Ben Aris in Moscow -

Money. It's the air that entrepreneurs and fast growing companies breath. It is also hard to come by for those in Russia and the current crisis has just made it a lot harder.

The Kremlin has started a big push to modernise the Russian economy, but while in the West anyone with a really good idea and a bit of development under the belt can usually find cash to continue, in Russia the nascent private equity business has been given a bloody nose and will take years to recover.

Richard Sobel, head of Alfa Capital Partners, is the old man of Moscow's private equity business. He has been working and investing into Russian business since the Iron Curtain fell in 1991, but after almost 20 years in the game, he still refers to Russia's private equity sector as a "young market."

Russia's private equity industry was just getting going in the boom years, but was still very lopsided. Prior to the crisis, Russia boasted about $40bn of private equity funds, according to Michael Calvey of Barings Vostok Capital Management, another doyen of the market. Of this money, only about $5bn was institutional money managed by professional (almost all western) fund managers. The rest was oligarch money that Russia's leading businessmen were investing into anything other than the sector that made them rich in the first place. By 2007, this oligarch money was becoming more sophisticated and several of these businessmen had hired professional fund managers to invest their billions.

But the crisis hurt Russia's super-rich more than anyone else and almost all the oligarch money has since evaporated. Sobel's fund has $611m of assets under management, of which it has invested about $300m. But most of what is left of the private equity assets under management now belongs to the international financial institutions like the World Bank's IFC and the European Bank for Reconstruction and Development (EBRD). "The Russian [private equity] market is young, but in each cycle it gets stronger," says Sobel, speaking at C5's CIS Private Equity and Venture Capital conference in Moscow in March. "The current downturn is to be expected. Private equity is an inherently cyclical business and the extremity of Russia's cycles exacerbate these flows [of money]."

Staying alive

For most funds, 2009 was a year of simply surviving as the game went from expanding into the regions as fast as you could, to consolidating assets and improving operational efficiencies. "You could find yourself in the position where your company was still profitable, but managing the debt and credit repayments became really hard," says Sobel. "Still, most banks were willing to sit down and discuss restructuring so there have been relatively few distressed sales."

Most Russian companies put in flat sales growth in 2009, but thanks to inflation and the ruble's appreciation that translates into a 20% real fall in sales in ruble terms and 30% fall in dollar terms, says Sobel. On the flip side, the cost of business has come down considerably and it has become much easier to find experienced managers - a longstanding problem in Russia.

As the main source of investment capital remains a company's own funds, most had a stock of cash at the start of the crisis. Some fund managers thought that they would be able to pick up some real bargains as the crisis hit. They were wrong. Valuations held up really well at first, as owners were reluctant to let their babies go. But as the cash ran out, some owners changed their tune. "In 2009, we saw the valuations come down slowly at first, but then they started to fall fast," says Sobel. However, other fund managers say that the valuations of the best companies - the ones that they were most interested in - didn't move and the cheap companies were often not worth buying.

Now the economy seems to have passed the bottom investors are getting interested in growth again. KPMG predicted in a recent report that the volume of mergers and acquisitions would go up by half this year over 2009 to around $70bn. However, the same report went on to say that it could take more than five years until the peak levels of deals seen in 2007 are reached again, when the volume of funds invested reached $125bn, or about 10% of GDP.

Russia has never been an attractive destination for international private equity funds because of the perceived risks. Fundraising surged between 2005 and 2007 to reach a total of about $5bn, almost all of which was invested. However, Russia will struggle to raise money now and was already lagging behind its Bric peers: Russia's private equity ranking in terms of assets under management has fallen from sixth to ninth place amongst the emerging markets, while China, Brazil and India have retained their slots of first, second and third respectively. "Making a list of the risks you will face in Russia is easy," says Sobel. "They are all on there - every risk you can think of. So you can't get any nasty surprises."

Enough to put anyone off? It would be, except that Sobel goes on to point out that investors are amply rewarded for taking these risks. Russian private equity investments have returned 7.2%, 24.1% and 15.6% over the last three, five and 10 years respectively, making it by far the best performing of any private equity market in the world, let alone its Bric peers.

And even with this stellar growth, Russian companies remain very cheap. The average company valuations are 8-10x ebitda against the other Bric valuation multiples in the high teens or close to 20.

Russia's economy is now clearly past the worst and owners are getting more confident again. If they got this far, then they will probably see the course through to the end. Sobel says that the time is now to get into the game for private equity funds. "The opportunities now are much better than they have been for years," says Sobel. "The valuations are lower and there is almost no competition."