As a result of the international tensions, Western venture capitalists that traditionally looked at Russia have found themselves in an uncomfortable position over the past year. The Russia label has become a stigma in the eyes of a large part of them, making international funding and development more difficult for local startups. In an exchange with East-West Digital News, Alexander Dadashev of InVenture Partners – an investor in taxi booking app Gettaxi and in a range of Russian startups – offered his analysis of this trend and his vision of the future prospects.
To which extent were international investors traditionally interested in Russian startups?
Firstly, it’s important to understand the structure of international venture capital in Russia. Startup investors can generally be assigned to one of two large groups. The first group supports startups directly; it includes angels, VC funds and PE funds. The second group consists of large institutional investors such as pension funds, mutual funds, corporations, etc., who invest a share of their assets (typically, rather small) into VC/PE funds, thus becoming their limited partners.
If we are referring to the first group only, it would be reasonable to assume that more than 90% of the deals and at least 60%-70% of the capital comes from Russian investors. But if we also consider the capital contributed by international institutional investors to Russian-based funds, the share of foreign capital is significantly higher – so in a way, international investors have indeed demonstrated their interest in the Russian market over the last several years.
Many international investors contribute relatively larger amounts of money, compared to local investors, to a smaller number of deals in the later stages. For example, GetTaxi’s $150 million from Vostok Nafta, Baring Vostok and other funds was the largest investment in the Russian VC market in 2014. [Editor’s note: Russia and Israel are the core markets for GetTaxi, providing for a very significant share of its revenues. Some of the investors who participated in the company’s latest round focus mainly or exclusively on the Russian and CIS markets.]
Why doesn’t the Russian startup industry look more attractive?
The main problem with the Russian venture capital industry now is probably a relative lack of exit options for investors, which may require them to hold stakes in companies longer than they might prefer.
Another problem is the so-called “Round B crunch.” It can be pretty challenging for companies to raise the significant amounts of funding required for scaling at later stages. This problem is not completely unknown to European investors either, although it is not as widespread there.
Finally, the Russian economy has always operated as a relatively closed system. Combined with an unstable political environment, this has always made it difficult to make forecasts for the prolonged periods of time that VC investments typically require.
In recent years, the healthy growth rates of the Russian economy and the significant potential of local market started to attract investments from Europe and other geographical areas. However, given the current economic turmoil and international political tensions today, the Russian market has once again lost much of its appeal for international investors.
What has been the impact of the recent international tensions and economic slowdown?
The new realities of 2014 have indeed caused a significant deterioration in fundraising opportunities for Russian startups. European and other international investors have almost completely stopped investing in early-stage startups – which never attracted them very strongly in the first place. As for later-stage companies, they are still able to raise money from European and other international investors, but even for them the situation has become much tougher.
Raising funds from international investors will be especially difficult for companies that generate revenue mostly or exclusively on the domestic market. These are better off seeking capital from local funds.
The ruble’s fall hasn’t helped startups that generate a significant share of their revenues in Russia. In most cases, startup valuations are determined based on certain financial parameters, such as revenues. In this context, some startups have had to accept lowering their valuation below the level of their last round of financing. This is an issue for the founders, who may find themselves significantly diluted in the process. The problem may be less acute for previous investors, who often enjoy anti-dilution protections at the expense of founders in case of down rounds.
International sanctions have also led to the suspension of investment activities in Russia of certain institutional investors (e.g. the EBRD) which previously acted as limited partners for several venture funds. Potentially, this could make it more difficult for Russian funds to raise new capital, with the amount of financing available for startups declining as a consequence.
Who will survive in the new conditions?
Some Russian startups could find themselves lucky crisis survivors – or at least have more chances to secure local or even international capital compared to their peers.
It’s difficult to name specific popular sectors today, although there are several segments that definitely looked promising in 2014. Among them were certain sub-sectors of financial technologies (2can, RocketBank), marketplaces and aggregators (GetTaxi), online education (Webinar.ru, Netology Group), marketing (CityAds), travel (Aviasales, OnlineTours, Ostrovok.ru) and some others. Some of these companies were lucky enough to raise international investments in 2014. Some may also succeed in 2015, even though market conditions are likely to be tougher.
Today European investors strongly prefer companies with diversified sources of revenue. They also prefer to support companies with the significant potential to build global products and services. To attract these investors, Russian startups should think either about starting in the global market from the very beginning or about how to scale their technologies globally once they’ve established their operations in Russia.
Proven leaders in the local market may attract the attention of international investors if they have a clear profit pathway and an understandable model for further scaling. However, even these leaders should make sure they are well ahead of all local competitors and are operating in the segments which are more or less resistant to the economic turmoil.
