As the Russian government pursues its stated ambition of diversifying and modernising its economy by moving away from raw material exports towards innovation-driven development, what opportunities does this present for Western technology companies and those that invest in them?
The story so far…
The Russian government has come to the conclusion that a technology-driven economy is not going to start by itself. The country may have a long history of science (Stalin and Brezhnev built special cities called ‘Sharaskas’ and ‘Naukagrads’ respectively for the development of science), but following the collapse of the Soviet Union the country’s capital was sucked into its booming natural resources and bricks and mortar industries and there has been a lack of success stories from investment in technology startups. This vicious circle needed to be broken.
President Medvedev announced that his government would create an equivalent of Silicon Valley at Skolkovo, a green field site in the Moscow suburbs. Skolkovo innovation city, for which US$ 4 billion has been earmarked for building its infrastructure alone, will enjoy a special status including substantial tax concessions. In March of this year, start-up Pirate Pay became the first company to receive funding as a result of cooperation between the US company and the Skolkovo Foundation. Head of Microsoft Russia, Nikolai Pryanishnikov, said that he intends to make grants of up to US$500,000 each to a further 100 IT startups in the next 10 years. The intention in due course is to use the experience gained from Skolkovo to build 20 innovation parks across Russia.
In addition, the Russian government has set up two leading institutions to provide funds for investment in the hi-tech sector: Rusnano is a state-owned corporation mandated to invest approximately US$10 The Russians are coming... billion in nanotechnology projects in Russia. The Russian Venture Company (RVC) is a US$1 billion government venture capital institution operating as a fund of funds and development agency charged with kick-starting Russia’s own VC industry. The terms of any investment by RVC into a VC fund are unusually generous. RVC caps its return on its investment at 5%. All returns made above that go to other limited partners and to the managers.
RVC has already invested in 12 VC funds which, as at December 2010 had between them 59 portfolio companies and invested capital of approximately US$200 million. Some of these VC funds originate from Russia but many are international. For example, Tamir Fishman, a leading investment bank from Israel with years of venture experience, established the Tamir Fishman CiG Russian Fund and Bioprocess Capital Ventures was established by biotech group Bioprocess and Silicon Valley veteran investor Pitch Johnson.
Two of the VC funds that RVC has invested in, Russian Venture Capital I LP and Russian Venture Capital II LP, were established in the UK in order to invest in late-stage technology companies alongside experienced Western VC funds. The idea here is that, by investing alongside the established players in the market, RVC learns best practices for dissemination in the Russian market, and it also allows RVC to develop relationships with these VC funds to encourage them to invest in Russia. They are already flexing their muscles. In June of last year, Russian Venture Capital I LP participated alongside the likes of Draper Fisher and VantagePoint in a US$150 million series D funding of BrightSource Energy, a US-based developer of solar thermal power plants.
Has the World changed?
The amount of Russian capital flowing into technology businesses outside Russia is comparatively small. The funds in which RVC and Rusnano have invested are, with some exceptions, required to invest in technology based in Russia. However, the government recognises that it cannot simply rely on a homegrown market – and it is bringing Western technology companies to Russia.
Rusnano recently announced a US$700 million investment in plastic electronics company, Plastic Logic, which sees the US-head quartered company move a substantial part of its future manufacturing capability to Russia. The Zelenograd factory, scheduled for production starting in 2013/2014, will have the capacity to produce hundreds of thousands of units of nextgeneration plastic electronics displays per month with the government’s aim to establish a commercial plastic electronics industry in Russia.
Others are following and the flow of established technology companies to Russia is likely to increase as the ecosystem of VCs – able to offer large amounts of money at good valuations and, increasingly, to operate to international norms -, skilled employees and science parks takes shape.
Venture capital is a risky sector, and Russia is a risky country. The implications are as relevant for technology entrepreneurs as they are for investors.
The US and European markets take for granted a legal system that recognises and protects intellectual property rights and that has a sophisticated body of corporate law that protects the rights of shareholders and that allows for flexibility yet certainty in their arrangements. For example, there is a great deal of uncertainty as to whether drag along rights and good leaver/bad leaver provisions work under Russian law, and there are also no employee share options, the key ingredient for the high pay-outs of Silicon Valley.
Alongside an undeveloped legal system and widespread intellectual property piracy, Russia has a reputation for corrupt business practices and abuse of legal process.
There is no tech-friendly stock exchange in Moscow, no history of business angel investing in technology companies (vital in most jurisdictions as a source of early-stage finance) and the country is short on people who have turned interesting ideas into mega-exits.
More to come
The country has a large, well-educated population, a government dedicated to bringing venture capital to the country and developing technology businesses, and a booming market for technology products and services, but a lack of start-ups.
It is early days but the indications are that there is a new player in the World’s venture capital market. Taylor