A recently published survey by VentureOne and Ernst & Young shows that venture investments in Silicon Valley have increased by 22% over the last quarter. For the first time since 2000, venture capitalists are investing more in newly established start-ups and less in second rounds at companies already in their portfolios. The venture business is trying to find new ways to grow. Wireless technologies like Wi-Fi, Wi-Max, and Bluetooth are still fashionable. Everything related to radio identification (RFID) is all the rage. There is also increasing interest in the new generation of internet projects, so-called social networks. But what about Russia? Last July, Expert published a pilot review of venture capital and venture investment in Russia (Expert #23, 2003). Here is our venture review for the second half of 2003.

By December, the last six months of 2003 seemed absolutely devoid of venture activity. The capital funds set up in 2003, Russian Technologies and Intel Capital, had yet to close a single deal since their inception. Akadem Partner, which received funds under the Venture Investment Fund Program (VIF, “the fund of funds” at the Ministry of Industry and Science), had yet to set up operations. However, in late November Delta invested $10 million in Compulink, a Moscow-based integrator company. A number of investors (Mint, Apax Partners and Amadeus Venture Funds) invested 12 million euros in ACOL Technologies, a company developing light-emitting diodes. These two deals created a 75-percent increase in venture investment in the second half versus the first half of 2003.
A further indication that venture activity has picked up is the appearance of new funds such as Draper Fisher Jurvetson (DFJ), one of the largest venture funds. DFJ has finally found a Russian partner and decided to set up a Russian subsidiary fund of potentially $50 million.

In our previous review, we stated that venture funds needed more early-stage companies. For this review, we decided to examine how things stand with respect to business angels, the name given in the venture community to wealthy private investors who make investments in technology companies and later sell them to venture companies.
Typical Russian business angels made their money in trade, real estate, or natural resource industries, areas remote from technology. Initially, angels usually don’t consider technology investments a good way to make a profit. More frequently, they see them as a combination of charity and “playing the technology game.” The charitable motive prevails, as angel generally find deals through friends and acquaintances.
The spontaneity of Russian angel investments/donations often becomes a major stumbling block. Andrei Golovin, one of the most successful Russian business angels with about ten angel investments to his credit, told Expert: “Angels often don’t consider invested funds as a problem to be solved. They simply take money and throw it into a business. They do this until they face problems or get bored.” Since their investments are “charity-oriented”, angels don’t set clear-cut goals. They have a vague idea of the market and the potential buyer, but they don’t have a business plan. As a result, most angels are happy if they manage to sell a share to a venture capitalist and at least break even. Many of them fail. “98% of the angels I know lose money in the end,” Golovin stated.
The main problem Russian business angels need to address is how to select companies more effectively. As long as investment decisions are made “because it was there” rather than “because it was profitable,” the early stage of venture investment will develop less efficiently than it should.

On the whole, both Russian venture and “angel” investors seem particularly drawn to projects targeting the domestic industrial market. A number of factors arouse their interest. Investors are not confident that they know how to promote a product on the world technology market. In Russia, many of them have extensive knowledge, contacts, and government connections that enable them to define their target audience and get desirable orders. In their eyes, the Russian market promises both quick and reliable money and a return on their investment, though with more moderate cash flows than in international business. Everybody has different resources and interests: oil companies, for example, have been investing in former industry research institutes for several years now, while financial-industrial groups rely on synergy within its own group of companies. Defense enterprises have made small investments in microelectronics and nanoelectronics.
Investors hope to work on the CIS and Chinese markets in the future. The Russian scientific community was very familiar with Southeast Asian market back in the nineties, but its rapid production growth has encouraged the countries of this region to develop technology on their own. This year alone, China, for example, will spend nearly a third of its national budget on science, education, and innovation. Entering the Chinese market will become more and more difficult every year. Chinese education, however, does not encourage individual creativity and innovation. The greater part of Chinese technology merely copies US, European, Russian, and Israeli products, making things easier for our engineers and innovation entrepreneurs.
Russia’s industrial market is developing with great difficulty. A leader of a large direct investment group told Expert that reality lags far behind companies’ plans. Replacing fixed assets in industry takes several times longer than replacing a company’s computer base, and it takes a long time and intense effort to sell even very productive technologies. Buyers tend to hesitate for a long time and have their doubts, as they have never replaced their company’s production facilities before. Russian companies have no upgrade mechanism in place. Thus, companies with a product to sell have to give buyers advice on how to set things up from scratch. This is not always in demand, nor is it always successful. Moreover, the kickbacks involved in offers of this sort, as our source noted, are considerably greater than with more popular and familiar products.
Nevertheless, technology investments are seriously targeting the Russian market. Russian funds are largely directed towards domestic industry. The Russian market may well become a springboard enabling the Russian engineering industry to reach global standards. For this to happen, however, two conditions must be met. First, Russian high-tech pioneers need to create greater demand for new technologies at home. Second, these technologies should be competitive in global terms. Apparently, the US technology market, the world’s largest, is preparing for a new growth cycle. Recently, the NASDAQ index passed the mark set on September 10, 2001 for the first time.
Nothing of the kind is afoot in Russia. The majority of investments are made in the second and third rounds at already existing companies rather than at new ones. The areas currently popular in the world are not in demand in Russia, except for perhaps biotechnologies. One of the winners of the Russian Innovation Competition held by Expert is successfully engaged in developing new types of RFID (a hit on the world market) but has failed to find an investor so far. Investors remain openly skeptical about the international potential of Russian start-ups. Experts ridiculed another finalist of our competition working on Wi-Max wireless technologies, laughing that “only a lunatic would compete with Cisco” (though Cisco has been buying up promising start-ups rather than conducting its own R&D for years). In a word, there is neither the desire nor, apparently, the ability to compete with developed countries.

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