What you should know before entering the Russian market

By Victor Orlovski, Fort Ross Ventures

As the ninth largest population in the world, Russia is home to a budding and dynamic tech scene. Moscow was ranked as the No. 2 city for fastest-growing private companies, and St. Petersburg was cited as the ninth best city for fast-growth firms according to last year’s Inc. 5000 Europe list.

After hitting a peak in 2012, when U.S. VCs backed nearly 50 rounds for Russia-based startups, there were many years of stagnation for the venture market in Russia. There’s been a gradual change in investor sentiment, however, as transactions have trended upwards in recent years. Transactions amounted to $243.7 million in 2017, a 48 percent increase over the previous year, according to a published survey from PricewaterhouseCoopers and the Russian Venture Company.

Investments from institutions like Sberbank (Russia’s largest bank), Yandex (Russia’s internet giant), Mail.ru (another Russian internet giant) and others are attracting more international startups from all over the world.

Uber was very active in Russia before the merger with Yandex Taxi. Airbnb offers accommodations from Vladivostok to Sochi. And U.S. investors, including Kleiner Perkins, Accel, Founders Fund and Intel Capital, all have invested in startups out of Russia.

Russia is no longer just an emerging economy promising great potential for investors.

But before deciding on any investment, there are key factors to consider. Let’s explore a few reasons why Russia is an attractive opportunity for firms, and a few reasons that might give entrepreneurs and investors some pause.

First, let’s examine some of the more compelling reasons to invest:

1. The Russian market has more than 100 million internet users. Russia’s people are the most active internet users among all EU nations and internet infrastructure is extraordinarily good (98 percent mobile internet penetration). Yet competition isn’t pervasive and advertising budgets are affordable. You may spend a fraction of the acquisition cost you would have in the U.S., EU or China with an equally large and loyal user base in return. The Russian market is prime for early-stage investing, with the average size deal at $1.5 million in 2017. Given these conditions, there’s a good chance that if a company is widely successful in Russia, it will be well equipped to scale internationally in global markets.
2. Skilled workforce in Russia is a fraction of Silicon Valley salaries. Talent may be as much as five times cheaper to hire; a good developer in Russia from a top-tech university and five plus years’ experience would cost about $50,000 a year, while a colleague at Apple would make more than $250,000. In addition, Russian developers are highly skilled since they have a very deep understanding of math and a great knowledge of theory in physics, chemistry and biology. Generally speaking, they are also very loyal and tend to have a “stickiness” factor for employers. Once hired they tend to work for a company for many years.
3. Russia offers lower tax rates and a lot of flexibility on the legal side. The national tax rate in Russia is around 24 percent (although regional states may elect to decrease the rate up to 4 percent) compared to the U.S.’s 35 percent tax rate. Russia’s regulatory and legislative environment is one of the most adaptive and fastest developing in the world. From drones in the air to autonomous vehicles on the roads and biotests in the labs, the regulatory approval process is much easier in Russia.

There are also areas of concern that may be a barrier to entry for some investors:

1. Intellectual property regulation (IPR) isn’t the same in Russia. IPR is protected differently in Russia than in the U.S., so it’s important to understand this and have an overall strategy. In 2018, Russia remained on the Special 301 Priority Watch List, a report on countries that engage in substantial intellectual property rights (IPR) violations and the U.S. Government cannot enforce rights on behalf of private individuals in Russia. In order to be enforced under Russian law, IPR must be registered (trademarks with the Federal Service for Intellectual Property and patents recorded in the Russian Federal Customs Service’s IPR Register). While there are steps to ensure portfolio companies won’t fall victim to infringements and face replicated counterfeits in Russia, firms have no guarantee, so that risk must be factored in to any investment. However, it’s also important to keep in mind this issue isn’t an isolated to Russia. Just look to China where IP theft is happening every day.
2. There are limited exit routes in Russia. Exit opportunities are not as efficient as in the U.S. given that global players still have limited interest in investing in Russia. And it’s even more difficult to IPO. The lack of exit routes creates some liquidity risks for investors, so be prepared to expect longer return delays compared to a U.S. startup investment.

Why invest now?

While many investors are weary because of the geopolitical climate, now is a good time to invest in Russia. The economy is seeing modest growth with GDP surpassing expectations in 2018. Forecasted growth of 1.2 percent in 2019 and 1.8 percent in 2020/2021 are in line with Russia’s overall potential growth of about 1.5 percent, according to the World Bank’s latest Russia Economic Report.

The biggest opportunity seems to be that the Russian market continues to be overlooked. VCs looking for a competitive advantage in the market should strike now.

Raising your profile now could lead to high-potential investment opportunities that others won’t even be aware of. If cross-border investments are in your scope, I recommend a visit to Russia.

Victor Orlovski is managing partner and founder of Fort Ross Ventures, a venture firm aiming to bring more U.S. startups to Russia. Successful Fort Ross investments have included Uber and Dynamic Yield, recently acquired by McDonald’s. Contact him at victor@fortross.vc.