Oleg Kouzbit, Online News Managing Editor
In its integration into global business Russia has had to learn the entirely new concept of business angel investment. To most Russians, the closest idea to a business angel is ďa patronĒ or ďa philanthropistĒ, but the differences are sharper than they look. Who are they Ė Russian business angels? What role do they play in the contemporary Russian economy? How do these new entrepreneurs relate to broader investment communities? Marchmont Capital Partners CEO Kendrick D. White gives us his insight.
The concept of ďbusiness angelĒ is fairly new to Russia and its markets. What is the difference between Russian angels and more experienced international business angels?
Russian business angels do not always know they are business angels. They do not know necessarily what their role is. Usually what Iíve seen is that Russian business angels are self-made entrepreneurs with a science background. They left their fields of expertise 15 to 20 years ago to go into business and make money. They were very often successful because they were very clever. They went into some trading, manufacturing, distribution business or something like that. But then, overtime, they started to support their friends from universities and academies they had graduated from, which had projects in science. They kept some personal interest in those. And because they were wealthy entrepreneurs themselves, they began to support those projects with their own money.
In my mind, that makes them a business angel. But itís different from the kind of a professional American business angel. Very often in the U. S. business angels might belong to some club and have some structure. Here that structure is just forming because the rules of the game are not clear here. They are clearer in America because thereíve already been several generations of business angels. More than 50-60 years of history of business angels working with startups and venture capital in the United States, and the whole cycle of investment. Thereís more experience on the part of business angels in the U. S. and thereís more of an understanding that not only do business angels provide money, and not only do they provide experience and advice, but they have an obligation to maintain their own reputation. Because usually a business angel will invest in more than one project and therefore, if they are going to be able to do future projects, they should be very ethically careful with the current projects they are working on.
So the rules of the game are very clear for Western business angels. Here you could have a ďwhiteĒ business angel, which is very good-natured, honest and helpful, and you could have a bad business angel here who could basically invest in a technology in order to take it away from the innovator.
In my opinion, the way to fix this is to develop a network of business angel clubs around the country, which tie different business angels together and, more importantly, tie them together collectively. If one member of a club begins to do things in an unethical way, it will have negative implications for other members of the club, and therefore the other members will self-regulate all members of the club.
It is extremely important. You canít make any regulatory law about this kind of informal structure, so it should be self-regulated. People should regulate themselves in order to improve their reputation and thereby attract more projects. From this structure will develop more experience, and after that thereíll be a better set of rules of the game for independent angels or groups of angels or different levels of angels.
If you look at any particular innovation cluster in the United States like Silicon Valley or Silicon Alley, you will find dozens of clubs and you will also find dozens, if not hundreds, of individual investors who are business angels at all levels, and they mix completely. So here you have to develop a foundation first, develop the rules of the game, develop the code of ethics for business angels, and then the system will develop and regulate itself.
What sectors of the Russian economy could produce the most interesting projects today? What are the ďpillars of successĒ for projects given the peculiarities of Russian business and the economy as a whole?
I think today the IT sector is most interesting as it is most liquid and it is the easiest for angel investors to see the exit for themselves: you can develop a project and sell it very quickly.
I think the difficulty of the securing of intellectual property makes it difficult to develop other sectors of technology in Russia. And I think the peculiarity is that the other sectors of Russiaís innovation economy are even much more attractive than IT. Biotechnology, nanotechnology, all sorts of areas in material sciences and others are extremely attractive with long history of experience in Russia. But these sectors were closed to private investors. They werenít easy to work in, and they also have a longer period of time to develop. And therefore their holding period, the amount of time the investor in going to invest in this project and support it is much longer and the risk is much higher. But at the same time the reward can be much higher in the long run.
So I think that Russia has a scientific base which is very diverse and wide and deep. But itís very hard for investors to go into those other sectors because they werenít always open to them. The laboratories were government-controlled; the institutes and the academies were government-controlled. Therefore the intellectual property and all the technology belonged to the government. And private investors saw no potential for profit and could not find the way to develop these projects.
I think legislation is required, which allows the institutes and the academies to secure the intellectual property within that institute and then allow investors and business angels and innovators to develop private companies, which can then have a clear ownership structure of the intellectual property. And that will attract investors into those institutions. Prime Minister Putin is strongly supportive of a bill put forward in May by the RF Ministry of Education regarding the setup of innovation firms within educational establishments, and President Medvedev supports Minister Fursenko as well. Unfortunately, the Duma rejected the legislation at the first reading. The reason is that the Ministry of Finance is deeply opposed to this legislation. They are afraid that the money from the federal government will go into these and then escape out of the institutes. So they have legitimate and understandable concerns, but Medvedev called the Duma back and said, ďYou must finish this legislation. We insist. The President wants this approved and the Prime Minister wants this approved.Ē So they have to address the concerns of the Ministry of Finance and must get this legislation approved. Itís critical for Russiaís development.
What will be the criteria for selecting and analyzing Russian projects?
For business angels the criteria are to find a revolutionary new technology, to my mind. Not evolutionary but revolutionary. What I look for as a business angel are projects that will change the world and address macroeconomic global problems. The fight against global warming; the fight against AIDS; the fight against impure water; the fight to improve productivity of global food production; how to create more efficient forms of an engine.
The combustion engine has dominated the industrial society for a hundred years. Why donít we create a new version of an engine, which does not require so much energy? How about creating lighter metals to use for automobiles, which will make the car much lighter and therefore use ten times less energy to be moving?
What I look for in a technology is something that is going to revolutionize a particular sector and have a global impact. Therefore, if I invest a hundred thousand dollars in that project, in ten years I might be returned a hundred million. I want that jackpot project. Thatís what every angel investor wants to be a part of. They want to identify a really interesting innovator thatís come up with a super-interesting project and technology that can change the world, and they want to work with that innovator to give him the money he needs to realize that dream. And in this case for the angel investors itís a satisfying thing that others will use their money to create something that will improve the planet.
What do you think will be approximate timeframes for investing in Russiaís hi-tech projects? Tentative paybacks? Timeframes for companiesí growth given the current market situation?
If Iím going to look into IT projects, I want a two or three year exit strategy. If Iím going to look at something more hi-tech, like nanotechnologies or other areas, I would be looking for five to seven years. And if Iím looking at biotechnologies or other more advanced areas, I would probably think of seven to ten years. It depends on the level of technology. Generally, the higher the level of technology and the more radically the technology can change the world, the longer your holding period.
Please assess the overall potential of the Russian market for fast-growing hi-tech companies?
I think the potential is tremendous in Russia. Unfortunately, there are a lot of administrative barriers to achieving this growth potential. It has to do with intellectual property; it has to do with lack of experience; it has to do with the high level of risk associated with investing in technology and the long holding period compared to previously investing in Russiaís stock or real estate market.
As long as there are super-profits to be made in relatively mature markets, the rational wealthy investor will put the money into projects that will give the highest return in a shortest period of time. But just as privatization in Russia had a beginning and had an end, and the real estate boom had a beginning and has an end, the crisis has had a beginning and will have an end. Ultimately Russia will develop a relatively mature, Western-style economy. In this situation the last horizon for a wealthy individual to make super-profit is high technology and venture capital investment.
So investors will ultimately turn to this sector in Russia, and this will be an innovation economy driven by hi-tech. I believe it with all of my heart.
Are Russian entrepreneurs willing and ready to participate in promoting Russiaís hi-tech companies? Or do you think startups need to rely on international capital?
I believe Russian entrepreneurs are already starting to support hi-tech. Just as I said earlier, I firmly believe there are Russian business angel investors out there supporting their personal friendsí projects; they are supporting their universities, institutes or academies they graduated from. And they do not really understand that they are a new generation of business angels. But they are supporting Russian technology with all the capital they have.
The problem is that they donít have enough capital to bring the projects to commercialization alone. They need the next level of venture investor. Todayís business angels donít have experience in how to prepare the company for venture capital investment from a professional fund. So, not only do they lack personal finance to take companies to that level, but they also lack the knowledge to get the companies ready for big VC funds to see the potential in startups.
VC funds can be Russian or foreign, it doesnít matter. There are lots of VC funds now. Thereís the Russian Tech Tour coming to Russia and bringing 50 or 60 European venture capital funds to look at projects here. And what they want to look at are projects that have Russian business angel investors in them already. Because if thereís a business angel investor, then very often the risk is lower as someone with money and business experience has helped this project.
The problem is that a Russian business angel doesnít always know how to create a proper financial model or a business plan, and therefore they donít exactly know and they donít have experience working with a VC investor. Thatís the missing link right now. The Russian business angel investor needs to understand how to present their projects to the next level of venture investor. Because they themselves cannot have enough money to go to the next level of production, or expand from unit production to series production where investments required are not tens of thousands or even hundreds of thousands but several millions of dollars. In that case you need a VC fund and thatís a professional investor, but an investment proposal should be clearly prepared in a professional way so that the fund can assess this projectís commercial viability.
This article is also published in an abridged form in a September issue of the MICEXís Exchange Review business journal