investor, you should be okay with losing money,” he says.
Venture capital financing has always been high-risk, but such outright deceit happens rarely, Vitchenko says. Ten other investment funds that comprise the Ukrainian venture market seem to think the same way.
Over the last seven years, these investors have put $1.5 billion into 800 local tech startups. Only five startups have been sold, while others are either still maturing or have already gone bust. Few investors, if any, have returned their money.
Despite this gloomy statistics, however, local lenders don’t despair. Having made their first investments in Ukraine’s tech sector, they believe they have prepared the local startup community for big international success. Once more successful startups begin to appear, foreign bankers will turn their eyes to Ukraine and the local venture market will take off, they think.
Running venture funds
A venture fund is a business. In essence, the venture capitalist buys a stake in an entrepreneur’s idea, and when the entrepreneur’s startup is sold, the fund gets paid for its stake and exits.
For a fund to make money on this, startups should grow to be worth hundreds of millions of dollars. Acquisitions for under $30 million can’t return invested money in most cases, because by the time a startup is acquired, investors usually have about 2–5% of shares. So if an investor put in from $600,000 to $1.5 million, it would almost always mean a loss.
“This is hard work to be a professional venture capitalist,” says investor Andrey Kolodyuk.
The profession is about funding, consulting, networking and risking like no bank is willing to, he adds. Banks don’t invest in high-risk ventures with no hard assets against which to secure the debt. Many startups are information-driven and have few hard assets.
Kolodyuk’s venture firm AVentures Capital has invested about $10 million over the last eight years (average investment: $500,000). And the fund has helped its startups raise $150 million from other lenders. Its portfolio startup Petcube, for example, has raised a total of $14 million over the last five years, $9 million has come through AVentures networking.
When investors put money into a company, they expect it to grow, attract more investment, and then grow more — until a corporation notices, acquires it and merges with it. It’s like when U.S. tech firm Snap paid $150 million for Looksery, a Ukrainain startup. Only, few make it like Looksery did. Statistically, nine out of 10 startups fail. To increase their chances, there just must be more attempts, says Kolodyuk.
Currently, Ukraine has about 5,000 active startups, about the same as in Israel. But there’s much less venture capital in Ukraine. While only 800 startups have ever gotten funded in Ukraine, Israel had 520 funding deals in 2019 alone.
Ukrainian startups are more cautious and grow slower, Vitchenko believes. His Digital Future fund has already been working for six years, but hasn’t broken even yet.
“Six years have passed and I’m asking myself if it’s profitable for me to keep investing. I don’t have an answer yet.” While the lifespan of a profitable venture fund — the time from creation to profitability — can last just seven years in the United States, according to the Harvard Business Review magazine, Vitchenko feels it takes twice as much time in Ukraine.
“Investing is wonderful. You learn a lot. It enriches your world,” Vitchenko says. “With time though, you sober up… Perhaps I should wait for six more years to start making conclusions.”
Kolodyuk agrees: “Companies aren’t created overnight. It takes decades to build a sizable (venture) business.”
His AVentures — with $10 million invested since 2012 — hasn’t broken even yet either. The fund has only exited two of its 15 startups, almost tripling its invested sum. Right now, AVentures is getting ready for three more exits.
Tech only
Venture investment isn’t only about information technologies, but it is tied to innovation in business. And innovations are usually driven by technologies, automation and software. Today 90% of venture investment is about technologies, industry players estimate.
“Software is eating the world, and while it does so, we invest in it,” Vitchenko says. “In IT, there are more opportunities, quick growth, something quite impossible offline.”
Quick growth seems to be a distinct feature of IT. Twenty years ago, technologies didn’t play any role in Ukraine’s economy. Today, however, IT secures 4% of the gross domestic product of Ukraine. Ukrainians exported $2.4 billion worth of IT services in 2019, the State Statistics Office reported.
“In other countries, tech industries grew with support from governments, but not in Ukraine,” Kolodyuk says. Instead, IT has been built “without any government money — it’s all about our people.”
But most of that isn’t startups. Up to 90% of Ukrainian techies work for outsourcing companies as contractors, writing code, creating websites and mobile applications for foreign firms, frequently under non-disclosure agreements.
Perhaps content with their average $2,000 monthly wages, four times as much as the average across Ukraine, very few tech specialists work on their own startups.
But creating products with low added value for someone else won’t help turn Ukraine into a startup nation, investors say. While Israel boasted over 550 exits over the last 10 years, there have been only five in Ukraine. Israeli exits brought $70 billion, Ukrainian — $540 million. The population of
Ukraine is 4.5 times larger than Israel’s.
The reason for such a difference is that entrepreneurial culture in Ukraine is still too young — startups started to appear only 10 years ago, according to Olga Afanasyeva, head of the Ukrainian Venture Capital and Private Equity Association, or UVCA.
“There was little information and little knowledge about… how to launch a startup, build a company, attract investment, start selling something across the world,” Afanasyeva says. She thinks the situation will improve when there are more success stories. “All in due time.”
Venture capitalists buy a stake in an entrepreneur’s idea, and when the entrepreneur’s startup is sold, the investors get paid for their stake and exit. Such investors risk like no bank is willing to, but if the startup they put money in is worth a lot, they can hit a jackpot. (Kyiv Post)
Startup mafia
In order to have more startups, there must be more investors. But investors will only come if there are many startups — a catch‑22, which Vitchenko thinks can be broken by one big success — a chiefly Ukrainain unicorn, a startup valued at more than $1 billion.
Once the founders and investors of such a startup make a fortune and attract attention by doing so, Ukraine will see more startups and investment inflow.
“We need our own PayPal Mafia,” Vitchenko says, referring to a group of former employees and founders of the U.S. online payments firm PayPal who each made a fortune after eBay bought the startup for $1.3 billion in 2002. These people have since founded tech companies such as Tesla, LinkedIn,
SpaceX, YouTube, Yelp and Yammer.
“They earned money and went on investing further,” Vitchenko says. “Until Ukrainian investors make money on a unicorn, there won’t be any mass inflow of foreign investors. There will only be loners like me.”
PayPal isn’t the only example of a company creating a buzz around its founders, investors and origin country. Estonia is known for its Skype, Sweden — for Spotify, France — for BlaBlaCar, and so on. Ukraine, in turn, has no unicorn to brag about.
There are Ukrainian-created startups worth $1 billion — Grammarly, GitLab and People.ai — but they are legal entities in the U.S., as are nearly all startups born here. According to UVCA’s Afanasyeva, they move because of Ukraine’s corruption, weak copyright laws and flawed judicial system.
All the same, despite challenging conditions inside the country, investors believe they have managed to create a “tech ecosystem” in Ukraine with mentors, a network, capital and promising startups. Now, success stories seem to be just a matter of time.
“We have weeded and sowed,” Kolodyuk says, “now we need to wait until startups mature to collect the harvest.”
Pitching Ukraine to foreigners
When pitching their startups to foreign investors, there are at least three benefits Ukrainian startups have to offer: entrepreneurial skillы to sell their product шn foreign markets from Ukraine, tech talent and the presence of local venture capitalists.
Nearly all startups founded here target foreign markets because Ukrainains don’t have the money to spend. With a $450 monthly average salary, Ukrainians aren’t keen on spending their extra $10 even on copyrighted things like films or music. Along with India, Turkey, Russia and Indonesia,
Ukraine has one of the worst online piracy rates, according to the European Commission.
In the U.S., the situation is different, as the gross domestic product based on purchasing power parity is 53 times as high as in Ukraine, and so most startups want to work there, where they can sell their products. Doing that from Ukraine is hard and requires entrepreneurial skill, venture capitalists believe.
On top of that, while Ukraine has 200,000 tech specialists and 30,000 new ones graduate every year, there are no big names to headhunt local talent. It’s a serious challenge to find and retain skilled people in the U.S., home to tech giants like Google, Facebook, Uber, Airbnb, Apple, Amazon, Microsoft and IBM. Ukrainian startups can hire and retain people more easily.
Kolodyuk claims many post-Soviet countries, unlike Ukraine, can’t boast about the presence of a venture capital market. For a foreign investor, on the other hand, it’s much easier to invest in a company that has already been backed by someone, even locally.
It takes time and skill for Ukrainian investors to talk through these benefits and reinforce them on the international stage, and so many were disappointed when Minchenko disappeared with $5 million.
Luckily, Vitchenko says, no big-name foreign investors put money in the guy or that might have been a nasty scandal for Ukraine. What’s left now is just a “bitter after-taste.”
