Russia’s Gold Rush

Serge Faguet, a Russian native, dropped out of Stanford University to launch a start-up in Silicon Valley and briefly worked for Google. After learning a lot at his first start-up and soaking up the DNA of the U.S. search giant, he moved back to Russia in 2010 and started an online travel company called Ostrovok.ru, which last July secured a $13.6 million investment from London-based Accel Partners, General Catalyst, Internet guru Esther Dyson, Niklas Zennstrom’s Atomico, Paypal co-founder Peter Thiel and Zynga founder Mark Pincus.

The company’s Moscow headquarters is inspired by Google’s: it features hammocks, beanbag chairs and balloons, and meeting rooms with names like Mountain View. But Faguet doesn’t regret leaving Silicon Valley. “There is a gold rush here,” he says. He and co-founder Kirill Makharinsky (pictured on Informilo’s home page) have hired the former head of Booking.com in Russia, plus talent from Yandex and Groupon to ramp up growth, not just in Russia but to expand internationally.

Fauget’s story reflects several market trends:  People who have lived and worked in Silicon Valley are coming to Europe to start companies; Russia’s Internet market-–now the biggest in Europe according to comScore–represents huge opportunities for enterprising entrepreneurs. Just as money from DST Global, the Russian multibillion-dollar investment firm that has taken major stakes in Facebook and Groupon, is flowing into Silicon Valley, Western venture capital is now pouring into Russia.

“There are tremendous opportunities for venture capital investment in Russian Internet companies as the market is relatively immature compared to the U.S. and Western Europe,” says Chris Grew, a partner in the London offices of the global law firm Orrick, which advised  Ostrovok on the investment.

Consider Ozon, Russia’s local version of Amazon, which pioneered e-commerce in Russia. It raised $18 million in 2007 from Index Ventures, Cisco Systems and German publisher Axel Springer. The e-tailer has thrived since then and in September announced that it had secured another $100 million in funding–-an eye popping amount for Europe–from a consortium that includes Index and Russian, Swiss and Japanese investors.

Avito.ru, an online classified ads site targeting the Russian market which boast 10 million unique views monthly and 100,000 daily listings, secured $26 million in November, with the help of technology investment bank GP Bullhound.

And online shopping club KupiVIP (Russia’s version of Venteprivee), founded by 29-year-old Oskar Harmann, who emigrated to Russia from Germany, got backing from Accel Partners and then raised an additional $55 million in venture capital funding earlier this year from new investors Balderton Capital, Bessemer Venture Partners and Russia Partners.

It is no secret why western VCs have been flocking to Russia. “Russia is the biggest opportunity in Europe due to sheer size,” says Jeremiah Daly, a principal at Accel Partners in London.

Daly was one of a group of venture capitalists who were taken on a trip to Moscow, Tatarstan and Tomsk by the European Tech Tour Association in 2009. (Informilo Editor-in-Chief Jennifer Schenker was also on the trip.)

The tech tour organized a similar trip in 2004 to introduce western VCs to Russian start-ups such as search engine Yandex and software companies Parallels (then called SWSoft), Acronis and ABBYY Software.At the time these companies had little, if any, Western investment and had trouble attracting it. Today, some of the same companies have valuations ranging from $100 million to $6.4 billion and venture capitalists are kicking themselves for not entering the Russian market sooner, says Sven Lingjaerde, the tech tour association’s president.

The scale of the opportunity and the speedy digitization of the market is what makes the Russian market so attractive. Russians have low personal debt, with salaries growing rapidly. They spend more time online than most Europeans, and boast the highest number of page views per visitor, according to a September 2011 comScore Media Metrix report. What’s more, the e-commerce market in Russia is expected to double by 2015.

It is also easier to find technical talent in Russia than in the U.S. or Europe, says Faguet. Soon, Ostrovok will have more engineers for its one site in Russia than Booking.com has across all of its sites globally, with plans to grow rapidly across Europe, he adds.

Ostrovok and other Russian e-tailers are cashing in on the fact that it is harder for non-Russian companies to penetrate the local market. The Russian market still remains largely dominated by local players, according to a recent report on the Russian market by investment bank GP Bullhound. Six out of the top ten Internet sites in Russia, including the three largest, are local, with U.S. giants like Google and Facebook trailing way behind.

But as Ostrovok knows, the opportunity is not limited to the domestic market. Kaspersky Labs is one of several Russian companies that have generated revenues of $100 million or more in the international market. And a new generation of Russian start-ups are also aiming to build global consumer numbers. Among them is ZeptoLab, the mobile Internet gaming company behind Cut the Rope, a mobile app that has been downloaded more than 60 million times by global fans. The company was started by Russian fraternal twins Efim and Semyon Voinov and attracted Diana Moldavsky as its chief revenue officer to help build up the business and  drive business development, sales, and monetization. A Russian native who was educated in the U.S. and worked for Google before returning to her homeland, Moldavsky says, “When I first moved back to Moscow in 2004, Russian companies were mostly focusing on the local market and were looking to hire talent with a U.S. or European education and background to help build the business in Russia. Now we are seeing products developed by Russian teams finding huge demand and popularity in the U.S. and globally.”

Then there is Concept Space, a Moscow-based tech and animation firm, launched in 2009, which is able to produce high-quality animation quickly and cheaply, a key stepping-stone for integrating media, tech and consumer commerce. The company says it can produce a 30-minute high quality animated show in a week for $6,500 versus the 32-52 weeks and $32,000 charged by competing studios.

Concept Space is going global via partnerships with U.S. creative talent and by building independent distribution channels on YouTube and social media, says advisor Saskia Aalders, who is syndicating investment in that company and others as part of a bid to connect Western money with Russian Internet and technology.

“The broader goal is to bring investment capital as well as strong operating partnerships to help them grow,” says Aalders, who was most recently the head of finance and operations for Naspers’ MIH Europe, leading over $1.2 billion in Internet company acquisitions in 2010, including Digital Sky Technologies/Mail.ru and its holdings of Facebook, Groupon and Zynga. Previously, she worked for Goldman Sachs and for Google.

The opportunities do not escape local investors. Runa Capital, which includes two of Russia’s most well-known serial entrepreneurs–-Sasha Galitsky and Serguei Beloussov–-is also focusing on early stage investing. The fund, which closed at $75 million, has made 12 investments in the last year: 50% in consumer Internet and 50% in cloud computing and middleware.

”When we started there were virtually no early stage funds in Russia–-we saw this as a great opportunity as we already were anticipating the IPOs,” says Dmitry Chikhachev, a partner at Runa Capital.  In 2010 Mail.ru went public in the UK with a $5.7 billion valuation and this year Yandex went public on Nasdaq, with a valuation of $6.4 billion.

Expect some more spectacular exits in the years to come, say industry observers. A whole generation of Russians in their 20s and 30s who grew up post-Soviet Union, with superior math and engineering skills, razor focus and big dreams, are starting new companies. “Moscow feels much more capitalistic than Europe and in some ways more so than the States,” says Aalders. “There is that much raw energy.”

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