Russian VCs Need a New Model
Lawrence Wright, CEO, Xlerate Technologies
A key factor in the success of Russian venture capital funds is the adoption of the right model. So many VCs in Russia today seem to be taking a traditional portfolio management approach to investing. The conventional wisdom of this approach says that 8 out of 10 investments will fail. Using such an approach in Russia may yield even worse results, because quality deal flow is limited and the lack of real business angels in the market force investors to go upstream in the investment pipeline (to seed and start-up projects) in order to source their deals. These same VCs lack the skills and experience to develop the projects they need. But moreover, their basic model is wrong.
Assuming a traditional VC approach, one might even caution entrepreneurs against taking venture capital , for even if they receive venture funding, the VC may quash the innovation process by formalities and an overly eager desire to exit the project. The entrepreneur may become focused on the concerns of the VC instead of the customer. With the traditional approach, VCs may do more harm than good. Thus, there is still an urgent need for bigger and more government programs and private support of early stage companies, in addition to needing more hi-tech entrepreneurs.
What the Angel and Venture industries in Russia need to be successful is a new approach: the “venture entrepreneur.” From world experience we can see that successful venture funds who emphasize value creation over managing a financial portfolio have the possibility of delivering drastically greater returns and a much higher success ratio. The successful experience of BioCapital in Canada demonstrates this approach (37 companies funded, none of which has failed with 25 of these having gone to an IPO). Other examples in my own experience within Russia confirm that this approach is viable in Russia.
But this novel approach requires more work and of a different sort. It takes more entrepreneurial skills and a specialization and depth in terms of market sectors that identify unmet market needs and create the solutions that turns the invention into innovation. It requires more advanced partnering strategies and closel cooperation with beta customers to commercialize technologies. Defining what the value is to be created and how it should be done is the challenge of this new approach.
It’s a common misconception in Russia today that a good invention equals innovation. But innovation refers not the invention itself, but to the process of commercializing the invention.. Thus, in the absence of an established national innovation system, VCs are put in the position of adding greater value to the investment process themselves. For lack an effective innovation support system, investors must fill the niche.
I see enormous innovation potential in Russia, potential that is far greater than a new twist on an existing idea or technology (e.g. FaceBook or YouTube). The impact of Russian invention taken to innovation is world changing and revolutionary. But this innovation is driven by the entrepreneur working with the scientists, not by the scientists alone. It requires an in-depth understanding of the market and potential customers, and the ability to see where the market is going. By focusing on value creation thru innovation over portfolio management, a VC is more likely to develop partnering agreements with industry that will result in new exits opportunities. In this way Russian-based VCs can lead the way in the rebirth of the VC industry, and engender new qualities that have not been the norm heretofore.
Also, when VCs invest in earlier rounds, they must rethink their due diligence process beyond financial and legal reviews, in considering the increased risks. The bulk of the due diligence process in this type of investing in the Russian environment relates to understanding the technologies, the underlying intellectual property, and their market applications. In Russia, more often than not, the IP is not adequately protected or worse. In most cases of Russian hi-tech startups, the target market application and business model are completely wrong. Thus the competencies pertaining to business entrepreneurs more than lawyers should be more sought after by VCs. Too many great Russian technologies are dying on the vine because they have no entrepreneur to evaluate the business potential and develop the business.
VCs should be about investing not only in deals, but in passion, creativity, and in a great new idea. That passion needs to be backed up with expertise that will support the commercialization process and won’t be focused on monetizing the process or formal procedures that defuse the entrepreneurial spirit. VCs should be in the business of value creation and innovation. They will become more effective when they are focused on harnessing the value of novel technologies.
VCs adopting this new approach can become a dynamic and revolutionary force in the new innovation sector that has the possibility of driving Russia’s oil & gas revenues into second place. The venture entrepreneur needs the foresight, passion, and the vision to see how the technology can be shaped into disruptive innovation, or one that significantly changes or advances the market. Russia has the unique opportunity to set a new standard and create a fresh approach to venture investing that considers the unique nature of Russian hi-tech.
Lawrence Wright has been working in the Russian hi-tech sector since 1992, including as a country director of a Fortune 300 IT/technology firm, as the US head of an international R&D foundation, and most recently as the CEO of Xlerate, an innovation and consulting company.