How Technology and Venture Capital Are Transforming Russia

In late March Bessemer Venture Partners became the first tier-one investment firm to partner with the Skolkovo Foundation, a Russian government-financed technology and innovation hub on the outskirts of Moscow.It is unlikely to be the last. A key part of Russia’s ambitious bid to transform from a resource-intensive economy to one based an innovation is to build strong ties to Silicon Valley and the rest of the U.S. venture community, a topic that is expected to be a key focus of the DLD Moscow conference May 27-May 29.

Skolkovo “splits the bill” with VCs that partner with it, so instead of investing, say, $10 million in a Russian start-up, a VC need only invest $5 million, with the foundation providing the rest as a grant. The catch is the start-up must be incorporated in Russia. The Foundation has set aside some $200 million of grant financing per year for such deals, says Alexander Lupachev, who heads up the Skolkovo Foundation’s venture capital program.

Bessemer is committing $20 million for Russian innovation, in exchange for priority access to the Skolkovo Foundation’s most promising projects and the opportunity to refer its existing companies to register in Skolkovo and receive the Foundation’s support.

Skolkovo, which has partnered with 34 venture firms and done deals with 14 (see chart page 7), is just one part of the Russian government’s multi-pronged strategy to lure Western venture money and technology companies.

Other initiatives include state-sponsored Rusnano and RVC. Rusnano is a $3.7 billion fund with a mandate to give Russia the lead in nanotechnology by accelerating the development of nanotech products. (It recently invested $50 million into two Massachusetts biotech companies, BIND and Selecta BioScience). RVC is a state-funded venture capital company created in 2007 with $1.25 billion in capital at its disposal, which aims to both help U.S. start-ups and venture capital firms enter the Russian market, and showcase the value that Russian engineers can deliver to U.S. companies.

RVC recently opened an office on Sand Hill Road in Silicon Valley, just down the street from the planned offices of Almaz Capital II, a  Moscow venture capital fund co-founded by DLD Moscow speaker Sasha Galitsky, a serial entrepreneur-turned venture capitalist and a member of the Skolkovo Foundation Council. (See Galitsky’s profile on Informilo’s site).

Fellow Skolkovo Foundation Council members include Google chairman Eric Schmidt, retired Intel Chairman Craig Barrett and Cisco Systems Chairman and CEO John Chambers — further evidence that with a concerted emphasis on innovation, billions of dollars to invest and the biggest and fastest-growing Internet market in Europe, Russia is now firmly on the radar of the global digerati.

What a difference from 2004, when the European Tech Tour Association organized a trip for a group of Western venture capitalists to Russia to introduce them to companies such as search engine Yandex and software providers Parallels (then called SWSoft), Acronis and ABBYY Software. (Galitsky was the tour’s president.) At the time, the companies had little, if any, Western investment and little prospect of attracting it.  Times have changed. Yandex has a current valuation of over $7 billion. All three of the other companies have gone global, with revenues of $100 million or more, and a number of venture capitalists are kicking themselves for not entering the market sooner.

Parallels’ path says a lot about the progression of the Russian tech market. Shunned by western VCs in 2004, the software automation and virtualization company turned to Galitsky, who put in some of his personal funds. It went on to raise money from Bessemer, Intel Capital and Insight Venture Partners in June of 2005. The company, founded by Russian serial entrepreneur Serguei Beloussov, raised another $11 million  in 2009, from Almaz Capital, a Moscow-based venture firm co-founded by Galitsky and backed by Cisco, EBRD and UFG Asset Management.

Parallels, now a Skolkovo resident, used a grant from the Skolkovo fund, as well as investment from the firm’s founders, Beloussov and Ilya Zubarev, to move into cloud computing. It has just started selling its cloud product, which is one of the first projects from the Skolkovo IT center to have reached the market in Russia and abroad.

Parallels Automation for Cloud Infrastructure enables any hosting or telecom provider to rent out virtual infrastructure, allowing them to compete with Amazon’s Web services. Parallels’’ cloud technology has been purchased by several international service providers in Europe and South-East Asia, including Japan’s Tsukaeru.

The company is expected to go public soon. As for its co-founder Beloussov: he has gone on to create two other successful international software companies, Acronis and Acumatic, which both have revenues of over $100 million. That’s not all. Beloussov and several partners have launched a Moscow-based $135 million venture capital fund, Runa Capital, which focuses on early-stage and growth companies, including several on Informilo’s Top 25 hottest Russian start-ups list (which will be published on-line May 29).

Russian companies like Parallels and Acronis, as well as Kaspersky Lab and ABBY Software, are all very successful global companies, but are still the exception, rather than the rule. However, they illustrate how the market is evolving. Two of the four managed to go global while maintaining their headquarters in Russia. Western venture capital, once scarce, is now available in abundance: 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.

The domestic Internet market is booming, allowing for the creation of local giants like Yandex and Ozon. And Russia now has a circle, albeit small, of serial entrepreneurs who are advising and investing in younger companies, and whose ties with Silicon Valley are growing stronger every day.

The country’s large home market gives it an advantage over other tech hubs with smaller markets, such as Israel, And it is now home to dynamic entrepreneurs like Oskar Hartmann, who has helped launched 21 e-commerce companies in the last few years.  Still, no one is yet referring to Russia as a “start-up nation,” as they do with Israel.

The Skolkovo Foundation hopes to change that. Russia is known for its brilliant scientists and mathematicians but research is not always linked to the market and there is still a lack of early-stage financing. The Skolkovo Foundation’s mission is to close the gap, says Steven Geiger, the Foundation’s chief operating officer.

In addition to partnering with VCs, the Foundation has a program that is attracting the likes of EMC, Cisco, Microsoft, IBM, Dow Chemical, Johnson & Johnson and SAP to create and operate R &D centers in Skolkovo and co-invest in promising Skolkovo start-ups. The foundation is also opening the Skolkovo Institute of Science & Technology, in partnership with the Massachusetts Institute of Technology, which is being billed as the world’s first graduate university to fully integrate research, education, innovation and entrepreneurship.

The plan is for Skolkovo City to become a hub for innovation in five technology clusters: energy; IT; biomed; space and nuclear medicine; and materials. To ensure that the rest of Russia is not left out plans call for the creation of a “virtual Skolkovo” – a Web-based platform that will help spread the wealth, the expertise and the opportunities for budding entrepreneurs in remote locations like Siberia. (See the map on the home page)

That said, there are certain problems you can’t fix with money, say skeptics.

It is hard to infuse a culture with an entrepreneurial spirit. Countries in Western Europe have been trying – and failing – to create mini Silicon Valleys for well over a decade. And governments have not proven to be good venture capitalists, since they need to be risk-averse and are not particularly adept at picking winners.

“It is a risky initiative on the part of the government,” says Igor Taber, Russia director at Intel Capital, another of the funds to sign up with the Skolkovo Foundation. “All the basic building blocks are there but there is a long way to go to create an ecosystem,” he says.

Today Russia has a handful of serial entrepreneurs; to succeed in its bid to become a premier global tech hub it will need hundreds, if not thousands. “I’d compare Russia to a well-funded start-up; they have enough money and the right vision. Now they just have to execute,” Taber says. “If Russia gets it right there will be a big pay-off but it is no different from any other venture capital investment – success is not guaranteed.”

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