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Analysis & Opinion
27.05.10 Wooing Business Angels
By Tai Adelaja

Even highly-skilled Kremlin spin doctors would have been hard-pressed to sell a product as nebulous as Russian nanotechnology to American venture capitalists, unless President Dmitry Medvedev pitched it himself. During a meeting with 22 heads of leading U.S. venture capital funds on Tuesday, president Medvedev said that he had invited them to discuss how to develop the nation’s innovation potential and ensure that investments into high-tech businesses flow in. But given the inchoate state of the high-tech business in Russia, is president Medvedev getting a little ahead of himself?

The venture capital market in Russia, Medvedev said, is underdeveloped. Efforts to grow domestic capital spending on scientific research and studies have fallen flat for lack of sufficient venture capital in the country. “About 20 funds are operating in Russia with a total capital of some $2 billion,” Medvedev said. “When compared to the venture capital available in the United States and many other countries, this is next to nothing.”

Those in attendance said they were impressed by the mixture of humility and self-confidence with which the president persuaded his guests to join in the onerous task of modernizing Russia. “He was very calm and collected, and seemed to have command of a lot of details,” said Anna Dvornikova, the president of the American Business Association of Russian-speaking professionals (AmBAR), one of the organizers of the meeting. “Delegates were also impressed with the way the president interacted with members, allowing each to speak while taking notes as they do. He displayed a thorough knowledge of all the issues discussed.”

The delegation comprised many big names on the U.S. venture capital market, which collectively manage more than $60 billion of funds in more than 6,000 high-tech companies. They include Accel Partners, Alloy Ventures, Almaz Capital Partners, Asset Management Company, Atlas Venture, August Capital, Bessemer Venture Partners, Canaan Partners, Domain Associates, Draper, Fisher & Jurvetson, EDVenture, Emergence Capital, Index Ventures, JK & B Capital, Mohr Davidow Ventures, Siguler Guff & Company, Sofinnova Ventures, Wellington Partners, as well as the well-known law firm of Wilson Sonsini Goodrich & Rosati.

The meeting was also attended by high-ranking state officials including the U.S. Presidential Aide Anthony Michael McFaul and Medvedev's First Deputy Chief of Staff Vladislav Surkov. The Minister of Economic Development Elvira Nabiullina and Ilya Lomakin-Rumyantsev, the head of the Russian Presidential Expert Department, were also present.
Venture capital slowed to a trickle in Russia last year, with investment falling by nearly 98 percent from 2008 as the financial crisis raged, drying up credit worldwide. The economy shrank 7.9 percent as oil prices plunged, scaring off many venture capital firms. According to data from the National Venture Capital Association, Venture capital firms, including those in the United States and Europe, invested only $18 million in Russian startups in 2009, compared with $771 million in 2008.

Nevertheless, experts and industry leaders, including some sitting down with president Medvedev on Tuesday, said that venture capital investment may be the least of Russia’s problems. The Russian president, they said, should retool his modernization package to skew it more toward improving Russia’s image tarnished by years of bad business practices. “Russia needs trust more than it needs funds,” Dvornikova said. “There is no doubt that Russia has the money but young and innovative entrepreneurs don’t always receive the type of support they need in order to take the forefront in modernizing the country.”

Stas Khirman, the founder and CTO of Khirman & Son LLC, said the image of Russia as hell rather than haven for foreign investors was for the most part wrongfully created by the media. “With Russia, good news is never news, while bad news always hits the headlines,” Khirman said. “We believe that by bringing in such a high-powered delegation to Russia to meet with officials at the highest level of government, including the president, we could remove some of this negative image.”

Andrew Somers, the president of the U.S. Chamber of Commerce in Russia, described the president’s latest effort to invite venture capital investment as “a kind of paradox,” adding that Russia has a couple of large nanotech funds – one headed by Rusnano Chief Anatoly Chubais and another by Russian Technologies' Chief Sergei Chemezov. “They have a lot of money,” Somers said. “What is needed here is a type of investor who is experienced in investing in high-tech projects with some risks. And the risks are: will the high-tech product be a commercial success and would there be a return on investment?”

Russia has many smart people, but they have almost no experience in investing in high-tech risk ventures where the return on investment is uncertain, Somers said. “That is why these guys from California, who have a special kind of experience in converting the results of research into a commercial application, came over here,” Somers said. “Russia lacks the experience of investing in projects like Skolkovo, where it is not certain whether a long period of research would eventually pay off or not.”

Esther Dyson, the founder of EDventure Holdings, said that what Russia needs most of all is to groom “entrepreneurs who are confident enough to start businesses, make mistakes, learn from their mistakes, and try again until they succeed.” Dyson, who also sits on the board of Yandex, Russia’s largest search company, sees high-tech companies as the nucleus of the country’s diversification and modernization efforts. “I believe that Russia's other sectors should become good ‘customers’ to the high-tech companies,” Dyson said. “That is, they should demand good products and services, delivered on time, which will make their own businesses more productive and competitive.”

“The innovations should serve useful purposes and deliver real benefits to the people of Russia. Then those people will support the private, innovative sector politically, and young Russians will be interested in getting an education and joining the modern economy,” Dyson said.

But by luring in venture capitalists at the formative stage, the country’s economic planners appeared to be jumping too far ahead, said Ron Lewin, the managing director of TerraLink. “What most projects in Russia need is not venture capital but angel investment, which requires smaller amounts and less strict investment conditions,” he said. Angel investors like Dyson, however, said that Russia would need both, along with “good customers and managers who can use innovation to get the full value out of the innovations funded by investors.”

Lewin said that in order to provide extra catalysts to jumpstart innovation in various sectors of the national economy, president Medvedev should reduce the high "country-risks" that Westerners attach to investment in Russia, and promote a culture of entrepreneurship by improving the regulatory environment. “Russia’s problems are not about capital as such, but about business environment and conditions,” he said.

While Russia is now more secure than, say, two years ago, industry leaders said that there are still serious concerns for Westerners wanting to invest in the modernization program in the country. "The biggest security threat is in the area of intellectual property," Somers said. “These investors would want to be sure that if they invest in innovation and research, that the ownership of the innovative products would belong to them and not be taken over by someone else." Dyson agreed: "Investors want to take business and technology risks, but they do not want to take security risks. An open, transparent market is key to attracting capital and also talent."

President Medvedev told his guests on Tuesday that, having himself been an entrepreneur at the age of 25, he understands a lot about grooming young entrepreneurs. He said that he would stake name and fame on creating a crop of young innovators that would keep the country’s economic engine humming. But can the president follow through on this? “We simply don't know,” Dvornikova said. “Our task is to open the door and let in fresh air.” The president could benefit from some fresh air, too.
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