When Guiseppe Zocco, a founding partner in Index Ventures, a Geneva-based venture capital firm, entered the May 24 board meeting of Ozon, an online e-commerce startup, he felt as if he could have been anywhere in Europe. The chief executive officer was Swiss, the auditors British, and the lawyers American.
If it hadn't been for the maddening Moscow traffic jams on his way to the meeting, says Zocco, he would have never even have known he was in Russia. But thanks in part to such increasingly global and sophisticated management, tech startups in Russia are coming of age. Indeed, after years of promise and potential, Russia finally looks poised to become the next hot destination for foreign VC investment.
Take Ozon. Russia's answer to Amazon.com, it's a vivid example of how Russian tech companies and even the government are attempting to adopt Western practices to attract Western money. The company, which claims to be No. 1 in e-commerce in Russia, raised $18 million in venture capital in April, much of it from Switzerland's Index, best known for its investment in Skype. The Ozon investment was Index's first venture in Russia.
Also joining the deal were US network equipment giant Cisco Systems and German publisher Axel Springer. Cisco is also a newcomer to Russian investing. "We have been in Israel for over a decade, in India for quite a few years, and in China since 1999," says Yaov Samet, Cisco's director of corporate business development in Israel, emerging Europe, and Russia. "As we look globally to where the next venture asset class is going to emerge, it is definitely Russia and Central and Eastern Europe."
To encourage such investments, the Russian government has set up a trust that matches investments from private venture capitalists. Already, it has agreed to dispense nearly $100 million to three groups of investors. Among them: Asset Management, run by legendary Silicon Valley venture capitalist Franklin "Pitch" Johnson, which has secured $52 million in matching funds from the Russia government for a new investment vehicle called Bio-Process Capital Partners. The Russia-based fund will scope out investment opportunities in biotech.
Other experienced tech hands also are piling in. Roel Pieper, a seasoned industry executive now based in the Netherlands, has set up a new fund primarily targeting Russian opportunities, including hydrogen technologies and light jets. Alexander Galitsky, a well-known Russian entrepreneur-turned-investor is planning to launch a new Russia fund later this year, in partnership with unnamed Western venture capitalists. And in April, Boston-based OpenView Venture Partners teamed with Moscow-based ABRT Venture Fund to form a "partnership for Russia" investment program targeting information technology companies in Russia and Eastern Europe.
Long Way to Go
"This is just the beginning," says Joe Bowman, a US venture capitalist working for Russian Technologies, a Moscow early-stage $50 million venture fund. "We're entering a new era for Russian venture capital."
To be sure, Russia still lags far behind other global destinations for venture capital. Since 1999, foreign venture capitalists have invested only about $300 million in total in the country's tech companies, says Yuri Ammosov, the adviser to Russia's minister of economics, who is overseeing the government's new investment fund. That's less than venture capitalists invested in China in the first quarter of this year alone, according to figures from Ernst & Young.
But the picture soon could change, say observers of the Russian scene. "The Russian market is going to get hot," promises Ashish Patel, the managing director for Intel Capital in Europe, the Middle East, and Africa. Intel got into the market early, back in 2003, and has invested in three Russian tech companies: Acronis, a maker of storage management and disaster recovery software; Yandex, Russia's largest search portal; and SWsoft, which makes virtualization and automation software.
Big Potential Market
Patel and others say they expect all three of these companies to achieve valuations of greater than $1 billion by 2008, and one or more of them could go public. Indeed Geneva-based venture capitalist Sven Lingjaerde, founder of the European Tech Tour Assn., anticipates lots of acquisitions and initial public offerings in Russia next year.
What a difference a few years make. Lingjaerde organized a Moscow visit for 53 venture capitalists from the US and Europe in 2004, but recalls that many of the participants were skeptical. Now, many VCs recognize the potential of Russian tech startups -- especially because, unlike counterparts in tiny countries such as Estonia or Slovenia -- they can gain significant scale just by serving a domestic market of 250 million in greater Russia.
Though the population of Russia is far smaller than China's, it offers investors some of the same advantages. For one thing, connectivity is exploding. Russia is now home to more than 140 million mobile-phone users, and Internet usage and broadband penetration is reaching critical mass. Also like China, local players have had the chance to gain traction in the domestic market, meaning that giants such as Amazon, Yahoo!, and Google don't dominate.
Making It Big at Home
"The opportunity is not as big as China, but it is absolutely up there," says Johan Brenner, a general partner at Benchmark Capital, a VC firm with offices in Silicon Valley and Europe. Benchmark has invested in Elecsnet, a Russian company that makes an electronic payment system allowing people to "top-up" their prepaid mobile-phone cards.
For some Russian startups, the biggest opportunity lies at home. Ozon, for instance, booked $30 million in sales last year, which works out to only about a dollar for every person currently online. "There is an opportunity to grow Ozon very, very fast," says Index's Zocco. "We see a 60 percent to 70 percent growth rate in the next few years."
Another local champion is Yandex, which boasts 23 million users and claims 60 percent of local-language desktop search in Russia, compared to about 8 percent for Google, according to researcher LiveInternet. Yandex rose to prominence on the strength of its search technology.
Now it's a full portal with its own mail service, news clustering and aggregation service, blog search, free Web hosting, research, shopping, and many other services, including its own payment system. It also runs one of the largest networks of free Wi-Fi hotspots in Russia. And like Google, it's branching out into mobile search. Its search engine was one of two recently incorporated into the Russian version of one of Nokia's new smartphones.
Yandex's success has not gone unnoticed. Mr. Lingjaerde recounts how he tried to help Yandex find a Silicon Valley-based investor a few years back. One well-known Valley firm replied "we don't do Russia," Lingjaerde recalls. Later the same firm begged to get into the deal, but it was too late.
Difficult to Do Business
VC funding will help other Russian companies grow their presence abroad. Galitsky, the Russian entrepreneur-turned-venture capitalist, sees particular opportunity for software firms such as Acronis and SWsoft that are less tied to language and culture. There are hidden gems in Russia, he says, that "need hope and advice and money." Venture funding can take them to the next level.
Despite the progress, Ammosov, the government official who oversees the new matching fund, says Russia was disappointed that more Western firms didn't vie for money. Only 12 have applied to date, and three have been chosen to receive funding. To encourage more applicants, the Russian government is now revising some of the rules regarding the investment of the matching funds to make them more in line with Western VC practices, Ammosov says.
But kick-starting the VC market in Russia isn't only a question of money. Key elements in the business ecosystem, such as serial entrepreneurs and angels, aren't yet in place. And despite government efforts to attract venture capitalists, Russia remains a difficult place to do business, says Index's Zocco, citing uncertain intellectual-property protection, chaotic taxation, and onerous business registration procedures.
"Clearly there is a higher level of risk doing business here," says Zocco. At the same time, he says, "there is a high level of opportunity." That's why Index and others are willing to make such high-stakes bets.
Jennifer L. Schenker is a correspondent for BusinessWeek.com in the Paris bureau.