Ukrainian AI struggles to overcome local, global problems

An artificial intelligence, or simply AI, companion can detect a user’s emotions and help millions of people suffering from loneliness.

AI can gather business intelligence to help sales specialists work with clients.

A smart, AI-powered proofreading service can learn on the fly and help people become better writers.

All three of these ideas have been developed or are under development in Ukraine. The country’s tech startups — particularly those focused on artificial intelligence — have been spreading their wings and drawing much-needed global attention to the country’s tech talent.

Outsourcing companies, which write code for Western clients, may still have the most employees in Ukraine’s tech industry. But product companies have surpassed them in valuation over the past two years, according to DataRoot Labs, a company which helps clients develop AI and big data solutions.

Meanwhile, Ukrainian-made companies like Grammarly and GitLab have achieved the lofty status of “unicorns,” being valued at over $1 billion. Other firms have attracted tens of millions in investments.

“Although outsource is still dominating the market… my hope is that after the first big success exit stories, that trend will reverse itself and more people with quality fundamentals will take a risk of starting their own business,” said Max Frolov, the co-founder of DataRoot Labs.

Ukraine’s focus on AI is similar to global trends. Today, even tech companies that don’t put out an AI product, often use it to power their core business model.

“There are a lot of opportunities for the creation of products based on artificial intelligence and Big Data both in Ukraine and worldwide,” Volodymyr

Kryvko, the managing partner of Chernovetskyi Investment Group, wrote in an email.

Still, Ukraine is hamstrung by local and global challenges.

IT professionals bemoan the country’s unreliable legal system, ambiguous taxation of entrepreneurs, lagging efforts to improve education at public institutions and the lack of venture capital. Globally, investors are growing warier of investing in early startups.

Strength to strength

For all its challenges, Ukraine’s status as a tech center has consistently improved, according to global metrics.

The analytics site Startup Ranking found that Ukraine occupies the 43rd place globally by total number of startups, with 259 companies. In this regard, Ukraine is ahead of Estonia, Latvia, the Czech Republic, Lithuania and Belarus.

StartupBlink, an online startup ecosystem map, found that Ukraine rose by four positions to 31st place, compared to 2018. Meanwhile, Kyiv has jumped 29 places up to 34th position, coming in ahead of Melbourne, Denver, Shanghai and Dublin.

The Tech Ecosystems guide found that, in 2018, $290 million was invested in Ukrainian startups, compared to $265 million in 2017 and $268 million for the 2014–2016 period. The guide forecasts that, by 2025, the Ukrainian IT industry will export $8.4 billion worth of products and services.

“During this year, we have had an opportunity to get several signals which are very important for the market — these are investment rounds of Ajax, Murka, Grammarly and people.ai,” Kryvko wrote. “Ukrainian technology companies continue to grow and attract more and more attention from investors and consumers outside Ukraine.”

Grammarly, which produced an AI-driven writing aid, attracted $90 million in October. Ajax Systems, which makes a highly regarded electronic security system, got $10 million from Horizon Capital in March. Murka, a social casino developer, was acquired by the giant Blackstone Group in March. And people.ai, which uses an AI platform to boost the effectiveness of salespeople, attracted $60 million in May and is now valued at $500 million.

According to Dmitry Kozlovksy, the general director of Valtech Ukraine, the country is 11th among 50 countries with the best developers and 6th in the world in best programmer ratings on the TopCoder ranking.

Silicon ceiling

Still, Ukraine is unlikely to break into the big boys’ club. The only serious startup ecosystems are in a handful of places in the world, said Alexander Soroka, the CEO of Startup.Network, a professional network for participants on the venture market.

“Our problem is not with startups,” said Soroka. “Our startups are no dumber and no worse (than in other countries). The problem for the whole world is with business venture (capital) — it exists only in a handful of countries.”

Soroka said the world has two major tech startup ecosystems — the U.S., with half of the world’s unicorns, and China, with a quarter of them. Next, small ecosystems in England and India have 5% and 4% of unicorns, respectively. Then the very small ecosystems, France, Germany and Israel have 2%, 2%, and 1%, respectively.

Other countries’ ecosystems are negligible by comparison, he said. Even Western European countries are far from the U.S. in tech startup development because of slower decision making and a smaller appetite for risk. Ukraine’s embryonic ecosystem is even farther behind.

Tech startups “need to grow in fertile soil that is constantly watered with startup investment rounds,” said Soroka. “And ours is starting from a very arly stage, with angel investors. And finding them is very challenging, not to mention later rounds.”

Insufficient protection of private investments, raider risks and a lack of intellectual property protections all round out the list of drawbacks.

Global shortage

The problems aren’t exclusively Ukrainian. Globally, the world has seen a decrease in venture activity and a tendency to invest in companies that already have a finished product and, in some cases, revenue, according to DataRoot Labs COO Yulia Sychikova. IT professionals told the Kyiv Post that it’s getting increasingly difficult to launch one’s own company.

“Compared to foreign markets (Israel), we have extremely few exits. Many startup projects do not even go through the launch phase, not to mention attracting investors,” said Valtech’s Kozlovksy

He says this indicates an “underdeveloped IT ecosystem” and a lack of incentives in the country.

The companies that do make it usually incorporate outside Ukraine to be closer to their markets and investors and to avoid Ukraine’s dodgy courts and bureaucracy.

Early stage financing is very hard to come by, said Sychikova. While Ukraine had a few attempts at launching incubators, most of them closed. This is in line with global trends.

“Over the past few years, there has been a shift — most of the funds shifted to investing in late seeds and Series A, when the companies already have traction, products or revenue.”

Seed funding refers to initial capital that an investor puts into a startup. In late seed funding, the enterprise typically has already figured out its market and product. Series A refers to the first round of venture capital. At this point the company has a product, possibly a revenue stream and wants to grow and expand.

Seed funding has been drying up globally, she added, as investing in tech is even more risky. Most venture capital funds have been unprofitable historically. Ukrainian teams that are passionate about products turn to other countries for acceleration, including Germany, Estonia or Chile.

“Early stage funding is extremely scarce and entrepreneurs have to prove what they have like never before,” she said.

Moreover, Ukraine lacks the legal structure to accommodate venture capital funds, according to Alexander Bornyakov, a deputy minister for digital transformation.

A lack of experience or workable ideas is the other major limiting factor. While some Ukrainian startups have demonstrated that they can overcome all the other challenges set before them with a good enough product, their experiences are characteristically rare.

“In my opinion, the main obstacles to develop newly created companies are lack of experience of the founders and unviability of the idea,” Kryvko wrote. “In particular, this is what venture investors are for.”

Some help is at hand. On Dec. 2, the Ukrainian Startup Fund (USF), which has a total budget of $18 million, began accepting grant applications from local tech startups. The state-owned fund will provide selected startups with grants ranging from $25,000 to $75,000 to boost development.

Launched by the Cabinet of Ministers, the USF provides pre-seed and seed funding for Ukrainian tech firms, meaning that the money will go to early-stage startups that only have prototypes of future products and need capital to develop their products further. Every startup has to have an element of tech and can be on the periphery of other industries and IT, including adtech, fintech, internet of things and big data. The startups also have to be registered in Ukraine with at least 50% Ukrainian ownership.

Setting up abroad

For most tech startups, there is little chance that they will register and stay in Ukraine.

Most companies want to go where the markets and the investors are, and they are not in Ukraine. The local market for tech products and services is very small by comparison to the United States.

Even in the U.S., most startups and investors only recognize 2 jurisdictions — Delaware and California, with 90% of U.S. startups registered in Delaware due to its preferential taxes and laws that protect investments. Other jurisdictions and countries do not suit most tech companies, said Soroka.

Sychikova agreed, saying that companies incorporate in places with good legal ecosystems where they feel more protected than in Ukraine.

Most have a Ukrainian entity as well, drawing on the skill and comparatively low cost of Ukrainian engineers. These back offices branch typically do the work that costs the company money, while revenue is made elsewhere.

Still, Soroka does not think that this is a bad thing. The fact that Ukrainian teams are developing projects here is a positive for the country.

“Development takes place here, the back office is here,” he said. “If the money is flowing, if people are paying income taxes, then everything is fine.”