The Russian venture capital market is becoming more mature and is waiting for the emergence of new players — late-stage funds. At the same time, the inexplicably high cost of some start-ups indicates the presence of a market bubble.
The annual study “MoneyTree: venture capital market navigator”, which RVC and PwC have been developing since 2012, shows that in the first half of 2019, the volume of venture transactions in Russia almost tripled compared to the same period last year and reached almost $250 million. In total, 129 deals were completed as opposed to 87 in the first half of 2018, the “average check” of investments doubled — from $1.5 million to $3.1 million. This was not always the case — a few years ago, we observed a reduction in the total volume of transactions, investor activity, and a decrease in average checks. The investment community looked at the venture market as at a victim of weak market conditions, and many of its participants expected a further drop in performance.
Several reasons for the growth can be distinguished. Firstly, this is an active position of the state, which understands that the venture capital market, although its contribution to GDP is small, is a springboard for technological breakthroughs, including in the sectors that determine the economy. That is why in a relatively small market, the volume of which is still about $500 million per year, a number of development institutions operate, and many legislative initiatives are implemented. These efforts have borne fruit.
The second reason that indicates the evolution of our market is an increase in the activity of investors in the later stages. Classic venture capital markets pass the project through several investment stages — seed, start-up, early-stage, expansion, pre-IPO, IPO or acquisition by a “strategist” — a large corporation. In contrast, in young venture capital markets, early-stage surviving companies cannot attract financing from more significant players. This imbalance is still characteristic of Russia, an experienced company with revenue of 1 billion roubles a year does not have the opportunity to raise the next investment round — it had to either sell itself to a strategist or seek funding abroad. However, recent trends show that the situation is improving.
We expect that in 2020, there will be participants in the market investing in mature companies — late-stage funds. Soon, the Russian investment cycle will be fully formed and will be able to serve venture companies of any size — from the sowing stages, when start-ups require, for example, three million roubles, to large players who plan to enter the Russian or international stock exchange and need venture capital, measured in tens or even hundreds of millions of dollars.
However, an increase in the average transaction amount may have a downside. Even in the early stages, it began to approach the performance of the American market. The fact that our start-ups sometimes cost about the same as American ones most likely indicates the presence of a market bubble, local overvaluation of projects in some industries.
In the industry structure of investments, consolidation is observed: fewer markets receive the main part of the monetary funds, and investor competition is intensifying. The traditional favourite of the Russian venture capital market is the information technology industry, with e-commerce leading the way, which accounted for 86% of all transactions in the first half of 2019. On the one hand, this means that in the preferred horizon for private investors (two to four years), you can now earn on a relatively small number of products. On the other hand, this demonstrates the growth of qualifications of investors who invest not so much in emotionally attractive or hype projects, but in predictable areas.
The remaining venture capital industries are attracting less investment. Biotech is still losing ground, although we should not forget that the study covers only the first half of 2019, and most transactions traditionally fall in the second half of the year. The decrease in investor activity is associated with the outputs of last year, when several attractive companies were sold, including by the RVC funds. However, at the same time, this is a sign of significant changes in the structure of biotech market, when large corporations begin to control the process of creating new companies, drugs and devices at much earlier stages and more and more effectively compete with private funds. Here the penalties of a shallow market begin to work when the pipeline is distributed between a limited number of players, and there is not much room for new participants.
We expect growth in the industrial technology segment. Russia is an industrial country and a vast market for digitalization projects, improving the quality, speed, and efficiency of existing technological processes. There are not many players working so far in this desirable industry. However, the market has already accumulated a sufficient number of successful cases, investments, and companies with good potential and supported by venture investors.
The major trend of 2018-2019 was the launch by many corporations of their systems for identifying promising start-ups, their acceleration, and support through their venture funds. Interest in venture projects is shown by Mail.Ru, MegaFon, MTS, Sberbank, AFK Sistema, Rostelecom, and many others.
The fact that corporate funds began to play a significant role in the market and generate the majority of acquisitions means that the Russian venture capital market has become even closer to the classic characteristics, which does not lower our expectations of a further increase in the activity of “corporations” — both as final buyers of assets and as investors. Obviously, they will be able to compete with state and private players.
Another serious trend in 2018–2019 was the continued volume growth of foreign deals conducted by Russian venture players — their size exceeds the size of the domestic market. Most of its participants positively perceive this trend, seeing a confirmation of the deep integration of our investors in the global venture market in it. Our funds and investors gain access to high-quality deals; they are taken to syndicates and clubs, admitted to the high levels of profitability that form the leading cases of our market. An example is the RTP Ventures fund of Leonid Boguslavsky, who, at an early stage, became an investor in the New York-based company Datadog, a developer of software for cloud storage monitoring. On September 19, the company entered IPO on the NASDAQ exchange, the placement was successful, now it costs more than $11 billion, and the share of RTP Ventures has risen to $844 million.
However, Russia can supply its “unicorns” to the global market. An example is the HeadHunter, whose shareholders earned $220 million on their NASDAQ in May 2019. The company was then valued at $675 million, and in September, its capitalization exceeded $1 billion. We are aware of upcoming deals and are expecting an IPO of comparable size next year.
At the end of 2019, we expect a significant increase in the venture capital market. If, in the first half of the year, it showed a rise of 161% — up to $248.1 million, compared with the first half of 2018, when its volume was $94.9 million, then for the whole of 2019 we can expect at least a doubling of it. However, it all depends on what significant deals the year ends. As a rule, corporations transfer their conclusion to the end of the fourth quarter. They do not advertise them until the agreement is signed. The industry focuses on the late stages, with corporations becoming the primary source of exits so that the average check will become even more substantial. A growing market will surely attract new players to the industry — both Russian and foreign.
By: Alexey Basov, RVC Investment Director.