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Slowly but surely... Russian seed investment takes root

0 January 2014

With the help of government stimulus, seed investment is growing in Russia. However, investors tend to be both risk averse and controlling. This infographic, based on RusBase data, portrays the current state of the Russian seed sector. 

Seed investments in IT and telecommunication startups are the most common type of investment worldwide. They are an indicator of how developed a startup economy is and whether a country has a meaningful ‘class’ of independent investors. In terms of seed investment, as of 2011-2013, Russia is only just approaching the levels in Latin-American countries where venture market infrastructure started to appear in the late 90s/early 2000s.  

What is seed investment?

Seed investment investment in a company at a very early stage in its development. Usually there is already an established team around the initiator of the idea, they have started work and begun to address the issue of legal status. During this period the valuation of the company is at its lowest level – abroad IT and telecommunications startups at this stage are rarely valued at more than a few million dollars. In Russia, in a similar scenario, the maximum value of such a project only approaches 2-3 million dollars, and that is after having secured seed investment. Experts interviewed by RusBase noted that the Russian market has elements of both pre-seed as well as classic seed investment. In other words, investors can be very flexible in evaluating both the company itself and their stakes in them.

How it works

The basic characteristic of seed investments is the high risk of default. The means that an investor  is guided by logic; each ruble paid into a company valued at 1 million rubles will eventually after a period of time yield ten rubles, but he can easily make a mistake and lose those rubles, or if he invests in several startups, several tens of roubles. This means that this stage offers the biggest potential payouts but also brings with it the highest risks. 

Abroad seed-stage investors tend to consider the capacity of a project’s target market, necessary spending on product development and its growth potential. They calculate how much it will cost to build a BETA service or to start taking pre-orders, they consider the prospects for cooperation with existing players in the market and whether the project’s existing team is capable of developing the project in the specific length of time required before transition from the early stage to the stage of growth or maturity.

How it works in Russia

Despite the success achieved by seed investors around the world, who buy into a project at a low price, provide enough money to give the project a chance of success and then watch their initial investment multiply many times, Russian investors still tend to think of seed as an “expensive” luxury. Investors invest fairly small amounts by Western standards (about $100-300 thousand, enough to fund an average startup for about a year) in a limited number of projects, expecting to see high growth from their investments in the next round. 

A very small number of Russian funds specialise in seed investment – there are about 7-8 VC funds, as well as 15-20 angel investors. In addition to these there are a number of state-funded development institutions which allocate grants and subsidies to very early stage startups (Bortnik Fund; funds at the Department of Enterprise and Development in Moscow, Kazan, St Petersburg etc.). About $20 million has been invested in more than 60 non-profit organisations and other infrastructure associations in the period since 2010, whereas previously grant support was episodic and meagre. Now they are offered to to virtually everyone that asks and passes a not-very-competitive internal selection process (most state and private grant providers have projects with overlapping profiles in their portfolios).

How things are changing

The total value of seed investments in Russian projects has increased fourfold in the past 2 years – with over 150 teams getting funding in 2013. However, the average size of investment of this sort has almost halved as the number of investors has increased. These investors have sped up the startup life-cycle, and now startups that got funding in 2011/2012 and those funded in 2013 are in a similar place in terms of securing the next round of financing.

The problem of seed investments in Russia is the excessive desire of investors to have control over the startup. The money invested proves very “expensive” for the creators of the project because the investor takes a larger share in the management (30 to 80%), as well as providing a range of services that make the Startup dependent on them (their own mentoring services, providing the infrastructure – the offices, executive staff, client base etc.) that complicate subsequent value-assessments of the business and the finding and procurement of other investors to the project, especially when it concerns foreign funds.

A particularity of Russian investors is the fact that they almost never invest in the idea or prototype stage if they see that there is a high risk to their investment. They are not interested in obtaining a minimal and non-controlling interest in a project whose prospects are not clear enough for them or which are contrary to the existing portfolio of startups or companies that they already own or control. 

The sale of a startup complete with its team to the biggest players in Russia is also unheard of. In the West major companies like Google, Facebook, Microsoft and other successful startups are actively buying projects that have just released product or are still at the prototype stage. In the West these projects are assessed at $5 million to $25 million, but in Russia the founders together with the startup are almost always absorbed by their book value (up to $1 million in the best case). In the West if a project is acquired at an early stage its considered an interesting outcome for investors, in Russia it indicates a failure.

Text by RusBase Analytics

Translated by Sophie Rigby

Top image via Shutterstock

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