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Partner, Head of Corporate and M&A, Evris Law Firm
Evris Law Firm
Private Equity in Ukraine
Private equity (hereinafter — PE) is important for growing and strengthening Ukrainian businesses in all industry sectors. However, the PE market is still in recovery mode after the crisis times of 2008 and 2014 and includes up to 10 major players that are private equity funds. These include, among others Dragon Capital, Horizon Capital, East Capital, AVentures, NHC Capital and Sigma Bleyzer.
According to common worldwide practice, PE funds make investments in private companies, whose shares are not publicly traded on a stock exchange. Generally, the strategy used with PE funds is to invest in share capital by acquiring a minority stake (20-40%), where the company’s founders and their management are dealing with day to day affairs at their discretion, while the fund is involved in strategic decisions. As a rule, investees are operating fast-growing companies that possess profit potential (usually rated top 10 in the market) but requiring additional funding or restructuring to reach a new, higher level. PE funds have long-term experience in company management, that allows them to provide businesses with capital and managerial input to increase their capitalization, enhance performance, upgrade technologies and support stable long-term growth. The investment horizon fluctuates within 5-10 years, following which the fund sells its stock at a premium, or alternatively, PE fund and investee mutually sell their shares to a strategic investor and distribute the profits earned. In general terms, this worldwide practice is applied in Ukraine.
The most significant transactions on the Ukrainian PE market took place in 2015-2017 (acquisition of Rozetka.ua by Horizon Capital, with transaction value of USD 200-700 million and acquisition by Arkema SA of Dutch manufacturer of adhesive sealants from the PE fund Egeria, transaction valued at USD 533 million). At present, PE funds continue to increase their focus on the IT sector (including e-commerce and cyber security), which is a driver of export services in Ukraine.
The legal regime of PE in Ukraine is established by the general rules of the Civil and Commercial Codes of Ukraine, Law of Ukraine No. 514-VI On Joint Stock Companies of 17 September 2008, Law of Ukraine No. 5080-VI On Joint Venture Investment Institutions of 5 July 2012 and by the recently adopted new and groundbreaking Law of Ukraine No. 2275-VIII On Limited Liability and Additional Liability Companies of 6 February 2018 (replacing the outdated provisions of the 1991 Law of Ukraine On Business Companies), which in unison create a flexible legal environment for private investors.
At the same time, the fundamental problems of the Ukrainian economy such as insufficient investment protection, monopoly abuse, overregulation of currency exchange operations, non-transparent rules of interaction with state authorities — are still topical and require special attention when conducting investment activities and structuring business in Ukraine. However, proper professional structuring of transactions can mitigate such risks to an acceptable level.
Recent Changes in Legislation for PE
Last year was fruitful for Ukrainian legislation in terms of positive changes.
In February 2018, Law of Ukraine No. 1984-VIII On Amendments to Certain Legislative Acts of Ukraine regarding Corporate Agreements of 23 March 2017 came into force. The Law introduced the notion of corporate (shareholders) agreement and regulated the legal use of such instrument. This is an undoubted breakthrough in the regulation of relations between participants/shareholders, considering earlier negative court practice, where such agreements concluded in relation to a Ukrainian company were not enforced in Ukraine.
Moreover, the Ukrainian Parliament adopted the long-awaited Law of Ukraine No. 2275-VIII On Limited and Additional Liability Companies of 6 February 2018, which significantly simplified the activities of the most popular type of entities among small and medium-sized businesses — a limited liability company (hereinafter — LLC). The Law improved and modernized the legal framework, provided for flexible regulation and discretion regarding relations between participants, introduced feasibility of a two-tier management system for the LLC and established completely new corporate instruments.
For the first time, the Law On Limited and Additional Liability Companies formalized the binding and enforceable corporate (shareholders) agreement specifically regarding the LLC, simplified the procedure for contributions into the charter capital, minimized the scope of non-discretional rules governing internal corporate relations and, to a large extent, increased the protection of private investors against illegal takeovers. The Law also provided for the possibility to elect a supervisory board as a governing body of an LLC and simplified quorum requirements for holding general meetings of participants. Moreover, a new institution of derivative actions allows the shareholder/participant of a company to file claims against the company official to reimburse damages caused by such a person.
It should also be noted that the Ukrainian Parliament and the National Bank of Ukraine jointly initiated the liberalization process related to currency control legislation, which significantly affected the investment attractiveness of Ukraine. In autumn 2018, Parliament adopted Law of Ukraine No. 2473-VIII On Currency and Currency Transactions of 21 June 2016, which, inter alia, changed the concept of state participation in exchange transactions towards its liberalization. The National Bank of Ukraine started, in its turn, to take actions to establish freer circulation of currency, as well as gradual lifting of currency restrictions via its own regulatory acts.
Undoubtedly, such steps to bring the Ukrainian legal system into conformity with best international standards, will simplify the investment process in Ukraine and contribute positively to promoting the PE market.
Legal Structuring of Transactions on PE Market
Despite the introduction of the aforementioned novelties into Ukrainian legislation, a combination of Ukrainian laws and laws from a foreign legal system are often used for structuring transactions on the purchase of shares.
Among the classic structuring options, the most commonly used are still those involving purchase of a stake in the target company by PE funds through purchase of shares in a non-resident holding company located in a respectable jurisdiction (e.g., the Netherlands, Luxembourg, Cyprus, Switzerland). At the same time, transaction documents (shareholders agreement, shares sale-purchase agreement, option agreements, etc.) are often construed under the law of England and Wales, which is transparent, predictable and allows more flexible arrangements.
Dispute resolution (arbitration) cases are usually referred to the London Court of International Arbitration. Unfortunately, for now Ukrainian courts are not able to effectively resolve all corporate disputes due to an absence of relevant relevant experience. Thus, subordination of disputes resolution to more developed jurisdiction can mitigate the risks inherent in the Ukrainian legal system.
When setting up a joint venture, the parties need to agree upon issues of joint issues of joint business management, confidentiality requirements, non-compete, reporting standards, financing tools, exit strategy, arbitration, etc. through a shareholder’s agreement, articles of the holding company, charters of Ukrainian companies.
Where the transactions are structured via foreign jurisdictions, it’s still vital to have instruments of control at the level of the target Ukrainian company. These instruments often entail appointment of the investor’s representative onto the board of the target company. For example, introduction of a second member to the board, who has to counter-sign major transactions, limits the competencies of the target company’s management to enter into sizable deals without the involvement of an investor that owns a minority stake.
Newly-introduced Ukrainian state services, such as automatic sms notification about changes in the company’s management and other corporate matters, completely open state registries of legal entities and real estate, enable the control of corporate actions and transactions with significant assets in real time, and are useful instruments to help investors feel confident throughout the complete life cycle of their investments in Ukraine.