Russian and global venture markets in 2007–13 3 Contents
Foreword 2
Methodology of research 4
Glossary 6
Global venture market in 2007—13 9
Key venture markets 21
Government incentives and VC funds: best practices 29
Tendencies in the role changes of the key venture market players 32
Russian venture market 33
Russian venture market executive summary 35
History of the Russian venture market 36
Russian Government and the new economy 38
Russian venture market in 2007–13 42
Afterword 62
Russian and global venture markets in 2007–13 | 1 Foreword
At EY, we believe that venture capital (VC) investments are one of the key drivers behind the global economy shift. The unprecedented change in the ways in which people communicate and share information, and how businesses go global and reach out to their customers would not be possible without major innovations. The innovations themselves, however, are the result of continuous effort by entrepreneurs and governments alike to develop a clear vision of the high-tech future and a path toward it. We believe it is crucial to keep fast-growing enterprises in the loop to understand the most recent and relevant trends, and support entrepreneurs offering the world their disruptive ideas and technologies. As technology advances and the global economy searches for a breakthrough to rebound from the difficulties of the past few years, the business environment around Alexander Ivlev us changes rapidly, and EY reflects these changes in its thought leadership. Country Managing Partner Our recent studies suggest that the problems of greenfield financing, for Russia, EY regulatory challenges and public-private partnership issues do not fade away. Businesses and governments therefore need to continue their discussion and exchange views and ideas. As can be seen from our report, produced in collaboration with RVC, the venture investment industry is still going through difficult times coming out of the severe financial crisis. In these circumstances, the rapid rise of the Russian venture market suggests that stakeholders continue to believe that the efforts of the Government and market players will result in a transparent business ecosystem and that the way to the prosperous future lies in building the innovative economy. The more challenges we face, the more will appear. In tomorrow’s rapidly changing world, EY, as ever before, will be there to help businesses navigate their way toward sustainable growth and success.
2 | Russian and global venture markets in 2007–13 Within the last seven years, one of the most important goals of development institutions created in Russia was to build the Russian innovation economy on the basis of the public-private partnerships. Specific attention was paid to the establishment of the VC industry in Russia, considered not only as a source of capital and business competences, but also as one of the key elements of the innovation ecosystem. Several years ago, the VC market was virtually absent in Russia. But now things have changed. Joint efforts from the Government, development institutions, the business community, science and education have shown high efficiency in terms of creating a national VC industry in Russia. An important stage for the Russian venture market was completed in 2013. The main goal of RVC, a government fund of funds and a development Igor Agamirzian institution of the Russian Federation, was to create a self-developing CEO and Chairman, RVC venture market (in collaboration with other development institutions) and to stimulate innovation in the development of innovative entrepreneurship. As a result, RVC activities in previous years have been focused on supporting the involvement of the private VC into the innovative entrepreneurship development, while ensuring the creation of institutional and sectorial venture infrastructure. These tasks are considered to be almost completed at this point. Over the past three years, the Russian venture market has increased several times. But a more important fact is that now the growth of the Russian VC industry does not depend on state financing alone. Of course, like any other growing market, the Russian VC industry needs further development. However, one could say that the Russian venture market has been established and it is becoming more attractive for Russian and foreign investors. Until recently, the world’s leading research agencies have not paid a lot of attention to the Russian venture market. But now the situation is changing. Authoritative international organizations acknowledge the positive outcomes of the Russian VC industry. Moreover, the interest in analytical studies that reflect the dynamics of the Russian venture market and its potential are growing all over the world. We hope that this report presented by EY will facilitate the integration of foreign investors and corporations into the Russian venture market and increase international cooperation in the key areas of technological development.
Russian and global venture markets in 2007–13 | 3 Methodology of research
In this report, an investment is considered a venture investment if Company development stages it is a cash-for-equity transaction with a company at seed, start-up and other early stages of development made by a special-purpose Start-up (no revenues) venture fund. Hence, Rusnano investments or similar equity- A company in the early, formative stage of development being based transactions, including debt-to-equity acquisitions through run by founders and possibly a few developers. Often, the start-up convertible loans, are considered venture investments. stage coincides with seed funding. A company generally goes The following transactions are not accounted for in the statistics: from the start-up phase to the product in development phase very quickly. • Venture investments of an undisclosed volume or investments of a volume that cannot be reasonably estimated Product in development (no revenues) • Grants A company is considered to be in the product development stage when it is developing an initial product and has no product or • Special-purpose R&D financing service revenues. Companies that provide a service rather than a • Investments made by business angels product are considered to be at this stage while developing their business strategy, prior to actually marketing the services and • Investments made by companies that are not managing receiving revenues. a special-purpose venture fund Product in beta test (no revenues) • Investments made by funds that are targeted at real estate and development, i.e., investments in construction projects For information technology (IT) companies, this is an intermediate and objects (although the statistics do include investments period between product development and product shipping. The in companies involved in the provision of engineering and company is technically still in product development, but a prototype architectural design services, production of construction is being tested by select customers prior to market introduction. materials and construction work) In the global market section, companies at the product in beta test The Russian market section of this report is based on the stage are included the product in development stage. statistical data for 2007 to mid-2013 provided by the Russian Shipping product or revenue Venture Capital Association (source: RVCA), processed data of This indicates that at least one product is being shipped for RusBase and EY data for 2011 to the first nine months of 2013 which revenues are being received, regardless of the number of (source: RusBase, EY). Due to the lack of detailed data, some other products still in development, beta test or clinical trials. sections of the report contain conclusions only for 2011 to the For service companies, this stage indicates that the company is end of Q3 2013. providing services to a customer base and receiving revenues for The global market and key venture markets sections of the report those services. rely on the data provided by the Dow Jones VentureSource database. Profitable This stage indicates that a company is shipping products or Each recorded transaction was classified by an industry group, providing services from which it derives revenues, and the the investee development stage and the investee financing company has reported that it is profitable on an ongoing basis. round according to the adjusted Dow Jones classification. The key quality characteristics of the classification are described Restart below; however, each particular transaction was subject to expert Infrequently used, this stage indicates that a company is judgment. reformulating its business plan and is restructuring. Since the restart period is generally brief, many restart companies will subsequently return to their stage of product in development or shipping product.
Later stages Investments are used for debt re-financing, acquisition of distributors or suppliers, preparation for exit or other activities aimed at short-term capitalization growth. On some graphs, the start-up and product in development stages and product in beta test and shipping product or revenue are combined so that the data obtained from different sources can be compared.
4 | Russian and global venture markets in 2007–13 Venture round types Industry classification overview The venture round is a stage at which a company is financed by Each company is assigned to one of the industry groups an investor. When determining the type of venture round, consisting of 27 industry segments. Industry codes are assigned a company’s development stage is taken into account, together with regard to the actual product or service the company with the total funding to be raised and the volume of the provides, rather than how the company provides it. For example, transaction in question. if a company is a social network website operator, it will be in the consumer information services segment of the consumer market Seed group, rather than the IT group. A cash-for-equity transaction made by venture investors in very early-stage companies. Typically, seed rounds have historically Industry group Industry segment been US$1m or less, but may be larger. Usually, seed financing comes within a year of the company’s start date and is used to Business and financial Business support services open an office, buy hardware and hire key personnel. services Construction and civil engineering
Round A and round B Financial institutions and services A cash-for-equity transaction typically made by venture or private Wholesale trade and shipping equity investors in companies that ship products and have a track of positive financial results. Consumer market — Food and beverages consumer goods Round C and further rounds Household and office goods A cash-for-equity transaction typically made by venture or private Personal goods equity investors into companies that are shipping product and have a track of positive financial results. Vehicles and parts Consumer market — Consumer information services Exit consumer services An equity-for-cash transaction and a disposal (partial or Media and content complete) of holdings by a venture fund. Two major types Retailers of exits are IPO and M&A. Travel and leisure
Energy and utilities Non-renewable energy
Renewable energy
Utilities
Health care Biopharmaceuticals
Health care services
Medical devices and equipment
Medical software and information services
Industrial goods and Aerospace and defense materials Agriculture and forestry
Machinery and industrial goods
Materials and chemicals
IT Communications and networking
Electronics and computer hardware
Semiconductors
Software
Russian and global venture markets in 2007–13 | 5 Glossary
CVC Corporate venture capital
EBRD European bank for reconstruction and development
GDP Gross domestic product
GP General partner
IP Intellectual property
IPO Initial public offering
IT Information technology
LP Limited partner
M&A Mergers and acquisitions
MNC Multinational corporation
MOED Russia’s Ministry of Economic Development
OECD Organization for Economic Co-operation and Development
OJSC Open Joint Stock Company
PE Private equity
RVC OJSC Russian venture company
RVCA Russian Venture Capital Association
SME Small and medium-sized enterprises
SPO Secondary public offering
VAT Value added tax
VC Venture capital
YTD Year to date (in this report — end of Q3 2013)
6 | Russian and global venture markets in 2007–13 Global venture market
Russian and global venture markets in 2007–13 | 7 8 | Russian and global venture markets in 2007–13 Global venture market in 2007–13
Amid the fragile economic recovery and highly volatile capital total number of the VC funds closed and the dollar amounts markets of the last few years, the VC sector is becoming closed rose in 2010 and 2011. In 2012, the trend reversed increasingly globalized. As the economic pendulum swings toward sharply, with the number of fund closings declining by 13% year the rapidly developing economies, the VC sector is experiencing on year to 280 in 2012 from 323 in 2011, and the value falling its own paradigm shifts. from US$46.8b to US$33.2b — a year-on-year decline of 30%. These show that widespread global economic uncertainty weighed The globalization of VC is assuming many forms, ranging from heavily on VC investment in the last two years, demonstrating global fund-raising and cross-border investment to exits on foreign also that limited partner (LP) investors are showing a preference stock exchanges or by foreign acquisition, as well as VC firms for the most successful “brand name” funds, seeking depth of opening offices overseas and helping their portfolio companies to experience and a track record. access markets in new regions. Globally, the share of investment directed to all fund-raising A shift toward the emerging markets can be seen in the stages has decreased; as mentioned earlier, investors stayed geographic VC patterns and the growth of new global VC hotbeds. devoted to companies in the revenue stage, showing the least Although the US will likely remain at the leading edge of VC- interest in start-up stage companies. backed innovation for many years to come, US VC fund-raising continues its decade-long decline. Elsewhere, in China, India Both the amounts raised and the number of rounds continued and other emerging markets, vibrant innovation hotbeds and to decline in 2013. Apparently, 2013 seems to be the second entrepreneurial talents are emerging, and investors are focused challenging year in a row for VC investments. In 2013, the overall on less risky, later-stage deals, at least for now. market sentiment was still affected by the continuing slow pace of global economic growth, which inevitably was reflected in the Global VC market 2007–13 YTD VC investments in all markets. The amount of financing in the seed and first-round stages dropped across all regions. However,
60 5,797 5,756 5,612 6,000 even in the volatile equities markets of the past five years, the 5,424 5,311 average one-day, post-IPO return of VC-backed entities in the US 4,732 50 5,000 was 19%, and a recent EY report published in February 2013, 40 4,000 Right team, right story, right price, confirmed that about 40% of 4,011 the institutional investors believe rapid-growth markets offer the 30 3,000 49.6 50.7 54.2 highest valuations. 46.1 46.8 20 2,000
35.1 33.2 Number of rounds Amount invested (US$b) 10 1,000 VC investment is strongest 0 0 2007 2008 2009 2010 2011 2012 9M2013 in the US and Europe Amount invested during the year (US$b) The year 2012 saw a considerable fall in the US dollar value of Number of rounds during the year VC investments compared with 2011. VC investments dropped Source: Dow Jones VentureSource by more than 10% in both the US (from US$35.8b to US$32.1b) and Europe (from US$7.3b to US$6.2b), while Israel (US$1.9b to US$1.1b) and China (US$6.4b to US$4.9b) reported drops of In 2013 YTD, as at 30 September, 4,011 VC deals were more than 42% and 23% in the value of investments, respectively. announced globally, with an aggregate value of US$33.2b. These In India, however, this indicator remained unchanged for 2011 VC investments have been made across a range of different and 2012 at US$1.6b. countries, sectors and stages, from the very early-stage seed and angel financing to the larger growth capital and later-stage Israel and Europe showed good growth for the first three quarters investments. of 2013, while Israeli indicators of the amount invested have already exceeded the figures for the entire period of 2012. Exploring markets of VC investment over the period 2007-2013 YTD, the picture has not changed across all the leading countries: The number of deals and the average deal size in 2012 fell the US, Europe, Israel, China and India. The sharp decline in 2009 significantly across all countries, excluding China (although clearly demonstrated that the VC industry was not immune to the the number of deals decreased by 40%, the average deal size 2008 financial crisis. increased by 26%). Then there was over two years of growth, and the global VC The slowdown in China’s GDP growth rate led to a decline in VC industry reached record highs in 2011, followed by a downward investment by more than 20% in both the number of deals and the trend in 2012 and 2013. Mirroring the investment trends, the total value. However, recent improvements in the forward-looking
Russian and global venture markets in 2007–13 | 9 indicators of Chinese economic activity point to a more optimistic Global VC investment by sector outlook for 2014. Over the last seven years, most of the investment value and The US and Europe will likely remain at the leading edge of VC- the number of rounds have been concentrated in four sectors backed innovation for many years to come, accounting for an (IT, health care, consumer services and business and financial average of 82% and 85% of global VC investment in the period services), with a specific share of 86% and 88% on average, from 2007 to 2013 YTD in both the amount invested and the respectively. The IT sector held the leading position with 28% and number of deals, respectively. 32% in the average amount invested and the number of rounds, respectively. The software subsegment was the most active. Countries’ share in global VC investment by number of deals Global VC investment by sectors — average for a period of seven years (2007–13 YTD) 2007 2008 2009 2010 2011 2012 9M2013 100% 59% 60% 62% 61% 54% 56% 58% By rounds Billion US$ 30% 27% 27% 26% 22% 22% 25% US 3% Europe 5% 3% 3% 4% 8% 10% Israel 5% 28% China 32% 16% India 15% 3% 3% Russia 2% 1% 1% 1% 1% 19% 18% 21% 25% 0%
Source: Dow Jones VentureSource IT Energy and utilities Health care Industrial goods and materials Countries’ share in global VC investment by amount invested Consumer services Consumer goods Business and financial services 2007 2008 2009 2010 2011 2012 9M2013 100% Source: Dow Jones VentureSource 69% 66% 69% 63% 66% 67% 69% US 15% 16% 16% 15% 14% 13% 13% Europe 10% Israel Since 2010, the sectors of business and financial services and China consumer services have attracted growing VC market interest. India 3% The largest number of VC rounds in China in the last seven years 2% Russia 1% 1% was in the consumer services sector. In Israel, however, a larger number of rounds was concentrated in the IT and health care
0% 0% 0% sectors. 0% 0% From 2007–13 YTD, the IT sector continued to lead in all markets
Source: Dow Jones VentureSource except India, where it has held the second position since 2008. The graph of behavior of all sectors during the seven-year period shows that two sectors — IT and consumer services — clearly have a similar trend, with a decrease between 2007 and 2009, then an increase to 2012, when the growth rate began to slow down again.
10 | Russian and global venture markets in 2007–13 VC investment in sectors during the period from 2007 to trend in the share of the number of investment rounds, from 56% 2013 YTD (2007) to 65% (2013 YTD). This is in line with the long-term trends observed. The software subsegment was the most active, 2,050 while in China, the IT sector showed a downward trend from 1,850 1,650 2007, with a minor recovery in 2011. 1,450 1,250 IT sector by the amount invested and the number of deals 1,050 (2007–13 YTD) 850 650 2,046 450 16,000 Amount invested (US$m) 1,812 1,795 250 1,725 14,000 1,608 50 1,488 2007 2008 2009 2010 2011 2012 9M2013 12,000 IT Health care Consumer services Business and financial services 14,000 1,171 Energy and utilities Industrial goods and materials 10,000 Consumer goods 16,735 14,293 13,377 8,000 12,000 Source: Dow Jones Venture Source 11,607 6,000 9,533 8,386
Amount invested (US$m) 4,000 Consumer services continued to dominate the deal volumes 2,000 in Europe and India, with the consumer information services 0 subsegment as the most popular. In 2013 YTD, this segment 2007 2008 2009 2010 2011 2012 9M2013 accounted for 20% and 45% of the total deals in the sector in Total amount invested Europe and India, respectively. Total number of rounds According to the data analysis of Venture One, the highest Source: Dow Jones VentureSource average deal throughout the period reviewed in this report was in 2008 in the energy and utilities sector (US$22.3m), while the lowest average deal was in 2009 in the industrial goods and Investments in IT by country materials sector, with US$5.4m. (average over the period 2007–13 YTD) Another interesting fact about sector behavior: business and financial services, consumer services and the health care sectors By rounds Billion US$ show an increasing trend in the number of years required to 1%1% exit via IPO. However, the IT sector has continued to show a 1%3% 5% 5% fluctuating trend in the last year. 5% 5%
IT 14% The IT sector continues to lead with 32% of the total number 23% of rounds for 2013 YTD. This sector has kept its leadership in 63% the last seven years, with 30% of the total number of rounds 72% annually. This sector also prevails in the annual average of the total investments category. After an annual decline of 2% to 3% in the amount invested and the number of rounds from 2007 US China to 2011, 2012 and 2013 saw a rise associated with the rapid Europe India development of mobile communications, cloud servers, big data Israel Russia and such terms as “the Internet of Things” and “bring your own device.” The increase was also associated with the attractiveness Source: Dow Jones VentureSource and reputation of the sector relative to others. The IT sector continued to lead not only on a global level, but particularly in the US, Europe and Israel, between 2007 and 2013. The sector attracted a major share of VC investment in the US, accounting for 77% of the total amount invested in this sector in the last two years (2012–13 YTD), and shows an upward
Russian and global venture markets in 2007–13 | 11 Health care Consumer services In addition to IT, in terms of dollar value, health care attracted Another attractive sector for the VC investment market is a large number of VC investments across the market during the consumer services, with 14% and 19% of the average value in the same period; it accounted for 25% of the total amount invested amount invested and the number of rounds, respectively. The and 21% of the number of rounds, with an average value of consumer services sector continued to lead in India and China US$10.1m — the second highest among all sectors. last year. China and India have a larger VC deal volume in the consumer services sector compared with other sectors. One more interesting fact about the health care sector compared with others: it continues to account for a larger percentage of Even in a difficult economic situation, the consumer services corporate VC investing at the product development stage in the sector was the only one to see activity in IPO during 2009. case of IPO as well as M&A exits. Consumer services investments have been on the rise since 2010 due to the growth in the number of smartphones, enabling the Health care sector by the amount invested and the number increase in businesses built on Facebook and Twitter’s distribution of deals (2007–13 YTD) platforms. As for category observations, e-commerce and
1,267 consumer services command the largest share of investments, 19,000 while media and gaming seem to have particularly high fund- 17,000 1,139 1,190 1,153 1,005 raising opportunities. 15,000 1,126 13,000 The median time to the next stage throughout the different 11,000 rounds of VC investment has remained relatively stable and is in 738 the range of 14 to 15 months for the consumer services sector in 9,000 14,290 12,120 9,990 2011, 2012 and 2013 YTD. 7,000 12,121 10,920 5,000 10,539 7,469 Consumer services sector by the amount invested and
Amount invested (US$m) 3,000 the number of deals (2007–13 YTD) 1,000 0 16,000 1,244 1,282 2007 2008 2009 2010 2011 2012 9M2013 14,000 Total amount invested 972 Total number of rounds 12,000 892 910 Source: Dow Jones VentureSource 778 10,000 835 8,000 Average investment in health care by country (2007–13 YTD) 12,602 6,000 By rounds Billion US$ 9,712 9,432 4,000 7,407 1% 1%
Amount invested (US$m) 6,289 1% 6,073 5,116 0% 1% 2,000 2% 2% 10% 3% 2% 0 2007 2008 2009 2010 2011 2012 9M2013
26% Total amount invested 16% Total number of rounds
66% Source: Dow Jones VentureSource 69%
US Israel India Europe China Russia Other
Source: Dow Jones VentureSource
12 | Russian and global venture markets in 2007–13 Business and financial services Global trends in the distribution of In the case of the business and financial services sector, 73% of the total deal amount is accounted for by US-based companies. VC investments In the US, median pre-IPO valuations over the last three years VC funds are adjusting their investing strategies, preferring to have been significantly higher for the business and financial invest in companies that are generating revenue and focusing less services sector compared with other sectors. on product development and pre-revenue businesses. Companies at the revenue generation stage continued to dominate VC activity In Europe, business and financial services had the highest share by the number of rounds and by the amounts invested across the of proceeds in the quarter. A total of 81 deals in the sector raised markets. Globally, the revenue generation stage accounted for US$388m in 3Q 2013. Out of these deals, 70% were made in the more than 60% of the amount invested across all geographies, business support services subsegment. apart from in India. During the last seven years (2007–13 YTD) in the US and Europe, VC rounds in revenue generation and the Amount invested and number of deals in the business product development stages constituted 85% and 91% of the total and financial services sector (2007–13 YTD) number of rounds, respectively. The share of investment directed to the revenue generation stage has increased from 56% prior to 964 11,000 the crisis in 2007 to 69% in 2012 in terms of the number of deals, 861 858 848 810 9,000 786 and has risen from 56% to 74% in value terms. Conversely, the 716 share of investment directed to the product development stage 7,000 has declined from 31% to 22% in the number of deals and from
5,000 8,485 32% to 17% in deal value. These indicators will remain almost 7,244 6,541 7,317 unchanged in 2013, with no significant decrease. 3,000 5,961 6,188
Amount invested (US$m) 4,575 1,000 VC investments by development stage 2007–1H2013 (by number of deals) 0 2007 2008 2009 2010 2011 2012 9M2013 Startup stage Total amount invested 260 239 220 225 216
Total number of rounds 188 77 76 68 69 65
Source: Dow Jones VentureSource 49 42 21 19 15 13 15 14 12 11 9 7 7 6 6 5 5 4 4 Investments in the business and financial services sector by 4 2 2 2 country (average over the period 2007–13 YTD) 2007 2008 2009 2010 2011 2012 1H2013
By rounds Billion US$ US Europe China Israel India
Source: Dow Jones VentureSource 0% 1% 7% 7% 6% 4% Product development stage 5% 9% 3%
2% 1,083 1,059 1,041 1,023 887 938
59% 536 405 379 346
11% 343 274 65% 21% 255 127 134 111 70 64 47 36 39 34 29 26 24 23 22 18 18 16 17 14 10 8 8 US Israel India Europe China Russia Other 2007 2008 2009 2010 2011 2012 1H2013 Source: Dow Jones VentureSource US Europe China Israel India
Source: Dow Jones VentureSource
Russian and global venture markets in 2007–13 | 13 Revenue stage Median round size declining in the US and Europe 2,295 2,129 1,735 1,486 1,597 1,644 1,112 1,042 914 867 908 816 884 As investment shifts to the later stage, the median round size 475 288
225 typically increases as the quantum of risk decreases. In the US, 195 191 185 216 149 164 148 131 92 93 92 102 80 83 however, VC funds are deploying smaller amounts of capital in the 75 63 65 64 54 later-stage investments. Over the last seven years, the US median round size in the revenue stage has dropped significantly from US$7.9m to US$5.0m, reflecting the VC investment being used to supplement operating cash flows as a bridge until an exit. The 2007 2008 2009 2010 2011 2012 1H2013 median size decreased from US$2.5m to US$2.1m in Europe in US Europe China Israel India both revenue and product development stages.
Source: Dow Jones VentureSource Median investment volume
Profitable stage Product development stage
203 183 7.0 US$m 7.0 147 139 136 6.3 128 133 121 5.9 113 111 107 5.2 5.0 5.0 5.0 4.8 76 79 4.6 4.5 4.4 4.4 64 64 4.0 4.0 4.0 3.8 3.8 55 3.6 3.5 3.5 3.3 3.0 3.0 46 40 2.7 2.6 2.5 2.6 2.1 2.1 2.0 2.0 31 1.3 1.2 16 0.5 14 10 10 8 7 7 7 7
6 2007 2008 2009 2010 2011 2012 1H2013 6 5 4
3 US Europe China Israel India 2 2 Source: Dow Jones VentureSource
2007 2008 2009 2010 2011 2012 1H2013
US Europe China Israel India
Source: Dow Jones VentureSource Revenue stage
10.0 10.0 9.5 9.6 9.0 8.8 US$m 7.7 7.9 8.0
Investment levels in start-up stage companies have not changed 7.8 7.6 7.3 7.0 6.0 6.0 5.5
significantly since 2008, except for the fall in the amount invested 5.0 5.0 5.0 4.9 5.0 4.8 5.0 5.0 4.7 4.5 4.6 4.4
in 2012 (47%). The profitable stage continues with its downward 3.0 2.4 2.4 2.2 2.4 2.1 2.1 trend since 2007, with the two-year exception for 2010 and 2011, when the number of deals stayed stable or even grew in 2007 2008 2009 2010 2011 2012 1H2013 some markets. US Europe China Israel India We see evidence of money flowing into companies that appear Source: Dow Jones VentureSource to present less risk. For example, there is a shift away from social media toward enterprise — the companies that are attracting greater VC interest are those that provide a service and are Profitable stage getting paid for it, rather than those that have an idea that is 101.9 good, but difficult to monetize.
US$m 31.6 20.0 20.0 14.6 10.0 9.5 10.3 8.5 9.0 9.0 9.6 8.0 8.0 7.9 7.3 7.8 6.9 7.0 7.2 6.7 5.7 6.3 6.0 5.2 5.6 4.9 5.0 4.0 4.2 3.6 2.4 3.1 2.6 4.0 2.8 2007 2008 2009 2010 2011 2012 1H2013 US Europe Canada China Israel India
Source: Dow Jones VentureSource
14 | Russian and global venture markets in 2007–13 Out of all the geographical regions, the round size for the VC funds landscape profitable stage has been the highest in India over the last two years. Profitable stage investment levels have been rising in India Roles of major groups in VC financing 2007–13 YTD since 2011, increasing from US$9.0m to US$101.9m as a result Mirroring the investment trends, the total number of the VC funds of two large deals, i.e., Flipkart, India’s largest online retailer, closed and the dollar amounts closed recovered in 2010 and previously known as the “Amazon of India,” has raised US$200m 2011. In 2012, the trend reversed sharply, with the number of and another US$160m from the existing investors during 2013, fund closures declining by 13% to 280 from 323 in 2011 and the with the final round E of US$360m the largest ever to be raised by amount closed falling from US$42.2b to US$29.0b, a decline of an internet start-up in India. India saw an increase in the median 31%. As of 2013 YTD, 133 funds closed and the amount closed round size for profitable stage investments in 1H13, indicating an was US$19.4b. The US continued to dominate global VC fund- improving investor appetite for risk in VC investments. raising activity, accounting for 63% of the total number of funds closed (84) and 72% of the amount raised (US$14b) in 2013 The trend toward later and smaller investment in less risky YTD. companies is being accompanied by a move toward tougher terms. LPs are demanding better terms from the VC funds, while, in turn, the funds are requiring portfolio companies to meet Amount closed by US VC funds 2007–13 YTD (US$b) stricter milestones and tighter time frames.
14.0 12.9 8.5 US$b 3.2 5.8 10.4 7.5 8.9 3.6 1.6 5.4 3.4 12.3 12.8 1.3 4.5 7.3 6.2 5.4 5.4 7.0
2007 2008 2009 2010 2011 2012 9M2013
Early-stage Late-stage Multistage
Source: Dow Jones VentureSource
Number of final closures of US VC funds 2007–13 YTD
100 96 96
80 69 63 62 60 57 54 54 52
40 30 29 29 19 20 17 16 12 12 12 7 5 6 0 2007 2008 2009 2010 2011 2012 9M2013
Early-stage Late-stage Multistage
Source: Dow Jones VentureSource
VC fund-raising activity in Europe continues its downward trajectory in 2013, with the total number of funds closed down from 101 in 2007 to 37 in 2012, and to just 20 YTD in 2013. The decline in the level of VC fund closures was most pronounced in the Asia-Pacific region, where there was a trend toward a greater number of funds closed for early-stage investment rather than multistage funds from 2010 to 2011 — a trend that reversed in 2012 and 2013. After strong VC fund-raising activity in 2011, the Asia-Pacific region has shown a consistent decline. There was a year-on-year fall of 41% in volume and 72% in the amounts raised in 2012. Activity slowed down further in 2013 YTD, with a
Russian and global venture markets in 2007–13 | 15 total of 20 VC funds raising a combined total of US$1.9b. Despite It is interesting to note the continued decline in the number of this softer activity in 2013 YTD, the average fund size across the active investors in the US, Europe and China — a shift to fewer but categories was higher than the 2012 levels, indicating that the stronger players, reflecting consolidation in the market. situation was stabilizing. Today, general partners (GPs) raising capital from LPs located outside their home country also invest in portfolio companies abroad. Limited partnership investors are showing preference to Amount closed by Europe VC funds 2007–13 YTD the most reputable funds LP (those that are well known and have a high reputation), seeking depth of experience and a good track 3.9 3.9 record. A VC’s reputation is a valuable asset. A high-reputation 0.2 0.7 2.3 VC is more likely to have its term sheets accepted, and it can pay US$b 5.2 0.1 2.4 0.6 5.0 1.2 0.2 1.3 lower prices (10% to 14% lower) for shares than low-reputation 2.7 0.3 2.4 0.2 1.3 1.4 1.1 VCs do. Top-tier VCs earn their reputation with superior 2007 2008 2009 2010 2011 2012 9M2013 investment performance, and many of these top-tier firms raise
Early-stage Late-stage Multistage their carried interest to 25% or even 30%. Nevertheless, there is
Source: Dow Jones VentureSource excess demand among potential LPs looking to invest in such top- tier VCs, even at these higher prices. This excess demand allows VCs to maintain long-run relationships with the LPs, minimize Number of final closures of Europe VC funds 2007–13 YTD the time needed for fund-raising, and maximize the chance of
60 53 maintaining their high reputation. This reputation is valuable 48 not only for striking better deals with the portfolio companies, 40 46 41 but also for increasing the value added to these companies. 25 27 25 This value is added through monitoring activities, such as 20 18 10 21 11 9 7 15 18 board membership, corporate governance, human resources, 2 2 3 0 1 1 1 0 matchmaking and strategy. 2007 2008 2009 2010 2011 2012 9M2013 Global VC fund-raising 2003–13 YTD (includes all funds Early-stage Late-stage Multistage focusing on Asia-Pacific, Europe and the US) Source: Dow Jones VentureSource Investor Amount % over the Cumulative Amount closed by Asia-Pacific VC funds 2007–13 YTD closed past decade % (US$m) since 2003 4.5 Sequoia Capital 9,983.1 2.64% 2.64% 1.5 New Enterprise 8,907.9 2.36% 5.00% US$b 5.3 Associates 8.4 2.9 2.6 2.0 1.0 2.4 Insight Venture Partners 5,975.4 1.58% 6.58% 2.7 0.1 3.3 0.2 1.1 2.0 1.1 1.8 0.8 Kleiner Perkins Caufield 5,801.4 1.53% 8.11% 2007 2008 2009 2010 2011 2012 9M2013 & Byers Early-stage Late-stage Multistage TCMI Inc. 5.300.0 1.40% 9.51% Source: Dow Jones VentureSource Accel Partners 5,159.8 1.36% 10.88% Number of final closures of Asia Pacific VC funds 2007–13 YTD Oak Investment 4,810.0 1.27% 12.15% Partners 60 54 Bessemer Venture 4,185.0 1.11% 13.26%
38 Partners 40 36 35 31 30 Battery Ventures 3,750.0 0.99% 14.25% 35 22 30 25 17 20 24 11 Matrix Management 2,875.0 0.76% 15.01% 7 4 9 Corp. 0 2 0 1 0 0 2007 2008 2009 2010 2011 2012 9M2013 Total of top 10 56,747.7 15.01% 15.01% Grand total amount 378,108.7 100% 100% Early-stage Late-stage Multistage closed Source: Dow Jones VentureSource
1 Andrew Metrick and Ayako Yasuda, Venture Capital and the Finance of Innovation, Yale School of Management, 2011.
16 | Russian and global venture markets in 2007–13 The increasing role of corporate VC In the current market, institutional investors are responding Israel favorably to well-positioned deals. It was found that 82% of 8% 7.4% institutional investors had invested in pre-IPO or IPO stocks in the 6% past two years. Those that have done so have strongly favored 4% 3.4% companies that come to the market well prepared, are priced 2.7% 1.7% 1.7% right, are run by the right team and have a compelling equity 2% 1.3% 1.2% story to tell. 0% 2007 2008 2009 2010 2011 2012 1H2013 Angel investors and crowd-funding platforms continued to step Source: Dow Jones VentureSource up their involvement, filling the gap at the start-up stages left by VC firms, which had moved toward later-stage, high-growth ventures. A higher percentage of VC deals in companies backed China by organized angel investors means less risk for the VC funds 4% 3.7% investing in start-up companies. The percentage of VC deals in 2% companies backed by organized angel investors has increased in 0.8% 0.5% 0.9% Europe, Canada, Israel and China for 1H13 compared with 2012. 0% 2007 2008 2009 2010 2011 2012 1H2013 However, VC funds in India saw a decline in angel-backed deals Source: Dow Jones VentureSource from 11% in 2012 to 7% in 1H13. In the US, the level remains approximately the same as 2012. India Percentage of VC deals in companies backed by organized 12% 11.1% angel investors (by countries) 10%
8% United States 7.0%
6% 8% 7.4% 6.5% 6.4% 4% 3.2% 3.6% 6% 5.6% 3.0% 4.8% 2.1% 4.3% 2% 4% 3.2% 0.9% 0% 2% 2007 2008 2009 2010 2011 2012 1H2013
0% Source: Dow Jones VentureSource 2007 2008 2009 2010 2011 2012 1H2013 Source: Dow Jones VentureSource In 2013, corporates cemented their important role in the VC market. Where they chose to make an investment (typically, it Europe would be a later-stage project in the US), the valuation of the 8% business in that round was usually greater compared with similar 6.1% companies without corporate investors. 6% 5.4% 4.8% 4.5% 4.3% 4.1% Helping to offset the weaker IPO market to some extent, 4% 2.7% corporate venture investment is rising and, in 2012, surpassed 2% the pre-dot-com levels. Corporates are now an important part of 0% the VC market. Between 2005 and 2013 YTD, Intel Capital and 2007 2008 2009 2010 2011 2012 1H2013 Google Ventures were the two most active sources of VC in any Source: Dow Jones VentureSource sector, with 606 and 180 transactions respectively. IT has witnessed both the largest number of corporate venture investments and the highest number of acquisitions. Activity in the IT sector is being driven by a combination of healthy corporate cash balances and the rapid pace of technological change, as the rise of mobile, big data and cloud computing creates a disruptive business environment. Corporates are keen to invest in and acquire venture-backed companies to fill the gaps in their strategy and innovation capability.
Russian and global venture markets in 2007–13 | 17 When corporate investors enter into a deal, the valuation of Exit landscape the business is typically greater than that of companies with no corporate investor at a similar stage. Over the last decade, the For much of the past 10 years, exits have been challenging for median valuation premium, created by corporate investors, was VC-backed companies. First, there was the dot-com bubble that 54% in the US. started in the late 90s and lasted until 2004, when Google went public. And then the financial crisis struck, which means the IPO The link between corporate investment and ultimate acquisition, markets have been difficult to access for approximately half of the however, is weak. For example, in 2012, in all sectors in the past 10 years. US, only 2% to 3% of the companies involved in M&A deals were acquired by an existing corporate investor. Also, the valuation In the last few months of 2012, global market uncertainties may premium evident at later-stage investment made by a corporation have held back VC investments. This is suggested by a drop in the does not consistently translate into a similar premium at the number of VC-backed IPOs and M&A exits, and VC funds again moment of acquisition. reduced activity in early-stage investment. However, an improved IPO environment and robust M&A activity in 2013 are expected to Lack of exits hampers the investment cycle support VC investment in the coming quarters. The decline in activity partly represents an understandable pause Over the past few years, there have been fewer VC-backed IPOs in the face of uncertainty, following two strong years (2010 to in Europe, where the number of IPOs and the amount they raised 2011) of growth. There is also, however, the constraining factor has also fallen. However, over the same period, VC-backed IPOs of a tough exit environment. With general partners finding it have increased in the US. harder to exit their portfolio company investments, the flow of capital being returned to LP investors is slowing, which in turn IPOs remain the most lucrative exit vehicle for VC-backed restricts those investors’ ability and willingness to reinvest in companies, although it is becoming increasingly difficult to fully new funds. The poor performance of many VC funds relative exit via a public listing, and the time taken to exit via an IPO has to benchmark indices, such as S&P 500, also does not help the increased since 2007, especially in the US and Europe. reinvestment case. In contrast, we are beginning to see a clear trend of decreasing time taken for M&A exits in the US and Europe. The median time to exit through M&A in the US has fallen sharply to 4.4 years, suggesting that the new generation of post-bubble companies is coming to the market. Another trend is that VC funds are starting to hold on to the shares in their investments even after an IPO — retaining an interest, as shareholders, in the performance of companies they once controlled.
Global VC-backed IPOs In the last three years, the amount raised via IPOs has declined globally by 38%, from US$26.3b in 2010 to US$16.1b in 2012. For IPOs, 2013 seems to have been a challenging year. With 65 deals and US$5.3b for 2013 YTD, the year saw levels close to those of 2009. In terms of a deal count globally, IPOs declined by more than 46% from 214 in 2010 to 115 in 2012. This decline was most severe in China, where there was a more than 50% drop in the number of IPOs. Despite this, the number of companies that have gone public in China is the highest in the world. The US bucked the global downtrend and saw the doubling of proceeds against 2011, albeit largely due to the US$6.8b raised by the Facebook IPO.
18 | Russian and global venture markets in 2007–13 Global venture-backed IPOs, 2007–13 YTD The third quarter of 2013 saw 169 venture-backed M&A deals (numbers of deals and total money raised, US$b) (with a total deal value of US$14.6b). This was the strongest quarter by deal value in the last 12 months. The average disclosed 212 deal value during the period was US$86.3m — the highest in the 35.0 last six quarters. As a result, gains in proceeds outpaced growth in 163 30.0 163 volumes in 3Q2013, up 3% and 1% respectively, when compared with the corresponding quarter of last year. 25.0 115 The US led the pack with a share of close to 70%, both in terms 20.0 of the volume of M&A deals and the amount raised, in 3Q 2013. 15.0 65 M&A exits are still the preferred exit route for companies in the US 26.3 22.1 and Europe.
Amount raised (US$b) 10.0 56 14.9 16.1 33 Outside the US, Europe and China were in the lead, with strong 5.0 5.5 5.2 activity seen in both markets during the quarter, although at 0 1.4 considerably lower levels than the US. In Europe, total proceeds 2007 2008 2009 2010 2011 2012 9M2013 jumped by a factor of 3.2, while in China, they were up by a Amount raised during the year factor of 7.4, as compared with 3Q12. Consequently, 3Q 2013 Number of IPOs during the year was the strongest quarter in China since 2008, with the market Source: Dow Jones VentureSource generating US$885m in five deals.
Key regions by number of M&A deals (3Q13) The US continued to dominate global VC-backed IPO activity, accounting for 94% of the amount raised and 89% of the deal 12,000 140 volume in the last months of 2013, primarily due to strong activity in its biopharmaceuticals sector; there were 28 new 10,000 115 120 listings that were valued at US$2.4b — up from US$1.9b raised 100 8,000 through 23 IPOs in the corresponding quarter last year. 80 6,000 IPO activity was comparably subdued in other regions. India and 9,867 60 Canada saw no activity during 3Q 2013, while other markets, 4,000 40
Amount raised (US$m) 40 including Europe, China and Israel, reported a single deal each Number of M&A deals 2,000 20 3,279 5 5 during the quarter. 2 2 0 0 In the US and China, investors can expect to generate early 885 35 420 101 US Europe China India Canada Israel returns compared with other geographies. A relatively high proportion of companies in these markets, which raised initial Proceeds Number of deals funding in 2007, are now publicly held or were acquired by Source: Dow Jones VentureSource corporations. The IPO outlook seems promising in the coming quarters, with the recent momentum seen in valuations along with very supportive The IT sector led in venture-backed M&A deals, with 71 out of the global monetary conditions, which are expected to support total 169 deals (42%) reported in the quarter. The sector also ongoing growth in venture-backed exits. accounted for 40% of the US$5.9b in capital raised. Software deals dominated in the sector, with 56 transactions raising close Global VC-backed M&A declining despite recovery in some to US$4b. markets The median time for exit in Europe fell sharply to 4.8 years, with VC-backed M&A activity continued its decline from the 2010 faster M&A suggesting that the new generation of post-bubble post-financial crisis peak of 856 deals to 722 deals in 2012, companies is coming to the market. decreasing by more than 15%. Activity in the US and Europe, which comprises over 90% of VC-backed M&A deals, fell by about M&A activity is expected to accelerate in the coming quarters to 20% between 2010 (752) and 2012 (597), returning to the level catch up with the recent solid trend in VC-backed IPOs. of 2009 (591). So far, 2013 seems to be without any significant changes (403 deals, YTD), offsetting an increase in M&A in India.
Russian and global venture markets in 2007–13 | 19 Global venture-backed M&A deals 2007–13 YTD Median time to liquidity via IPO and M&A (number of deals and amount invested, US$b) Europe 100.0 10 9.2 909 894 8.3 834 7.8 762 8 80.0 722 698 6.4 6.2
6 6.6 6.7 5.8 6.0 6.1 60.0 5.6 5.5 years 4 3.8 479 40.0 69.1 65.4 2
Amount raised (US$b) 56.3 54.8 0 42.8 20.0 38.2 0 34.2 2007 2008 2009 2010 2011 2012 1H2013
IPO M&A 0 Source: Dow Jones VentureSource 2007 2008 2009 2010 2011 2012 9M2013
Amount raised during the year (US$b) Number of M&As during the year China Source: Dow Jones VentureSource 6 4.5 3.8 4.0 3.7 3.8 3.4 3.5 4
years 3.0 Median years from initial VC financing to IPO and M&A exit 2 2.6 2.3 2.5 2.4 1.9 falling NS 0 In 2012, the lack of momentum in the IPO market was reflected in 2007 2008 2009 2010 2011 2012 1H2013 the median time it took to go from initial financing through to IPO. IPO M&A In the US, it takes longer, on average, for companies to go from Source: Dow Jones VentureSource initial VC investment to IPO than it does for them to get to M&A. This means that companies reaching an IPO in the US are typically more mature and can command a higher valuation than those United States exiting via M&A. 10 8.7 8.7 It is interesting to consider whether changes should be made to 7.9 8.0 7.3 8 the existing typical VC fund life term of 10 years, given that the 6.8 6.4 time to IPO is now around seven years. A longer fund term may 6 6.5 encourage greater levels of early-stage investment. 5.8 5.5 years 5.3 5.3 4 5.2 The median years from initial financing to exit in 2013 across 4.4
China and European regions reflect the lack of momentum in 2 the capital markets, leaving minor changes in the median year period of M&A since 2008. At the same time, its downward trend 0 2007 2008 2009 2010 2011 2012 1H2013 continued in the US since 2007, with a sharp decline in 2013. IPO M&A Source: Dow Jones VentureSource
However, shortening the time to exit will help VC funds to return capital to their investors, show a track record of success and thereby start the process of opening, raising and closing a new fund. It has also helped liquidate the older companies in their portfolios, allowing them to focus on companies that have a better option of exiting, either via IPO or M&A, and repatriating those investment returns back to the fund.
20 | Russian and global venture markets in 2007–13 United States Tradition with some new spirits Start-up VC funding declined from 262 rounds in 2011 to 224 in 2012. There has also been a decline in product development United States VC investment 2007–13 YTD funding rounds over the last four years. The three-year increase in funding for companies at the revenue generating stage has been 40 4,000 3,577 3,601 slightly declining in 2013. Traditionally, companies at the revenue 3,129 35 3,154 3,500 3,076 8.3 stage continued to dominate US VC activity. However, another 30 8.8 6.7 3,000 7.8 2,462 2,781 trend for the US for 2013 YTD is new investments in early-stage 25 9.7 2,500 9.0 10.4 8.6 7.5 7.8 companies. This suggests investors are taking some “bigger bets” 20 8.1 2,000 6.2 in some of these firms. 15 6.0 1,500 8.9 8.4 9.2 9.0
936 7.9 Number of rounds 10 739 723 6.3 677 8.0 740 893 1,000 Amount invested (US$b) 806 3Q13 US VC Investment by Stage of Development 5 8.0 9.1 7.9 7.5 500 4.7 5.3 7.1 0 0
2007 2008 2009 2010 2011 2012 9M2013 1% 16% 78% 5%
Amount invested during Q1 (US$b) Amount invested during Q2 (US$b) Amount invested during Q3 (US$b) Amount invested during Q4 (US$b) Start-up Product development Revenue generation Profitable Number of rounds during the year Number of rounds during Q3 Source: Dow Jones VentureSource Source: Dow Jones VentureSource
Start-up funding size squeezed Activity declines, Silicon Valley still dominant Median round sizes fell in the product development stage from US$5m in 2011 to US$3m in 2012, and to US$2.7m in 2013 The US and Europe continue to receive the largest amount of YTD, reflecting VC funds’ efforts to more carefully use the lower VC investment, with 88% of the total dollars invested and 87% of amount of the capital being invested in this stage. Lower round the total number of rounds during the beginning of 2013. US VC sizes also partly reflect lower capital requirements, particularly investment activity declined by 15% to US$29.7b in 2012 against in the early stage, as companies increase their proportion of 2011. The number of investment rounds also fell, but the drop variables relative to fixed costs, for example, through software was not as pronounced, declining by 4% to 3,363. This tendency as a service (SaaS) and more flexible real estate and staffing of a slight decline remained in 2013 as well. On a cumulative options. basis, the US VC-backed industry remains very substantial. As of January 2013, US$167.9b was invested in 8,288 companies US VC exit landscape through IPOs and M&As and is still heavily weighted toward Silicon Valley. Since 2000, Companies exiting via IPO are typically more advanced than cumulative equity raised in the Silicon Valley of US$62.2b exceeds those exiting via M&A. The median amount raised prior to IPO the total raised in all other US VC hotbeds combined. of US$100.92m and the exit time of 6.96 years far exceeds the For the period 2007–13 YTD, the IT sector was the most respective figures of US$10.91m and 4.88 years for M&A. There attractive for VC investors. was a slight increase in these numbers in 3Q 2013.
Longer-term trends 3Q13 US VC Investment by Sector (amount invested, US$m) Consolidation is continuing in the VC industry. LP investors are showing a preference for the most successful “brand name” IT 2,292 funds, which suggests that this trend will continue. US VC Industrial goods and materials 147 investment is expected to continue to become more international, Health care 1,840 with the growing realization that the US does not have a Energy and utilities 189 monopoly on innovative ideas. US firms are showing an interest in Consumer services 1,347 investing in rapid-growth markets, often preferring Israel and the Consumer goods 137 Business and financial services 2,163 relative proximity of South America to Asia.
Source: Dow Jones VentureSource
Russian and global venture markets in 2007–13 | 21 Europe Within the overall total, the focus on later-stage investment remained. The revenue generation stage of investment dollars declined slightly compared with 2012. In Europe in 3Q 2013, the Europe VC investment 2007–13 YTD median deal size of profitable companies was higher than that for companies at the revenue generation stage. Across all stages, 9 2,000 investors still demand to see evidence of the concept or business 8 1,755 1,800 1,398 1,600 revenue generation stage in terms of turnover and clients before 7 1.8, 1,473 2.1 1,300 6 1,282 1.8 1,400 committing an investment. 2.5 1,270 1.5 1,200 5 2.0 995 1.7 2.1 1.7 1,000 The average round size for Europe remained small in 2013, 4 1.4 1.5 1.4 800 suggesting that VC investors will continue to be cautious about 3 1.8 2.1 1.3 1.8 600 1.6 1.9 2.2 Number of rounds making larger investments in the region. Since 2008, the average 2 368 352 284 400 Amount invested (US$b) 1.1 292 298 298 319 1 2.2 1.9 200 round size remained in the range of US$4.7m to US$5.4m across 1.6 1.1 1.5 1.4 1.4 0 0 the three key hotbeds — the UK, France and Germany. 2007 2008 2009 2010 2011 2012 9M2013 In Europe, business and financial services were in the lead by Amount invested during Q1 (US$b) Amount invested during Q2 (US$b) Amount invested during Q3 (US$b) Amount invested during Q4 (US$b) their share of proceeds in the quarter. A total of 81 deals in the Number of rounds during the year Number of rounds during Q3 sector raised US$388m in 3Q 2013. Out of the total number of
Source: Dow Jones VentureSource investments, 70% were made in the business support services subsegment. Consumer services continued to dominate deal volumes in Europe, with the consumer information services Shift toward later-stage investment subsegment being the most popular. In 3Q 2013, the segment European VC investments declined in 2012, but in 2013, they accounted for 20% of the total deals in the sector in Europe. showed signs of recovery. In 3Q 2013, VC activity in Europe Regulation and economic uncertainty squeezing VC increased by 4% in terms of the proceeds raised and 7% in terms of rounds when compared with the corresponding quarter of last The principal reason for the decline in activity in 2012 was year. The increase, although marginal, suggests that the recent the ongoing economic uncertainty produced by the Eurozone declining trend is stabilizing. However, the VC fund-raising activity sovereign debt crisis and its negative impact on investor in Europe continues its downward trajectory in 2013, with the sentiment. The continuing trend toward tighter regulation of the total funds closed down from 101 in 2007 to 37 in 2012 and European financial services industry through legislation, such just 20 YTD in 2013. Importantly, the 2013 YTD results show as Solvency II and Basel III, has contributed to the decline, as fund sizes are steadying, which suggests that activity could be tougher regulation and higher capital requirements have reduced stabilizing as well. appetite, or ability, to invest in the VC funds. In specific instances, changes in tax regulations have also played a part. In France, for instance, a reduction in the tax advantages that individuals enjoy European VC funds 2007–13 YTD from investing in VC vehicles has weighed on investor inflows and, (amount closed — US$ billion) ultimately, on investment in portfolio companies.
VC-backed IPOs hold steady 3.9 3.9 The number of VC-backed IPOs in Europe declined (Q3 2013 — 0.2 0.7 only five IPOs). In 2010–12, the number of IPOs in Europe was 2.3 0.6 1.2 relatively stable (18, 15 and 16), the capital raised continued its 5.2 5.0 0.1 2.4 0.2 0.3 1.3 sharp descent, reaching US$143m in 3Q 2013 within the total, 2.7 2.4 0.2 Amount invested (US$b) 1.3 1.4 1.1 and the vast majority of IPOs were in the health care sector. For 2007 2008 2009 2010 2011 2012 9M2013 technology companies, we anticipate companies will increasingly
Early-stage Late-stage Multistage look to the developed VC ecosystem in the US and a possible US
Source: Dow Jones VentureSource listing — a trend that will be facilitated by the reduced compliance burdens on SMEs introduced in the US JOBS Act. Median pre- money valuation in Europe has been relatively low since 2007. The UK maintained the largest number of active VC firms over The energy and utilities sector in Europe has had a relatively the last six years across Europe’s hotbeds, primarily driven by higher median pre-money valuation historically compared with investments in the IT sector. other sectors because of investments in the renewable energy companies.
22 | Russian and global venture markets in 2007–13 US investors to fill the gap in Europe The US investment in European-based businesses is expected to increase, particularly for companies requiring more than US$10m in capital, which the European VC market struggles to provide.
Corporate and family venturing set to rise Increased US investment is one of the ways we expect the gap left by the lower number of European institutional investors in the VC market to be filled. Two other types of investor are also likely to help fill the gap. First, with less competition from bancassurers, family offices are expected to look at opportunities in the VC market. Second, corporates, which need to drive growth through innovation, but face a reduced pipeline of VC-backed candidates, are expected to increase their direct participation through corporate venturing. European growth will remain very subdued, with the trend toward tighter regulation firmly in place. The latter is contracting VC investment activity in the region and, despite the slight recovery in 2013, this trend of cautious investment will remain.
Russian and global venture markets in 2007–13 | 23 Israel 3Q2013 VC Investment by Sector (by amount invested, US$m)
IT 104 Israel VC investment 2007–13 YTD Industrial goods and materials 65 Health care 50 2.5 350 Energy and utilities 0 281 286 300 Consumer services 33 2.0 0.3 250 Consumer goods 0 0.5 0.5 0.5 1.5 0.6 177 200 Business and financial services 56 0.2 165 0.5 0.6 160 0.4 0.3 150 Source: Dow Jones VentureSource 1.0 0.3 140 0.2 0.9 111 100 0.5 69 0.3 Number of rounds 0.5 58 0.3 0.6 0.6
Amount invested (US$b) 48 41 33 39 0.2 0.2 37 50 0.4 By the number of rounds, the IT sector continued to lead in Israel 0.8 0.2 0.2 0.3 0.2 0.3 0 0 in 3Q 2013 and attracted a major share of VC investment (34%). 2007 2008 2009 2010 2011 2012 9M2013 In terms of the amount raised, industrial goods and materials, Amount invested during Q1 (US$b) Amount invested during Q2 (US$b) business and financial services, and health care held the major Amount invested during Q3 (US$b) Amount invested during Q4 (US$b) Number of rounds during the year Number of rounds during Q3 shares. Source: Dow Jones VentureSource Across markets, companies at the revenue generation stage continued to dominate VC activity by the number of rounds and by the amounts invested. In 3Q 2013, VC activity at the product Innovation continues to drive VC activity development stage showed improvement (increasing from 30% to In Israel, deal activity in 3Q 2013 remained similar to that seen 32% of the investment rounds compared with 3Q12). in 3Q12. The number of rounds declined from 39 to 37 in 3Q 2013, and the amount invested increased by a mere 3% compared 3Q2013 VC Investment by round class (US$m) with the corresponding quarter in the previous year. The amount invested so far in 2013 YTD exceeds the overall total invested in 8.1 2012, which is a clear sign of stabilization and improvement. Seed First round. Start-up 6 3Q2013 VC Investment by Sector (by number of deals) Second round Later stage 3.3 IT 16 Industrial goods and materials 1 Health care 7 NS Energy and utilities 0 Consumer services 5 Source: Dow Jones VentureSource Consumer goods 0 Business and financial services 8
Source: Dow Jones VentureSource 3Q2013 median deal size by stage of development (US$m)
8.1 Start-up Product development Revenue generation
Profitable 3
NS 0
Source: Dow Jones VentureSource
24 | Russian and global venture markets in 2007–13 Israeli VC firms have shown their continued ability to raise follow- Strong showing in M&A exits on funds, and market fundamentals remain solid because of the Acquisitions remain the most viable exit option for Israeli continued determination of Israeli companies to innovate. This companies and their investors, who remain attracted to the innovation has been bolstered by the implementation of the innovative nature of many Israeli businesses. Although median Government’s Comparative Advantage Program for technology valuations dipped, 2012 saw VC-backed M&A exits similar to the companies, which is already showing signs of success. levels of recent years.
Foreign investment on the rise In 2012, there were no IPOs, and M&A remained on a par with the The current vintage of Israeli VC funds has not yet raised the past two years. same amounts as previous ones, such as those operating in the Cybersecurity: the sector to watch period from 2005 to 2008. As a result, there were not enough Additionally, 2012–13 saw significant VC interest in cybersecurity, funds available in 2012 to support both the existing portfolio which is shaping to be a renewed Israeli trend. In line with global and new investments to the levels seen in the run-up to 2009. trends, there was increased investment last year in big data However, the decline in overall VC investment has been, to some analytics, cloud and SaaS companies, as well as health care. degree, offset by the continuing upward trend of foreign VC For historical and geographical reasons, Israel has always been funds investing in Israeli companies. In 2013 YTD, both local and a leader in developing defense technologies. This sector can be foreign investments have been increasing, but are still far from expected to receive continued investment, along with a rise in VC the record levels of 2008. The Israeli VC sector is more reliant interest in smart mobility and health care, as part of a long-term on foreign investors than local investors, so any new government trend focusing on technology (cybersecurity in particular). plans should specifically relate to foreign investors. When foreign investors increase their allocation to Israeli VC Funds, Israeli To survive, innovation must power transformation2 institutions will likely follow. As many organizations have learned, sometimes the hard way, Those foreign VC funds investing in Israel used to be cyber attacks are no longer a matter of if, but when. Hackers predominantly mainly from the US, but in 2012–13, funds from are increasingly relentless and often politically motivated. At the other countries were also active in Israel. same time, technology is increasing an organization’s vulnerability to attack through increased online presence, broader use of social Israeli best practices — start-up program for early-stage media, mass adoption of mobile devices, increased usage of cloud companies to fill the gap left by VC for early investments services, and the collection and analysis of big data. The Office of the Chief Scientist (OCS) in the Ministry of Economy Over the last year, many organizations have made improvements is charged with executing government policy for support of to their current information security programs to better protect industrial R&D. The goal of the OCS is to assist in the development themselves from known cyber risks. Budget allocations toward of technology in Israel as a means of fostering economic growth, security innovation are inching their way up, enabling VC firms, encouraging technological innovation and entrepreneurship, and governmental companies and organizations to channel more leveraging Israel’s scientific potential. Unfortunately, the budget resources and efforts toward innovation solutions that can protect of the OCS has been reduced by over 40% in the past decade. OCS them against the great unknown. programs have proven to be effective and have boosted hundreds of companies, and the decrease in the funds available has had direct repercussions on the Israeli start-up scene.
2 Global Information Security Survey 2013,EY, 2013.
Russian and global venture markets in 2007–13 | 25 China 4Q09. The software segment was the most active. By the amount invested, however, the consumer services sector continued to lead, although the sector’s share decreased from 64% in 3Q12 to China VC investment 2007–13 YTD 55% in 3Q 2013.
7 450 Economic and political factors having an impact on VC 393 393 372 400 6 360 To some extent, the drop in VC activity reflects a broader 310 1.5 350 5 1.6 slowdown in the Chinese economy, which has seen a drop in 0.7 1.6 300 1.5 domestic consumption and a drop in GDP growth rates. 4 0.9 239 250 1.4 1.2 200 External factors, such as the US fiscal cliff and ongoing 3 1.1 1.7 0.9 175 1.3 1.7 0.9 150 uncertainty in the Eurozone, contributed to a decrease in global 2 109 100 93 1.4 84 0.7 76 0.8 100 Number of rounds demand, and this weighed heavily on China’s manufacturing 53 77 Amount invested (US$b) 1 0.8 2.4 1.7 1.2 0.7 0.5 50 activity, as evidenced by the declining numbers of the country’s 0.5 0.5 1.1 0.5 0 0 monthly HSBC purchasing managers’ index (PMI) in 2012. 2007 2008 2009 2010 2011 2012 9M2013 However, market sentiment is improving: the index rose in early Amount invested during Q1 (US$b) Amount invested during Q2 (US$b) 2013, pointing to a promising outlook for VC investments in the Amount invested during Q3 (US$b) Amount invested during Q4 (US$b) Number of rounds during the year Number of rounds during Q3 remaining year. Source: Dow Jones VentureSource With 2012 as the last year of the previous Chinese administration, investors were in a wait-and-see mode as they awaited the announcement of the next five-year plan, which would show the VC activity slows from record high industry sectors that will benefit from government policy. For the second consecutive year, VC activity dropped from the record levels of 2011. In 2012, US$3.7b was invested in 202 IPOs set to rebound rounds, a year-on-year decrease of around 40% for both figures. Since 2010, in spite of the dropping number of VC-backed IPOs Despite this, the median deal value of US$10m was significantly in the country, China has been the global leader in terms of the higher than that in other parts of the world thanks to substantial amount raised and the number of exits, with investors attracted investments in profitable companies. by the rapid time to exit and the high returns on offer. In China (mainland), the revenue generation and profitable In 2012, however, China experienced more than a 50% decline stages have historically been the two most popular stages of VC from 2011 in the number of IPOs and a drop of over 70% in the investment. In 1Q13, there was only one round of investment amount of capital raised, pushing the country into second place in the profitable stage, compared with three in the product behind the US. This was due to China’s IPO processes coming to a development stage. The start-up stage did not see any investment halt in the second half of 2012. in China in the first quarter of 2013. In 3Q 2013, revenue Under the current rules for public share sales, the China generation accounted for 91% of the total amount raised in China. Securities Regulatory Commission’s listing committee must examine each application and determine whether the company China VC investment by stage of development 2007–2013 YTD is suitable for listing. The committee has not authorized an IPO (amount invested US$m) since October 2012, in an effort to reduce the pressure on China’s stock markets caused by the drainage of funds to the IPOs. 1% 12% 56% 31% Despite all this, in 2012, China still had two of the top 10 largest IPOs by funds raised. Start-up Product development Revenue generation Profitable Consumer industries continue to attract VC Source: Dow Jones VentureSource Unlike in most of the other geographies, consumer services remains the most prominent VC sector in China and is set to remain so, followed by the IT sector. E-commerce is one subsector M&A continues to be the preferred exit for VCs globally, but not that continues to struggle, with many businesses still in the in China, where IPOs are favored. Following the 2008 recession, consolidation phase and yet to make a profit. Other industries China’s IPOs surpassed all other countries in 2010 and 2011, that are attracting the interest of VCs include education-related both in the deal volume and value. However, 2012 witnessed a companies and health care. steep decline in the number of VC-backed IPOs and the amount raised. By the number of rounds, the IT sector took the top spot in China for the first time, after holding second position since
26 | Russian and global venture markets in 2007–13 India schools. VC firms and private equity players have demonstrated their faith in the growth of e-commerce in the country. This is amply substantiated by the significant increase in the total India VC investment 2007–13 YTD investments (US$305m in 2011 against US$55m in 2010).
2.0 250 The e-commerce market in India has enjoyed phenomenal 224 growth — almost 50% in the last five years. Although the trend of 0.2 200 1.5 181 e-commerce projects raising funds in India has been around for 0.4 0.3 0.4 160 15 years, the appropriate ecosystem has started to fall in place 0.4 150 just now. The level of online transactions has been increasing, and 1.0 119 116 0.5 0.5 100 96 0.2 0.3 100 is expected to reach US$35m in 2015, up from US$11m in 2011. 0.9 0.4 0.6 0.2 0.3 66 0.5 0.3 0.4 56 Online travel has traditionally been the largest e-commerce 0.3 0.2 28 63 50 Number of rounds 39 0.2 Amount invested (US$b) 0.1 20 0.5 subsector (by revenue) in India. Nevertheless, online retail is 0.3 0.3 0.4 11 0.2 0.2 0.2 0 0 catching up fast and is expected to match online travel revenues 2007 2008 2009 2010 2011 2012 9M2013 in 2015.
Amount invested during Q1 (US$b) Amount invested during Q2 (US$b) Amount invested during Q3 (US$b) Amount invested during Q4 (US$b) Later-stage investment dominates Number of rounds during the year Number of rounds during Q3 Since 2011, the Indian VC industry has been heavily weighted Source: Dow Jones VentureSource toward later-stage investment. Fifty-six percent of the capital raised in 2013 was invested in later-stage deals. The reason for the predominance of later-stage investment is that, compared with Silicon Valley, Indian companies are focused less on innovation and more on application development and efficient Investment rounds increase in India delivery models, which means they take less time to develop into The total capital invested through 3Q 2013 almost reached the the revenue generating stage. levels of investment seen in 2011 and 2012. India saw a large number of VC rounds in the consumer services sector, followed Number of deals in India by round type (number of rounds) by the business and financial services and consumer services sectors. The levels of reported VC investment also probably 100 84 understate the true level of activity, because of the unreported 80 66 57 deals not captured in the data. 60 45 40 30 22 Economic development is supporting VC industry growth 10 20 9 6 9 The growing wealth of the Indian economy and the accompanying 0 increase in consumerization are underpinning the growth of 2007 2008 2009 2010 2011 2012 1H13 the VC industry. The two predominant themes from a demand Seed round First round Second round Later perspective are: Source: Dow Jones VentureSource • Companies addressing changing consumer behavior patterns — the largest proportion of the total pool of VC-backed companies is in consumer services • The introduction of new technology, particularly internet-based applications, such as cloud and mobile From a supply perspective, rising economic prosperity has increased the pool of entrepreneurs willing to take a risk in VC investment. Some of these high-net-worth individuals have already made money as successful entrepreneurs prior to becoming VC or angel investors. The entrepreneurial environment in India is becoming more developed as the availability of higher education has spread to third- and fourth-tier cities, with a corresponding increase in the number of engineering and medical
Russian and global venture markets in 2007–13 | 27 More deals, but smaller in size The median round size decreased in 3Q 2013, almost equaling that of 2012. Conclusion It is worth recalling that over 50% of Number of deals from 2005–1H13 today’s Fortune 500 companies were Intel Capital 30 created during an economic downturn, Qualcomm Ventures 14
eBay 5 so it is not surprising that competition SAP Ventures 4 for high-quality deals remains fierce, with Info Edge (India) Ltd. 3 VCs competing against each other and Cisco Systems 3
Capital18 3 against alternative sources of capital. BlueCross BlueShield Ventures 2 The challenge for VCs is to prove their Naspers 2
Applied Ventures LLC 2 worth as accretive and value-added
Source: Dow Jones VentureSource investors offering good terms and post- investment support. As funds continue to build this capability, the cost of investment rises, which VC funds hope will be offset M&A is a more popular exit than IPO Strategic buyers are a more likely exit route for Indian VC-backed by attractive returns. Establishing companies than IPOs. The very low level of IPO exits (two in both a robust VC value proposition for investee 2011 and 2012) reflects the absence of a junior stock market, such as London’s Alternative Investment Market (AIM). The most companies is a must-do strategy. common exit routes are through fresh investment by new VC funds and strategic M&A, with a bias toward the latter because Looking forward, 2014 is expected to be strategic deals tend to command higher valuations. a better year for VC. Steadying economic The growth of India’s investor community and the resulting conditions will bolster investor confidence increase in the amount of capital being invested in purely domestic opportunities provides India’s VC industry with a degree and generate increased risk appetite. of insulation from global shocks, and the outlook for the coming year is therefore relatively positive.
28 | Russian and global venture markets in 2007–13 Government incentives and VC funds: best practices
The global VC industry is undergoing a period of significant VC in Singapore transition in which the number of industry players is shrinking because of poor returns in the post-dot-com bubble period and When Singapore’s high-tech industry was first developing, the resulting increased selectivity of LPs. Actually, this transition multinational corporations (MNCs) provided the investment that has been slowly underway for a decade, but the arrival of the drove the sector. Venture financing for this sector is, in fact, global downturn, coinciding with the end of the 10-year term relatively weak in Singapore, despite the Government’s efforts to of VC funds raised in 2000, has accelerated the process. The strengthen it. In the 1990s, VC funds began to grow in Singapore, consequences of this trend can be clearly seen in the downsizing both in numbers and in value. Many of these funds were co- of the US VC industry. founded by the Government, either through holding companies or direct investment. This transition is creating a VC environment with fewer players and generally smaller VC funds (though leading global firms Toward the end of the 1990s, the Technopreneurship Investment will still be able to raise and leverage large ones). It is also Fund (TIF) was established with US$1b. The aim was to establish encouraging the development of capital-efficient business models Singapore as a regional hub for VC, capable of attracting foreign with a short path to profitability, which has led some to liken funds to establish themselves there. The initiative, though, was the current investing environment to that of the early 1990s. regarded as only a moderate success. These models will probably benefit such sectors as social media, Angel investment is also a fairly weak component in the consumer services and SaaS, where scale can be achieved innovation ecosystem in Singapore. To address this, the Start-up quickly and inexpensively. In sectors such as renewable energy Enterprise Development Scheme (SEEDS) was introduced in 2001 and life sciences, where the time lines are longer and the capital as a co-investment program to strengthen this component. Similar requirements are high, it will be important for specialist firms, co-investment programs include Business Angel Funds (BAF) those with an in-depth knowledge of the risks and opportunities, and the Business Angel Network (BANSEA), which advises the to continue to make investments. And, in these sectors, corporate Government on how to structure programs such as these. venturing and partnerships, as well as strong government support, will undoubtedly also play an important role. One of the Today, many VC funds have regional headquarters in Singapore, elements that has changed as a result of the above-mentioned which they use to manage deals in the region. However, most of industry shift and other macroeconomic parameters is the VC the funds managed in Singapore do not invest there, but rather funds’ approach toward government funding. More than ever in other regional countries, meaning that it has done little to before, investors are seeking complementary funding resources strengthen the R&D economy in Singapore. to mitigate their risk. Funds have become more aware of government incentives and, as a result, portfolio companies are more active today in using such tools. If, in the past, different Main considerations for government government regulations and restrictions related to receipt of support government financing were considered unacceptable, today, the funds are evaluating the effect of the regulations on their model. As mentioned above, the VC approach toward government support has changed. Having said that, where government Another evolving initiative is the Government’s cooperation support comes with conditions detrimental to VC funds, investors with VCs. The lack of private money for innovation has forced have made sure that their portfolio companies have not accepted governments to look for solutions to assist private funds to raise the help. money. Different models have been developed, for example: A good example of that was the Israeli R&D law. Until 2005, a) Direct government investment in funds that are operated by a the law forced companies that received funds from the Office private general partner of the Chief Scientist to keep the IP developed in Israel without b) Government security for the fund’s losses up to a predefined the option to move it abroad. This obstacle, in some cases, percentage of the fund’s assets prevented investors from selling their companies to foreign parties that wanted to use the IP abroad. Because of this, most c) Direct government investment in companies together with VC funds would not allow their portfolio companies to access this private investors, giving the investor, in the future, an option to government support. Eventually, the Government altered the buy the Government’s shares in the company as well as paying law and enabled IP transfer abroad with a predefined payment the historical price mechanism. d) Tax incentives for foreign investors in local VC funds The lesson learned from this process is that, in the technology sector, governments should be aware of the industry players’ needs and should shape the support mechanisms in a way that supports companies, but also takes into consideration the businesses’ needs.
Russian and global venture markets in 2007–13 | 29 Israel — the Yozma Program While the Inbal Program had far greater bureaucratic and reporting requirements, it would seem from these contrasting In an effort to encourage the creation and development of the examples that positive incentives can be more effective than VC industry, the OCS created Yozma in 1993. Yozma was a fund negative (insurance against loss) incentives. of funds that established 10 dropdown funds in three years, each capitalized at US$20m. Competition between the 10 funds prevented a monopoly from being formed in the new sector. The 10 main criteria for successful The program succeeded by offering 40% of the funding to VCs programs that were willing to establish branches for investing in Israel. The money was drawn from a US$120m government pot and Many case studies show that there are common factors within was capped at US$8m per fund. The VC funds were managed successful programs, initiatives and incentives. They are: privately, with the option to buy the Government’s shares at cost 1. Addressing the industry’s needs plus 7% annual interest when privatized within seven years. Each VC fund was required to include an experienced foreign partner 2. Sufficient number of potential beneficiaries and a local financial institution. The state was a passive investor in 3. Pre-defined program goals order to allow for market-oriented decisions to be made; this also cut down bureaucracy, allowing the funds to be managed more 4. Coherent and clear evaluation process smoothly. 5. Manageable and balanced bureaucracy By 1998, all the funds had been privatized. Private investors felt 6. Suitable rules and regulations more confident, knowing that the Government’s involvement would be limited to a short period of time and that a specific exit 7. Sufficient government budget date was already determined. 8. Continuing long-term visibility In an effort to attract foreign investment, the Yozma Program 9. Active market feedback mechanism required the involvement of experienced foreign partners in the funds. This meant that the Israeli market benefited not only from 10. Central government guidance and overview foreign investment, but also from foreign experience, know-how and training. The companies receiving investment also benefited from the international networks that foreign VCs brought with Governmental tools to support them. the VC ecosystem One of the factors that led to the success of Yozma was the Usually, VC plays a critical role in the commercialization phase of situation in the local high-tech sector. The availability of good deal early-stage companies, and matching governmental grants add to flow and strong market needs conformed to the new financial the chance of success. resources presented to the market by the Yozma-backed VCs. This brought success stories that helped to create the VC industry in The same issue arises in other stages of company development. Israel and form dozens of new VCs. Matching grants programs are likely to work when support for the latter stages of the innovation process is available. Companies The success of the Yozma Program is in sharp contrast to the will be able to work better with the commercialization of R&D failure of its complementary program, Inbal, which sought to activities, using the relevant support instruments available provide insurance against losses for VC funds to encourage their with governmental support. In countries with a developed establishment. VC industry, such as the US, Israel, Australia and Canada, there are governmental support programs at all stages of the
30 | Russian and global venture markets in 2007–13 innovation life cycle: from grants to VC support programs. For A number of markets, such as Israel, Taiwan, mainland China example, Australia has the R&D Start Program to provide grants and the US, have established successful models of government for the commercialization of innovations by SMEs, which is support of the VC industry. complemented by its Innovation Funds Program to encourage VC These activities led to the development of a private VC investment in innovative SMEs. industry, and the governments have played a significant role Due to limited VC financing in the middle-income countries, in the development of the local VC ecosystem. Actually, the such large multinational corporate investors as General Electric, governments have provided “seed money” to establish the VC Siemens and IBM are suited even more than VC investors to industry by investing in privately managed funds. Governments provide access to financing innovation. MNCs usually co-invest to share some of the risk of investing in technology-oriented SME form public-private funds locally, particularly to finance projects in start-ups, and the VCs provide commercial and managerial the vertical sectors of the economy in which MNCs are interested expertise. This approach gives funds the option to graduate from in developing new technological companies or start-ups to government support to avoid restrictions placed on them from the strengthen the supply chain. The corporate VC (CVC) industry is beginning. There are a number of tools to form that: a significant player in the VC ecosystem and plays a critical role in • Direct co-financing. Government lends credibility to the the development of the local and global economies of innovation. privately managed fund and actually acts as the primer LP The success of the local and national VC industries depends on and catalyst for other potential LP investors (e.g., the Yozma the maturity of the VC fund teams. Based on statistics from the Program). It can work only for developed LP models and OECD, the success of the most prominent VC funds relies on three suitable legal forms of funds. aspects: • Leveraged returns. Government acts as a subscriber for • Investment expertise. VC fund managers should bring ordinary equity shares or for providing grants, acting as co- management and commercial expertise to ensure success and investor with other private investors, with only a small part exert influence over the company’s management decisions. of the return as a result of “leveraging” the upside potential VC investment analysts are highly specialized, with a good for private investors. For example, the Australian Innovation understanding of different technologies and their markets. Investment Fund (IIF) program provides up to two-thirds of the capital for the VC funds, but takes only 10% of the return. • Risk profile. It is important to manage risk as part of the The remaining 90% is allocated to private investors and the VC strategy in order to define the risk profile, depending management team. In exchange, fund managers are required on the fund’s business model: for example, managing a to invest a portion of their fund in SMEs and early-stage distributed portfolio with very high returns from the successful companies and start-ups. investments, which compensates for the expected failure of the rest of the investments (cross-subsidization). There are more or less similar programs in other countries, such as the US Small Business Investment Company program. Please • Deal flow. This is one of the most important criteria – a supply note that these programs are successful only in countries that of high-potential companies emerging from the earlier stages of offer opportunities to achieve high returns. business, technological or innovation start-ups. • Guarantees. In regulated and financially developed economies The US and Israel exemplify the financial model for early-stage with a risk evaluation approach, there are models of guarantees companies, including internal funding, angel investors, VCs and against losses. Such models have been used successfully to government-supported grant financing. promote investments in VC funds. Actually, a government Not all models can work; they depend on the maturity of the local significantly lowers the downside risk by guaranteeing a ecosystem. State-owned and state-managed VCs, in particular, certain return to investors. In some cases, the government should be carefully defined to meet local needs and the needs of protects investors against major losses of principal, taking a the business environment. Typically, government officials do not subordinated position in the distribution of the funds’ profits. have the desired VC and technical expertise or risk-taking mindset to support the innovation process at the commercialization stage. In addition, VC funds managed by government entities usually operate with commercial success and a minimum risk profile, and largely invest in small, more mature companies with less risky product lines. It should be noted that a business-oriented approach should be followed, and that the private sector’s participation is critical for success.
Russian and global venture markets in 2007–13 | 31 Tendencies in the role changes of the key venture market players in 2007–13
Roles and relationships between governments, venture funds Because of the lack of private money during the above-mentioned and investees in the VC industry have changed over the past five period, local governments became more important as a years. These changes were driven by a number of major issues: major player in supporting national innovation infrastructure, the situation within the venture industry after the VC bubble especially in sectors with heavy capital requirements and period and the unprecedented size of funds and investment longer development periods, such as life science and clean activities of VC and PE funds up to 2007; the ensuing crash and tech. In addition, the governments started to strengthen their the liquidity pressure suffered by the majority of LPs; and the collaboration with the VC market, assisting in raising private unexpectedly poor performance of many VC funds due to the money and creating new forms of operation to support the new global economic crisis and waves on the IPO markets from a near business environment. freeze in the global IPO market, especially on NASDAQ (2008– This period of significant transition to a VC market with fewer 09), with the highest peak in 2010 with US$26.2b. and smaller VC funds has had a serious impact on the level of In general, the period of economic crisis characterized by risk and funds available for start-up companies (investees), as has been lack of transparency is leading to massive involvement and control shown in this report. Because of the lack of available capital from of the financial sector by governments, directly or indirectly, private VC funds, this period is characterized by the influence of including the VC and PE industries. angel and super angel funds at the early stages, and CVC at the later stages, as well as the importance of government incentives One of the lessons learned from this period is that government and grants. For example, in order to support the VC ecosystem investment in national innovation and the VC ecosystem over and overcome the lack of seed money from VC in the market, the time is one of the key success factors for stabilizing the economy Israeli Government initiated, in 2011, the so-called “angel’s law,” and initiating a rapid recovery from the crisis and a return to which provides significant tax incentives for angels. sustainable growth. The level of this type of investment has become one of the major factors for measuring a country’s During this period, governments became far more important attractiveness for investors in the local VC industry. As a result, players in the VC market as potential LPs and as complementary the creation of knowledge-based capital has emerged as an investors (to mitigate risk), as well as a source of economic important driver of investment, innovation and growth in national incentives for funds and portfolio companies. economies, which was illustrated during the aforesaid period. As an LP in the funds and an active VC player, government- In addition, globalization trends and the influence of the BRIC related institutions and banks have an interest in financial return markets have led to new forms of venture industry operations, and, in addition, are motivated by the desire to encourage from global fund-raising and cross-border investment to exits on entrepreneurship, national economic development and the foreign stock exchanges or foreign acquisition, and to VC firms development of the VC ecosystem. opening offices overseas and helping their portfolio companies to CVCs, including those in traditional industries, are assuming access markets in new regions. far more significant roles in investment and the acquisition of innovative companies as part of the global strategy involving market penetration and as an internal corporate venturing process to support innovation internally. Historically, large MNCs have worked very closely with the government sector and have benefited from the government incentives supporting local innovation and the local VC ecosystem. During the said period, corporates aggregated a significant amount of cash. For example, US corporates alone are now sitting on over US$3t of cash reserves, over half of which is held overseas, according to market estimates. Over US$1t of this is held by technology companies who are looking to acquire VC-backed companies.
32 | Russian and global venture markets in 2007–13 Russian venture market
Russian and global venture markets in 2007–13 | 33 34 | Russian and global venture markets in 2007–13 Russian venture market executive summary
Market size Macroeconomic factors Russian technological innovation has come into full swing. Global trends affect the Russian market: The Russian venture market is growing in terms of: • Global monetary policies contribute to the increasing availability • Volume — from US$108m in 2007 to US$1,213m in 2012 of funds for Russian companies going global. • Number of venture funds • US markets have a significant pull over Russia due to their size and experience. • Number of incubators • Certain macroeconomic factors make the Russian venture • Number of angel investors and angel clubs market unique. • Number of start-ups • The Russian Government plays a significant role as the provider • Number of early stage deals of the infrastructure, creator of the ecosystem and the endorser of the venture market as a whole. In the venture market, the The record-breaking volume of deals in 2012 made the Russian key institute responsible for this is RVC. venture market the second largest in Europe and the fifth largest in the world. Investors are showing trust in the Russian venture The Government should continue its efforts to support technology market. innovation and the VC industry.
Market segments IT and the consumer market are the preferred market segments: • Venture industry growth is driven primarily by investments in IT and the consumer market. • Investment in the consumer market segment is being driven by the shift to online retail. • Private venture funds tend to invest in internet companies, while state-operated funds prefer science, materials and chemicals. In Russia, as well as in other countries, the IT and consumer market segments are easier to innovate in in than other segments and provide a shorter return on investments.
Market maturity The Russian venture market is in the early stages of its maturity: • There are relatively few exits: Russian corporations have not actively pursued M&A, and international exits are not common yet. • There is a large and growing number of small funds on the market. Consolidation is yet to begin. • The ecosystem and access to information on investors and centers of excellence are fragmented. The Russian market is risky yet exciting for VC investors.
Russian and global venture markets in 2007–13 | 35 History of the Russian venture market
It is common to connect the birth of the venture investment The first VC funds began to access the Russian market after market in Russia with the activities of the European Bank of 1997. Most of them were associated with participants in the Reconstruction and Development (EBRD). However, there had banking services market and major holding companies. The been earlier attempts to invest according to the classical venture economic crisis of 1998 pushed the young VC market back investment model in the USSR. Examples include the operations several years. More than half of the investment funds operating in of cooperatives and the “youth R&D centers,” ANT, RostInvest and the Russian market at that time did not survive the crisis. some other organizations in 1988-93. Unification of the functions The 1998 financial crisis hit the EBRD investment funds just of a fund and those of a management company into one entity as hard. Because of management changes, restructuring and was a characteristic feature of such cooperatives. liquidations, most of them did not survive. Only three made it to The market began to develop more systematically in 1993. the next century: Quadriga Capital, Eagle and Norum. Privatization of industrial enterprises promoted the emergence of At the end of 1999, the Government Commission on R&D and an equity investment market, and foreign investors could access Innovation Policy approved the main directions of development of the Russian market when some trade and financial barriers were extra budgetary financing of high-risk projects, which set out the removed. Russian Government’s policy on R&D for the years 2000–05. This The EBRD was the most active investor at that time. Between strategy aimed at making the Government a key player as both a 1994 and 1996, the bank established 11 regional venture funds participant and an enabler in the VC market. in Russia, with capital ranging from US$10m to US$30m. The The establishment in 2000 of the Venture Investment Fund (VIF), EBRD investment program was targeted at supporting operational a non-profit organization funded by the Government, was one medium-sized enterprises with total employee numbers ranging of the first steps in the strategy. The VIF’s main objective was to from 200 to 5,000, but it did not invest in the high-tech sector. establish an organizational structure for the VC system that would The EBRD investment funds were particularly interested in both align with the Government’s strategy and would encourage the consumer goods sector, as their mandate prevented them investment in high-risk and R&D-intensive projects. from investing in the financial and insurance sectors. These investments were structured as VC deals because of the high risks In 2000, the RVCA initiated the annual Russian Venture associated with investing in the country. The financial results of Investment fairs, which became notable events for participants the one-off investments depended on the amount invested and in the Russian VC market. The fairs provide an opportunity for were hard to project. companies seeking investment for business development to present their projects to investors and to establish professional Around that time, participants in the new VC market were joined contacts with VC experts, businessmen and representatives of by the International Finance Corporation (IFC), which is a member government agencies. of the World Bank Group and focuses on investment in the private sector of developing countries. The US-Russia Investment The results of the joint efforts of market participants and the Program was initiated, and the US-Russia Investment Fund, with Government were already apparent by 2001: the Russian VC US$440m of capital, was established under the auspices of this market began to grow again. This growth occurred during the program. According to the estimate made by The Financial Times, economic recovery after the crisis and during the dot-com boom, by the end of 1997, there were 26 investment funds operating which hit Russia somewhat later. Yandex, Rambler and Ozon in Russia and they had a combined total capital of approximately received the first investments and became the leaders of the US$1.5b. Russian internet industry for many years to come. The main trend in the Russian VC market had already become clear: IT and In March 1997, the management companies of 10 out of the 11 consumer products were the sectors receiving the most financing. EBRD investment funds operating in Russia at that time signed an agreement establishing the Russian Venture Capital Association (RVCA). The RVCA became the first professional association of Russian investment funds to declare the objective of establishing and developing an equity and venture investment market in Russia.
36 | Russian and global venture markets in 2007–13 At the same time, the total equity and venture investment taken as a share of the total economy remained minimal. Nevertheless, Russian business still does not generate much demand for R&D. the market participants’ strategy progressed toward the classic › But on the whole, the domestic and foreign nanotechnology markets are growing day by day. In 2012, the domestic market venture investment model, and 2001 was marked with the first was 11% over 2011, amounting to about RUB 230b. Although investment fund exit by a portfolio company. The sale of the this is not a bad result, there is potential for much more. What investment by a regional EBRD investment fund yielded the should be done? First, there should be less state presence in investor a 100% return on invested capital. the economy. State corporations and companies with state In 2005, Russia’s Ministry of Economic Development (MOED) participation make up a very large portion of GDP. And a market controlled by state business is always less competitive. Second, realized the program for the establishment of regional investment we need to improve the system of technical standards and funds support VC in small R&D companies. Within the program regulations. These two measures could increase the demand over 20 public-private VC funds in different regions have been for nanotechnology in Russia. Among the positive signs in established. the last few years, I would point to the large companies’; even OJSC Russian Venture Company (RVC) was established by a budget organizations’ turn to nano products. These products are nothing if not innovative, and demand for them says a lot government directive in 2006, and the investment funds of the about an increasing interest in R&D as a whole. We collaborate MOED were placed under its control. with the largest state corporations from various industries: Russian railways, Gazprom, Transneft, Avtodor, Russian Post, Avtovaz, federal state reserve and federal space agencies, and companies in the defense sector. Last year’s growth on the nanotechnology market had to do with this involvement of the Russian consumers. As for what I think should be done, the Government definitely needs to make the system of technical standards friendlier. The Government has to work to convince state corporations that they can make use of innovations and that the risks are taken care of. We also need innovation efficiency controls for procurement organizations, for management of state corporations and for companies with state participation. The Government should protect innovators, because global competition is very high. Now that Russia is a World Trade Organization (WTO) member, it is time to start introducing innovations, nanotechnology included, to prop up the economy’s traditional mainstays. WTO members widely use high-tech monitoring of products to protect home industries. Simply put, you can only put pork on the market if the meat has a government-approved electronic passport with its entire “biography.” For example, as a sanitation safeguard, every one of a slaughtered animal’s diseases and the drugs used to cure it must be recorded there. Introducing such requirements would stimulate Russian agriculture to explore high-tech solutions, including nanotechnology, and would protect our breeders from competition with foreign exports. Every industry that is traditionally strong in Russia could benefit from similar innovations protecting the home market.3 Alexander Morozov, Director, Program Promotion Department, Rusnano’s Fund for Infrastructure & Educational Programs
3 Hereinafter, expert views styled this way are quoted from the public analytical report on the implementation of the Strategy for Innovative Development of the Russian Federation for the period until the year 2020; Russia: Focus on Innovation, RVC, 2013.
Russian and global venture markets in 2007–13 | 37 Russian Government and the new economy
The Russian Government plays a significant role in developing the The Government’s efforts are also recognized by the World Bank’s innovation economy in Russia. At the early stages of the history of Doing Business rankings. Recent positive legislation changes have the Russian VC market, particularly in 2004–09, the Government moved Russia up 19 positions, ranking it 92nd out of the total of set up several innovation-oriented institutions (RVC, Rusnano 189 countries. and Skolkovo) that catalyzed and endorsed the interest in the Although Russia still remains very much a resource-based new economy, in innovations and in entrepreneurship in both the economy, the new economy is starting to take hold. The share of society and the business community. high-tech and innovation-driven enterprises grows at a higher rate At the same time, significant efforts to make the tax environment than the country’s GDP. A significant part of this growth can be friendlier for new businesses were made. A batch of incentives attributed to the institutions created by the Government. was introduced, such as the special tax status of Skolkovo The key institute responsible for venture market development is residents, VAT exemption for software licensing, reduced social RVC. The role of RVC in setting the market environment can be security rates for IT companies and others. illustrated by the following graph: These changes were acknowledged both by local business and foreign investors. Share of investments made by funds with RVC’s participation on the Russian venture market
3,600 160 143 3,200 140 121 To my mind, in the next few years, talking about Russia, it will 2,800 120 be the IT projects that will show the best growth. The support › 2,400 91 infrastructure for innovations is still not very far along, but IT 100 2,000 companies do not need much of it. As far as other industries are 80 1,600 concerned, the Government needs to focus on the fundamental 54 60 sciences and keep improving the educational system. For 1,200 business, it is necessary to decrease administrative barriers and 26 40
Amount invested (US$m) 800 to stimulate state interest for R&D. “Exercises” with various 14 20 programs, subsidies and grants are obviously useful, but not 400 6 too important. Unless administrative barriers go down and the 0 0 Government itself becomes an active consumer of innovations, 2007 2008 2009 2010 2011 2012 9M2013 setting an example for others on the domestic market, it is hard Total volume of RVC investments Total volume invested by other funds to expect private business to be interested in the innovative Number of RVC investments projects. Procurements could be an effective tool for innovation development. Another important tool is to make all government Source: RVCA, RVC, RusBase, EY funding instruments (both grants and investments) work through private-public partnerships. Government financing alone does not show high efficiency. For the same reason, the The percentage of investments made by funds with RVC support physical parts of the “infrastructure” — e.g., technoparks and in relation to the total investments made since 2007 has dropped incubators — should be in private hands. The Government can from 39% in 2010 to 13% in 2013 YTD. Although the annual only subsidize them for a limited time. volume of investments made by the RVC funds remained almost Konstantin Fokin, Head of the Moscow Center for the same throughout the period, the share of these funds in the Innovation Development annual volume of new investments on the market decreased from 58.9% to 8.5% in 2012. Thus, it can be concluded that the state development institutions have achieved their objectives. The majority of the investments on the market are now made by private Russian and foreign investors.
38 | Russian and global venture markets in 2007–13 EY believes that boosting entrepreneurship is EY G20 Entrepreneurship Barometer 2013: one of the most powerful things the Government coordinated support can do to support the economy. To compare the G20 country Ranking business environment in the top economies, EY Russia 1 issues the G20 Entrepreneurship Barometer, Mexico 2 which ranks each of the G20 countries by the Brazil 3 level of support it provides for entrepreneurs. Indonesia 4 It does so by looking at the five pillars that are India 5 vital to a robust entrepreneurial ecosystem: China 6 access to funding, entrepreneurship culture, Turkey 7 tax and regulation, education and training, and coordinated support. South Africa 8 Argentina 9 The Barometer captures the voice of the Germany 10 entrepreneurs, surveying more than 1,500 of France 11 them across the G20. The survey covers the Saudi Arabia 12 insights of entrepreneurs concerning the rate of EU 13 progress within each country’s entrepreneurial South Korea 14 environment, and identifies the key enablers Australia 15 and barriers that are faced by entrepreneurs. Canada 16 The Barometer also uses a range of quantitative United Kingdom 17 indicators to measure the level that each Japan 18 country’s ecosystem has attained. Italy 19 United States 20 The most recent Barometer ranked Russia number one in the G20 in terms of coordinated It is important to note that this support provided by the Government. Russia’s pillar is based only on survey responses about the extent impressive performance in improving the to which specific initiatives coordinated support it offers entrepreneurs and services have improved or deteriorated over the past is notable, and it highlights the strongly three years. In short, it reflects positive sentiment on these grounds. Business the current trend across these incubators, dedicated industrial parks and other countries, not the base level of support available. forms of support are all on the rise, and they have helped Russia secure the number-one position for this aspect of the ecosystem.
Russian and global venture markets in 2007–13 | 39 At the same time, the Government still accounts for most There are still a lot of barriers preventing innovative businesses investments made into the capital-heavy segments, such as from enjoying faster growth. The most significant ones relate science, materials and chemicals, and plays an important role to the quality of state infrastructure and the unavailability of there by supporting qualified specialists and the level of expertise. certain legal and financial instruments that are crucial for deal Private investors are not yet ready to invest in the sophisticated structuring. Market performance, however, shows that investors and innovative segments of the economy that do not guarantee believe in the Russian VC market and are ready to get involved, positive financial exits. By doing this, the Government executes its regardless of any difficulties. social functions and allows innovative companies to develop early stage products in such a way that they will be suitable for private Venture funds with RVC’s participation funding at the later stages of their development. Fund Total Number of Projected number of exits fund volume, investments US$m VTB Venture Fund 15 0 99.0 There is an obvious positive dynamic in infrastructure for R&D. › There is a good supply of new instruments to support small Maxwell Biotech 9 0 99.0 enterprises, and earlier conditions and incentives also remain. Bioprocess Capital 9 0 97.0 The Moscow Development Fund of Venture Capital Investment in Ventures Research and Technology for Supporting Small-scale Businesses Leader Innovations 10 0 97.0 has started a credit program for companies in the early stages of development. That is clearly the area where instruments Innovative Solutions 5 0 64.7 are needed the most. We have already approved around 17 RVC InfraFund 17 0 64.7 projects, and six of them have already received funding. My own experience confirms the idea of public-private partnerships RVC Seed Fund 56 3 64.1 is right. State bodies should follow private investors’ S-Group Ventures 8 0 58.2 expertise when distributing investments or grants. For the RVC BioFund 8 0 48.5 Moscow innovations ecosystem, I can mention the success of technoparks. The Strogino Technopark is an excellent example RVC IVFRT LP 4 0 38.8 of a park where companies are growing, attracting investments, RVC I LP 3 0 32.4 and starting regional and global expansion. The park’s residents Civil Technologies, Ltd. 0 0 32.3 include successful projects, such as Lingualeo, Your tutor and others. No doubt, the state is supporting infrastructure the New Technologies 2 0 19.8 right way. For some instruments, it is too early to say whether they will work. Innovations in the country can’t “spring up” in a year or two, or even five. The game rules of the innovations market should not change too often. To support R&D more effectively, we need coordination between the existing programs, The players in the Russian young innovation market still rather than inventing something else. › need more experience of modern business models focused Alexey Kostrov, Executive Director, Moscow Seed Fund on fast-growing companies. There isn’t enough experience in going to global markets as well. Practice is always the best teacher. However, it would be careless to rely on the trial-and- error method only, because it could slow down development of innovations in the long run. To stimulate this market, its players need to be “trained” — not just the businessmen, but also the investors. Without mentoring processes, we will have to wait several times as long for an economically noticeable change. Strategic planning, product image creation, business models usage within the global labor division — these are the competencies that Russia needs most from its innovative individuals. Albina Nikkonen, Executive Director, RVCA
40 | Russian and global venture markets in 2007–13 RVC is a government fund of funds and is one Initial objectives and mission of the key government tools for establishing a RVC’s main objectives include the promotion of a national innovation system. RVC plays an integral VC industry in Russia and a substantial increase part in the development of the venture market in financing available through venture funds. The in Russia. It is a kind of a coordinator of the company acts as a government fund of venture innovation development process and a discussion funds by means of which the Government platform for all members of the innovation creates incentives for venture investment and process: the Government (in its capacity as the provides financial support to the high-tech regulator of the modernization process in Russia sector in general. It also acts as a government and as the founder of RVC), R&D organizations development institution in the venture (including Skolkovo), venture funds, investors, investment sector of the Russian Federation. business angels, innovation start-ups and the relevant infrastructure providers. RVC’s mission is to ensure the development of an effective national innovation system that will RVC is widely recognized as the trigger that set be competitive in the international market. It off the Russian venture market. Since 2007, RVC aims to do this through the establishment of a has been facilitating the money supply within the self-developing venture industry — in cooperation public-private partnership projects. By November with other development institutions — by 2013, the number of public-private funds formed mobilizing private VC, developing innovative with the aid of the RVC has reached 13 (including entrepreneurship and hi-tech business expertise, two funds incorporated outside Russia). The total and by using Russia’s human potential. volume of these funds is RUB27.7b.
RVC believes that its efforts in building the New objectives and mission venture ecosystem have provided an outcome for RVC feels that it has achieved its initial goal of the Russian economy that is no less significant establishing a Russian venture market and is than other investment vehicles. Currently, RVC thus expanding its focus to include non-financial considers its initial mission to be completed investment vehicles. RVC’s new goals are: and is shifting its focus to non-financial vehicles increasing volume, encouraging growth and crucial for VC environment, such as developing adjusting the development lines of Russia’s “smart money” investors and infrastructure, venture market, subject to such government endorsing the innovations and supporting the priorities as greater competitiveness of Russia’s global expansion of Russia’s innovations industry. innovation sector in the international market.
This change is reflected in the RVC’s current As of 2014, RVC’s main objective will be to main objectives and mission. provide, on the basis of an effective public- private partnership, a balanced structure of Russia’s venture market, broken down by stages and industries, and its sustainable growth and globalization, subject to government priorities.
Russian and global venture markets in 2007–13 | 41 The Russian venture market in 2007–13
The Russian VC industry has shown triple-digit growth since 2007, reaching the record-breaking volume of US$1,213m in 2012, making it the world’s fifth largest.
The Russian venture market has shown explosive growth in recent announcement. It would be wrong, however, to expect the market years. The most conservative estimates suggest that, in 2007–12, to demonstrate over 60% year-on-year growth in the future. The the Russian venture market experienced at least a four-fold market is becoming more mature. The growth of 2010-11 was, increase, both in terms of the volume and number of deals. In to a great extent, driven by the activities of new funds collecting 2007, RVCA estimated that the venture market in Russia hosted portfolio companies. In the coming years, the existing funds will a total of 34 deals, which were together worth US$108.3m. By shift their attention to managing portfolio companies, which 2009, the annual value of investments had increased by 49%, will have a negative effect on the market dynamics in terms of while the number of deals doubled. The global financial crisis of volume. late 2008 affected market performance in 2009, but the recovery In January 2013, Dow Jones VentureSource published a study was quick, and more growth followed as 2010 saw a 24% increase that ranked the Russian venture market fourth in Europe for high- in volume over 2009. tech investments. In related comments, VentureSource experts The accumulated efforts of the market players and the and The Wall Street Journal analysts noted that, in recent years, Government resulted in US$746.2m of investments in 2011. VC investments were booming in Russia. Throughout the past four Although a direct comparison of 2010 and 2011 may seem years, the amount of VC investments in Russia has grown almost incorrect since different data sources were used for these years, tenfold, making Russia the fastest-growing market in Europe. Just such large growth cannot be attributed to entirely different two years ago, Russia lagged behind Ireland, Finland, Spain, the methodological approaches. The market underwent a qualitative Netherlands and Sweden in terms of venture market size, but in change throughout the period, and for the first time ever, it would 2012, it stormed into the European top five. be true to say that private funds became interested in the venture These positive conclusions can be regarded as conservative. market and trusted it. The Russian VC market is not yet fully transparent, and a large In 2012, a new market record of US$1,213m (63% year-on-year number of deals occur that are not accounted for by analysts growth) was set. During this period, two hundred and sixty-seven and researchers. There are a large number of deals for which not venture deals were recorded, which is 34% more than for 2011. just the value, but also the existence of the deal, is kept secret. By the end of 2012, the aggregate volume of investments made Moreover, Dow Jones’s report was focused on deals in specific since 2007 has reached US$2,506m. In other words, the value segments, such as IT, internet, telecommunications, e-commerce of investments in 2012 was almost the same as that of the five and internet-backed tourism services. Our data covers more preceding years combined. market segments than the Dow Jones report did. Looking at the market from a Russian perspective gives us the ability to include a It is clear now that the market volume in 2013 will be higher large number of deals previously unaccounted for. than in 2011. As of 1 October 2013, there have been 118 deals accounted for, worth US$628.2m in volume. It would be safe to say that the total volume and number for 2013 will increase by at least 25%, as we are aware of several large deals that occurred in 4Q13 and were not included in the statistics presented in this report. In addition, full 2013 data will only become available in April–May 2014. This is because, in the Russian market, there is usually a gap between the execution of a deal and its
42 | Russian and global venture markets in 2007–13 Number of deals in the Russian venture market 2007–13 YTD In robotics today, I do not see one Silicon Valley-type center, 300 267 › as there is in the online industry. We are keeping an eye on everything that happens in the industry in Europe, the US, 250 Asia and Russia. They all have their interesting projects and 199 200 strong points, which is good because it means our country stands a decent chance of finding a place in the multibillion 150 118 and fast-growing global robotics industry. As far as the Russian robotics market is concerned, most start-ups appear Number of deals 100 81 67 in robotics software. That is no surprise, given Russia’s strong 48 50 34 programming tradition. Without quality software, successful projects in this sector are impossible, so we have here a 0 potential advantage that we should explore. Grishin Robotics as 2007 2008 2009 2010 2011 2012 9M2013 an investor is mostly interested in robotics products for the end Source: RVCA (2007—10), RusBase, EY (2011—3Q 13) consumer. It is in that sector that we see the most breakthrough potential and possibilities for global growth. But, regrettably, there are few Russian start-ups in that field now. The robotics Volume of deals in the Russian venture market 2007–13 YTD companies we have now mostly make components for military and space products on state contracts. How can the number of 1,400 quality start-ups in consumer robotics be increased? I believe 1,213.2 we should think in broader terms — how to help develop an 1,200 entrepreneurial culture in the country. There are many ways: 1,000 making incorporation easier, granting tax incentives and so on.
800 746.2 Better availability of qualified investors in the sector is also 628.2 important. I am happy to see that, with Grishin Robotics on 600 the market, many Russian VC funds are taking more interest in 400 robotics start-ups and have a better opinion of them. Amount invested (US$m) 161.8 200 108.3 123.8 153.3 Dmitry Grishin, co-founder and CEO,
0 Mail.ru, and founder, Grishin Robotics 2007 2008 2009 2010 2011 2012 9M2013
Start-up and product in development Product in beta test and shipping product
Source: RVCA (2007—10), RusBase, EY (2011—3Q 13)
Aggregate value and number of VC deals since 2007
3,600 900 814 800 3,000 696 700 2,400 600
429 500 1,800 400
1,200 230 300 149
Volume of investments, (US$m) 200 600 101 34 100 0 0 2007 2008 2009 2010 2011 2012 9M2013
Start-up and product in development Product in beta test and shipping product Number of VC deals
Source: RVCA, RusBase, EY
Russian and global venture markets in 2007–13 | 43 Russian VC market highlights Top VC markets in 2012
US UK Germany Russia 2012 venture pipeline US$32.1b US$1.8b US$1.0b US$1.2b
Number of seed Start up 136 US$69.8m and start up deals is growing
Product in development and product 101 US$343.4m in beta test Average seed The record- round and C+ breaking value round size' size of deals in 2012 decline made the Russian Shipping product 30 US$800m venture market the second largest in Europe and the fifth largest Israel India China in the world US$1.1b US$1.6b US$4.9b • There have been a few exits. • Certain macroeconomic factors • Market consolidation is yet make the Russian VC market unique. to begin. • Some Russian companies are seeking As of the first 6 months of 2013, there were 173 funds in Russia, • Silicon Valley has a significant pull global funding. over the Russian VC market. managing a combined total of US$5.2b
Information technology, consumer goods and consumer services are the key market segments
Other 13% e-commerce
Cloud services Consumer market (goods and IT services) Media 34% 53%
Telecommunications Tourism
2011 to 3Q13 average
44 | Russian and global venture markets in 2007–13 Russian VC market highlights Top VC markets in 2012
US UK Germany Russia 2012 venture pipeline US$32.1b US$1.8b US$1.0b US$1.2b
Number of seed Start up 136 US$69.8m and start up deals is growing
Product in development and product 101 US$343.4m in beta test Average seed The record- round and C+ breaking value round size' size of deals in 2012 decline made the Russian Shipping product 30 US$800m venture market the second largest in Europe and the fifth largest Israel India China in the world US$1.1b US$1.6b US$4.9b • There have been a few exits. • Certain macroeconomic factors • Market consolidation is yet make the Russian VC market unique. to begin. • Some Russian companies are seeking As of the first 6 months of 2013, there were 173 funds in Russia, • Silicon Valley has a significant pull global funding. over the Russian VC market. managing a combined total of US$5.2b The most active VC funds of 2012–13 Top five seed funds of 2012–13
Fund Number of Number Approximate average Aggregate value Number of investments of exits investment value, of investments, Fund investments Information technology, consumer goods and consumer services US$m US$m are the key market segments Runa Capital 35 2 1.5 >75 Altair 60 Ru-Net Holdings >25 1* >1 Tens of US$m* RVC Seed Fund 52 TMT Investmens 21 3 1 Tens of US$m* IMI.VK 41 Bright Capital Energy 21 3 >1 144.4 Other Moscow Seed Fund 17 e-commerce Prostor Capital 15 0 1.5 20 13% Softline 15 Phenomen Ventures 15 5— 7 Tens of US$m* * Source: Firrma Life.Sreda 14 0 1.5—3 30 Cloud services Consumer market Leta Capital 13 1 1 10 Top five foreign funds of 2012–13 (goods and Pbf 12 2 6 82 services) Media Number of IT VEB-Innovations 12 0 0.5 6.5 Fund investments 34% 53% Bright Capital Digital 11 1 >1 20 Intel Capital 4 iTech Capital 11 0 >2 Tens of US$m* Telecommunications Frontier Ventures 10 1 1—5 Tens of US$m* Mangrove Capital 4 Tourism Almaz Capital 8 1 2—4 Tens of US$m* Partners Maxwell Biotech 9 * 1—5 Tens of US$m* Ventech 4 Kite Ventures 6 4 1—10 60 Kreos Capital 3 2011 to 3Q13 average Russia Partners 5 0* 5—7 Tens of US$m* Accel Partners 2 * – Unavailable, unconfirmed or approximate information Source: Firrma, RVC Source: Firrma Russian and global venture markets in 2007–13 | 45 The number of funds present on Number of active VC funds the market grew rapidly, reaching 70 200 173 180 60 a total of 155 by 2013 and showing 160 no signs of consolidation 50 155 140 120 The Russian VC market has been demonstrating good 40 97 91 100 performance not only in terms of the funding raised, but also in 87 30 80 terms of the volume of funds managed. According to RVCA, as of 64 80 the first six months of 2013, cash in the amount of US$5,211m Number of funds 20 60 was under the management of 173 funds. These statistics do 40 Number of funds (aggregate) 10 not include the VC activity of PE funds, and thus may differ from 20 other market estimates. The record-breaking level of capital 0 0 2007 2008 2009 2010 2011 2012 9M2013 inflow that was achieved in 2012 — more than US$1.3b — was driven both by the recapitalization of existing funds and the Number of new funds Number of terminated funds Aggregate number of active funds establishment of new ones. This outcome is quite the opposite of the challenging results of 2012 on the world’s other key venture Source: RVCA markets. At the same time, 2012 showed a significant decrease in the average value of a fund. Each year, throughout the period 2007–13, the number of newly There is no doubt that the Russian internet market has grown set up funds significantly exceeded the number of terminated › up. This can be seen in the high number of online campaigns funds. and the increasing activity of domestic and Western investors. In the global business community, the Russian online segment The Russian market is still far from being consolidated. Although is rightly considered as one of the most promising, both for there are several management companies with a positive track businessmen who want to build a successful company and for record that continue to raise new funds successfully, none of investors eager to get involved in a growing industry to secure them managed to grab a significant market share. This is a clear rapid returns on their investments. Fastlane Ventures has today indicator of a developing market with the consolidation phase still become a kind of entrepreneurs’ club. Our strategy is based on to come. In the coming years, larger players with a better record, the idea that founders and key team members must themselves be experienced businessmen with impressive success stories. well thought-out strategy and superior market insight should They use their experience and knowledge to help young people emerge and consolidate (at least partially) the funds going into fulfil their dreams. We are not a regular kind of investment fund, the market. because we help our partner teams in new companies with both funding and advice. Our goal is to help new leaders turn a good Total amounts of financing raised by active VC funds (US$m) idea into a successful online company that can compete with the top companies in various online segments. We expect the 1,600 6,000 internet market to keep expanding in every direction now. We 5,211 think there will be at least 1,500 new online projects appearing 1,400 5,000 every year in Russia, 10 to 15 of which will become new stars on 1,200 the local market and maybe on the global market, too. Of course, 4,557 3,449 4,000 competition in practically every niche is already quite intense, 1,000 so it is important to seize the day and start putting ideas into 2,854 800 2,687 3,000 practice now. We believe that our business model gives serious 600 advantages to those who are beginning start-ups, allowing 2,408 2,000 them to make use of all our collected experience when building 400
Amount invested (US$m) 1,625 a business model and saving them a lot of time and resources
1,000 Amount invested (aggregate, US$m) 200 by giving them a proven development course or using tried and tested tools. How a business idea is put into practice is still a 0 0 2007 2008 2009 2010 2011 2012 9M2013 key factor in how successful it will be, and it is also central to the company’s chances of taking a leading position in its industry. Value of new funds Value of terminated funds Aggregate value of funds raised Marina Treschova, CEO, Fastlane Ventures
Source: RVCA
46 | Russian and global venture markets in 2007–13 The most developed projects Value and number of VC deals, 2007–13 collect most of the funding 1,400 300 1,200 supplied 267 Similar to the trend observed in other key VC markets, the 1,000 199 200 Russian venture industry is heavily weighted toward the later 800 stages, rather than the seed and start-up stages. In 2011, the funding raised by companies at the stages of product in beta 600 118 test and shipping product was US$474.7m or 63.6% of the total 100 Number of deals 400 investments made. This imbalance further increased in 2012, Amount invested (US$m) with these stages accounting for US$827.9m or 68.2% 200 of the total funding supplied. 0 0 2011 2012 9M2013 In terms of the number of deals, the situation is quite the Start-up Product in development Product in beta test opposite. In 2012, there were 136 start-up deals and 90 Shipping product Deals count investments into companies at the product in beta test stage, Source: RusBase, EY amounting to 50.9% and 44.8% respectively of the total number of investments. This proportion remained almost the same as in 2011. The 2013 data is not yet complete, and so it is too early to Average value of venture investments by development stage draw any firm conclusions, but there are unlikely to be significant (US$m) changes in these figures. The average investment value of start-up deals has gradually 50 24.95 declined throughout the period, from US$0.6m in 2011 to 26.67 40 US$0.48m in 2013. At the same time, the median volume 20.59 of start-up deals increased from US$0.16m to US$0.3m. 30 The average funding raised by companies at the product in 11.93 development stage was US$3.15m, US$3.51m and US$2.50m 20 in 2011, 2012 and the first nine months of 2013, respectively. 8.99 10 The median deal value hovered around US$1.5m to US$2.0m 3.15 3.51 2.53 2.50 for this stage from 2011–13. Average investment value (US$m) 0.60 0.51 0.48 0 A typical investment (average volume adjusted by standard 2011 2012 9M2013 deviation) into a shipping product stage company was US$6.6m Start-up Product in development to US$34.6m, with an average of US$20.6m and a median of Product in beta test Shipping product US$7.0m. In 2012, the average deal size at this stage increased Source: RusBase, EY by 30% to US$26.7m, while the new typical frame of raised funds became US$40.2m from US$13.1m. The increase in the median deal volume for shipping product companies was even more Number of venture investments by development stage significant — up to US$15.75m (125% year-on-year growth). These conclusions are based on 20 recorded deals in 2011 and 30 160 in 2012. So far, 2013 has demonstrated an increased dispersion 140 136 120 in the volume of deals, with the typical deal size fluctuating 106 between US$7.7m and US$42.2m in 13 recorded deals. 100 90 80 66 60 45 46 40 30 20 14 13 20 7 11 0 2011 2012 9M2013
Start-up Product in development Product in beta test Shipping product
Source: RusBase, EY
Russian and global venture markets in 2007–13 | 47 The boom in the Russian VC investment market took place around three years ago with the accession of active exchange- Average seed round and round traded institutional investors, such as Almaz Capital Partners C+ size declines as the investors and Runa Capital, and is still going on at a good pace. The total number of investment funds is increasing by the day. As become more sophisticated more people declare interest in the establishment of a venture Since, in general, financing rounds are, to a certain extent, investment fund, it is becoming increasingly fashionable either associated with the stage of a company’s development, the to be a venture investor or to set up a business counting on the conclusion drawn in the previous section can be projected to the attraction of VC. Although the total number of transactions is round metrics. growing, the number of high-quality venture deals, particularly at the seed and round A-stages, has been insignificant in Russia The average seed round value declined through the period so far. 2011–13 from US$0.56 to US$0.48m. The median deal value of the seed round demonstrated the opposite trend, growing Based on Skolkovo’s experience, I can say that, by 2011, there from US$0.15 to US$0.29m. The number of seed deals in 2012 was a number of high-quality projects that were seeking funding showed a 36% increase compared with 2011, reaching a total of in the VC market. It is noteworthy that all of them were in 135 investments. Moscow or in cities with autonomous innovation ecosystems. Some of these companies come from the non-industrial regions. There are two main factors that influence the number and the value of seed investments — the supply of “free” money and the greater Unfortunately, in the course of time, the first pool of projects experience of investors. At various times, different state-affiliated with the best prospects got exhausted, the flow of investment and private organizations distributed grants on the market that seekers began to dwindle and the quality of new projects are not part of our statistics for this report. The key players here somewhat deteriorated. High-quality start-ups are definitely are (by the number of grants) the Foundation for Assistance to a renewable resource; however, one should not expect more than Small Innovative Enterprises in Science and Technology (FASIE), 15 to 25 truly promising projects a year at the Russian venture Skolkovo, Microsoft Seed Fund and others. The number of such investment market. Besides, start-ups always tend to look for grants hovers around several hundred per annum and fulfills a the gratuitous money. In this context, it would be inappropriate significant share of demand for pre-seed and seed financing. The to extend Skolkovo’s experience to the venture investment founders of the projects often prefer this type of financing over market because far from all of the successful companies would be VCs, as it does not reduce their share in the company. prepared to split shares in the business with an investor. The second factor has even more significant influence over the On the other hand, there are sufficient resources for good decline of the seed round value. The market is leaving the initial projects in Russia. Smart money, with expert high-tech “gold rush” era, and investors are starting to look for more experience, can be found through the VC funds with a high-tech accurate project assessments and are tending to spend resources expert capability; however, one should not expect investment more carefully. This results in both a smaller investment volume funds to be experts in all spheres. Besides, such expertise and higher portfolio diversity. can also be accessed through public institutions that focus on supporting the market, such as Skolkovo and RVC. As a result, Another hard-to-measure and thus unaccounted funding source is a whole range of professional grant receivers — those who win business angels. There are a large number of pre-seed and seed tenders and receive finance, but who never produce goods — has deals that are made with angels. Although in recent years sprung up. a lot of “serial” angels with positive track records have appeared on the market, and the community has started consolidation by In my view, it is wrong to say that the Russian VC market has introducing two self-organized associations, this market is still far fallen significantly behind the European market. In terms of the less transparent than the venture market. In addition, we have number and total value of deals, the Russian market has already seen a large number of start-ups running a pre-seed and even exceeded most European markets and is going to outrun the a seed round based on a friends-and-family approach, which they largest European markets in the near future. There are regulatory are not announcing publicly. problems, which are a special case due to the general situation in this country and can be applied to all the Russian companies. A small number of accessions in the market is a consequence In December 2013, the National Business Angels of its immaturity and the evolved system of project selection at different stages. Russian companies have good prospects for Association (NBAA) published a report on the successful access to different markets, global market included. business angels’ investments in Russia. The aggregate value of the angels’ early-stage investments in 11 Alexander Turkot, founder, Maxfield Capital months of 2013 was estimated at US$116.58m, showing a 4.5-fold increase as on the figure for 2012. The NBAA has recorded 96 deals, 4 of which exceed US$10m in value. The total number of financing rounds grew 2.7 times as from its 2012 figure.
48 | Russian and global venture markets in 2007–13 Similar to the seed rounds, the late-stage rounds are also showing Number of venture investments by round a slight gradual decline from the average of US$48.3m to US$42.9m (US$50m to US$30m in median values) as the most 160 capital-heavy deals ran out in 2011 and 2012. Most C+ deals 140 135 were in the consumer market sector, and were aimed at financing 120 99 102 the core investees’ business processes, such as efficient logistics. 100 83 Most of the largest online retailers have finished investing in 80 their supply and logistics operations. Although there is still a 60 55 42 large internal market to explore, the first signs of online retail 40 saturation are beginning to appear. This is reflected in the amount Number of investments 19 20 14 of capital expenses made by online retailers and may have 10 7 11 7 0 resulted in a slight decline in the number of high-volume C+ deals. 2011 2012 9M2013
Round B Round C+ Total value of VC investments by round (US$m) Seed Round A Source: RusBase, EY 1,400 300 267
1,200 250 199 1,000 200 800 The bigger Russian companies have begun to understand that, 118 150 600 › if they want to expand into the global markets, they have to become more innovative. They realize that innovations are
100 Number of deals 400 needed for survival, but they must be able to finance new Amount invested (US$m) technologies from an open market. Russia is not very far along 200 50 in this. There is no connection between scientific results and 0 0 corporate needs. Technology transfer is thought to be a better 2011 2012 9M2013 prospect. We often ask scientists why they are doing research Seed Round A Round B Round C+ Number of investments and what goals they are seeking. And I find very often that
Source: RusBase, EY nothing has changed in those few years when Russia has been on the innovation development track. There is no commercial demand for innovations in Russia. And researchers are afraid to take to the market what may not sell. This is why people here do not believe that there is a good chance to succeed. Average value of venture investments by round (US$m) In the Skolkovo Start-up Academy, I have chaired meetings between promising scientists who have come up with interesting 70 48.36 42.86 technologies and managers and MBA students who want to 47.19 60 begin a start-up and are looking for ideas — a kind of speed dating. Managers could meet the scientists, the scientists could 50 explain to the potential co-founders what they had done, and the 40 students could then receive advice on how to run a business. 30 I think we need more formats like this. It is a way to connect 13.12 researchers and businessmen, who do not always have the 20 12.23 10.99 technical knowledge, but could be great partners and help to get 10 2.92 3.68 2.48 a product to the market. Average investment volume (US$m) 0.56 0.51 0.48 0 Lawrence Wright, Director, Skolkovo Start-up Academy 2011 2012 9M 2013
Seed Round A Round B Round C+
Source: RusBase, EY
Russian and global venture markets in 2007–13 | 49 Success stories
Success story: The project of iiko system development was initiated in August 2005 by David Yang iiko (founder of ABBYY) and Maxim Nalsky (founder of Fingrad). At the end of 2007, Troika Dialog, the managing company of the Venture Fund of the Republic of Tatarstan, invested Investors: several million dollars in the project. A deep understanding of the needs of restaurants Venture Fund of the Republic of Tatarstan, and restaurant-chain owners, and huge experience in the development of successful IT Leader Innovations solutions, allowed the iiko team to create a next-generation restaurant management system. Investment result: In October 2011, the iiko team introduced an innovative iiko.net solution to the market — Development of new products and entry into a loyalty system based on mobile social marketing. Also in 2011, the first projects were foreign markets implemented to introduce iiko abroad. In October 2012, iiko raised its second round of funding from the Leader Innovations fund. The money was used to speed up expansion Innovative product: into foreign markets and to develop new products and services for restaurateurs. iiko — restaurant management system, Almost at once, the unique potential of iiko products was highly appreciated by the iiko.net — mobile social loyalty system market professionals. Large chains such as Sbarro and Coffee House were among the first iiko clients. Currently, iiko is used by approximately 5,000 restaurants, including 180 restaurant chains. Among these are Dunkin’ Donuts, Elki-Palki, Jan-Jak, Asia Café, Tashir Pizza and Little Japan. You can receive a restaurant bill printed out using the iiko system in 19 countries, including Vietnam, Egypt and Liechtenstein. Product introduction and servicing is performed by a dealer network that includes 150 companies around the world. A distinctive feature of iiko solutions is the unique online integration of all business processes. Transparent management accounting and reporting, staff salaries and incentives, guest loyalty management, video monitoring integrated with events within the system and music management in the restaurant hall — this is by no means a full list of the features offered by iiko.
Success story: ShareKnowledge is an innovative IT solution that maintains records of staff learning Competentum and development and supports the integration of learning processes into the company’s shared IT environment. ShareKnowledge uses Microsoft’s SharePoint platform, leading in Investors: the sphere of corporate portals development, e-content management and interconnected Svarog Capital, S-Group Ventures operation support. The ShareKnowledge system provides solutions for formal and informal (via the interaction of employees) training, spread of knowledge and exchange of Investment result: experience. Development of a product and entry into The idea to create a new-generation learning management system that would support foreign markets staff communication during the learning process and allow integration of learning into other corporate business processes appeared in 2008. By that time, Competentum Innovative product: had more than 15 years of experience in the development of solutions in the sphere ShareKnowledge LMS — corporate system of e-learning and various learning management systems, including participation in the for staff learning and development development of e-learning systems of federal importance. management The first round of outward investments in July 2008, when the company was funded by the Direct Investments Fund managed by Svarog Capital, allowed the company to implement the ShareKnowledge system project and start selling the system on the Russian market. The attraction of investments from the S-Group Ventures Fund — which was established with the participation of the RVC — allowed the company to adapt the system for the worldwide market in 2010 and start active sales of the system in the US in the second half of 2011. Currently, the ShareKnowledge system is used both by companies in the SME sector and organizations included in the top 100 of the Fortune 500 list. The company’s customers can be found in 11 countries, and more than 90% of sales are made abroad, mainly in the US and Canada.
50 | Russian and global venture markets in 2007–13 Success story: MOBI.Money has been operating in the sphere of e-payments and mobile commerce since MOBI.Money 2009. The company was founded by the developers of PayCash, the first Russian e-payment technology, who have more than 15 years of experience in the development of systems Investors: enabling non-cash payment for goods and services. In 2002, the MOBI.Money founders VTB Venture Fund developed Yandex.Money, a remote payment system, then they established Moneta Express (USA), a company providing finance services on the internet, and in 2006, they established Investment result: Processing Technologies, a company specializing in the development of intelligent platforms Creation of payment processing company that enable remote payments for public services. MOBI.Money in 2009 and product launch CJSC MOBI.Money is the owner of the intellectual property rights to PayCash. PayCash technology is widely spread both in Russia and abroad, thanks to the high level of reliability Innovative product: ensured by specialized patented data security, storage and processing protocols. The MOBI. Universal mobile and e-payment system — Money mobile and e-payment system was recognized as conforming to the international PCI a non-cash payment instrument enabling DSS security standard developed and applied by the leading global payment and processing payment for goods and services on the systems. internet In 2009, MOBI.Money raised investments from VTB Venture Fund, a fund established with the support of the RVC. The attracted funds were used to create an infrastructure for non- cash payment processing. Investments allowed the company to reinforce its leading position in the e-commerce segment and enter the new rapidly growing segment of payment processing for the e-commerce market. Today, the MOBI.Money payment solution may be integrated into any IT infrastructure, allowing internet services, quickly and at minimum expense, to expand the list of payment methods they can accept from customers. As well as B2B partners, MOBI.Money technologies may also be used by members of public. System users actively use such options as payment for goods and services, money transfers from mobile accounts and bound credit cards, and virtual card issue. The number of system users has exceeded 22 million people, and the number of goods and services that may be paid for via MOBI.Money has exceeded 4,500. According to the company’s own estimates, MOBI.Money’s share on the e-commerce market is over 40%.
Success story: Automated facial recognition systems are in demand in the modern world; primarily, these Vocord systems are needed to ensure security in crowded places. So far, however, there has been no reliable technical solution for work in the non-cooperative mode. Most of the modern Investors: facial recognition systems are based on an analysis of 2D images. Such systems compare 2D S-Group Ventures, Leader Innovations photos to the 2D photos contained in the reference database. However, this technology has considerable setbacks. The result is largely affected by the shooting angle; to ensure proper Investment result: recognition, the person should be exactly face forward. Vocord Company has developed the Ready production sample VOCORD FaceControl 3D innovative system, which ensures 3D facial recognition. VOCORD FaceControl 3D recognizes faces by using 3D face modeling based on simultaneous Innovative product: photos made by stereoscopic cameras and by comparing the 3D model with the reference Non-cooperative facial recognition system 3D model or a standard photo. Such technology resolves the main problems encountered by based on innovative 3D computer vision the traditional systems of biometric identification, i.e., sensitivity to the head angle, facial technology expressions and makeup. To develop this system, Vocord Company created a new team for advanced development projects. Initially, it was financed by the proceeds from the sale of its main commercial products (telecommunication systems and intellectual video monitoring systems, among others). The first laboratory prototype of this system appeared in 2009. In March 2010, Vocord introduced its first functioning sample of the VOCORD FaceControl 3D system at the major security industry exhibition MIPS-2010. In 2010, venture funds established with the participation of RVC showed their interest in the company. In 2011, investments were made in Vocord by two Russian venture funds — Leader Innovations and S-Group Ventures. These investments enabled the company to promote the system’s development and invest additionally in marketing the product and promoting it to foreign markets. Currently, the product is at the final stage of development, i.e., it is being tested. Although the product is not commercially launched yet, many public and commercial organizations in both Russia and abroad have already become interested in it. The VOCORD FaceControl 3D system is scheduled for pilot usage in 2014.
Russian and global venture markets in 2007–13 | 51 There have been only a few exits on of contacts limits M&A exit opportunities for a large number of projects. The internal Russian market for acquiring innovative the Russian venture market so far companies is still limited, and a lot of large players are incapable of closing deals on the terms favorable to a fund. Furthermore, The key performance indicator for any financial market is the large players who can afford M&A-driven expansion have the return on investments. The ability to deliver this metric is difficulties integrating the acquisitions. something that still needs to be developed in the Russian VC market. In the last three years, for instance, several independent Difficulties in accessing the international capital markets and sources collected market statistics, but none of them seriously the weakness of the domestic capital market in turn influence focused on the exits and return on investments. the number of IPOs in Russia. This leaves M&A as the major exit route. We expect to see a noticeable increase in M&A in the The number of known or publicly announced exits (either M&A or coming years. IPOs) on the market remains relatively low, hovering around 10 to 20 deals per annum in recent years. One may say that this fits There have been, however, several featured stories that had a with the relatively small and decreasing number of exits on the very positive impact on the market. Six Russian or Russian-backed global market, but actually, the reasons for this trend in Russia high-tech companies have had international IPOs in the last three are more complex. years, and there were several smaller local IPOs. Three of these offerings have risen to about US$1b each or even more. The most obvious reason is the non-maturity of the market. As noted above, the Russian market became active in 2007, with a The most interesting recent IPO was Tinkoff Credit Systems. noticeable increase in the volume of deals from 2010. In Europe Although officially a consumer bank, the company is widely and in the US, the median time to liquidity varied by the type of considered an IT-driven organization because of its business model, exit (IPO or M&A) and in general hovered around four to eight focus on technology and lack of non-financial assets other than IP. years in 2007–12. Projecting this statistic onto Russia, we should The company raised its last venture round in May 2012, a year expect the first wave of exits in the coming years. and five months before the IPO. This proves that it is possible There are other reasons for the limited number each type of to get a quick return on investment in Russia. It is especially exit. The lack of experience entrepreneurs and VC investors have interesting in the light of the long median time to liquidity on the in pitching to corporate buyers and the still-emerging network leading venture markets.
The most significant exits on the Russian venture market in 2010–13 Company Industry Exit type Buyer Deal size, US$m Date Yandex Internet IPO IPO 1,435 May 2011 Tinkoff Credit Systems IT* IPO IPO 1,087 Oct 2013 Mail.ru Group Internet IPO IPO 912 Nov 2010 Vkontakte Social networking Exit (other) UCP PE Fund II 700 Apr 2013 Yandex Internet SPO SPO (founders and BVCP 551 Mar 2013 partial exit) EPAM IT IPO IPO 490 Feb 2012 QIWI Business and financial services SPO SPO 287 Oct 2013 QIWI Business and financial services IPO IPO 244 May 2013 Yandex Internet Exit (other) Public market (exit of Almaz 188 Nov 2012 Capital and Tiger Global Management) Qik Social networking M&A Skype 121 Jun 2011 Luxoft IT Exit (other) VTB Capital exit 87 Dec 2013 Luxoft IT IPO IPO 80 Jun 2013 B2B Center Business and financial services M&A Elbrus Capital 52 Apr 2013 Sapato E-commerce M&A Ozon 50 Feb 2012 Sotmarket E-commerce M&A IQ one 50 Aug 2012 Darberry E-commerce M&A Groupon 50 Aug 2010 Slando Consumer market M&A Naspers 50 Oct 2011 EPAM IT Exit (other) Public market (exit of Russia 37 Sep 2013 Partners) Source: EY
52 | Russian and global venture markets in 2007–13 In the last three years, there has been a significant increase Over the last few years, the value of the Russian VC market in the number of projects and the value of investments. has increased, as has the average value of a transaction; a lot Whether this growth will maintain its momentum in the of new private and public investors have appeared, as well as future or slow down depends on the economic situation in funds managed by regional and local authorities. And, unlike Russia. There might be a slowdown in the rate of VC market private investors, the Government assesses investments in growth if there is a deterioration of the country’s business rapidly growing projects from more than just a commercial climate, which is expected due to existing conditions. Foreign point of view. Investments of this kind may have no competition may also have its effect: Ukraine and China have commercial impact, and a part of the money invested by the vigorously joined in the battle for financing, and there are Government will probably be written off. still traditionally strong countries, such as Israel, the US and Despite the notable positive changes, the ecosystem of Canada. venture financing is still underdeveloped, and many investors In Western countries, unlike in Russia, quite well-established are not experienced enough. Therefore, at this stage of teams are usually at the back of venture projects. Russian development, the percentage of unsuccessful projects in founders still have a problem with the quality and manner of Russia will be higher than in Silicon Valley. Judging by the presentation, which affects the investor’s general impression investment activity of the funds, many of their decisions of a project. The projects are just not prepared to work on are not mature enough and risk giving a low return on the highly competitive and often monopolized corporate investment. market. That is why we rarely have any potent projects in In the course of time, some of the funds with unsatisfactory B2B sphere. portfolios and ill-considered strategies will disappear, and the As for development of the venture community itself, in the projects supported by them, without getting new rounds of last year, there have been a lot of positive changes, which is financing, will cease to exist. The surviving market players proved by the growth of investment volumes. However, there will acquire experience, learn to build investment teams and is still no strong competition on the VC market. Another make more-balanced investment decisions. This will lead to characteristic feature of the market is the small number of consolidation in the market: more than half of the funds will exits. The reason is that Russia has practically no major hi- cease to exist, thus making the market look less like a casino tech players of its own who would be able to buy start-ups. IT and more like a professional environment. start ups are not a subject of interest for the majority of big The local Russian market, especially when we talk about companies, with the only exception, perhaps, being projects segments closely connected with the internet, still has a in telecommunications. high capacity and a high-growth potential. In the past, we Another Russian problem is that the legislation has not witnessed the success of companies mainly focused on the been adapted for the innovation sector, especially in the part Russian or Russian-speaking market. And we know of much concerning investors’ rights protection and the regulation of fewer success stories connected with Russian businesses relations between shareholders. Perhaps there will be some breaking into the global market. Eventually, with experience changes in the future, but, for the time being, the legislation accumulation and technological development, Russian focuses mainly on raw material industry and export, and not projects will become more global — and will be able to be on innovations or investments. integrated into the global market — but it will not happen soon. Igor Ryabenky, business angel We should not expect that, from the point of view of fund exit strategies, the Russian VC market will essentially differ from the European or the American market. Globally, the most widespread exit method for venture funds is the sale of the business to a strategic investor. In Russia, this method will be even more common, since there is practically no local IPO market in Russia, and the entry barrier to holding an IPO on a foreign stock market is considerably high. Therefore, we will see several IPOs per year at best, and M&A will be the principal exit method for the funds. However, since only the biggest players will be able to hold an IPO, by the value of transactions, the exits through IPO will be comparable with the sale of business to a strategic investor.
Dmitry Alimov, founder and Managing Partner of Frontier Ventures, co-founder of ivi.ru
Russian and global venture markets in 2007–13 | 53 The Russian venture market is still Distribution of venture investments and number of deals 2011–13 YTD mainly about IT, consumer goods 1,400 300 and consumer services 267 1,200 One of the strongest historical trends in the Russian venture 199 market is that IT, consumer goods and consumer services 1,000 200 together account for around 90% of the total value of 800 investments. However, our data shows that these sectors have 118 lost some of their share of total investment to the health care and 600 business and financial services sectors. In 2011, the consumer 100 Number of deals 400 market and IT segments accounted for 95.8% of all investments, Amount invested (US$m) decreasing to 88.4% in 2012. Conclusions cannot yet be drawn 200 for 2013, because the data is still incomplete. 0 0 2011 2012 9M2013 Looking deeper into the market’s structure, one can identify IT Health care the real drivers of market growth. In terms of value, these are Energy and utilities Consumer goods and services e-commerce, telecommunications, media, tourism and cloud Industrial goods and materials Business and financial services services. The year 2013 showed that social networks or social Totals feedback services still have not gone out of fashion, although Source: RusBase, EY they are much more noticeable when talking about the number of deals, rather than the value. Another notable segment is mobile Average share in investments value 2011–13 YTD apps, which has the best prospects in terms of global expansion of the product. Each of the above segments has been showing 1% growth throughout the said period. (22.3) 4% (104.3) There may be a fundamental reason for such strong B2C IT focus in the market. Following our discussion of the domestic 34% Health care (822.4) Russian market, we can note that consumption is its most Energy and utilities important feature. Russia has a potential local audience of over Consumer goods and services
140 million and 57% of households have internet access, and 53% Industrial goods and materials this figure is rising. While the B2B side of the economy still (1,450.8) Business and financial services 7% remains undeveloped, the B2C is the one with the most feasible (46.4) Total values in US$m monetization and thus exit possibilities. 1% (43.5) The situation will change over time. We already see that the Source: RusBase, EY growth of «connected» business is promoting the growth of auxiliary B2B services. The companies focusing on back-office solutions now represent a noticeable part of the market. The good thing about it is that such growth ultimately increases the efficiency of the economy. Thus, private companies could soon be the main driver of innovations. As of today, the Government still accounts for most of the investments made in such capital-heavy segments as science, materials and chemicals, and it plays an important role in supporting qualified specialists and the level of expertise. For private investors to take interest in these segments, some qualitative changes in the economy should be made. The only other option is for these companies to consider global investments from the start.
54 | Russian and global venture markets in 2007–13 Distribution of venture investments, 2011–13 YTD There have been colossal changes in the Russian venture (by number of deals) investment market over the past few years. When we began operations in 2006, the situation was somewhat like a desert; 300 there was a very limited direct equity market and virtually no high-quality investors with a transparent strategy. 250 The community was established over the next seven years and a few well-structured projects were set up. And the 200 market landscape is now more like a steppe than a desert. Investors’ quality is improving — people learn from their 150 experience and mistakes. We are now looking forward to a 100 more testing education stage, which will be more like an examination.
50 Investors will likely begin to exit from the invested companies. There have already been a few of such exits. 0 2011 2012 9M2013 These upcoming exits will give an objective estimate of IT Health care investment quality, and show the best performers and weak Energy and utilities Consumer goods and services ones. Industrial goods and materials Business and financial services
Source: RusBase, EY One can surely say that there are many strong performers in the IT sector. We have not accumulated a sufficient number of success stories in the biotechnological sector yet. However, the moment of truth is approaching. In the next Average share of venture investments received by each sector, two to three years, we look forward to the first investors’ 2011–13 YTD (by number of deals) exits from the projects financed by Skolkovo and from the first RVC investment funds. The aforementioned projects are of reasonably high quality and have good prospects both in 9% Russia and abroad. 4% (50) IT (22) It is essential for a biotechnology start-up to comply with 33% Health care (188) international standards and to have good prospects at Energy and utilities the international market. Under such conditions, foreign Consumer goods and services strategic investors will be prepared to buy out companies Industrial goods and materials from venture investment funds. There is virtually no 47% 6% Business and financial services (297) (35) domestic demand for such projects: Russian business houses are not yet prepared to acquire non-production biotechnology 1% companies — both because of the difficulties in business (10) integration and because of their inability to offer attractive Source: RusBase, EY buy-out terms to investment funds. Russian projects have had a good business reputation at the international market so far, where the assessment of project quality is the key for investors.
Participants in the Russian venture investment market also meet other problems, for example, Russian law does not regulate the use of options. In the West, options are a part and parcel of the venture investment business and are one of the main tools for giving incentives to staff. It is worth noting that Russian funds are good at adapting to new conditions. Investment funds may have numerous legal restrictions and obligations to prepare volumes of reporting, but we continue to work and invest.
Vladimir Tezov, CEO, Bioprocess Capital Partners
Russian and global venture markets in 2007–13 | 55 I believe that the Russian venture sector is still in an embryonic state, judging by the market size and the level The Russian venture market of experience and expertise of its participants. Despite the ecosystem still remains fragmented positive dynamics, the development rate for the innovative, high-tech economy in Russia is not even fast enough for the Over the last few years, the Russian Government has created country to maintain its current global position. To speak several institutions and organizations to receive venture market metaphorically, in the modern world, our country has to run support. However, these efforts seem to be quite uncoordinated, to stay where it is. Positive developments in the spheres of since these new institutions and organizations somewhat IT, digital technologies and media really stand out against the duplicate the functions of others. Access to information on background of the national venture sector. mentors and centers of excellence still remains fragmented and, Perhaps the problem is that there is no fundamental, genuine for some start-ups, it may be difficult to find out about all the interest in the promotion of innovations. The major objective government support programs available. The level of this support of the private sector in Russia is making money in the current also significantly varies from one region of Russia to another. moment. I am not sure that there is a serious initiative in Finally, a large number of projects oversee the Government’s tax our country to create an open and transparent market for incentives. venture investments, or a comprehensible ecosystem. We live in the conditions of rental economy, where wealth is The lack of information makes knowledge and information sharing based not on hard work and knowledge, but on access to, and seem insignificant. A large number of market players do not control over, resources, both literally and metaphorically. If, see the importance of sharing the information on their projects in such conditions, anyone raises owing to their knowledge or investments, since they are unlikely to benefit equally in and innovation, it will become an immediate menace to the return. This limits market transparency and leads to significant prosperity of those who live on rent, because it can lead to discrepancies between different market studies. redistribution of the flow of money and resources. In the last two to three years, however, the situation has improved I would like to point out three things that, in my opinion, are dramatically in relation to investees and investors. The funds have absolutely necessary for making qualitative changes in the started seeking publicity, expanding their activities in the social situation. First, we need a law-governed state with functional laws, independent courts, protection of property and an networks, promoting portfolio companies and sponsoring subject- independent media. Second, we need competition. Domestic related events. At the same time, several blogs and websites focus demand for innovation can only be created by robust on VC projects and the venture market in general. We believe competition. Currently, the level of competition is low or zero that these developments will ultimately result in increased market in many economic segments, and it is continuously decreasing transparency. as a result of direct or indirect governmentalization of the economy, which means that there is no motivation to change anything to focus on business efficiency. And the third necessary thing is the removal of customs barriers and Looking at the positive tendencies in the innovations market in other obstacles related to both import and export, to ensure the country, I can single out “diagonal” connections between the effective cooperation of our start-ups and innovative › competences centers, investors and projects. These connections companies with foreign suppliers of components and with were not there just two to three years ago. Entrepreneurs and foreign consumers. investors still speak different languages, and that is a major problem — but they are beginning to understand each other. Valery Krivenko, General Partner, Also, the venture industry is starting to see people from the FPI Innovation Fund LP non-financial sectors of the economy, and companies that have “pushed off” with it and the internet are themselves showing interest in investing. But there are issues too, and the worst is incompetent start-ups. Most of them have great teams and excellent ideas, but they imagine their product audience to be like themselves. They do not understand how the market they want to conquer really works. Young people from start-ups need to have mentors who can explain the rules to them. At the same time, there are plenty of large corporations in the country with experienced managers. They know how the market works. At the moment, middle-level managers rarely want to try coaching start-ups or help them — not just with money, but with advice. But the trend is there — innovations are becoming more popular, and start-ups are not a shocking novelty anymore. Now is the time to start involving white collars. Renat Garipov, co-founder, greenfield project
56 | Russian and global venture markets in 2007–13 Silicon Valley and the global The level of government support makes Russia similar to both China and Israel. Indeed, the venture industries in these countries financial markets have significant were created and launched by their governments’ coordinated pull on the Russian venture market efforts, rather than by the efforts of private investors. Russia also resembles Israel and China in its strong IT focus. Silicon Valley serves as a role model for the Russian venture At the same time, the substantial differences in regulation, market. One obvious aspect of this is the attempt to import government role and consumer patterns make it impossible to successful Western business models. But Silicon Valley’s influence find an exact match for the current state of the Russian market is felt in another, more important way. There are a large number (even if we look into the past of other markets), which again of projects that cannot be started in Russia because of the serves to show the unique set of circumstances and the business lack of experience, ecosystem quality or, most importantly, the environment in Russia. market size and transparency. The size and level of expertise accumulated in the US market is drawing a number of talented Russian entrepreneurs to consider starting their own ventures in Silicon Valley. Silicon Valley also offers benefits other than experience and the Looking back at the last few years, we can say that the Government has finally noticed the technology business, .e g., ecosystem. Monetary policies in the US and Europe contribute › software development. The dialogue between the industry and to the increasing supply of funds. For some projects, it may be the authorities has started; the ARPPSOFT and RUSSOFT easier to get funding overseas, or the amount of financing may business associations are actively working. There are be higher than that available in Russia. Given the high project- considerable social insurance benefits. R&D eligibility for income screening standards in the US, this ultimately means that the tax relief includes the most important IT sectors. Then there higher US supply of money leads to a drain of high-quality projects is Skolkovo with its tax remissions. All this has taken some of from Russia. the fiscal burden off software developers and has helped R&D business. On the other hand, there are still macroeconomic growth ceilings, such as very high (and climbing) salaries for Certain macroeconomic factors developers, especially in Moscow, where most of them live. That is closely related to a general growth of salaries in large cities make the Russian venture market and a shortage of graduates from technical schools qualified for work in modern IT sectors. There are some excellent unique administrative changes in that area, but it will take time for Market projections are commonly made by taking account of them to have an effect. Another ceiling is high rental costs in the performance of similar markets under analogous conditions. Moscow — several times the costs in California. Relocating to We believe, however, that the set of economic conditions in the another town is often not an option, as there are not enough Russian market does not allow a direct comparison to be made specialists there. Debt financing for software developers is still basically non-existent. The Central Bank’s current policy with any of the key global venture markets. means the banks cannot sponsor software, with its recoupment As discussed above, the key factor affecting the Russian venture cycle of two to three years and no material assets to put up for market is domestic consumption. In this respect, Russia is similar security. As a company grows and moves to outside markets, to the US. Another factor that can be observed both in Russia and it meets a harsh competitive environment, but the Government in the US is a large defense budget that finances a substantial has almost no instruments to support exports. Any Russian segment of the economy, driving the demand for the relevant company venturing into the US market is on its own against the US’s aggressive patenting system. Large American corporations technologies. In Russia, however, most of the military-oriented use it as a non-financial barrier for outsiders. Consistent help research is non-venture R&D funding, which goes to non-private with these non-market barriers would be very valuable to all contractors, and investments in high-tech companies still make up domestic developers with global ambitions. a fairly low proportion of Russian VC deals. Vadim Tereschenko, Senior Vice President and CFO, One may compare Russia with China, claiming that innovations ABBYY Group in both countries are currently driven by engineers and programmers rather than by serial entrepreneurs. A similar trend was observed at the early stages of the development of Israel’s VC market.
Russian and global venture markets in 2007–13 | 57 Assessing the positive results of innovations development, I can what the development institutions set up in Russia are working › say that, in the last several years, Russian entrepreneurship has on. There are some well thought-out initiatives in Moscow and started to move ahead. This is an outcome of many initiatives other regions of Russia. We see more than an emerging layer and events, launched to increase an interest in start-ups among of businessmen in innovations. An infrastructure and, most young people. Society, at least the youngest part of it, highly importantly, an ecosystem for businessmen to learn and to welcomes innovations and entrepreneurship initiatives. get experience, are shaping up. This will also help corporations to learn and will get them more interested in things such as However, the trust question still remains important to the local corporate venture funds and different growth models. The innovations market. A lot of companies and entrepreneurs are still Government cannot stimulate corporate interest in start-ups considering moving away from Russia. There are both objective directly. But it can invest in education for the corporate and (an unfriendly environment for entrepreneurs, especially for business environment. And this counts. It is also important for hi-tech companies; issues with legislation, business environment the Government to build up scientific research in the country, in and ecosystem as a whole; and domestic hi-tech market volume) both the fundamental and applied sciences. We will not have good and subjective grounds for that. The subjective grounds are ideas for start-ups without subject knowledge. This makes raising associated with the lack of trust between investors and the the level of scientific activity one of the most important goals of Government. Many start their companies outside Russia and the Government. Science needs investment — this is money spent afterward open only branch offices here. Then they, for example, on future generations. But we need to keep in mind that investing go to Skolkovo to get grants and open a Russian-registered now will pay off only in 15 to 20 years for fundamental science, representative office in order to get residency there. This means and in 5 to 15 years for applied science. Properly conducted that distrust is still a factor. Considering the fact that the Russian research needs patience, and we are short of that. market is as small as it is, about 1%–3% of the global market, I hope the Government will learn to distinguish between “develop” it’s easy to see why start-ups often want to go elsewhere. and “make” — these are two different things. “Developed” things The other big problem is the lack of demand among big players bring more profits than “made” ones. For example, the assembly for innovation companies and their products. There are almost of one iPhone device costs US$5. The entire production cycle cost no acquisitions of Russian innovation companies. Only a few is about US$60 to US$80. But the selling price makes hundreds companies are sold a year and the size of the deals is not so of dollars. Whoever has developed breakthrough products and impressive. The «Big Three» telecommunications and internet has the rights to it gets the biggest pay-off. Where and how the giants prefer to grow with their own research instead of buying product is actually made is not so important — you can set up companies. production anywhere. This is something that our Government still has problems in understanding. We are too used to building When will the corporations turn to the open innovations pipes and factories, with thousands of people going to those model? In five years’ time, at the earliest. competition between factories every day. But the world is changing and we need to turn large Russian and foreign companies might help. Then our our efforts to creating intellectual property and game-changing heavyweights would have to boost growth, and that can be done mechanisms for putting ideas on the market. by buying ready-made, working businesses. Our Government has to pay more attention to the innovation ecosystem. This is Alexander Galitsky, Managing Partner, Almaz Capital
58 | Russian and global venture markets in 2007–13 From my experience of working with start-ups in the Microsoft Seed In recent years, the Russian VC industry has developed as Fund, I can say that, in the last two years, the number of good projects a market — a lot of sellers (entrepreneurs) and buyers (investors) on the market has multiplied in size. And I do not see a lack of good have appeared there. Until 2007, there had only been sporadic pre-seed and seed-stage projects with quality levels sufficient to raise investments, which rarely led to successive rounds and exits. financing. And now, the Russian market is structured according to both entrepreneurs’ activity profiles and specialization of funds by At the same time, the Russian start-up ecosystem is still very young, industry sectors and stages. The market has become more notable and there are certain problems that should disappear in the course from the economic point of view — more than 1,000 entrepreneurs of time. For example, we have an underdeveloped mechanism for have been financed in the last six years and more than 50 funds “entrepreneurial couples” formation. The characteristic feature of have made more than one investment. Russian projects is that they are often created single-handedly, by the technical founder. At the same time, to launch a successful project, Traditionally, in Russia, VC used to go to the IT sector, represented apart from technological expertise, one needs a strong business by the three principal areas of our market: development and sale of component. Foreign projects applying for seed funding, as a rule, software and related services, internet projects with monetization already have an established team of co-founders representing both of via advertising sales, and e-commerce. This trend will continue those components. for at least a few years: the sector has good prospects for development on the local market (revenue growth by 10% to 20% Another specific feature of Russian projects is, in many cases, a vague per year) and serious export potential. Russian IT companies have notion of the niche for one’s product and an absence of feedback from certain competitive strengths on the global market, such as the the market. Very often, start-ups begin product development before quality-to-price ratio of programmers’ services. they talk to their potential customers, and they see no point in such communication. And this situation has to be rectified, because too The Russian VC market is far from saturation. In the US, Europe much effort and energy is put into unwanted products, resulting in and Israel, the number of active funds is significantly higher, as failure and disappointment. well as the volume of capital under their control. The number of funds on the Russian market will increase further, basically Nevertheless, the situation is certainly changing for the better. Serial because of the creation of new funds by managing companies entrepreneurs who have already created and left successful businesses of the first generation. Currently, more than 90% of managing should become the force that will promote ecosystem development. companies have only one fund under their control. The developing They are the best source of expertise on the market, and they can Russian market should reach its crucial point during the period of pass on their experience to the next generation of entrepreneurs. They first exits and the establishment of second- and third-generation have experienced success, the formula of which they can pass on, funds by managing companies. Then, it will be possible to make and mistakes, which they may help to avoid. And, most importantly, a conclusion on the investment results of the funds and the they can serve as angel investors. We have not yet seen a strong efficiency of their managers. supply of such serial entrepreneurs develop in Russia; however, in the foreseeable future, there is a good chance that it will develop as a Alexander Lupachev, Director, result of the recent active development of the ecosystem. Russia Partners Technology Among the positive features of the Russian market, I would also point out a great number of games projects that are quite successful on the global market. Many of the leading global games companies presenting their products on the Microsoft platform are Russian.
Another very important achievement in the last two years is the significant increase in the number of regional projects. While, formerly, the most interesting start-ups originated mainly in Moscow, now there are a lot of good projects from Kazan, Novosibirsk and other cities.
On the whole, the growth of the ecosystem is obvious. And I believe that this success should mainly be credited to the RVC, first and foremost, for the popularization of innovations, the development of the right attitude toward entrepreneurship and for the development of the cultural basis for an innovative ecosystem.
Sergey Yeremin, Managing Director of the Microsoft Seed Fund in Russia
Russian and global venture markets in 2007–13 | 59 In the last few years, investors’ activity in the Russian VC Just seven years ago, there was almost no venture market in market has been principally concentrated around pre-seed and Russia. Leading Russian venture funds were not established, seed-stage VC projects. Over the last few years, the number of there were no experienced management teams, and foreign funds transactions has increased tenfold. The money flow on the market avoided Russia. The market had some stand-alone investors, but has increased, too; this has been mainly directed to the early there were no formalized funds. stages, where entry is easier for a beginning investor. And public In recent years, the venture market has shown considerable funds and development institutions remain the main drivers of growth due to a number of factors. First, leading Russian the VC market in Russia. technology companies, such as Yandex, Mail.ru, Kaspersky Lab, At the same time, there is still a shortage of professional Acronis and Parallels, have been playing a notable role since investment teams. Members of the existing teams are either 2008. It is largely because of these companies that foreign entrepreneurs retrained as investors or specialists who came into investors started to have a different idea of Russia. Practice the VC sector from the direct investments sector. A qualitatively shows that the main income of venture funds is generated by new generation of investors will appear on the market in the next projects with capitalization exceeding US$1b at the moment the 5 to 10 years, as soon as the young professionals grow up. investor exits the project. Venture business is like hunting whales. Currently, Russia has just a few technological companies with In my opinion, the VC sector development requires three key a potential value exceeding US$100b; however, there are already components. The first of these is money. Money supply is the hundreds of them whose potential value might exceed US$1b in responsibility of VC investors and, to a certain extent, the the future. The Russian venture market began to see such growth Government. The second component is people. Responsibility largely because investors realized that the Russian economic for the training of qualified specialists in the most promising environment has technological giants and that more of them will directions lies completely with the Government. The third appear in the future. component is the development of technologies that can be commercialized by start-ups. New technologies may only grow Second, in 2007–08, state initiatives were launched to support out of fundamental science, which is also the responsibility of the innovations, and technologies and entrepreneurship were widely Government, since hardly any private company can afford solid popularized. Another important driver for the venture industry long-term investments in R&D. in Russia was the stability and predictability of its economy. Some five years ago, not all small enterprises could do business As yet, the Russian VC market has only managed to solve the in full compliance with Russian law, and this scared away many problem of money supply. That is why I always say that the most investors. The situation is now improving after the laws were important events in the Russian VC sector in the last two years changed. are the observed practical efforts of the Government to carry out reforms in higher education and academic research. This will give Today, Russia hosts even more venture funds than some Russian specialists an opportunity to retain their competitive European countries do. Competition between the funds makes strength on the global scale and will enable Russian companies some Russian investors pay more attention to projects abroad. I to develop new technologies, not only in the IT sector. This is the believe that, instead of growing, the number of funds will decrease most useful thing that the Government can do to develop the VC in the next few years, and only professional funds capable of sector. attracting new investors will remain in the market.
The small number of exits is not a systemic problem, but the Dmitry Chikhachev, result of the fact that the Russian venture market is quite young. Managing Partner of Runa Capital Funds existing for more than five years already have a positive history of investor exits. After a few years, the younger funds will also have investor exits.
Serguei Beloussov, Senior Founding Partner and Investment Advisor, Runa Capital
60 | Russian and global venture markets in 2007–13 Success stories Success story: NGINX is a high-performance open-source web server powering some of the busiest sites NGINX on the internet. NGINX development has started in 2002 as Igor Sysoev’s hobby project. The first public version was released in 2004. Although the product was not advertised, Investors: by early 2011, NGINX was used on about 7% of the world’s top million sites. Igor believes e.ventures, Runa Capital, MSD Capital, there were three key reasons behind NGINX’s success. It is a free and open source, it helps New Enterprise Associates, Aaron Levie people to resolve common scalability issues, and it is robust and high-quality software. (US$13m in two rounds) While the founder was committed to the open-source nature of the product, there was a certain demand for professional solutions and services from the customers using NGINX Investment result: in production environments. To fulfil the demand, in 2011 NGINX Inc. was incorporated Launch of new products, solutions and and it received US$3m in venture funding from e.ventures, Runa Capital and MSD Capital services, and entering the US market (Michael Dell’s private investment firm). A year later, Gus Robertson, a former Red Hat manager, joined NGINX as CEOCEO. Innovative product: In the third quarter of 2013, NGINX raised US$10m in round B financing backed by A reverse proxy server for a variety of existing investors, along with the New Enterprise Associates fund (NEA), the lead investor protocols, as well as a load balancer, for round B, and Aaron Levie, founder of Box.net. Currently, NGINX Inc. consists of 16 HTTP cache, and a web server with people, split between the engineering team in Moscow and the sales and marketing team in the US. NGINX Inc. offers professional services and has recently released its first a strong focus on high concurrency, commercial product — NGINX+. Currently, the company has more than 100 commercial high performance and low memory customers, including public companies such as Netflix. usage According to the latest W3Tech report, NGINX is currently used by over 36% of the top thousand websites and is the clear leader in this category. NGINX’s open-source users include Facebook, Instagram, Box.net, DropBox, Groupon, Zynga, Wordpress, CloudFlare, Intel, Yandex, VKontakte and Mail.ru. The company estimates that NGINX serves no less than one-third of worldwide internet traffic. Apart from that, NGINX is used by 15% of the top 10 million websites and is currently the second-most popular server after Apache web server.
Russian and global venture markets in 2007–13 | 61 Afterword
The issue of creating an independently developing venture investment sector was resolved in the last few years thanks to the efforts made by the state, private business, RVC and other development institutions. The Russian venture market is growing in volume and quality. Moreover, the key aspects of the venture investment ecosystem were formed in the country. But the most important fact is that private investors, including foreign investors, are sharply stepping up their activity in the market. Obviously, the young and rapidly growing Russian venture investment market still has a few disproportions concerning stages — where capital supply at the seed and pre-seed stages of innovation projects is inadequate — and capital supply is inadequate in most of the priority sectors, except for the internet, e-commerce and telecommunications. Roman Kosyachkov There is also the problem of scale, which applies to not only the venture sector, but to the entire Russian knowledge economy; the share of Chief Strategy Officer, RVC innovation business (products and services) in the country’s overall GDP is still relatively small. In the next few years, the sector’s development will largely be determined by the impact of the efforts made by all parties to the Russian venture investment market. Taking account of the private-public partnership mechanisms, which proved to be effective, it is necessary to harmonize the stage and sector structures of Russia’s venture market and promote its sustained growth and globalization. As a state institution working for the development of the Russian venture sector and the national innovation system, RVC will help attain that aim by using an effective set of financial and non-financial tools designed to support technological entrepreneurship at its early stages and projects realized in the priority sectors, draw Russian and international private capital into Russia’s venture market, improve the market infrastructure, and assist Russian innovation businesses to enter the global market and become integrated into international value chains. The Russian venture investment industry is entering a new phase relating to the transition from the stage of launching the market to its harmonization and growth. RVC is optimistic about the prospects of the Russian venture market, which is growing thanks to the close cooperation and partnership of the government authorities, the development institutions and business representatives, including international business.
62 | Russian and global venture markets in 2007–13 This report has been prepared by EY with the support of RVC Key contributors: EY Russia Vadim Ilyin Partner [email protected] Vadim Balashov Partner [email protected] Vasily Davydov Senior Manager [email protected] Alexey Ivanov Senior Expert [email protected] Elena Skazhenyuk Venture Development Executive [email protected]
EY Israel Itay Zetelny Partner [email protected] Dan Sztybel Manager [email protected] Kamil Gazizov Advisor [email protected] Vesselina Georgieva Business Development [email protected]
In cooperation with:
Russian Venture Capital Associationn www.rvca.ru
RusBase www.rusbase.vc
Russian and global venture markets in 2007–13 | 63 EY | Assurance | Tax | Transactions | Advisory
About EY About RVC EY is a global leader in assurance, tax, transaction and RVC is a government fund of venture capital funds, advisory services. The insights and quality services we a development institute of the Russian Federation, deliver help build trust and confidence in the capital and one of Russia’s key tools in building a national innovation markets and in economies the world over. We develop system. RVC was established by the Russian Government outstanding leaders who team to deliver on our promises in accordance with Order No. 838-r dated 7 June 2006. to all of our stakeholders. In so doing, we play a critical RVC’s authorised capital stands at over 30 billion rubles. role in building a better working world for our people, for It is a wholly owned subsidiary of the Federal Agency for State our clients and for our communities. Property Management (Rosimuschestvo). EY refers to the global organization, and may refer to In 2013, the number of RVC-backed funds reached 13, and one or more, of the member firms of Ernst & Young their total volume, 27.67 billion rubles. RVC’s contribution to Global Limited, each of which is a separate legal entity. these funds exceeded 16.85 billion rubles. The total number Ernst & Young Global Limited, a UK company limited by of companies financed by RVC-backed funds is 144. The guarantee, does not provide services to clients. For more aggregate volume of investments made is 13.29 billion rubles. information about our organization, please visit ey.com.
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