Russia is experiencing a gold rush of sorts, as venture funds from the U.S and Europe attempt to cash in on the largest and fastest-growing Internet market in Europe.
Esther Dyson recognized early that innovation was occurring outside Silicon Valley. So, she began nurturing young start-ups in emerging markets, investing in Russia as far back as the 1990s. Arkady Volozh, co-founder and CEO of Russian search engine Yandex and a speaker at DLD Moscow, remembers the first time he saw her. The year was 1991. Volozh walked into his tiny Moscow apartment – which also served as an office for his start-up, housing not just his wife and two children but two computers and four or five programmers writing code. Dyson, who had been granted a preview of the prototype by Yandex’s co-founder, was sitting on the floor, taking it all in. Volozh wondered ‘who is this American woman?’
Flash forward to 2012. Everyone in the Russian IT sector knows Dyson, who went on to become an advisor and investor in Yandex as well as many other local start-ups. And everyone in Russia knows Yandex. Now the country’s most popular search engine, the company raised $1.4 billion last May in an initial public offering on Nasdaq.
Dyson wasn’t the only investor to dive in early. Intel Capital got into the market a few years later, in 2003, investing in Yandex and two other Russian tech companies that have gone on to great success: Acronis, a maker of storage management and disaster recovery software and SWsoft (now called Parallels), which makes virtualization and automation software.
Other early movers include Cisco, which in April 2007, co-invested together with Holtzbrinck Ventures and Index Ventures in a $18 million round in Ozon, the Russian Amazon.
These investors pretty much had the field to themselves. No longer .“The volume of venture investment activity and the arrival of new venture funds in the past six to nine months has ramped up pretty dramatically,” says Brian Feinstein (pictured on Informilo’s home page), Russia director for Bessemer Venture Partners, another early investor in Parallels.
Russia is getting lots of buzz, thanks in no small part to the sheer size of its Internet market and its increasingly flush middle class, which has disposable income to spend online, says Feinstein.
The potential profits to be made from serving Russia’s consumers are clear, thanks to successes such as Ozon, Yandex, and mail.ru, an operator of Russian social networking, instant messaging and online game sites which raised $972 million when it went public in London in 2010.
“There was a craziness after the Yandex IPO — Russians got a flavor and a taste of technology as another vehicle for money making and literally overnight the space overheated,” says Alexandra Johnson, a partner at DFJ VTB Capital Aurora, a Russia-focused seed and early stage emerging technology venture fund with offices in Silicon Valley and Moscow. It is part of the DFJ Network, a fund family with over 30 offices and more than $6 billion under management and also includes one of the largest financial and investment banking groups in Russia: VTB.
While e-commerce captures the hype andthe headlines, serious money is also being poured into material sciences. To that end, DFJ VTB Aurora is teaming with Rusnano, a multi-billion dollar government fund with a mandeate to give Russia the lead in nanotechnology by accelerating the development of nanotech products.
DFJ VTB Capital Aurora Innovation & Nanotechnology Fund, a $100 million fund that is 50/50 financed by Rusnano and VTB Capital and is managed by VTB Capital, invested in two nanotechnology start-ups in April. One, a US-Russian start-up named Rolith, develops nano-structured coatings for solar enerby, green building, solid state lighting and efficient dispaly products using a proprietary nanolothography technology, It was founded by Boris Kobring, who earned a PhD in Physics from the Institute of Chemical Physcis in Moscow. DFJ VTB Capital Aurora also invested $6 million in a German nanotech company, SmS Tenzotherm, co-founded by Vladimir Kaminsi from the Ioffe Physical-Technical Institute in Saint Petersburg.
A condition for Rusnano to invest is that start-ups outside Russia agree to move business or research and development there. Venture capitalists in Silicon Valley don’t necessarily consider that a barrier. “If anyone told me three years ago that we would consider production somewhere in Russia for our companies I would not have believed them but now it is possible — why not?,” says DFJ VTB Aurora’s Johnson. “ We are open to investigating production in Tatarstan – of all the Russian regions they have really got their act together — and other regions in Russia are picking up as well, so I am more optimistic.”
Although there is a lack of management talent, the availability of highly-educated world-class engineers, mathematicians, statisticians and scientists in Russia is an added plus for foreign investors.
But for all the optimism, investors say caution is merited. Russia is known for rampant corruption and is not the easiest place to do business. “It is a challenging and tricky market,” says Guiseppe Zocco, a partner at Index Ventures. “You need good visibility, so it’s important to have a local partner.”
For some investors, the Skolkovo Foundation is now playing that role, helping foreign funds scout for new deals and making it easier for them to do business in Russia. Bessemer has just partnered with Skolkovo, pledging to invest $20 million in exchange for priority access to the Skolkovo Foundation’s most promising projects.
“Having made a few investments in Russia that have generated attractive returns Bessemer feels comfortable making that kind of commitment,” says Feinstein. As more venture funds test the waters in Russia the Skolkovo Foundation can only hope that more investors will come to the same conclusion.
–Eric Sylvers contributed reporting to this story