COMMENT: The VC and angel investment landscape in Russia

By bne IntelliNews October 5, 2009

Vladimir Vilensky in New York -

In 2006, the then Russian president Vladimir Putin personally pushed through a set of laws to create a venture capital industry from scratch. Thanks to its Cold War legacy, Russia boasted a huge intellectual capacity, but with fat returns to be made from simple investments, most capital avoided cutting-edge high technology. Why risk your money on a Russian internet application when you could make a decent return from just installing some German equipment in a Siberian sausage factory? But nearly four years down the road and VC funds are starting to catch on.

One of the consequences of Russia's massive territory is that the internet has exploded and telecommunications arguably plays a more important role for Russia's national economy than in any other country, as the only way to run a territory that spans 11-time zones is by phone. The point is underscored by the recent high-profile investment by Russian investor Digital Sky Technologies, which paid $200m for a 2% stake in the social networking site Facebook in May, and the fact that the only segment of the advertising market expected to grow this year is online advertising, according to the Association of Communication Agencies of Russia.

Activity in the Russian VC sector only really began after the sovereign debt default in 1998 and has accelerated since. With this, we've seen increased attention to this market from leading western VC firms as well, which have created a number of investment funds, incubators and angel networks focused on the Russian market.

Unlike in the US, the level of disclosure, whether through regulatory filings of some kind, press releases or social media, is less in Russia, making it difficult to paint an accurate picture of the development of the venture capital business. But I've identified 185 companies that recently received venture funding from 56 Russia-focused investors.

No angels

Institutional money is the main source of funding, as would be expected: 69% of identified deals were done by venture capital and private equity firms, followed by angel investors (rich individuals making private investments) who were a distant second. This is unusual, because in the US the angel and venture capital funds have an equal share of the amount invested into start-ups. This shows that Russia's venture capital market is clearly still very much driven by the government.

In line with the mantra that venture capital is often a local game, investment companies primarily establish their shops close to the companies they finance in. Not surprisingly, 69% of them have a presence in Russia and 11% in Estonia, the birthplace of the global VOIP phenomenon, Skype.

Russian start-ups that have global ambitions tend to have a presence in the US. 19% of funded start-ups (or 35 companies from our sample) by Russia-focused investors have operations in the US.

Unsurprisingly the founders and management teams of most of the companies (regardless of their location) that received funding from Russia-focused investors have Russian nationals as important members of their teams. In most instances, these ventures have some technical or research responsibilities occurring in Russia or one of the former Soviet republics, but the headquarters have been set up in the US to go after customers, get access to the capital of the larger venture capital community in the US, to pursue partners or to attract different types of talent.

Estonia has emerged as the second-largest home to the former Soviet Union's venture capital industry, mostly thanks to the activity of Skype's founders' Ambient Sound Investments. Ambient has also benefited from active government support through the Estonian Development Fund.

Moscow, as might be suspected, is the most attractive city for company headquarters, with 44% of companies having a main office in Moscow. St. Petersburg and Tallinn are tied for second place, but after that, the remaining companies are spread across 50 cities and 19 countries.

Although institutional investors were a primary source of capital to these companies, I did identify many Russia-based companies that received angel or seed investments from individuals (40 companies).

From a sector perspective, internet- and technology-related investments represent 45% and 22% respectively of the deal total. Within the internet sector, social networking companies comprised 23% of the companies funded by investors in Russia. Among technology start-ups software companies dominate, representing 64% of all funded technology companies where application software firms led with 46%. The third largest sector representing 12% was mobile and telecommunications. Almost half of these start-ups (49%) were traditional telecom service providers and mobile operators.

While Russia's VC business is growing fast, it remains tiny and would benefit from improved legal business environment and government support.

Vilensky is the head of Vlad Investment Group which provides investments, advisory and research services to start-ups and investment community.

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