Exit liquidity of Ukrainian miltech companies

BLUF: With limited exit opportunities, foreign investors are turning to non-Ukrainian entities to invest and build up Ukrainian startups. Here’s how some Ukrainians envision fixing this. Meanwhile, Ukrainian company Odd Systems launches mass production of thermal cameras to compete with Chinese optics. And the head of Ukraine’s export control agency Oleksandr Pavlichenko huddles with defense companies in Kyiv.

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THE BIG STORY: How limited exit liquidity holds back Ukrainian startups... and how to fix it.

Ukrainian defense companies are hungry for investment to fuel rapid growth, and from Western investors in particular. But there are serious risks for investors, especially with regards to exit liquidity: the ability to recoup money from an investment. 

Due to legal and financial barriers, Ukraine faces an exit liquidity problem. And so for Ukrainian startups to attract major investment, they need to have their corporate entities and intellectual property registered abroad – at least in the short term.

"Investment is always a risk. Investment in defense: risk squared. But investing in a Ukrainian defense company registered in Ukraine… — it’s risk taken to the fourth degree," says Dmytro Kuzmenko, CEO of the Ukrainian Venture Capital and Private Equity Association.

Workaround: Invest using a non-Ukrainian entity or find strategic partner

Without a non-Ukrainian entity, the Belgian fund Seven Capital – which has bought stakes in Ukrainian startups HIMERA, KitSoft and Aeromotor – won’t even consider investing, explains co-managing partner Brent Christiaens.

“I have never heard of anybody getting funds when a company is registered in Ukraine, because you can't do follow-up, you can't sell this company, which means that you take out all the upside of investing,” said Christiaens. “Most companies operate with a cost center in Ukraine, which means that they have all of their people there or a big part of their people there.”

Corporate registration abroad means that all the money flows into jurisdictions like Estonia or Delaware. Money comes into Ukraine for salaries and operational expenses, but not the core capital of the business. 

Kuzmenko said relocating company assets and IP to another jurisdiction in the West – the United States and Europe, where companies can be more easily bought and sold – is the only certain option.

“Exiting an investment in a Ukrainian company is, in Ukrainian reality, nearly impossible—a fantasy, really. To use classic strategies, investors usually recommend relocating.” said Kuzmenko.

Another option is a sale to a strategic partner who is interested in building up the company.

Long-term: Reboot a moribund capital market

Ukraine lacks a developed stock market, making it impossible to sell a stake in a Ukrainian company on the public market. 

After the global financial crisis, the Ukraine’s stock market stagnated. Within Ukraine, a significant portion of the wealth was with oligarchs who did not want to expose their companies to public markets, explained financial advisor Alina Shukh, COO at Smart Family Office. In addition, Ukraine had currency restrictions, a lack of transparency around laws and a lack of knowledge among domestic investors and new techs and startups.

Now, due to the ongoing war, it is almost impossible to transfer dividends abroad, Shukh said. Currently, the stock market functions mainly as a platform for selling domestic government bonds, which occupy more than 88 percent of the market since the start of 2024. 

“There has never been a deep stock market in Ukraine,” wrote economists Yuriy Gorodnichenko and Alexander Rodnyansky earlier this year. “Markets that do not achieve a certain level of liquidity often fail… This pattern points to the broader need for Ukraine to team up with other countries to ensure that trade volumes and liquidity for Ukrainian stocks are adequate.”

A well-developed stock market would allow companies to go public and raise additional funds for investment. However, this would require continued reforms: reducing corruption, decentralizing economic and political power, increasing transparency and affirming rule of law. 

If reforms could be achieved and confidence built, it would offer manufacturers an alternative way to raise funds. Instead of just government bonds, Ukrainians could purchase shares in a hypothetical drone manufacturer to help it grow

What’s next: increased risk tolerance and coming reform proposals:

The last few months show that Western and Ukrainian VC’s are ready to handle slightly more risk. This is because the Ukrainian defense sector has been rapidly developing new technologies due to decentralization of innovation; and direct connection between innovators and soldiers on the battlefield, explained Ukrainian member of parliament Halyna Yanchenko.

Swarmer, a Ukrainian startup developing AI for autonomous drone swarms, raised $2.7 million in investment in September. AI-powered company Osavul, which focuses on combating disinformation, secured a $3 million seed investment last month from 42CAP, U.ventures and SMRK. 

Liquidity is a part of the bigger issue attached to the investment climate. 

Yanchenko, who is also secretary of the National Investment Council of Ukraine, has created a working group of large domestic manufacturers to propose reforms.

They are working in three directions:

• Improving the procurement process in Ukraine to make it more transparent and understandable; 

• Creating a state program for providing loans to defense companies so they have financing to manufacture and grow. This proposal was included in the budget for 2025 and was approved by the committee;

• Reducing barriers to exports.

BUSINESS LUNCH TOPICS: What our reporting shows!

1. Odd Systems launched mass production of thermal camera ‘Kurbas-256’. Production of FPV-drones is dependent on Chinese spare parts. But Ukrainian companies recognized the problem and are actively replacing components on domestic products (Read our coverage about Chinese components in our previous issue). 

The main feature of Kurbas-256, if compared to Chinese mass market thermal cameras, is that it was created for warfare. It has unique features that were developed with Ukrainian drone pilots:

• Adjust contrast and brightness on the fly;

• No condensation on sensor in winter due to seals;

• Curtain control: Smooth shutter motion. Developers moved curtain control to drone operator;

• Pseudo-color mode: taking a grayscale image and assigning colors based on intensity values.

Their number-one priority is to meet demands of the Ukrainian army for thermal cameras with 256x192 resolution, said Andrii Taganskii, COO at Odd Systems. In the future, Odd Systems is planning to make drones autonomous and after that teach them to swarm as a single unit.

2. What are the prospects for the use of marine drones? Ukrainian combat experience shows that sea drones can become a major strategic asset that makes the use of shipboard platforms financially unprofitable, reports DataDriven, a Ukrainian consulting firm specializing in defense/demining.

How to think about the pros of sea drones: 

• low visibility;'

• cost-effectiveness;

• and maneuverability.

Cons of sea drones:

• relatively low speed compare to other means of destruction like cruise missile;

• constant risk of losing communication with the operator and the command center due to dependence on Starlink network;

• limited range of sensors – radius about 10 km – which complicates targeting in changing conditions;

• the need to constantly update targeting.

3. “We unequivocally support the controlled export of what is in surplus and what our defense forces do not need.” The head of Ukraine’s export control agency Oleksandr Pavlichenko told Ukrainian defense companies this in huddle with them on Friday, moderated by SHERP CEO Oleksandr Biletskyi.

But from the perspective of Ukrainian defense companies, they don’t expect drastic changes. 

“We can say that everything that does not contradict national interests is allowed. However, this is a rather broad concept and can be interpreted in different ways. As I understand it, each appeal is considered separately and an individual decision is made on it,” said Alyona Artemenko, project manager at Brave Inventors accelerator platform,  after the event.

Overall, Artemenko believes that it's a nice signal that Pavlichenko is interested in constructive suggestions for improving the service.

In addition, Oleksandr Pavlichenko told us that one of the main problems is lack of communication. To improve that, the export control agency will create an online form to react to the requests. He also points to the permit approval mechanism in MoD as an issue.

The first meeting of the interdepartmental commission at the National Security and Defense Council of Ukraine will soon be held to discuss these issues. Last Friday, the head of this group was appointed. Pavlichenko said that the export control issue is a systemic problem, and the situation can’t be solved immediately.

In Collaboration with CENTRE.UA – Ukrainian orders/legislation we’re tracking: Cabinet of Ministers Order No. 980-р of October 11, 2024
Changes Introduced: Approved new members of the Supervisory Board for the MOD’s defense procurement agency.

Why it is important: The supervisory board guarantees independent control over the processes, minimizes the risks of corruption and increases trust in the system.

Independent candidates on the supervisory board:

• Patrick Auroy - has more than 30 years of experience in the defense sector in France and in NATO structures;

• Kateryna Kuznetsova - has more than 25 years of international experience in audits and corporate finance, including as a director at PwC UK;

• Lukasz Soliarski - managed multinational teams and complex logistics during 18 years at NATO NSPA

Designated representatives of government:

• Taras Chmut - director of the ‘Come Back Alive’ Foundation

• Yuriy Dzhuhur - deputy minister of Defense of Ukraine; economist with more than 20 years of experience in promoting reforms in public finance management.

ON THE MOVE:

Know someone in the defense tech space who has made a professional move? Drop us a line at [email protected]! 

• Former Polish Chief of Defense General Rajmund Andrzejczak joined Frankenburg Technologies as a strategic adviser.

• Oleg Davydenko leaves the Ministry of Digital Transformation after 2.5 years in the communication department.

30 SECOND ELEVATOR PITCH:

One of the challenges on the Ukrainian battlefield is the presence of so-called ‘refusers,’ Many soldiers are simply afraid to carry out any tasks. A group of Ukrainian soldiers have launched a new initiative: First Battle Experience.

“For many who come into the army directly from civilian life, the main fear is the unknown — what comes next? This training shows one of millions of potential scenarios, helping the person to understand that certain situations could unfold in various ways. Consequently, the fear becomes smaller or more manageable. Now we are fundraising $7,500 to make new films,” said Vitalii Kyryliv, head of Department of Arms Development and Innovation of MoD.

MUST READS:

• A Baykar plant in Ukraine is set to open next August. Currently, approximately 80 percent of the facility is completed.

• Ukrainian MoD has proposed that Sweden and Finland finance domestic miltech manufacturers through direct financing, as Denmark already does.

• Ukrainian UAV manufacturers are second in the number of applications for the British UAVs and FPV-drones contract as a part of a Coalition of Drones initiative.

• Ukraine and India discussed potential for collaboration between defense sectors between two countries. The parties agreed to identify specific areas in which they can work together. 

• Six Ukrainians were chosen to join innovation startup schools. Among those institutions were National Aviation University, Vinnytsia National Technical University, Kyiv Academic University, Sumy State University, National Dnipro Polytechnic University and National Odesa Polytechnic University. They will work in different fields and on defense tech, AI and cyber in particular.

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