Startup ecosystem gauging impact of Ukrainian crisis

As the conflict between Russia and Ukraine unfolds, investors must now take geopolitical risk into account when looking to fund startups in Central and Eastern Europe. Though the impact on neighbouring countries remains limited, the sentiment could worsen if regional tensions show no signs of easing on the longer term.

By Ovidiu Posirca

The economic cost of Russia’s invasion of Ukraine is set to shrink global economic output this year by 1.1 percent, according to an estimate by the Organisation for Economic Cooperation and Development (OECD). In late 2021, the organisation expected global GDP to grow by 4.5 percent during 2022.

“We also see that this war has set in train de-globalisation forces that could have Ukranian startups became unicorns and raised some USD 1.3 billion from investors, according to a report by Kreston Ukraine and the Ukrainian Venture Capital and Private Equity Association (UVCA). Grammarly, an AI-powered service that checks English grammar, and GitLab, an open-source platform for software developers, are some of the Ukraine-born startups that have grown rapidly in the recent period.

“The venture industry is a component of the larger economy, and any geopolitical events that cause economic disturbances

profound and unpredictable effects. Government policy has a crucial role to play in re-establishing some of the certainty and security we have lost,” said OECD secretary general Mathias Cormann.

The crisis erupted roughly two months into 2022, following a year in which venture capital funding across the CEE reached USD 5.4 billion, according to a report by Vestbee. The total investment volume had doubled compared to the previous year.

Report authors point out that a year-onyear increase indicates that the compulsory digitalization of many large companies in 2020 has become a kind of springboard for technology startups.

Ukraine's startup industry had been growing rapidly in recent years, which could also be seen in the number of firms that attained unicorn status by reaching a valuation of more than USD 1 billion. Since 2018, five

By comparison, only one startup with Romanian roots reached unicorn status during the same period.

UKRAINE AND ROMANIA HAVE SIMILAR IT TALENT POOLS

The question is what will happen with all the startup talent in Ukraine and with its overall tech community amid the ongoing conflict that could cripple the country's economy for years to come. Investors in startups are used to operating in high-risk environments, but it remains to be seen whether the CEE market can withstand the uncertainties generated by a major military conflict. could also harm venture capital. Fortunately, the current situation in Ukraine has had a limited impact on VCs operating in the CEE region. I would say that the turbulence has forced startups to take quick decisions in the short term, rather than VCs to change their investment strategies,” Early Game Ventures (EGV) managing partner Cristian Munteanu tells BR. “In the meantime, we’re working with our portfolio companies, helping them grow, hire teams, build their products and acquire clients. Nothing has changed in this respect, but we are all a bit

more worried and hoping to see better days.” The war has also left the burgeoning IT community in Ukraine in limbo. The country

was hosting the research & development centres of dozens of large companies, including giants such as Google and Huawei. Over a hundred Fortune 500 companies were using Ukrainian IT services, and the industry had over 200,000 tech specialists, a figure similar to Romania’s.

“Ukraine and Russia both have large talent pools, and as the war and economic challenges are prolonged, the regional labour market is likely to be impacted by the influx of refugees,” says Cristiana Bogateanu, the CEO of Romanian Tech Startups Association (ROTSA). Players in the startup industry say it is still too early to say if Romania could prove attractive for IT workers from Ukraine and even for entrepreneurs who could start new firms locally.

“In such a sensitive and unpredictable

context, tech startup investments are likely to change, adapting to current realities and the corresponding challenges. In today's economy, venture capital is a key component. In Central and Eastern Europe, Estonia was the leading country for venture capital investments between 2013 and 2019, followed by Romania, with over EUR 1 billion. Moreover, our economic relations with Ukraine and Russia are limited, and the same can be said for the entire region, as CEE investors generally have no major ties to either country,” Bogateanu explains.

After the Covid-19 pandemic and the emergence of a military conflict, startups in our region might find it harder to raise money, according to the ROTSA CEO.

On top of these major events, most economies are dealing with a spike in inflation and soaring costs in the energy sector. Munteanu of EGV wonders whether this could generate a “perfect storm” for a larger global financial crisis.

“The global investment industry has already reacted, and private markets quickly aligned with public markets to adjust valua-

tions as well as the number and size of transactions. Everything slowed down,” Munteanu says.

Representatives of Romanian angel investment group Growceanu suggest that in this context founders should be more focused than ever on solving relevant problems and validating their models by showing market traction.

“We all know and love Ukrainian startups and their wonderful founders, their tech people, and other stakeholders. Though these good people's lives have been badly disrupted, countries like Poland and Romania could end up benefiting from the influx of talent,” Growceanu’s representatives tell BR.

Ukraine announced from the very first days of the conflict that they would relocate their workers in safer countries. In some cases, employees were given the option to temporarily relocate in order to protect themselves and their families. However, a presidential order that bans men aged 18 to 60 years old from leaving the country could be putting evacuation plans on hold.

According to PitchBook data, before the invasion there were at least 158 Ukraineheadquartered companies that had received VC or angel backing, and almost 300 such companies had a secondary office in the country.

One week after Russia's invasion started, Oleksii Shaldenko, cofounder and CEO of software startup Wantent, told Sifted.eu that the situation regarding investments was already becoming critical. The startup was negotiating a USD 2 million seed round, and

potential investors had decided to postpone a decision until the conflict de-escalated.

“An early-stage startup is already a risky proposition; when you add a risk to a risk [that’s not a great way to] go about raising money,” Dominique Piotet, CEO at Kyiv’s UNIT.City innovation park, told Sifted.eu. SECOND ECONOMIC SHOCK IN 2 YEARS

The Russian invasion has disrupted supply routes and generated a spike in energy costs, pushing the European Union to reassess the timing of its transition to renewable sources. Until now, the green economy had been touted as one of the drivers of a new generation of startups and it is unclear how entrepreneurs will move in the new environment. The economic fallout from the conflict is still hard to measure, but the UN's trade and development body (UNCTAD) has already downgraded its global GDP growth projection for 2022 to 2.6 percent, from a 3.6 percent previous estimation.

“The economic effects of the Ukraine war will compound the ongoing global economic slowdown and weaken the recovery from

the Covid-19 pandemic,” UNCTAD secretarygeneral Rebeca Grynspan said in a statement. The economic shock will be more intense in developing economies, which are already dealing with a higher stock of public and private debt due to the pandemic. UNCTAD specialists underline the fact that the war has put further upward pressure on international energy and primary commodities prices. It has stretched household budgets and added to production costs, while disruptions to trade and the effects of sanctions are likely to have a chilling effect on long-term investment. Advanced economies are on course to reverse the stimuli they enacted during the pandemic, by tightening policy rates, unwinding central bank asset purchases, and closing down furlough programmes, transfers, and support to businesses and households, according to an UNCTAD report.

Businesses in the Eurozone are already seeing an increase in costs, with a subindex tracking the manufacturing and services sector reaching a record 81.6 points in March, up from 74.8 points in February.

“The war has aggravated existing pandemic-related price pressures, which will inevitably feed through to higher consumer prices in the months ahead,” said Chris Williamson, chief business economist at S&P Global, quoted by the Wall Street Journal.

Russia is already facing a barrage of sanctions from western economies and VC investments in the country will also decline significantly. Some large investors had already cut ties with Russia since 2014, when the country took over Crimea and annexed additional territories in eastern Ukraine. Until the invasion of Ukraine, Russia was the 12th largest economy in the world.

In the few cases where western VCs still are invested in Russia-based startups, investment firms will likely be expected to help companies relocate abroad wherever possible, divest from them or walk away from the investments entirely, Marina Temkin wrote in a PitchBook analysis.

The humanitarian efforts to support people who have been displaced from their homes remains paramount, while negotiations are underway to reach a peace agreement. More than 300,000 refugees from Ukraine have reached Romania so far, and it is unclear how many of them will decide to start new lives here. Companies have already started to hire Ukrainians and, going forward, we might see some of them opening businesses of their own in Romania.

Key players in Romanian EdTech and lessons from other countries

From the Netherlands, we can learn that EdTech can also pursue B2B, and not just B2C models Despite the shortcomings of the Romanian education system, the local EdTech ecosystem has undergone sharp growth in the last two years. In 2022, education in the country continues to make steps into the digital space, but at too slow of a pace considering the huge underlying potential.

By Claudiu Vrinceanu

KEY INSIGHTS

EdTech businesses are still lagging behind other startup sectors such as Fintech, HealthTech or eCommerce, which have all experienced enthusiastic support from investors. The most successful Romanian EdTech startups so far have been those founded by people who had previously worked as managers in other companies. Despite the growth and increased adoption of technology in education, the EdTech industry still faces considerable challenges, including the need for more cooperation between public and private organisations and a reliable budget allocation from the Education Ministry.

LOCAL PLAYERS

EdTech Romania is the only active community specialising in connecting education and technology. The platform brings together startups and companies, schools and universities, investors, enthusiasts, and other supporters of education in the country. The EdTech Romania community aims to form a critical mass of technology enthusiasts and people who are actively involved in co-creating future education. Romanian edtech startups and scaleups are Kinderpedia, Ascendia, Colltrain, Code of Talent, Voxikids, Houston, Investory, EduKiwi, and Nestor. Just three case studies indicate these companies’ interest in internationalisation and highlight the potential for creating digital educational content. First, local startup Kinderpedia, which has developed a digital communication and management solution for schools and kindergartens, recently partnered up with Maple Bear Global Schools, Canada's largest network of bilingual schools and kindergartens, which offers its platform to a network of over 550 Maple Bear schools in 32 countries. Second, two Romanian entrepreneurs with more than 15 years of experience in training and software development have launched Colltrain, a platform that runs remote, live collaborative training activities. After an initial investment of EUR 150,000, Colltrain now has over 140 trainers operating on the platform, aiming to double the figure by the end of 2022. Third, online course platform eduKiwi has launched the eduKiwi School project, an application set to be used by 300,000 students in Romania following an investment of EUR 1 million. The app will contain over 2,000 hours of video course content featuring the best teachers in the country. INVESTORS

EdTech has gained prominence worldwide in the context of the covid-19 pandemic, with investors and entrepreneurs in the educational and training sector having emerged in Romania as well. European EdTech VC investments tripled to USD 2.5 billion in 2021, from USD 790 million in 2020. In Romania, the investment landscape is still in the early stages, with funds like Early Game Ventures, Catalyst Romania, RocaX, and Growceanu actively investing in this sector. Two notable financing rounds have been obtained by Kinderpedia (EUR 1.8 million) and Code of Talent (EUR 1.7 million).

LESSONS FROM OTHER COUNTRIES

Romanian EdTech startups still rely primarily on their founders’ resources. In other countries, including Poland, we’re seeing scientists carrying out research or running projects for businesses. Researchers can also create products and start enterprises that can help solve the problems faced by education. From the Netherlands, we can learn that EdTech can also pursue B2B, and not just B2C models, as many growing Dutch EdTech companies sell to education institutes or corporate clients.

Possible effects of Ukraine war on Romania’s FDI prospects

As the world waits for a diplomatic solution to be reached to end Russia’s invasion of Ukraine, Romania’s economic strategy should focus on attracting foreign investors, since it may stand out as one of the safest and most stable investment destinations in the region.

By Claudiu Vrinceanu

The governmental body should proactively look for companies that are interested in our region

In the post-war period, Romania’s chances of attracting foreign investors – a crucial lever for rapid economic rebound – might grow. The first positive signs are coming from two current case studies. First, German company Varta is considering Romania for its new electric car battery factory. The investment would amount to one billion euros. The company is looking at the Arad area, which is near the western border of the country, according to Economedia. The Germans already have a small factory in Brasov, producing batteries for hearing aids. The new factory would be much larger and produce the latest Varta batteries for electric cars. The second opportunity involves Canadian company Rock Tech Lithium, which wants to build a factory in Romania to produce components for electric car batteries, with an investment that will amount to EUR 400 million. These two potential investments have three things in common: they are the result of Romania’s constant economic diplomacy actions; they are tied to European funds and, implicitly, to the new vision in Brussels; and they have the support of central authorities. Romania can strategically seek out new foreign investors to ensure a rapid and healthy economic recovery. The momentum is there: the flow of foreign investments in Romania in 2021 grew to over EUR 7.2 billion, after only reaching EUR 3 billion in 2020, the lowest level in seven years, due to the pandemic. So, what opportunities could Romania pursue following this period of uncertainty caused by Russia's invasion of Ukraine, doubled by the wider geopolitical threats in the region? What might a list of economic priorities look like?

RETHINKING INCENTIVES FOR FOREIGN INVESTORS

A first option could be to re-evaluate investor backing schemes via state aid, on two main pillars: diminishing the country’s energy dependence on Russia and favouring the development of joint projects with Romanian entrepreneurial companies. Economy minister Florin Spataru said recently that 20 international companies in the automotive or consumer goods industries were thinking of relocating to Romania in the coming period as they sought to leave Russia and Belarus.

A second strategic course of action could be strengthening the American presence in Romania from a business point of view. The potential for cooperation with the US is significant both militarily and economically: companies controlled by American entities have made foreign investments of EUR 5.8 billion locally so far, making the US Romania’s fifth most important partner in terms of these flows. Alongside sanctions on Russia in the context of the war, strategic investment opportunities were also among the main topics of discussion between Vice President Kamala Harris and Romanian government officials, so we can expect bilateral relations to continue developing in the coming period.

CHANGING COUNTRY BRAND POSITIONING AND NEW GOALS FOR INVEST ROMANIA

To attract new investors in the future regional economic competition, Romania must polish its country brand and its reputation as a destination for foreigners. More specifically, when it comes to greenfield investments, we can no longer solely rely on the competitive advantage of low labour costs. It would also be healthy to focus on security arguments and support government institutions that aim to promote Romania abroad, such as Invest Romania. The governmental body should proactively look for companies that are interested in our region. In the context of the harsh economic sanctions applied to Russia and the ongoing fighting in Ukraine, many companies will seek to relocate to safer countries. If Romania manages to attract at least 20 percent of these companies, these gains will balance out the losses caused by any delayed or cancelled investments in 2022.