The potential role of venture capital (‘VC’) funding in supporting Ukraine’s post-conflict reconstruction is high on the policy-making agenda. Prior to the conflict with Russia, Ukraine had already established a thriving innovation ‘eco-system’, with a significant number of university-industry collaborations, and a high rate of VC funding by comparison to other countries in central and eastern Europe. Since the summer of 2022 a number of VC partnerships based in London and New York have announced new funds to support early-stage investment in Ukrainian companies, and the Ukrainian government has prioritised VC in its plans for post-war reconstruction. The Ukraine Venture Capital and Private Equity Association (UVCA) has issued a Redevelopment Plan, which was discussed at the Davos World Economic Forum of January 2023.
With the focus on VC funding as a part of Ukraine’s reconstruction, it is relevant to consider how far Ukraine’s legal framework supports VC. It is generally recognised that the legal framework for VC financing is an important variable in explaining its incidence and effects across countries. Law-and-economics analysis, drawing on transaction cost economics, understands VC funds as acting as information intermediaries, linking ultimate investors (ranging from pension funds, mutual funds and wealthy individuals) to startups. By pooling expertise, VC funds can help overcome agency costs and learning externalities, and diffuse risks associated with innovation. There are features of the legal framework in Ukraine which may require particular attention from the point of view of encouraging an indigenous VC sector. The Ukrainian civil code lacks an exact equivalent to the limited partnership form. An overseas investor can enter into a joint venture with a Ukrainian partner through a ‘joint activity agreement’, but there are complexities associated with the process through which joint ventures are registered with the Ukrainian tax authorities. In principle, a distinct tax regime applies to VC funds, with zero tax payable on capital gains; however, in practice, Ukrainian VC fund structures are often used as tax evasion devices. Additional issues arise from the rigid legal form of the ‘joint activity agreement’: participation rights cannot circulate freely, as any change to membership creates legal complexities, and it is difficult to organise management, as there is no established template for board membership or the operation of the board’s powers of oversight and control. These difficulties can be avoided in practice through the incorporation of funds under a foreign jurisdiction, for example US or English law. As of 2021, Ukrainian law allows a foreign law to be chosen for a shareholder agreement, if at least one of the parties is non-resident. Allowing this option has increased the attractiveness of investment in Ukraine-focused funds, but it poses the question of how far returns from successful startups will eventually flow out of the country.
Aims and objectives
Given the need for research on the role of commercial and company law in supporting Ukraine’s reconstruction, the project will address the following questions:
- What, in general, is the optimal legal and transactional framework for venture capital?
- What are the current legal obstacles to venture capital in Ukraine?
- What changes should be made to the law and to transactional structures to promote venture capital in post-conflict Ukraine?
Research on VC illustrates a ‘considerable divergence between the law and practical reality’ (Armour, 2002) that can only be overcome through empirical research. We therefore propose an empirical project to examine the interaction of law and practice in Ukrainian VC funding.
To understand the macro-level rules governing VC, we will conduct a review of relevant laws and regulations. We will use the Cambridge Leximetric Datasets (Deakin et al, 2016) to benchmark Ukrainian laws in the areas of shareholder, creditor and worker protection. This will enable us to get an initial measure, based on formal law or ‘law in the books’, of how far the Ukrainian legal environment is conducive to VC funding, following the approach of Armour and Cumming (2006) and Cumming and Johan (2014). The Cambridge datasets provide a method for ‘leximetric’ data coding which has been widely adopted and used in similar studies. Ukraine’s labour law has recently been coded up to 2022 as part of a recent update to the labour regulation index. A new coding of Ukraine’s shareholder and creditor protection laws will be carried out, enabling Ukraine’s laws to be compared to those of other European countries in the current version of the Cambridge dataset (several other central and eastern European countries have recently now coded up to 2022 as part of the current update).
At the micro level of transactional structures, we will conduct a literature review, using online sources, of relevant materials on the types of contractual and other arrangements made in VC agreements. A number of national venture capital associations make standard form agreements available for public use. Where it is not possible to derive standard forms from online sources we will directly approach the relevant bodies.
To get a deeper appreciation of how VC funds operate in practice we will conduct interview-based fieldwork with relevant stakeholders. We anticipate conducting around 20 interviews across a range of potential respondents: industry associations, ultimate investors, VC funds, law firms with VC expertise, and investee companies, with a focus on the IT sector, which is sizable in Ukraine. Around 10 of the interviews will focus on the experience of Ukrainian funds, with 10 focusing on the experience of British and US-based funds by way of comparison. Where British-based funds and other specialists are interviewed, we anticipate being able to conduct interviews in person. For US-based and Ukraine-based interviewees, the interviews will be conducted by Zoom (currently, most Ukraine-orientated funds are based outside the country, predominantly in London or New York).
The project is being carried out by Simon Deakin and Hanna Sitchenko (Simon was initially advising Hanna under the auspices of the Cambridge University Ukraine Academic Support Scheme). The work began in June 2023.
By mid-summer 2023, we had conducted four interviews, with a further number planned for the rest of the year. Work on the literature review and on the addition of Ukrainian data to the CBR’s leximetric datasets is also underway. The project is due to be completed in the summer of 2024.