What the West needs to know about Russia’s tech scene

Nick Davidov is the Investment Director at iTech Capital and Managing Director of The Pult Group.

For many investors and entrepreneurs in the West, doing business in Russia can seem like a step into the unknown. However, these fears are largely unfounded.

Within the Russian tech sector, the differences in business practices between the West and East are growing rapidly smaller. With a little knowledge of some of the key cultural differences and unique properties of the local tech scene, Russia can easily become one of the most attractive tech markets in the world for investors.

Russia in numbers

To fully grasp the size of the opportunity Russia offers, let’s start by looking at the numbers.

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Russia currently has the largest online market in Europe. The latest estimates put the number of Russians online at 66 million, with growth expected to continue by around 15 to 20 percent year-on-year up until 2018.

As is the case in other countries with a relatively new, rapidly growing tech sector, e-commerce is Russia’s fastest growing vertical. This growth is reflected in investor sentiment; according to RusBase, in December e-commerce businesses accounted for the largest growth in VC deals, with an increase of 33 percent.

This was closely followed by software, multimedia and games, which all grew at 22 percent. The FinTech sector also saw substantial growth at 12 percent.

Of course, Russian VC funds are far fewer in number and smaller in size than their counterparts in the US and UK. There are only around 50 major funds and anything over $10 million is considered to be at the top end of the deal scale.

Russian angel investors also invest, on average, $50,000 to $200,000. That is five to ten times less than the average investment in the US.

However, in terms of the complexity of deal making and buoyancy of the Russian VC market, there is little to differentiate it from the West. One only has to look at some of the recent successful exits of several Russian VC firms.

One of the most recent success story is the IPO of QIWI plc on the NASDAQ in May 2013. QIWI plc is the largest Russian operator of electronic payment systems and was founded by a group of iTech Capital LPs. Since the date of the IPO, the company has tripled in size.

Entrepreneurs should be aware that in relation to securing investment, the cultural rules are pretty much the same as in the UK or US. VCs attend tech events, receive pitches and consider investments largely in the same manner as in other mature markets. There is no secret Russian handshake that lands a deal.

It is also worth noting that the laws which govern the tech sector, although less developed than the West, will eventually offer the same level of protection and clarity as in the EU. Last year, the Government adopted important regulations covering anti-piracy and online payments.

The role of the Russian Government

Much of the slack at seed stage funding is taken up by the Russian state. In sharp contrast to the US and UK governments, in 2013, the Russian Government provided around 38 percent of seed deals and 24 percent of startup stage funding.

The investments were predominately in more technical segments that find it difficult to attract private investors such as biotech, and industrial technology.

The principle behind this active role is that the state can help to foster public-private partnerships which will then in turn support domestic innovation. These partnerships are ideal for helping high risk projects receive serious capital at an early stage, especially as private investors are more willing to commit funds when the state acts as a guarantor.

For example, one of the priorities of Internet Initiatives Development Fund (IIDF) is to provide financial and expert support to startups in their early development stage. The IIDF also plans to launch a variety of educational programs and to perform a number of legislative initiatives.

These steps will help to increase transparency and ensure effective cooperation between entrepreneurs, investors, and state agencies in the field of venture capital investments in Russian online projects. The IIDF’s plan is to provide support to more than 400 startups in Russia within three years.

In a similar vein, the Russian Venture Company is a government fund of funds, and a development institution. It is one of the Russian Government’s key tools focused on building a national innovation system. This includes 15 funds of totaling $750 million, and has several direct and joint investments in both Russia and the US.

Russian tech: Sectors to watch

While e-commerce may be the dominant tech segment at present, other verticals such as online and mobile advertising are making waves far beyond Russia’s borders.

Specialist companies have grown exponentially in recent years, creating products with the reach and complexity to rival anything produced in the West. The reason Russia has produced dominate local players is a combination of strong indigenous tech talent, national pride, flexible labour laws and a solid funding base, which has allowed companies to scale quickly.

Western entrepreneurs and investors should also look closely at the statistics underpinning the Russian tech scene. Key performance indicators are low when compared to the UK.

For example, mobile internet penetration currently stands at 34 percent in Russia, only 8 percent behind the UK and 11 percent behind the US.

Crucially, according to Advertology.RU, the value of the market is much lower: $35 million per annum compared to $1.1 billion in the UK and $5.5 billion in the US.

This reveals not only the growing ubiquity of the mobile market, but the potential value the sector has to realise. There is plenty of room for growth for the current players in the market and plenty of capacity for new businesses to try their hand at launching innovative products.

What does the future hold?

Looking ahead, the biggest challenge facing the Russian tech and VC scene is adapting to the speed at which the market is changing.

The industry is quite young by Western standards and is having to quickly scale and adjust to rapidly changing consumer demand and expectations. With this in mind, the best course of action for an entrepreneur or VC seeking to enter the market is to initially seek local advice and if possible, a local partnership.

The potential the Russian tech market offers is impossible to ignore and it is far from an alien environment. Indeed, the similarities between the West and East far outweigh the differences.

The perception that Russia is a riddle is outdated, and as the tech scene develops, it will rapidly converge with the West and become an even more inviting prospect to Western entrepreneurs and investors.