Russian venture discusses the investment drain

Against the background of Russia’s dire political and economic situation, venture funds are increasingly losing interest in startups at home, in favour of their overseas rivals, with several major players abandoning the Russian market altogether.

At the beginning of December Konstantin Sinyushin, CEO of the Untitled Venture Company, referred ironically to this tendency on his Facebook page as “a new wave of venture patriotism”, noting that “Russian investment funds have started to dump their Russian assets on a huge scale, freeing up even more capital for investment in foreign startups.”

Here at RusBase we predicted that over the course of the year the crisis would cause the majority of those in the venture industry to cut their losses and look for a quick exit from startups in their portfolio, leading to a shrinking in the number of venture funds operating in the country.

This anticipated investment flight is indeed being widely discussed in Russia. Clearly Russian venture funds investing abroad is nothing new, but there is now a real danger that domestic startups will find themselves without any source of investment.

Having said that, any crisis will find some people preaching Armageddon and assuming the worst. To get a clearer picture of the mood in the industry, we decided to find out what those on the inside really think: to what extent is this ‘investment flight’ taking place, and will its consequences be as serious as some have suggested? We also asked venture fund representatives whether they plan to leave Russia, and what startups should do in the current situation.

Leaving already?

The consensus seems to be that the investment drain is very real. Those not convinced merely have to read the venture industry news. Besides the fact that there is very little mention of investment in domestic startups, many major players have either officially announced that they are ceasing activity in the Russian market, or have physically left the country, moving their offices and teams abroad.

A notable example was last month’s announcement by Life.SREDA that it was planning to sell the majority of its Russian assets and to stop investing in Russia temporarily in order to focus on overseas startups, particularly in Asia. At the beginning of February, the fund announced the takeover of iboxPro, its first deal in the continent.

Igor Pesin, Investment Director at Life.SREDA:

“In spite of its headquarters in Moscow, Life.SREDA was always envisioned as a global fund investing in foreign finance startups. We have always been interested in American and European startups, but at the end of last year we took the decision to concentrate on projects from the Asian region, since it has demonstrated such fast growth and potential. In terms of our physical presence, it is most likely that the fund’s headquarters will also move to Asia. This is because the fact that we are concentrating our investment on this region means having a physical presence in Singapore or Hong Kong will have a big impact on our access to deals and potential partners. However, this will not stop us from being able to invest in those Russian projects which we consider most interesting.”

It has also emerged recently that Igor Matsanyuk’s investment company IMI.VC will be moving permanently to Lithuania along with several of its portfolio companies.

Flint Capital has also moved its head office to Barcelona and plans to close its Moscow office by the end of this year. The company maintains that it is not abandoning the Russian market and will continue to look at Russian startups which are targeting global markets.

Don’t blame the crisis

There is widespread consensus that the crisis is not by any means the main reason for the current investment drain, and is in fact simply acting as a catalyst, accelerating the problems which have been affecting the Russian venture sector for years.

Oleg Seydak, Partner at venture fund Flint Capital:

“Even longstanding Russian investment firms like the Sberbank are starting to look increasingly to foreign companies, never mind small private funds like Flint Capital, Life.SREDA, TMT Investments, AltaIR etc. But we would not call the economic crisis, which only really took off a few months ago, the main reason for this trend. Over the last four years a host of critical problems have built up in the Russian venture sector, which would have led to this drop in activity in the domestic market all by themselves.”

Seydak puts the lack of firm interest from strategic buyers both at home and abroad, in the acquisition of companies working in the Russian market, at the top of the list of these problems. According to him, the majority of Russian startups have difficulty in making the step up to the global market. This makes exits from these startups very challenging for Russian venture funds, and means that companies cannot make profit on the capital invested, rendering the process devoid of all economic sense.

Mikhail Lobanov, Managing Partner at Target Ventures:

“For us this is a conscious decision taken as part of our long term plans, rather than a way of getting through the crisis. As for the [investment drain] as a whole, the crisis is just a catalyst. The real causes are more deeply rooted. In my opinion, it is the near total lack of exits in the Russian market. If funds are going to make a profit, they need to sell companies from their portfolio and reinvest the money. If they can’t get their money back, then it is hard to see what the point is in investing. Do you know what the difference is between a venture investor and a normal person? They enter a room backwards. Why? So they can see the exit.”

Target ventures came to the venture sector from the stock market. Mikhail Lomanov notes that in 2009 the stock market returned fairly quickly to the position it had been in the year before. In the venture sector the process will take longer, but, as he notes, “when you’re at the bottom the only way is up”. He believes that there are still a lot of extremely professional funds and investors who will offer financing to the most promising and professional startups. Target Ventures has no plans to abandon the Russian market.

Runa Capital, Russia’s most active venture fund last year in terms of exits, selling four startups in total, has also always considered itself a global fund. As Managing Partner Dmitri Chikhaev notes, the investment strategy of Runa Capital’s second fund, launched in 2014, remains unchanged. Runa’s first fund made around 60% of its investment in Russia, whereas the second makes a larger portion of its investment in foreign startups, up to around 60%. Its geographical focus is still global, but it is prioritising investment in Central, Eastern and Western Europe as well as Israel.

Dmitry Chikhaev, Managing Partner at Runa Capital:

“Many venture funds had already taken the decision to invest abroad before the crisis began. This was because the bubble had burst. The amount of money in the venture market had grown tenfold, while the number of startups meriting investment had not grown proportionally, causing inflation. Companies became more expensive, as did personnel. If funds are leaving Russia it’s because things didn’t work out here for them.”

Nevertheless, Chikhaev still believes that the activity and competitively of the Russian market will make a comeback.

Although, as described above, the majority of funds have long been investing in Western companies and the Russian venture sector’s problems have deep roots, there is no doubt that the crisis significantly exacerbated them.

German Kaplun, Cofounder and Director of Strategic Development at TMT Investments:

“The market is worth half what it was in dollars and the economy is not growing. Therefore, startups who rely on the Russian market for sales and the success of their brand are not attractive. They not only have to start a new business from scratch, but also fight against the economic tide. The crisis has seriously aggravated these difficulties. We are a developing market with many unknowns. To invest in the Russian market investors want to see double the profits compared to more developed markets. This is their reward for greater risk, weaker legislation, unpredictable government and general instability. When investment in Russia is even less profitable than in other countries there is simply no reason to invest. Of course there are exceptions…but they only prove the rule.”

Like the abovementioned funds, TMT is holding firm in its strategy. Its priority markets are the US, Israel, the Baltic region, Russia, Belarus and Ukraine. It will continue to invest in Russia, but will do so very carefully until the situation stabilises.

Where’s the exit?

Prostor Capital works with a Media for Equity model, in which the company offers startups advertising space in exchange for a stake in the company. The fund works in the Russian market and has no plans to change strategy so long as domestic startups are still willing to work with this model. Nevertheless, Managing Director Alexey Solovyov agrees that the fall in investment activity in Russia is inevitable, but he insists that this has its upsides.

Alexey Solovyov, Managing Director at Prostor Capital:

“The trend is there, and it is not something that started only yesterday. The crisis only sped it up. Because of the surge in the dollar, the market fell back, the value of assets in roubles collapsed and so people invested primarily in dollars, but the capitalisation of a portfolio’s Russian assets is calculated based on revenue and earnings in roubles. This persuaded many of my colleagues in the profession that diversification of their portfolio in terms of startups is an important factor in keeping risk to a minimum. This doesn’t mean that there won’t be any more deals with purely Russian companies. Of course there will be. The rules of the game have simply changed, so only startups who prove that they are the best of the best with actions and not just words will attract investment, or those who have clear global potential.”

Alexander Galitsky, Managing Partner of Almaz Capital Partners, also believes that the tendency to invest abroad is not such a bad thing. He advises funds investing in foreign companies to “attach” personnel to their investments, who will be trained up abroad and come back to Russia to help develop their sector. Furthermore, he also suggests that investing in foreign companies and bringing them to Russia to grow in the domestic market is a good development strategy. He notes that many startups achieve very strong sales in their own regions, but for various reasons do not expand, citing American company Vyatta, whose stake the company sold to global corporation Brocade.

Almaz Capital Partners also has no plans to change its basic strategy: the fund invests in companies with the potential to enter the global market, focussing on Silicon Valley startups, as well as those from the Baltic States and Eastern Europe.

Maxfield Capital employs a similar strategy, investing in b2b startups with potential to enter the European, US and Israeli markets. It recently invested in Russian company Zdravprint.

Alexey Melnichek, Analyst at Maxfield Capital:

“The startups hit hardest by the current economic turbulence are those operating in the domestic market. It is harder for them to attract investment than it was a year ago. For us, the most important thing is for a startup to offer unique technology and a strong team. Where the startup operates geographically only comes into it afterwards. As far as funds moving abroad, it is important to understand that they may meet with a sceptical reception. In order to successfully enter the global market a fund needs a strong partner which can recommend it as a competent investor, and which has a big pipeline in the region.”

What can startups do? 

German Kaplun (TMT Investments): To the West!

If a startup has the potential to develop abroad, then it is best to go to a western incubator, the sooner the better. If it is targetting the Russian market then it should try to make a profit as quickly as possible and look for a Russian investor. It should seek investment from one of Russia’s well-known business angels.

Dmitry Chikhaev (Runa Capital): Look for funds with experience of Russia

Seek for investment from funds which have experience of working with Russian startups in the past. If you try to attract investment from a foreign fund which has never invested in a Russian company it is unlikely you are going to change its habits.

Mikhail Lobanov (Target Ventures): Don’t overestimate your worth

Keep your feet on the ground. We are not Silicon Valley. Russia’s rating is BB+, Brazil’s is BBB-, Thailand’s is BBB+. It’s an interesting comparison don’t you think? We think of these as ‘developing countries’ and yet they are already ahead of us. Therefore, Russian companies should not try to compare themselves with American ones. Look to Brazil and Thailand for comparisons, and get a realistic valuation so you can raise investment.

Alexey Solovyov (Prostor Capital): Think global

Think globally: this goes for scaling your business inside Russia just as much as across the world. Companies that go for the big markets and show good traction will look a lot more attractive to investors. You only have to look at companies like GetTaxi, which went for the huge taxi market, and Netology, which went for the huge online training market. If you want the venture industry to get behind your business, you will only get investors on side with a truly scalable business. This does not mean that if you have a more modest business idea you should abandon it. You should definitely go ahead and try; it will just be harder to attract external investment.

Igor Pesin (Life.SREDA VC): Have a global development strategy from day one

In the current reality, in order to attract the attention of funds Russian startups need to be thinking about entering global markets, and doing it this year. They should have a global development strategy. For example, LifePay had already made the decision to concentrate on global expansion back in 2014, and now it has entered the Southeast Asian market through its acquisition of iboxPro.

Despite the fact that many professional funds are slowing down their investment activity in Russia, there are a lot of private investors left in the domestic market who have made exits from their companies but are always on the lookout for an opportunity to grow their assets. There are also still state venture funds (for example FRII) and the funds of major state corporations.

Source: RUSBASE
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