State innovative development institutions in Russia are often criticized for inefficiency. Despite the impressive financial injections, Russia’s venture capital market is not growing fast enough. The Accounts Chamber has not found any positive trends, putting the volume of venture capital investment in Russia at 3% of that in OECD countries. Vadim Veshchezerov, General Director of Iksdaikon LLC, explained to Invest Foresight what is hindering venture capital market development, how difficult it is for an investor to find a really strong high-tech project and how well Russian startups work with corporations; in 2011–2019, he served as Director of Analytics and then as Investment Director at Rusnano Management Company.
— Rusnano is often criticized for ineffective investment. When you worked for the corporation, how much of the portfolio were actually successful projects? Is the criticism deserved?
— About one-third of all Rusnano Group projects were a success. About as many can be viewed both ways: although quite successful technologically, like flexible electronics, those projects barely generated enough returns to cover the costs, which means they were unprofitable from a financial point of view. The remaining part generated losses of various sizes. This is actually a very good result for a venture capital fund, especially given its tight mandate restrictions.
We were limited to the framework set by the state shareholder; a private fund would have been able to act differently in some cases. As a state corporation, we had to keep some of the projects going where a private owner would have abandoned them at an earlier stage for economic reasons. At the same time, a private fund would have invested in a number of projects for financial reasons, while Rusnano could not join them. And there were many such projects.
— Which projects would you describe as the most successful?
— First of all, Novomet, a Russian manufacturer of pumping and downhole equipment for the oil industry. Rusnano joined the project at an early stage, and the corporation’s financial investment and lobbying capacity have definitely contributed to its further success. It is now a super successful company valued at over $1 bln. Incidentally, the business has had two offers from foreign investors, one of them the US company Halliburton. However, the deals never went through for non-economic reasons.
All renewable energy-related projects have been successful, including Hevel, which is the originator of solar energy in Russia. I mean, the results have been quite good for a government venture fund, where financial success is not the only criterion. Then there was Eterno, a project with Chelpipe, to manufacture equipment for the oil industry, where Rusnano’s financial and lobbying contribution was quite significant as well. The Metaclay project was extremely valuable technology-wise and quite profitable, too; it was sold to Gazprom. In Rusnano’s portfolio, the project actually completed the technological chain making pipes for gas transport systems. That was a difficult project where we had to take over management and correct the errors made at the initial stage, and to use our lobbying opportunities, so it ended well for everyone.
— You mentioned projects that were successful technologically, but did not bring much money. Could you give an example?
— Yes, there were several projects that were technologically successful, but with questionable results from the financial perspective. One of them was Mapper – it was bought by ASML after its main investor in Holland died, but a branch of the company remained in Russia and is still operating. Russia had not had that technology before; it does now.
Many recall, with irony, the so-called Chubais’s e-reader by Plastic Logic, a company that develops the plastic electronics technology (used in such devices as flexible displays). Although the company was not financially successful, the technology itself was saved and transferred to Russia. Technology-wise, it was a promising project so the concept was developed into a working solution. Perhaps the company will eventually break even. Its Western investors, including Intel Capital, even thought of shutting down the project. Speaking of venture tech projects, Soft Machine, which worked on boosting microchip productivity, turned out to be technologically successful while being financially mediocre.
— Why didn’t Rusnano invest in all potentially successful projects?
— The corporation’s investment focus is the key. In Russia, venture capital businesses in IT are quite successful but Rusnano did not invest in the sector out of principle. It did not correspond with the mandate and also, there was an understanding that a large state-run fund with numerous restrictions will unlikely be able to successfully compete with private investors. That prevented us from investing in an industry with a potentially efficient outcome and high profitability.
— What did Rusnano focus on?
— Initially, Rusnano worked with the market of hardware startups. This market is more complicated; projects are growing slower and cost more. For an IT project in Russia, $5 mio is a tremendous amount of money. In hardware, anything decent only starts with $5 mio or even $10 mio. I can tell from the project I am developing right now. Moreover, venture capital funds targeting the IT market often act like gold finders and, once they have found a team, they start considering possible relocation to the West.
The same approach does not apply to hardware projects: it is very hard and sometimes impossible to root out founders and rend them away from their scientific school. This is what often discourages Western investors. If before 2014, Rusnano cooperated with the US and Europe more or less successfully and there were even certain agreements regarding joint fund, Crimea closed these opportunities for us. For example, Rusnano and the European Bank for Reconstruction and Development agreed on launching a foundation to invest in hi-tech companies and, despite the fact that Rusnano was not formally under sanctions, the project didn’t work out. It was a blow on Rusnano’s strategy as a corporation and we had to make serious changes.
Shortage of hi-tech projects
— Have you had to deal with any hidden pitfalls when searching for projects?
— For many years, there’s been a myth that our country has plenty of advanced scientists and serious projects and the only thing that the market lacks is money. The government fell for this myth, too, and actually allocated huge funds for the industry and provided it with opportunities to adopt the best practices of Western ventures. However, soon it became clear that finances are the only thing that the country has in abundance. In fact, there was a serious shortage of strong tech projects, including those founded by members of the academia. Yes, there are talented scientists and perhaps they are driving the science forward. Still, there are no projects that we could recommend to investors. Our startup founders – and scientists, in particular – believe that “investor” and “sponsor” are synonyms. The main idea they come with is to raise funding without any obligations or control whatsoever. When you explain that a fund manages somebody else’s money and for every invested ruble they will have to return two rubles plus operating expenses, what you get in return is hatred. This is a common issue, including for scientists. When you try to explain that an investor would love to make some money, too, they shoot you down in flames.
— Did anything like that happen at Rusnano?
— We were showered in hate only because we allegedly didn’t want to finance another genius scientific development. Between 2011 and 2016, there was hardly a day when somebody didn’t report about it. After all, Rusnano is an investment fund rather than a body that finances scientific research, which is directly prohibited by the founders. Rusnano didn’t have public money: the major part of invested funds was attracted from the market, including through major bond-secured loans. Yes, a significant part of the money was attracted using state guarantees but there have not been any defaults on bonds or loans over the entire history of the corporation.
— What else in your opinion stalled the development of the venture capital market?
— Of course, it is not only about the quality of projects or founders, including from the engineering and tech environment. Western venture capital funds prefer dealing with people who have market background and understand how business works. Projects that come to investors are competently structured. Yes, they could be good or bad but in the West, investors almost always invest in a company that can be evaluated using more or less standard methods. In Russia, anyone can apply for investment. It could be a large project that sales internationally; by the way, Rusnano had such a project, Monocrystal (a global leader in manufacturing synthetic sapphires to be used in LEDs, smartphones, tablets and smart watches, camera lenses, fingerprint scanners, displays, etc.). But this is an exception. Imagine a person with three legs, five arms, one eye, six noses and no ears: this is what an average Russian project looks like. Investors have to whip it into shape first by sinking deep into management processes. No Western venture fund is going to do that. In Russia, they have to, otherwise they will be left without projects at all. This is our reality and we have to live with it.
Russian money not valued
— Is investing in projects on foreign markets an option?
— Rusnano had a potentially sensible idea regarding searching for new projects for investment. They suggested looking for them on foreign markets and introducing solutions in Russia afterwards. But this strategy was found ineffective. We are on the other side of the planet and do not really see what is happening in the Valley, and we are very slow. But the main problem is that Russian money is unpopular, even as compared to Arab money. If a project reaches a Russian investor, it means that everyone else, including the Arabs, have rejected it. It is pretty obvious what kind of projects we get. The Chinese had the same problem, but they just threw money at the market and managed to deal with some issues. We could not afford doing the same.
— Did it affect the investment model? Did the corporation find new approaches?
— Yes, we had to admit that no Western-type investment models are possible in Russia. So the painful search began of a more or less working domestic investment model. In some cases, we had to dig deep in management processes and streamline them. Our colleagues are currently using this approach. The second approach was to pick an obviously successful project that would require not the money, but the corporation’s lobbying capacities, or what the West calls “smart money”. For instance, this approach was used with all projects related to wind power. They have become successful as an innovative sector was created in the country from scratch.
— Did all Russian venture capital investors face these problems, not only Rusnano?
— I’d rather speak about a mistake that another wave of innovation investors is making right now. One of the harmful results of the state’s attempt to boost the venture market through financial injections ten years ago was the development of the startup culture. Many still believe for some reason that startups are nothing else than youth entrepreneurship with hipsters, co-livings and fun. But in reality, an average funder in the West is a male aged 40 or even 50 who knows that a co-living is nothing but a communal residence, and working for a startup isn’t all smoothie and co-workings, it’s hard work. They know that this is a long obstacle race. Both the state and private investors must not buy into fancy appearances, for real projects cannot not be found under a streetlight, so to say. The best thing you can find there is yet another IT project.
Working with corporations
— In Russia, it is difficult to both find and exit a project. Why is that a problem?
— It’s all about lack of understanding what large corporations need and how to work with them. First of all, a technology project must be interesting for the production sector, and the first thing to do is to get their opinion. If they want this project, you will receive a powerful ally, and the work will begin immediately. But the first selection must be done, while many venture capital and innovation investors often forget about it. At the same time it is preferable that the project solves a medium level problem for a corporation. Manufacturers have their own main business, they have their own research capacities and R&D facilities; they don’t need anyone else. If you come to Gazprom with a new genius way to produce gas, they will look at you in surprise. But there many tasks at the level of “a stone in the shoe”, so to say, and this is the level of venture capital investors. Why was Rusnano’s deal with Gazprom successful? I think because those two conditions were met. And, of course, the solution you offer must be workable. Many come and ask for money for development. This is not the way to get it.
— Do venture capital investors need to cooperate with corporations?
— Absolutely. If we look at actual Western venture capital investors, they sell the major part of their companies to corporations. When a big corporation wants to buy a project, it is a big deal for a venture capital fund. In fact, they rely on such an outcome. Corporations benefit, too, by obtaining the hi-tech solutions they need.
— Venture capitalists are wary of government money. Is this a problem and what can be done to change it?
— I think this is where Anatoly Chubais’s approach would be helpful. He always insisted that portfolio performance is the key. What does it matter if one of the portfolio projects failed if the fund received $1 bln and paid back $1.5 bln or more? Why should it be a problem? The state should assess a fund and its management company based on the portfolio performance. Of course, there is no point in auditing the fund’s operations every year. With an investment horizon of five to seven years (a shorter period is unrealistic for hardware projects), reviewing a project one year after the investment is a waste of time.
By Olga Blinova