In Russia, startups need angels, not bodyguards — and now they may get them

Several proven Russian entrepreneurs have formed what looks to be the first promising seed-stage venture capital firm in Russia, called Runa Capital.

This is a significant development for the country, even if the sums involved are relatively small: The firm announced this week it has already raised $30 million and plans to raise more. The news is encouraging because the fund will provide the advice traditional angel investors in Silicon Valley have provided over the years: like how to rent an office, who to hire, and how to pay them.

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Last month, I wrote that if you’re hoping to invest in Russia, you may want to hire a bodyguard and lay low. Russia’s lack of a rule of law and scant experience with capitalism has tragically set it behind many other countries.

But I also wrote that things are changing for the good, albeit gradually: The Russian government is slowly tackling corruption and thuggery; it’s investing in high-tech startups may start to diversify the economy away from its reliance on oil; and President Dmitry Medvedev is encouraging moves to bolster the legal system and business culture that could spark revival in all other parts of its economy and society.

Russia’s size and wealth in both natural and human resources (thousands of scientists and science students) holds huge potential for investors. Right now, though, many sorts of businesses are vulnerable to shakedowns. While things have gotten more secure recently, hiring bodyguards to keep executives secure has been common in the past. But when angels — wealthy, independent individuals with an enthusiasm for entrepreneurship — start providing a different kind of protection, Russia could become very interesting very quickly.

Runa’s launch comes amidst another important change. This week, Russia announced it would sell start selling off more state property, in what is reportedly the largest privatization program there since the post-Communist sell-off in the 1990s. The government will sell minority stakes in 11 companies, from its national oil company, to state banks, and a company controlling hydroelectric dams. It’s not a tech boom by any means, but it will reverse the wave of nationalization over the past decade. More important, because new investors typically demand accountability in return for their investment, they’ll bring more transparency to these companies. This, in turn, will reduce corruption — something both U.S. and other investors have been lobbying for.

In my piece last month, I wrote it would take years for Russia to become interesting for outside investors. However, if they move carefully, laying down roots now may actually be smart for those with high tolerance for risk. Venture investments typically take years to nurture anyway. We’re seeing that now in China, for example, where IDG’s Patrick McGovern is reaping the benefits of that country’s growth, after about three decades of patient investing.

There are other signs that Russians are starting to protest endemic corruption. Take the brave police officer Aleksei Dymovsky who stunned the country when he posted two videos on YouTube appealing to Russia’s prime minister Putin about the rampant corruption in the police force, and begged him to explain what he was doing to stop it. The videos, uploaded in November, have been viewed millions of times. Of course, he was fired from his job, and thrown in jail, and continues to be harassed with relative impunity, the New York Times reported in a story this week about Dymovsky. Questions do remain about Dymovsky’s character and motives, and there’s clearly been no mass uprising against police. But he’s since been joined by a handful of others calling for drastic reform, including a politician within Putin’s party, Andrei Makarov.

What do these bigger trends have to do with small fry like Runa? There are a few early-stage venture funds in Russia, but most of them are run by investors with little experience. There’s also Troika, a venture effort led mainly by one individual within a much larger investment banking operation. The emergence of firms like Runa is a crucial bolstering of Russia’s move to an entrepreneur-oriented economy.

The fund is led by credible folks like Serguei Beloussov, founder and chairman of Parallels, the early virtualization company and one of only 10 or so homegrown Russian tech companies whose annual revenues have exceeded $100 million. He’s joined by Alexander Galitsky, one of the earliest venture capitalists in Russia, and a founder of Almaz Capital, arguably the most credible early- to mid-stage venture firm there.

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The fund will focus on software and Internet companies, and also focus on specific areas like cloud computing, machine learning, virtualization, and mobile. Runcap will limit its investments to $1.5 million into each company, and will invest mainly in pre-revenue companies or even ones that haven’t formed their teams yet. It will invest in Russia and neighboring Ukraine.

I interviewed both Beloussov and Galitsky during my visit to Russia two months ago. They both seem to be in the business for the right reasons: They love entrepreneurship, and they’re also realistic. While the overall return on investment in percentage terms can be high in early stage investing, it almost always yields smaller overall returns in absolute dollars than does later stage investing. Beloussov says he’s ok with that, saying it is more fun. The later stage you invest in, the more money you make, but the less fun it is, he said.

Beloussov also says Russia is a much safer place than I depicted it in my original piece. High-tech, web-oriented businesses, the kind he invests in, are largely virtual. Without big physical infrastructure for corrupt “fire departments” to inspect, they can often escape the scrutiny of graft-minded officials. But another reason is because these businesses are puny compared to Russia’s trillion-dollar oil and gas businesses. Hermitage Capital, an investor in the energy sector, now operates outside of Russia. In 2008, it claimed it was the victim of a $367 million fraud. The company continues to release new facts based in its own investigation. Despite the melodramatic tone of these recently released videos they’re worth watching.

So yes, while you may need to hire a bodyguard to invest in some traditional, money-soaked sectors like oil and gas, you don’t actually have to hire security to invest in technology startups. You do, however, need some lawyers. And that brings us to the real challenge for firms like Runa.

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According to Runa’s Beloussov, it’s not corruption that stands in the way of Russian startup success as much as other Russian weaknesses. For example, his firm wants to help the Russian startups think globally early on, because Russians have tended to be slow on that front. Runa is seeking to work with other venture firms, including in the US, to join Runa in investments, to compensate for the relative lack of venture capital there. Investing in early-stage Russian companies has been extremely difficult for US firms. It entails several hundred thousand dollars in transaction costs, and that’s on top of the already risky proposition of investing in a pre-revenue project. Traveling to Russia requires getting a visa. The legal and business framework in Russia can be daunting for foreign investors doing due diligence on companies, and hiring international lawyers is a must.

The firm is also seeking to build a business incubator called Runapark, where companies can grow, get mentorship and network all in the same place — though Runa is still discussing ways to finance that project with its limited partners. Such an incubator is important because even basic things like renting office space are hard to do in Russia. And because Russian entrepreneurs are largely first-timers and have few role models in business in general, they need more help to sort through Russia’s bureaucracy.

The fund is also considering investing in start-up efforts that get backing from Russian government’s ambitious Skolkovo project, the multi-billion dollar plan to create a Silicon Valley-like high technology incubator city on the edge of Moscow.

Runa Capital’s venture partners, who will help the firm source its deals, also include Andreas Gauger and Achim Weiss, co-founders of 1&1, a major hosting provider based in Germany, Ilya Zubarev, who was co-founder together with Beloussov of another company, Acronis, and Igor Borovikov, founder of the largest Russian software distributors Softline, which does about $400 million in revenue.

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[Photo credit: Downtown Pictures, Flickr]