FAQ: Investing in Ukrainian Defense Startups – Risks and Opportunities

By: Leon Beker
Leon Beker is the Managing Partner at Beker & Co., an investment advisory firm based in Kyiv. He oversees strategic initiatives across investments, government and defense, leveraging over 30 years of experience across sectors.

1. What makes the Ukrainian defense startup sector attractive to investors?

The Ukrainian defense startup sector is a compelling investment opportunity due to its rapid growth and the urgency of the ongoing conflict with Russia. 

With a defense tech market valued at nearly $1 billion and a significant increase in the number of private defense companies, Ukraine presents a fertile ground for investment. The country's defense industry is heavily supported by both government and private funds, making it a dynamic environment for startups, particularly in high-demand areas like UAVs, robotics, and electronic warfare technologies. The need for innovative solutions and the relatively low capital and regulatory requirements for military technologies further enhance the sector's appeal.

2. What are the key risks associated with investing in Ukrainian defense startups?

Investing in Ukrainian defense startups involves several risks, including:

• Overvaluation and Market Dynamics: Ukrainian startups are often perceived as overvalued, partly due to limited investor experience and high demand. Startups may project inflated valuations, which can pose risks for investors if these valuations are not grounded in real-world metrics or business viability.

• Regulatory Compliance: Many Ukrainian defense startups may lack awareness of international regulations governing military tech, such as the U.S. International Traffic in Arms Regulations (ITAR). Compliance with these regulations is crucial to avoid legal issues and ensure smooth international operations.

• Intellectual Property (IP) Risks: IP strategy is critical. Investors need to assess whether the IP originated from government-funded programs and how it was transferred to offshore entities. Issues may arise if the IP was not legally or transparently managed, potentially leading to legal disputes or regulatory objections.

• Security and Corruption Concerns: Despite ongoing efforts to combat corruption, concerns about security and corruption in Ukraine remain. While some investors report manageable risks, others highlight challenges related to navigating local business practices and ensuring transparency.

3. How should investors evaluate the IP strategy of Ukrainian defense startups?

Investors should rigorously evaluate the IP strategy of Ukrainian defense startups by:

• Verifying IP Origin: Ensure that the IP was developed in compliance with the terms of any government grants or funding received. This includes checking whether the IP was appropriately transferred or licensed to any offshore jurisdiction, and if such arrangements comply with legal and regulatory requirements.

• Assessing Legal Frameworks: Review the startup’s IP management and legal frameworks to ensure they align with both local and international regulations. This helps in mitigating risks related to IP legitimacy and legal disputes.

• Conducting Due Diligence: Engage experienced legal counsel to navigate complex legal issues and ensure that all IP-related documentation and transfers are legitimate and transparent.

4. What specific export control issues should investors be aware of?

Investors must be aware of several export control issues:

• Export Regulations: Military technologies are subject to strict export controls to prevent misuse. Including Dual-Use. Understanding these regulations, such as ITAR, is essential for startups to legally operate and sell their technologies internationally.

• Dual-Use Technology Transfer: If the startup’s technology falls under dual-use categories (i.e., having both civilian and military applications), ensuring compliance with relevant regulations is critical to avoid legal complications.

• Jurisdictional Considerations: Consider investing in startups registered in more stable jurisdictions if possible, as this may offer better legal protection and easier compliance with international regulations.

5. What are the strategies for mitigating risks when investing in Ukrainian defense startups?

Investors can mitigate risks by:

• Conducting Comprehensive Due Diligence: Assess the startup’s market potential, regulatory compliance, and IP strategy thoroughly. Verify that the startup’s technology is legally sound and that its business practices align with international standards.

• Engaging Local Expertise: Collaborate with local partners or consultants who are familiar with the Ukrainian business environment and legal landscape. This helps in navigating the complexities of the market and ensuring effective risk management.

• Considering Alternative Funding Models: Has the team explored various funding options such as government grants, crowdfunding, or bootstrapping to diversify risk and avoid the pressure of unrealistic valuations.

• Developing Contingency Plans: Prepare for potential challenges, such as key personnel loss due to military service or unexpected legal issues, by having robust contingency plans in place.

6. What is the outlook for Ukrainian defense tech investments?

The Ukrainian defense tech sector is poised for growth, driven by the need for advanced military technologies and strong government and private sector support. Despite the inherent risks, strategic investments in this sector can yield significant returns and contribute to vital technological advancements. By understanding and addressing the key risks and implementing effective strategies, investors can navigate the complexities of the Ukrainian defense startup landscape and capitalize on emerging opportunities.

7. How can I figure out who to trust when conducting business transactions? 

• Engage with established networks: One option is to connect with organizations that have already engaged in defense accelerator work or foreign investment in Ukraine.

• Consult local expertise: Working with a local defense consultant is invaluable. They can help you navigate IP vectors, tactical implications, procurement opportunities in Ukraine, and assist with accurate sales forecasting, ensuring you understand the local market dynamics.

• Seek professional legal support: Partnering with experienced professionals, particularly lawyers with strong corporate and IP expertise, is a smart first step. 

8. Do I need to create a Ukrainian entity to invest in a Ukrainian startup? 

When investing in Ukrainian startups, particularly in the defense sector, it’s not always necessary to create a Ukrainian entity. Many Ukrainian defense companies have already established holding companies in jurisdictions like Estonia, Cyprus, or even Delaware, which simplifies international investment.

However, if the startup operates solely as a Ukrainian entity, you still have options. You can invest directly as an individual or through your personal Special Purpose Vehicle (SPV) from another jurisdiction to become a shareholder.

That said, it’s always wise to work out the legal and tax implications beforehand with your lawyers and tax advisors to ensure your structure is optimized and compliant with both Ukrainian and international regulations.

9. I’m interested in investing. What should my first steps be? 

If you're interested in investing, here’s a step-by-step guide to get started:

1. Conduct Thorough Research: Start by understanding the market you're entering. Research the industry, the specific company or startup, and the broader economic landscape. For Ukraine, for example, it's crucial to assess the sector's regulatory environment, market potential, and any geopolitical risks.

2. Engage Experts: Consult with local experts such as industry consultants, legal professionals, and tax advisors who can offer insights into market trends, risks, and compliance requirements.

3. Evaluate the Investment Opportunity: Perform a detailed due diligence on the company, including its financial health, management team, and growth prospects. Also, assess the legal structure—whether it's a Ukrainian entity or an international holding—and the terms of your investment.

4. Determine the Investment Structure: Decide whether you’ll invest directly as an individual or through a Special Purpose Vehicle (SPV). This is also the stage to decide whether you need to establish an entity in the country or can invest from abroad.

5. Consult Legal and Tax Advisors: Before finalizing any investment, consult with your lawyers and tax advisors to structure your investment in a way that optimizes your returns and ensures compliance with local and international laws.

6. Execute the Investment: Once all the due diligence and structuring are in place, you can proceed with finalizing the deal and becoming a shareholder in the company.