Two years after the start of the Russia-Ukraine war and the plethora of sanctions that followed, Western private capital has almost entirely exited Russia.

With new investments largely prohibited, foreign private equity and venture capital investment in the country fell 39% annually in 2023. Nearly all private capital now comes from domestic firms, according to data from S&P Global Market Intelligence.

In Ukraine, the data indicates an opposite but slower trend. Private equity investment spiked to $540.2 million in 2023, driven by one large deal: French private equity firm NJJ Capital SAS' $525 million agreement to acquire the Ukraine-based assets of Turkcell Iletisim Hizmetleri AS.

The data — which includes only announced investments in Ukraine-headquartered companies — shows that private investment is pacing upward, and deals are typically small venture capital stakes in startups. Without the NJJ deal, investment would still be up more than 60% annually to $15.2 million.

In Russia, overall M&A deal value was up in 2022, driven by hundreds of foreign companies offloading their domestic assets to Russian buyers after the war began. In 2023, M&A activity dropped 71.48% after the majority of the assets had been acquired.

Private equity's pullout from Russia

Exiting Russia is a slow-moving, opaque process through multiple state bureaucracies with high uncertainty about the outcome, according to Laura Brank, partner at law firm Dechert LLP and head of its Russia practice.

Brank has assisted about two dozen companies in various sectors with their exit from Russia through third-party sales, management buyouts, or liquidation of assets.

Western assets that go through the sale process are heavily discounted. "The buyer can pay no more than 50% of the appraised value of the company," Brank said.

Offloading Russia-based assets takes between three months and one year, depending on how long the application works its way through Russian state bureaucracies and possibly US or European government agencies due to export controls.

"There were concerns [on the Russian side] about capital leaving the country because there were some very big exits in 2022 that took a lot of currency out of the country. So there's scrutiny applied when a company is trying to leave."

Brank has worked mainly with Russian corporate buyers, but domestic private equity has been involved in some larger acquisitions, according to Market Intelligence data. Russian private equity firm Kismet Capital Group was a buyer in four of the largest deals, which are all foreign company divestments and capped by the $2.35 billion acquisition of a stake in classified ad site Avito Group from exiting Dutch internet company Prosus NV.

Kismet was also a buyer of the Russian assets of German household products company Henkel AG & Co. KGaA and Netherlands-based Heineken NV as those companies pulled out.

Seven of the 10 largest deals since the start of the war involved Russian private equity buyers.

Private equity's slow flow into Ukraine

The investment data on Ukraine does not reflect locally founded companies that moved headquarters abroad but maintain a Ukraine office. Several have attracted substantial capital.

Examples are Unstoppable Domains Inc., a digital identity firm founded in Kyiv and headquartered in Las Vegas. It had a post-money valuation of $1 billion after a $65 million funding round led by Pantera Advisors LLC in 2022. Another unicorn is airSlate Inc., a developer of an automated document workflow platform with headquarters in Brookline, Mass., which has a valuation of $1.12 billion, Market Intelligence data shows.

"To mitigate risk for international investors in Ukraine, one solution has been to relocate the core team of the startup to any safe location either Eastern Europe or Western Europe or the US and in this case, the start-ups attract investments pretty easy," said Dmytro Kuzmenko, CEO of the Ukrainian Venture Capital and Pvt. Equity Association (UVCA).

Military technology startups

IT companies have been the preferred venture capital investment target, particularly fintech and cryptocurrency-related companies. UVCA's Kuzmenko said private equity is starting to invest in the military and defense sectors. The need for dual-use military technology startups in areas such as drone manufacturing and cybersecurity is mounting as the war continues.

Innovations in battlefield technologies are drawing the attention of investors, said Peter Manos, a managing partner at Arlington Capital Partners.

"[W]hat you are seeing, in Ukraine in particular, is the use of technology can far outweigh pure metal hardware — tanks, et cetera," Manos said. "You can use drones, you can use reconnaissance type of technologies to make you much more efficient in your battle against a much bigger foe. So, what it is doing is it is prompting new inventions."

A Ukraine government program that helps local military technology startups sell their solutions to the Ministry of Defense is one of many initiatives that promote investment. Other incentives include Western government and private financial support, investment insurance, taxation benefits and a skilled workforce.

Western governments are also investors in local private equity funds. The European Bank for Reconstruction and Development and government entities from the US, the Netherlands and Finland, as well as Swiss private equity firm The Swiss Investment Fund for Emerging Markets committed a combined total of $115 million to Horizon Capital Growth Fund IV, managed by Kyiv-based Horizon Capital.

The UVCA, together with partners including the British Pvt. Equity and Venture Capital Association Ltd., hopes to attract capital from family offices and high net worth individuals through a local fund of funds initiative, Kuzmenko said.

Exits remain a challenge, with few domestic avenues. The Ukrainian stock market was "in hibernation mode even before the invasion," Kuzmenko said. "Mostly exits happen abroad, and most of these exits are related to either an M&A transaction or we see another VC entering for a mature round."

The security risks of investing in a country at war are obvious, but private equity capital is nonetheless trickling into Ukraine.

Kuzmenko said a main obstacle is outdated Ukrainian legislation, which needs to be adapted to EU standards — a process that is moving along with Ukraine's EU candidacy.

"We are already on this path, but we still need to carry out certain reforms," the UVCA CEO said.