Ben Aris in Moscow -

The size of a recent press conference is indicative or how far Russia's e-commerce business has to go.

In the US, if you got together one of the biggest e-commerce companies in the country to sign off on an investment deal with one of the biggest private equity funds in the country, the blogosphere would be alight with comment and the 24/7 news programmes would be running retrospective specials in a blitz of media coverage. Think Morgan Stanley and its efforts to organise the IPO for Facebook.

Yet just a handful of journalists turned up at the iconic Hotel Ukraina (now the Radisson Royal Hotel) in central Moscow on April 24 to eat canapés and drink champagne (which was actually Prosecco) at the signing ceremony that saw VTB Capital Venture Business spend $18m to take an undisclosed stake in Fast Lane Ventures (FLV), probably Russia's most successful e-commerce company with 17 websites in its portfolio. "There were 6m people online when we started the company 10 years ago," says Pascal Lament, president of Direct Group Holding and co-founder of FLV, who made his first money in the catalogue business with PPE and then founded Rusfinance that he later sold to French bank Société Générale. "Twelve years on there are already many websites, but there is still not a lot. There is a window to create new and very professional websites that are not just for Russia as websites are by definition international."

FLV is not an incubator in the traditional sense, as it carries its companies much further. Setting up one new company every two months or so and investing in other people's start-ups too, after ten years of work FLV is only just starting to find buyers for some of its babies. The whole internet sector is only now starting to mature and the going is still very tough.

In February, FLV sold Sapato.ru, Russia's principal online shoe and accessories retailer, to Russian online store OZON Group, and at the start of April it completed its second deal by selling the mail-order company Shopping Live to the German-based Home Shopping Europe. FLV CEO Marina Treshchova said Shopping Live was one of the first of its portfolio companies launched and was a very successful investment both in terms of profitability and also demonstrating FLV's unique ability to achieve rapid growth.

Major market

Russia, or more accurately the Russian-speaking world, is a huge market of some 250m people. Internet penetration has been soaring and currently stands at 43%, half the European level, but growing very fast, which is sucking in investment. Treshchova estimates there was a total of $1.3bn invested in Russia internet companies in 2010 in a total of 59 deals, which rose to $2.15bn in 2011 in a total of 213 deals. And no one is expecting the pace of growth to slow. "Now there is a radical growth in interest in investing into start-ups and at the seed capital stage or grant funds," says Clement, "but finding the second round of funds and finding an exit is hard."

That's where VTB Capital Venture Business comes in. Russia's oligarchs have become very interested in the internet - especially after Alisher Usmanov, who Forbes listed as Russia's richest man in April, made a fortune investing in Digital Sky Technologies in 2005, which has since bought, among other things, a 2.28% stake in Facebook that has risen five-fold in value. "Raising $100,000 to $1m from angels and funds for an online company in Russia is easy," says Aidar Kaliev, global head of VTB Capital Venture Business, who will get a seat on FLV's board. "The trouble is raising the second-stage investment."

The FLV deal is testimony to the dearth of more institutional-sized deals. While there is plenty of money floating about in Russia, despite the best efforts of President Vladimir Putin there is a paucity of private equity and venture capital funds. In effect, FLV has been forced to tie up with Russia's second largest state-owned bank to help it tap big investors and bigger sums, because the state-connected bank is one of the few big players at the party.

Clearly, in the short term the cooperation is a savvy move. VTB Capital Venture Business's average ticket size is just what is needed: $2m-5m up to a maximum of $15m. And tickets can get even bigger if VTB Capital Venture Business takes the deal to its sister institution VTB Capital, Russia's leading investment bank, which has access to serious money - its own and other people's; VTB counts six out of 10 companies in Russia as clients. Currently, the bank's private equity division is investing the bank's own money, but can also match this one-to-four with clients' investment for the right project. "We bring a lot to the party, as in addition to financing we can provide loans, organise IPOs, syndications amongst big investors, debt - the full spectrum of investment possibilities," says Kaliev. "Now with Fast Lane as a partner, we can provide the full cycle and international investment."

State of play

The development of the online investment business is following a similar partner to what happened in the rest of the economy. In the early stages of transition, the state played a key economic roll because it was the one with resources and so could choose to get strategically important sectors moving. The private sector simply didn't exist at the start of the process.

The problem that Russian online ventures face today is they are in competition with simpler, more obvious investments that still pay extremely high and much more predictable returns. However, Putin said in 2006 there was a need to create a venture capital industry to tap into Russia's enormous, world-renowned intellectual resources. VTB Capital Venture Business is one manifestation of this desire by the state to bootstrap this sector into existence. "We spend all our time in the private equity sector talking about the government, but that only shows how bad things are when it comes to raising funds in Russia. The government is not a sustainable source of finance," Henry Potter, managing partner at Alpha Associates, complained at a private equity conference a few days after the FLV presser.

But it is all Russia has at the moment. Russia is badly underperforming the other BRICs when it comes to attracting private equity capital: a mere $1.5bn of funds in 2011, according to Emerging Markets Portfolio Investor, against the $5.0bn for Brazil, $15.0bn for India and $28.6bn for China.

Potter goes on to cite another recent industry survey that found Russia ranks last amongst the emerging markets in terms of capital raised for private equity projects, just behind the Middle East and North Africa region, which has been destabilised by the Arab Spring during the last year. "It means investors see the risks in Russia as higher than those in the Middle East, but those of us who have made investments in Russia know this is not true and the returns in Russia are amongst the best in the world," says Potter. "What can the government do, as clearly it needs to improve its image? But I have been waiting for 18 years for that to happen."

The lack of institutional interest in Russia will stymie the government's much-hyped plans to modernise Russia. The job of Rusnano, the state agency tasked with the job of bringing in investors into the hi-tech sector, has been made harder because of the lack of funds.

Flush with cash, Rusnano can match investors' capital dollar for dollar, but a spokesman for Rusnano said: "We have some projects where co-financing is already approved, but they have stalled because our partners have been unable to raise the money they promised."

The lack of interest is making the whole business of raising money for private equity funds hard, as international investors will not invest into local teams until they have a track record of proven outperformance, but the local teams can't prove themselves until they have raised some funds. Currently, there is only one fund in Russia that has escaped this chicken-vs-egg trap and that is Barings Vostok Capital Partners (BVCP), run by Michael Calvary. "But even BVCP's success causes problems," says Christopher Rose from C5 conferences, who is trying to create an industry lobby group. "When it goes to market to raise fresh funds, it sucks up all the money that is currently available for Russian investments and leaves very little for anyone else."

Still, the FLV-VTB Capital Venture Business tie-up is a landmark deal, as it means the whole sector has moved off square one. VTB Capital Venture Business won't bring hordes of blushing western brides to the altar of investment anytime soon, but it can play the very useful role of matchmaker.