About startups "with us" and "with them": personal experience
Presumption of success
Notes of a technology startup
about the venture capital industry – Russian and WesternDmitry Klimov, General Director of Stereonic LLC
By world standards, I am a startup with very little experience: I graduated from MIPT in 2006, worked in fundamental science in the field of elementary particle physics, bioinformatics and materials science, I have been working closely on my startup project "Fluorescent Nanoscope" for about five years. The main developer is my father, who has been conducting research on this scientific topic for about forty years. (Andrey Klimov, Candidate of Biological Sciences, Senior Researcher at the Institute of Theoretical and Experimental Biophysics of the Russian Academy of Sciences.)
The project claiming to revolutionize microscopy became the winner of BIT-2008 – VM
Over the past few years, we have made good progress in patenting the development (we received the second patent in the USA – the "umbrella" one just the other day), but not enough in commercialization. Some foreign competitors who started later than us have already managed to enter the market with best-selling products and the brightest prospects, but we have not.
At the same time, we have the right team: the project is assisted by entrepreneurs with experience in conducting global innovative business, who have already "pulled" new products from the laboratory to the market and brought their sales to the level of several million dollars a year. Our project managed to "cook" in the right places: So far we have become the only Russian finalist of the world's largest business accelerator MassChallenge (Boston, USA) and a finalist of the Startup Sauna accelerator (Espoo, Finland).
None of the above has helped us to attract significant funding in Russia so far.
I dare say it's not just about ourselves, but also about external, purely Russian factors. I know quite a lot of Russian startups that have similar problems, so I will allow myself a few generalizing observations – without the goal of blaming or justifying anyone.
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With the exception of IT projects, all technology startups require significant capital investments. Of course, they can be developed "organically", without external financing, but it will take, say, twenty years (competitors will overtake for sure!). Therefore, the ability to make applications for grants or investments is one of the most important competencies of a technology entrepreneur.
I know from my own experience: in Russia, writing a grant application in its entirety usually requires one or two months of work; its volume is usually several hundred pages, including appendices. This is a scientific and technical justification, a calendar plan, an estimate, a draft state contract, tax certificates, etc. The process of printing, signing and stitching the application alone takes a whole day! And it should be delivered on paper. Therefore, when you see the restrictions that are initially put forward in similar cases in the United States ("the volume of the application should not exceed 20 pages" and "submission is carried out only through an online form"), you fall into emotion. You are even more touched when you hear a European professor complaining that he needs to report on a grant of 15 million euros, "and the bureaucrats are completely arrogant: they demand 80 pages!" Or when a young man who decided that he was an entrepreneur comes almost from the street to the Finnish VTT research Institute - and after after a short conversation, he receives 15 thousand euros "to work out a business concept" of one of the institute's developments.
Obtaining private investments, as a rule, requires even more effort: nevertheless, people risk not with state funds, which still need to be spent by the end of the year, but with their own blood! Although in terms of private investment, everything depends very much on both the project and the investor.
A textbook fact from the history of American business: a startup called Intel started with a business plan consisting of three - not even pages – paragraphs! The plan ended with the words: "It is assumed that many of the customers will be located outside of California." Of course, the founders of Intel, who came from the legendary company Fairchild Semiconductors (a pioneer in the field of silicon integrated circuits), could write much more in the business plan: they had no experience in business and technological developments. But even these few paragraphs were enough for them to receive from the investor the $ 2.5 million needed to start. So, you say, it was a distant 1968?
There are plenty of examples of the informal and non-bureaucratic approach of American investors to startups even now. The famous American investor and entrepreneur John Landry, head of Lead Dog Ventures, speaking to us during the MassChallenge in Boston, told a story from personal experience – "about the most disgusting deal in life," as he called it. Some time ago, after a joint business breakfast, he wrote a check for $ 300 thousand to two innovators with a "bare" idea of a new website, who had no experience in either development or business. As a result, the project "shot", and six months later the company has already attracted almost $10 million of investments with a very high valuation of the founders' share. The only thing Landry regretted afterwards was that he gave the money not in exchange for shares, but in the form of a kind of loan (more precisely, convertible notes). I could have become the owner of 20-30% of a fast–growing company, and just multiplied my investments by just a few percent.
The same light stroke of the pen received money and the guys who had not yet fledged Sergey Brin and Larry Page, who wrote the Google search engine, and many others. This is not exactly the norm, but it is quite a frequent phenomenon.
Is it easier to part with money in America because there are a lot of them there? No, it's more like something else…
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The heads of venture funds in the United States and Western Europe with whom I have had the opportunity to communicate are mostly former serial technology entrepreneurs who have gone through fire, water and copper pipes, who have personally grown more than one company to a capitalization of tens, hundreds of millions and even billions of dollars. Or, alternatively, people from the top management of large high-tech companies - with the highest level of expertise both in business and in the technological direction, which is a priority for the investments of the fund headed by them. Employees of the fund's management company – the so–called general partner - as a rule have a reputation, an investor's flair based on personal experience, and a great credit of trust from the "limited partners", whose money makes up the bulk of the fund. Such people usually perfectly understand the situation of high uncertainty in which any technology startup exists, they know that its success requires a successful combination of many circumstances, only part of which can be managed. They understand the principle: "Investing money in a startup is already a risk. Don't aggravate it, don't stop people from working!"
In Russian venture funds, everything is completely different. With rare exceptions, the top management of the domestic venture industry is represented by two categories of managers. The first is former investment bankers and business consultants who have never personally reached any heights in the field of entrepreneurship – at best they stood next to each other and therefore now know how to reason intelligently and intelligently. The second one comes from the scientific and technological community, who are well versed in technical nuances, but understand little about business, especially startup business. Both categories are also characterized by deep unjustified pessimism. These people often believe that the startup they are dealing with is doomed to failure in advance. Former investment bankers – because they know: according to statistics, one out of ten "shoots", and scientists – because they themselves once failed to realize their entrepreneurial potential.
Hence the sad consequence: these people can be arbitrarily experienced in their field, reasonable and pleasant in communication, but with a very high degree of probability their reaction to the challenges that the company they invested will face will be far from adequate. They did not walk on the rake, they are not characterized by managerial and behavioral patterns related to startups. And the patterns adopted in established business or in science absolutely do not work here.
Add to this the fact that the capital of a significant part of Russian venture funds is somehow formed with the participation of public funds and that fund managers, of course, understand the "full measure of responsibility" associated with this. In addition, our management companies are often "conditionally private" (many are divisions of state–owned companies like VTB, Gazprom, VEB, etc.) - which means that two swords of damocles hang over the managers at once. Naturally, this does not have the best effect on the speed of decision-making and does not contribute to the removal of internal bureaucracy.
That's why it's difficult to speak the same language with our venture capitalists when discussing a project. You start telling them about disruptive innovation, about the fact that your project can "shoot" and bring billions, or it can die on the vine.
Disruptive – "destructive", "subversive". In the theory and practice of venture investment, this is what technology is called, which destroys the existing market of goods or services and creates a fundamentally new one.
And they, wanting to cover themselves with the maximum amount of papers, in response to you: "We read your business plan and did not understand what kind of IRR you will still have" (internal rate of return - internal rate of return). During the time I spent in foreign business accelerators, I don't think I've ever heard this abbreviation. This is probably the last thing that a qualified venture investor will be interested in there. Because trying to answer this question is akin to fortune-telling on coffee grounds. If a startup is lucky enough to receive funds from such a fund, it should be prepared for the fact that literally every penny, every purchased fountain pen, will be checked by specially trained supervisors.
There is certainly logic in the actions of Russian venture fund managers. JSC RUSNANO, by its mandate, can finance only very technologically advanced and very mature companies. And it's not his fault that there are no such companies in Russia. RVC funds are aimed at an earlier stage, and Skolkovo – in general, as if for a sowing campaign. But they all walk under the watchful eye of the inspection bodies and have a number of restrictions that do not allow them to act truly effectively. I liked the wording of one guru on this topic: "There are stupid projects, and there are not stupid ones. There are no projects at too early a stage." But only a select few can afford such an approach – those who have a lot of money, and the mandate allows them to take the most outlandish steps.
In addition, alas, there is no pronounced layer of business angels in Russia. There are a quarter of a million of them in the USA. These are people with high incomes who are ready to risk their money and invest it in a high-tech business. As a matter of fact, they do not invest so much: often only from 3 to 25 thousand dollars. But if 10-20 business angels are going to a project, this is already strength!
In Russia, any business, apparently, is already high-risk, so most private investors are simply not ready to add technological risks to the risks of doing business. The stimulation of private investment in the technology sector in Russia occurs mainly through financial instruments (co–financing), and not through the write-off of part of the tax base (and moreover with a multiplier), as is done in many countries - therefore, it is still more profitable to invest in real estate and trade: there are fewer risks, and profitability is all it is still high. So, choosing between venture and non-venture, most investors prefer to make a decision in favor of the latter.
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Over the years of startup work, I have managed to communicate with many Russian venture investors – with almost all major funds, associations of business angels and intermediaries in this market. Summing up the experience of my own and my colleagues, I can say: a Russian venture investor is very often unshakably convinced of his a priori superiority over a startup. Sometimes it is justified, but more often it is not. And this is already bad, because it creates a conflict situation when a startup knows for sure that he is right and understands where to lead the project, and the investor is trying to prove that since he has money, it means that he is in charge here and decides everything.
There is also a fashion among Russian investors to additionally wind up a whole bunch of requirements to the terms of an investment transaction. These conditions are often such that an entrepreneur, accepting investments, in fact, signs up for a long hard labor – hard low-paid work with a very modest reward at the end, even if the project is successful. Why this is being done is completely unclear. As in the old joke about monkeys who were doused with cold water from a hose: "It's customary here!" What things can be called typical? Firstly, the investor often insists that it is he who will appoint the majority of the members of the board of directors – regardless of his share in the authorized (share) capital. Secondly, he does not like to transfer money in a single tranche, preferring to do it fractional – almost monthly – depending on the achievement or non-achievement of the agreed goals. Thirdly, the investor says: "I will give you $2 million: 100 thousand today and another 1.9 million – my option to buy out your share at a pre-agreed estimate, and I can exercise this option within three years at any time." Fourth, the investor stipulates for himself a number of privileges, which, in fact, give him the opportunity to do almost anything with both the management of the company and the distribution of shares in it.
In principle, these conditions are already enough to turn virtually any startup into a living corpse with a high probability: the primacy of the investor in the board of directors leads to delays in resolving operational issues, the breakdown into tranches demotivates employees (no one knows if he will have a job tomorrow – and everyone "looks to the side"), and an option is from the field of "promising does not mean getting married." Moreover, the essence of the option is not even a "promise", but "an investor's expression of an assumption about the possibility of getting married someday" – with the condition that the startup, in turn, will be obliged to "get married" on demand. And this is regardless of where the investor will wear during the entire term of the option and how successfully the company will develop, deprived of "investor affection".
In addition to all this, many Russian investors also gravitate towards obtaining a controlling (50%+1) or supercontrolling (75%+1) stake in the enterprise. Although, it would seem, why? They already hold the entrepreneur by all the strings. Let's think about the future of such a startup – for example, about the moment when you need to attract another investor. I can assure you: with such a "fellow traveler" in one "boat" few people will want to sit down.
It is because of such a bouquet of conditions that a startup at the time of negotiations with a potential investor should generally discuss the issues of pre‑investment evaluation of the company and its share in the business only in the very last place. It is more important to focus on ensuring that the necessary amount is transferred to the startup within a clearly stipulated period, so that the backbone of the company remains in control of corporate governance and that the company's employees have considerable freedom of action (not contrary to business ethics and the criminal code, of course).
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Technology startups are mostly big enthusiasts and for the sake of implementing an idea, they are often ready to agree with the most draconian requirements. But this does not save the project from destructive actions on the part of the Russian investor, who often does not understand the logic of creating a technology company from scratch.
I will give a typical example from the life of real startups. My friends, entrepreneurs from the field of high technology, a few years ago got an investor from the sphere of the oligarchy (mining, of course). What happened from their union? Shortly after the start, the investor began chronically delaying the next tranches. He was provided with enough formal reasons for this, since it is difficult to clearly link the progress of R&D with any schedule. The project became feverish: entrepreneurs were forced to disband or hire employees, the enthusiasm of developers began to fade, the costs of designing and maintaining extremely complex high-tech production equipment increased significantly. As a result, the investor invested two or three times less funds than agreed, and for twice as long.
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By and large, the Russian venture industry has so far borrowed from the Western one only the conceptual apparatus, institutions and procedures, but not the business culture, spirit and atmosphere of mutual support. A typical situation: an investor is interested in your project and offers to sign a so-called exclusivity agreement for a period of three months. A Western venture investor needs such a period to conduct a scientific and technical examination, audit, evaluation of the company and make a final decision. He demands three-month exclusivity because he wants to be sure that after spending money on all these events, he will not hear from a technology entrepreneur: "Sorry, I changed my mind: here other investors around the corner offer twice the best conditions!" In fact, quite often the deal is "closed" (that is, they sign a contract and transfer money) in just two months. Of course, usually a fairly significant penalty is prescribed in the exclusivity agreement, which the entrepreneur will have to pay if he refuses the conditions agreed in advance. In addition, the reputational costs of a startup for violating such an agreement are very high.
The majority of Russian venture funds, as it seems to me, require an exclusivity agreement for something else entirely. Namely, in order to keep a promising project on a leash while the gears of their own internal bureaucracy are slowly scrolling. It doesn't even come to audits and examinations during this time. Many funds with state participation do not even have a budget line for carrying out all these procedures! Or, for their initiation, a decision of the board of directors is required, which meets God forbid once every three months. A typical real-life situation: immediately after signing an exclusivity agreement, a large Russian venture fund may, for example, simply stop responding to letters and calls or give some other signs of life. And this despite the fact that he does not promise to invest at all: he only expresses a desire to consider the project in detail! For a startup, this means one thing – a loss of pace. Time goes by, and the startup does not even have the opportunity to continue negotiating with other potential investors while the first one leads him so "exclusively" by the nose. If you talk like this with three or four foundations, it's been a year already!
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Our reality has recently revealed another national phenomenon. It has become fashionable to be a venture investor in Russia. Is it any wonder that a whole layer of people who call themselves investors has appeared solely in order to "please the girls". These poor souls have no sums behind their souls that they really wanted and could invest. But the "girls" like it. Not so much for startups. Usually these guys type a "portfolio of projects" and then strut around other investors, telling them how deeply they have studied "their" startups and why it is an ideal investment. Of course, not for free, but with the expectation of a commission of 5-10% of the invested amount or a share in the company. By the way, in many US states such intermediary activity is called financial brokerage and requires a corresponding license. There, such an "investor" working without a license faces criminal liability. We don't. Probably, that is why recently in Russia it has been increasingly heard about ugly stories when such intermediaries "threw" partners for considerable sums. For startups, of course, this situation is also unpleasant. Therefore, I can advise fellow startups to figure out in advance whether they have a real investor in front of them or not. "Citizens! Beware of fake Christmas tree toys! They look like real ones, but there is no pleasure!"
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I had the opportunity to compare the venture culture of Russia, the USA, Finland and Israel. I had assumed before that it wasn't very great with us, but I understood exactly how much only by contrast. Take the American Boston: 250 thousand students per 6 million population, research centers of the largest high-tech companies, two leading universities in the world – the Massachusetts Institute of Technology and Harvard (each budget is comparable to the budget of the Russian Academy of Sciences). Finland, the birthplace of Nokia, is the world leader in the share of engineers, significantly ahead of the rest of Europe in terms of venture financing per capita. Israel is a byword, a "technological boiler" – a country that consistently holds, despite its modest size, the second place in the number of companies whose shares are traded on NASDAQ.
High startup activity in all these clusters is a derivative not only of the money that is in the venture "turnover", but also of a special business culture. Business leaders here, including billionaires, for some reason find time to condescend to an unfamiliar startup and take a lively part in its fate, despite the obvious employment. For example, by suggesting who you can contact next, and giving an appropriate recommendation. Characteristically, at the same time, they do not ask for "five percent of the volume of a future investment transaction" for the exchange of business cards, which is what gentlemen from some Russian business angel associations traditionally start a conversation with (at the same time, these gentlemen usually find it difficult to explain what exactly they are going to do for this reward - not counting the exchange of business cards). Venture capitalists who manage funds with a capitalization of many hundreds of millions of dollars do not behave like celestial beings in the West, and it is really possible to arrange a meeting with them in a few days. Financial support for start–up businesses here is the lot not only of the state with its special programs (for example, in Finland – a million euros at 2-5% per annum for 2-5 years with a refund only in case of success of the project under which the loan is taken, and not in case of success of the entire company as a whole), but also a large stratum of individuals – including in the form of donations. And university professors are willing to invest in technology startups of their own students and graduates: with a personal annual income of $150,000, this is at least possible – not like in our universities. Isn't this the best investor for high-tech at the seed stage!
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What to do? Probably, the system needs to change. Russian venture funds should start working in conditions of less centralization and greater freedom. Gradually, the concept of "presumption of innocence" should appear in an investment transaction: if a technology startup and an investor make every effort to make a project happen, but it still fails, this should not become the final collapse of a career, fate, reputation or - God forbid! – a reason for criminal prosecution (venture has the right to make a mistake!). And I think I know what it takes. It is necessary that a truly private capital, and not quasi-public money, still takes the main share in venture capital turnover. There is a lot of talk about the notorious "demand for innovation" – but it is also desirable to adopt a tax system that will stimulate investments in high-tech more than investments in resource extraction. Moreover, both investments within the corporation and financing of startups. Then, quite quickly, a sufficient layer of people with a sound venture biography will appear – which means that new sound startups will arise.
Portal "Eternal youth" http://vechnayamolodost.ru19.04.2012