Ever since Russia become the ‘R’ in Jim O’Neil’s BRIC acronym in 2001, Western investors and entrepreneurs have increasingly sought to take their chances in Moscow, St. Petersburg and beyond. O’Neil’s assessment of the size of the opportunity within the Russian market has been shown to be decidedly correct.
However, the flow of investors from the West can be characterised as a steady stream, rather than a torrent. In my view, part of the reason some Western investors eschew Russia is, at its most basic, a fear of the unknown.
However, as I will show, these fears are largely unfounded. The differences in business practices between the West and East are growing rapidly smaller. Indeed, the Russian approach to investment and the VC scene in general only differs in a handful of areas.
Setting the scene
First, it is important to realise that Russia is currently undergoing a revolution in investment similar to the changes the US underwent half a century ago. In the US, the first VC funds were established after the Second World War. By the 1970s, some of these funds had evolved to target early stage company development. Only in recent years, has a similar system developed in Russia, as a result Russian venture capital funds have not yet developed themselves into worldwide brands. There are currently no Russian equivalents to Sequoia or Summit Partners. At the initial stage of Russia’s VC market development, simply having the money and the expertise has been enough.
As a result, Russian VC funds are far fewer in number and smaller in size than their counterparts in the US and UK. There are only around 150 funds and anything over $10 million is considered to be at the top end of the deal scale. Russian angel investors also invest, on average, $50,000 – $200,000, that is five to ten times less than the average investment in the US.
The perception of risk
Perception of ‘risk’ in Russia is somewhere between the Asian and European approaches. In short, Russian investors are generally more risk adverse than their US or UK based counterparts. This approach is a product of Russian culture which is, with the exception of certain areas of major cities, very conservative. Consequently, in sectors such as tech, deal making is concentrated in established, proven segments such as e-commerce and ad tech. According to RusBase, e-commerce business accounted for the largest and fasted growing segment in terms of VC deals, growing by 33% in December. This was closely followed by software, multimedia and games, which all grew at 22%.
However, in terms of the complexity of deal making and buoyancy of the Russian VC market, there is little to differentiate it from the West. One only has to look at some of the recent successful exits of several Russian VC firms, for example, DeliveryClub was sold to Phenomen Ventures which is also backing Rocket Internet’s Delivery Hero and FoodPanda.
Another good example is the IPO of QIWI plc on the NASDAQ in May 2013. QIWI plc is the largest Russian operator of electronic payment systems and was founded by a group of iTech Capital LPs. Since the date of the IPO, the company has tripled in size.
The role of the Russian state
Another fear Western investors often have is in relation to the role the Russian state plays in investment. However, the truth is that the Russian Government has geared its approach to attracting outside investors. In the tech sector the Russian Government is particularly active and more than a willing partner with foreign investors. In 2013, the state provided around 38% of seed deals and 24% of startup stage funding – predominately in developing technical segments such as biotech and industrial tech.
The principle behind this active role is that the state can help to foster public-private partnerships which will then in turn support domestic innovation. These partnerships are ideal for helping high risk projects receive serious capital at an early stage, especially as private investors are more willing to commit funds when the state acts as a guarantor.
The Russian Venture Company (RVC) is a government fund of funds and a development institution. It is one of the Russian Government’s key tools focused on building a national innovation system. It includes 15 funds of totaling $750 million and it has several direct and joint investments in both Russia and the US.
The RVC, like many other Government funds, actively favours partnering with outside investors. Indeed, the preference for foreign money is so prevalent, that many Russian companies seek to increase foreign investment and staff with one eye on courting state funds.
Going East
The Russian business landscape has been transformed over the last decade or so, with many entrepreneurs and investors stepping forward to take advantage of the new freedoms previously unavailable to them. The results of this are evident in the successes of home-grown tech giants such as Yandex and Mail.ru. These leading tech companies are highly competitive with the Western market, for example in Russia the search engine Yandex holds a 62% market share, whereas Google commands only 26%.
With the state playing a positive role in investment and business practices converging with the West, the question for investors should not be whether they can afford to risk investing in Russia, but rather can they afford not to invest.
- Nick Davidov, Investment Director at iTech Capital and Managing Director of the Pult Group, provides advice for investors in Russia.
