Venture Capital, Russian Style

Russia’s scientific community may have experienced a “brain drain” over the past twenty years but the fundamentals of the famous soviet science are still in place, and Putin’s government is revitalizing science-based industry. Betting on nanotechnology, companies can potentially generate substantial returns. Enter Rusnano, a venture capital fund with plans to become a player in the global capital market.

Created by the Russian government, Rusnano places its capital in companies that occupy the niche of nanotechnology. The firm has invested $6.3 billion in over 100 firms at home and outside of Russia – including the US – and overall manages about $10 billion in funds. After five years of operation, Rusnano has decided to attract private investors by offering equity to the tune of 10% of its shares.

Among large emerging economies – Brazil, Russia, India, China, and South Africa – Russia is still somewhat underexplored and investors remain cautious. However, interest is growing and opportunities are there, especially with the Russian government’s willingness to spend money.

Venture capital is a new territory for this post-Soviet country, with the government being the main strategic investor in tech, life sciences and innovation. The government backs technical incubators, innovative entrepreneurship, and tries to boost various industries and shift Russia’s economy away from its traditional focus of oil and energy.

“You can’t simply jump over the abyss, you need to transition smoothly,” Oleg Kiselev, Rusnano’s Deputy CEO, said in an interview with Forbes. “This private placement is to attract investors to manage on the board level.” He said that by 2015 the ratio of private investments versus government funding will be larger, eventually growing to over 50 percent. Ideally, the company would go public, but this ambition is still far in the future.

“We don’t need just the money,” Kiselev said. “We need knowledge, qualifications, mutual interests.”

Making Science Profitable

Despite the fact that after the collapse of the Soviet Union many scientists and technologists left the country seeking opportunities abroad, Russia still remains strong in scientific education and human potential. The country’s infrastructure, while in need of a makeover, is well developed. Combine this with entrepreneurial spirit, unique research projects and new technologies and you have a breeding ground for potentially profitable companies.

The government’s role in managing the fund is noticeable—although there are no federal ministers on the company’s Board of Directors, there are a number of top executives of state-backed companies, former governmental officials, with only one independent director, billionaire Michael Prokhorov. All main decisions, including the 10% private placement, have to be run by the Board and by the Russian Ministry of Economics.

When Rusnano was formed in 2007 there were few large investors in the life sciences and biotech sectors. A handful of small business that dealt with nanotechnology – the main criteria for investment candidates – applied for funding and, after thorough vetting and long negotiations, received much needed investments.

For instance, when three years ago vacuum coating equipment maker, ESTO-Vacuum, realized that in order to survive in the market it needed to expand, it sought capital from Rusnano. In 2009 it received funds and in two years went from making under $2mln in 2010 to $10 mln in projected earnings for 2012. “With Rusnano we received not just financing, we also got into the right environment, met other successful projects, expanded our regular market,” said Danil Chelapkin, the CEO of ESTO Vacuum.

“We often have to defend Rusnano,” said Igor Pivovarov, the CEO of HemaCore, a company that specializes in thrombodynamics and has developed a test to diagnose blood coagulation disorders. Rusnano has committed to investing $22 mln of total funds, of which HemaCore has received $19mln.

Pivovarov explained that people in Russia are suspicious when a company’s new beginnings come from state-based financing.  “I work with many funds,” Pivovarov said. “Rusnano has tried to do everything right, it’s the only firm that used the best western standards.” Having the government as the main investor brings certain perks, such as connections and being part of a federal strategy, and in some cases the influence to change outdated laws.

Even today, in 2012, the presence of the Soviet past is very powerful everywhere—in the exterior of the buildings where companies now set up shop, in the leftovers of old research labs, in bureaucratic language, and in the antiquated and reserved style of some managers. At the same time, the transition is going at full speed—companies become more transparent, they hire western management and specialists from around the world, embrace an entrepreneurial spirit and shoot for the stars in their effort to make science profitable and elevate homegrown businesses into global companies.

About a year ago, Rusnano started earning dividends from some of its portfolio companies, at the same time making three exits from partner companies. The firm has been transformed from a government structure into a commercial enterprise – into a joint stock company – where the government owns 100% of shares.

Navigating the market

Dmitry Lesenkov, the managing director of Rusnano, has been with the firm since 2008. He described it then as a start up. “At first, it was a government corporation. Confusing, it was not clear who to be friends with,” Lesenkov said. “Now we are a joint stock company, with a potential IPO in the future. Like a growing child who knows where he’s going.”

A few milestones turned Rusnano from being Putin’s pet project into a legitimate player in a larger game. The recent $760 mln partnership with American venture capital firm, Domain Associates, is one of them.

Brian Dovey, a partner of Domain Associates, who broached the idea of a partnership, said he was very impressed with Rusnano’s CEO, Anatoly Chubais.  Both, Rusnano and Domain agreed to contribute $330 mln to finance about 20 health care firms. Part of the deal is to incorporate a “Russian angle”, meaning to market and manufacture products in Russia.

Among the projects that seem to contribute towards Rusnano’s credibility in the international market are Selecta Rus and Bind Rus, two subsidiaries of Boston-based research labs founded by Robert Langer, an American pioneer of new technologies. Bind Rus develops targeted nanomedicine for treating cancer. Selecta is developing synthetically engineered vaccines and immunotherapies with nicotine vaccine among its lead products. Both companies are building four research facilities in Khimki, an area just outside of Moscow, replicating the labs of their partners in Boston.

Robert Rosen, General Director of Selecta RUS, said that Boston Enterprise needs Rusnano because the Russian firm is nano-focused and has the money, while Russia’s government is committed to redeveloping research and medical technologies. “With all the so-called brain drain, the area of polymer chemistry remains strong,” he added. Both Selecta and Bind each received $25 mln in investments and have won tenders from the Russian ministry, receiving more support.

While boosting the nanotechnolgy industry in Russia, Rusnano continues exploring partnerships with the outside world: Virgin Group, owned by British businessman Richard Branson, created a $200 mln fund to finance energy efficiency projects in Russia.

Risk and Rewards

The world’s emerging economies attract a lot of interest from international investors, with their rapid growth and big potential. For companies that are expanding internationally, doing business in all of those countries can pay huge potential dividends. “But there is a certain style, the diplomacy that needs to go with each of those countries”, said Bennedict Willis, the senior floor director for Albert Fried & Company, a financial services firm in New York Stock Exchange.

The idea of creating government venture capital funds to spur innovation is not new—governments of European countries, North America, China and other countries are no strangers to such strategies.  “I don’t know of any country that’s been able to accomplish (a diversification of its economy) without using the government as the tool to propagate that system,” Willis said.

“Bureaucratic processes are longer than in private companies,” Kiselev said. At the same time, being tied to the government comes with substantial benefits. It gives access to large companies like Gazprom, Russia’s railroad, government contracts, and Rusnano’s companies could potentially use connections to broker good distribution deals.

Such benefits also present a certain risk. “The question is how is the government going to be maintained and sustained,” said Willis. “We’ve seen the change from Mr. Putin to one of his nominees back to Mr. Putin.” According to Willis, for investors the concern is the future evolution of the Russian government and the impact it will have on businesses and possible change of contracts.

“From the American perspective, we don’t necessarily believe (Russia) is as open and honest a partner as some of the other economies in the world.” But it’s still a significant economy, Willis added.

When Domain Associates decided to do business with Russians, it took some time to get to know each other and develop the necessary trust and understanding. The contract was in negotiation for over two years until both parties finally felt like their interests were legally protected. Dovey said he was not overly concerned about the risks often mentioned when working with Russia, such as the government taking his investment away. “It’s only about $400 mln. That’s a small amount to be dishonest,” he said. “If you pick somebody as a partner, I’d rather pick the government.” Dovey said that there is always a risk: “If you are afraid of stuff like that, don’t leave Philadelphia.”

Willis thinks that it is possible for a Russian venture capital firm, fully funded by the government, to get about 50% of private capital. “Do I think this can happen? Absolutely,” he said, but it requires rebranding. “People with this firm are going to take a very close look, in terms of how they’d be able to sell to the outside world.”

Rusnano is aware of the importance of maintaining a good record and tries to operate the western way—adopting western business style, networks, and creating partnerships.

“We would like to overcome the attitude towards us, and our attitude towards Americans,” Kiselev said. But the change, he said, is not possible only on Rusnano’s level, it eventually would be the result of various interactions between people.

Dovey, of Domain Associates, sees Russia as an interesting – and potentially lucrative – market, growing rapidly. “People would say: ‘Oh my god, you are doing something in Russia,’” he said. “You really need to upgrade yourself. Things are overheated in China, and Russia is under-discovered.”

“I don’t think doing business with Russia is as risky as with China,” Willis added, “In China it’s riskier.”

Reporting in Russia for this article was made possible by Rusnano and the Open Innovations Forum in Moscow 

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