Mobilizing $$ from Wealthy Families in Peru (& L. America). And Why Family $ is Not Angel $—Day #3 in Lima, Peru

Entrepreneurs’ most frequent complaint is how challenging it is to raise money, especially risk capital: founders in developing countries have even more difficulty since the amounts of venture money for investment in most emerging countries is less vs. the USA.

Yet with the millions invested in food & beverage, fast moving consumer goods, retailing, wholesaling, and construction to name a few in the developing world, why does so little of this money flow to tech enterprises—from Peru to Paraguay to the Philippines, Beirut to Buenos Aires to Bangalore—or from Moscow to Manila to Mexico City? One reason is the mismatch between risks sold enthusiastically by entrepreneurs and risks willingly purchased by investors.

Investors are as frustrated as you are—having the means to invest for impact, but not presented with the right venture capital, corporate governance and tech business model solutions required to open their wallets.

On Day #3 in Lima, I met with five of the wealthiest families in Peru—discuss solutions, business models and financial instruments to unleash capital for innovation, 1st time entrepreneurs and early stage SMEs. The business interests of these families range from construction to real estate, insurance, banking and financial services, consumer segments like food to clothing to entertainment, mining/minerals and agriculture—mainstream sectors of economic growth in Peru, and sectors which are heavy users of technology.

Much to my surprise, each family had made small investments in tech start-ups and learned that angel investing is not for them.  It’s not that the investment went bad (some did, others performed well), it’s that they are not organized nor structured to invest and manage angel investments. I’ve found this to be true of family wealth in other countries too, Russia, Kazakhstan, Croatia, Slovakia, Slovenia, S. Africa, Kenya & Tanzania as well.

A better instrument for domestic capital is investment in structures like funds—committing capital in bigger chunks, divorced from making individual investment decisions, and the management of a portfolio of young companies.  They want and seek to be ‘active’ investing sponsors by opening their networks and contacts to drive the revenues forward.  Yet in some countries and legal regimes, such direct involvement violates the principles of limited liability in LLPs, and puts families at risk greater than just the capital invested in a fund.

It’s critical that the fund invest in markets which wealthy families know, understand & where they can add value—how to enter a customer segment, secure a beachhead and execute, recruit ‘friends’ to help open doors, when to zig and when to zag as examples.  It’s not technology which frightens domestic wealth so much as it is markets targeted for new innovation and customers’ willingness to adopt untested solutions. Fund managers must finance {and entrepreneurs must create} business models/tech products for industries where local wealth made their billions, sectors like fishing and farming, oil/gas & minerals, retailing, banking and financial services as examples—industries which they have deep understanding of to help achieve positive investment outcomes.

So for example, look closely at industries at the foundation of economic growth in L. America, sectors in need of solutions to drive them forward in the 21st century. One Columbian start-up took such an approach to successfully raise money.

This start-up inserts RFID chips into cows.  The chip sends a signal to a receiver on the neck of a bull with a ‘damaged’ penis.  The bull chases the cows, but can’t copulate.  Columbian ranchers can now easily identify cows in heat for insemination.  This start-up is now deploying its solutions beyond Columbia to ranches and haciendas in L. America.

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If wealthy families are not angel investors in L. American, who are?  Besides the normal cast of characters like other entrepreneurs and accelerators, I have two specific suggestions for you:

1. Seek capital from general partners and senior managers of private equity (PE) funds investing in your country, not money from the funds they work for.

I met such guys from international, regional and Peru-specific funds with offices in Lima, Bogota, Buenos Aires and San Paulo.  These general partners have the personal cash and net worth to invest as angels or in angel syndicates.  They possess the skills and experiences to make such investments and manage a small portfolio + access co-investment networks.  Some of these angel investments will ‘grow up’ to be investment opportunities for their PE funds.

Yet when I asked these PE managers how many seed investments they made in emerging growth SMEs, their answer was none—because entrepreneurs had not approached them & entrepreneurial support organizations like accelerators and incubators had not engaged them!?

2. Corporations—and I don’t mean attempting to convince corporates to create internal venture funds as multinationals like Intel, Siemens, Shell Oil, etc., have done. 

Instead create business models which support the industry restructuring efforts of domestic corporates. Let me give you an example.

Peruvian insurance companies are purchasing hospitals and clinics—a counter intuitive strategic initiative to their core business. Yet these insurers are doing so to improve the delivery and quality of health care services to citizens in Peru—a logical and rational strategy to reduce health care claims—thereby increasing profits of insurers. Certainly much of the innovation implemented to accomplish this objective will be foreign tech purchased from giants like General Electric, Siemens and Philips as examples.  But plenty of room exists for Peruvian entrepreneurs to clone & localize health care business models from the West & the East + innovate new solutions for the genetic specifics of Peruvian citizens.

******

Plenty of domestic $$ exists to finance all the innovation and entrepreneurs in all developing countries.  Domestic wealth has more intense personal interests vs. other sources of capital in alleviating poverty, creating jobs/new wealth in the local economy. And families make investment decisions faster vs. alternative sources of money.

Yet they are as frustrated as you arehaving the capital to invest for impact, but not presented with the right venture, investment and tech business models required to open their pocketbookssolutions which must match their behavior to risk.

 

 

Part V: Scaling Up Investment—Finance the Startup of Start-up Communities

In Part V, subjects discussed:

1.)   For Entrepreneurs—What are You Selling to Investors?

2.)   For Investors—Let’s Be Realistic

3.)   For Governments/Development Finance Institutions—Atypical Leadership Needed

4.)   Concluding Remarks

5.)   My Next Blog Series—Mobilize Local Capital to Finance Your Dreams

6.)   About Me

7.)   Links: Evolution of Runet (Russia Internet) & the Russia Tech Scene

Last time in Part IV, the Quest for Growth, I discussed:

1.)   Clonentrepreneurship or Alternative Paths to the Start-up of Start-up Communities?

2.)   Change the Culture & Amazing Things Happen

Read Part IV here.

The ‘take-away from Part IV.

Clonentrepreneurs sensitize local investors to the rewards of investing in technology since clones match the behavior of local investors to risk. As results are achieved and money is made by all, investors open up to new investment opportunities a bit more adventuresome and innovative—disruptive vs. cloning.

Cloning and Clonentrepreneurship is one strategy to impact the DNA of local investors in emerging countries to spark the startup of start-up communities, but of course others exist.

What are the other actions which each you can take to achieve your objectives and fuel the startup of start-up communities?

For Entrepreneurs—What Are You Selling to Investors?

Entrepreneurs raising money too often attempt to shape investor risk behavior to their investment opportunity. Instead, shape your business model to match the needs of not only your customers but investors too.  Think creatively to find the solution which your customers will pay for—no matter how little the revenue is per customer—to craft your business model to match investors’ DNA to risk.  Design your business model and its execution to systematically attack each of their fears to early stage tech deals.

Once you have this business model executed with paying customers, approach investors by ‘selling risk, then opportunity,’ i.e., demonstrate how you’ve eliminated risk in each of the four categories to prove your great investment opportunity. Once you raise money, execute yes but also pay forward in your start-up community; be the role model to other entrepreneurs, teach/mentor them in the solutions which you executed to overcome the fears of local investors in emerging markets.

For Local Investors—Let’s Be Realistic

Rarely will Western clones match the big returns as your investments in telecomm, real estate, construction, food/beverages, fast moving consumer goods, wholesaling and retailing have performed.  Yet as the economy in your country progresses and incomes grow, populations and enterprises open their pocketbooks to products and services which better match changing needs. 

In the Chinese online travel industry for example, Ctrip and eLong have millions of registered users. Entrepreneurs seeking money to compete against them is risky and uncertain; however opportunities exist for unorthodox business models. For example, Chinese company Qunar is a travel search engine for online travel services. It aggregates travel information like air tickets, hotels and holiday offerings so Chinese consumers can make better and more informed travel decisions. Qunar serves the evolving needs of consumers and achieves success by approaching the market differently by making competitors—its partners.

Tell entrepreneurs your needs for business models which generate revenues in the immediate term; postpone your demands for immediate profits and cash distributions. Be creative in deal structuring and flexible to valuations since tech business models scale better across customers and geographies to justify higher prices paid vs. investments in brick and mortar.

Structure the investment agreement to align and incentivize entrepreneurs to your attitudes and behaviors to risk.  Oh, how does that work? An example:

American investor financings typically include an equity option plan for founders and employees.  In some emerging countries, legislation permits the issuing of equity options to management of start-ups. When permissible, distribute equity shares based on revenues realized vs. traditional metrics like length of time served in the company or # of users engaged. If legislation does not permit this action, structure the investment agreement as equity earn-ins held in escrow with shares issued when agreed-upon metrics are achieved.

For Governments/Development Finance Institutions—Atypical Leadership Needed

Governments and their finance institutions conceive venture initiatives to catalyze venture funds, to finance the startup of start-up communities.  Frequently these funds are modeled to the program called Yozma, the Israel Government’s fund-of?funds.

Yozma was capitalized with $100 million; $80 million which financed new VC funds with $20 million for direct investment into Israeli tech SMEs.  It invested $8 million into a private VC fund with a minimum of $12 million/fund invested by Israeli and foreign venture capitalists. Yozma financed ten VC funds with a total capitalization exceeding $200 million. These funds went on to finance innovative companies and spur the development of the high tech SME and VC industry in Israel, where one did not exist before. Fast forward 10 years and the 10 funds supported by Yozma were managing over $3+billion with the VC industry in Israel managing $10+billion.

Yozma-type schemes offer economic incentives to induce investment and build learning experiences in seed and early stage tech investing such as:

1.)   Commit up to 49% of the capital to the creation of a new VC fund

2.)   Offer preferential returns to investors

3.)   Take 1st losses on failed investments

4.)   Cap financial returns to the Government so as to boost profits to investors

5.)   Subsidize management fees &/or pay the costs of investment due diligence

6.)   Allow private investors to ‘buy-out’ the Government’s equity, usually within the 1st five years of fund operation, at cost + a bank interest rate of return

Yozma worked exceedingly well in Israel and a few industrial nations.[1]  But results in China, Russia, Chile, and other emerging countries has not been so spectacular; local investors didn’t respond in the #s or volume of investments in the seed and early stage sector as expected and targeted by sponsoring governments.[2] 

Hmmmm. Reality sets-in as staffers scramble for new solutions and a chair before the music stops.  “Let’s try something different.”

When domestic capital does not change its risk behavior to seed/early stage tech, government staffers work vigorously to create a new class of investor—angels—since their risk behavior better matches the profile of entrepreneurial ventures. While angel investors are welcome in all countries, developing this community takes years to accomplish with multiple false starts and entrepreneurs seeking money now going unfunded.

Hmmmm—let’s rethink what the initiatives should be.”

Plenty of money exists in the pocketbooks of local investors in emerging markets to finance start-ups for a start-up community to emerge.  What’s required is the unlocking and mobilizing of local capital for investment in technology, 1st time entrepreneurs and early stage tech SMEs. Certainly encouraging a cloning strategy in the entrepreneurial community is one solution to unleashing local capital as the successes of Russian clonentrepreneurs proved. 

Another solution is to think forward—design venture schemes which better match local investors’ behavior to risk and the mentoring of local investors in early stage tech investment. Include in this mentoring ‘show & tell’ sessions of other financing solutions: royalty based or technology performance financing schemes, i.e., capital invested in technology SMEs with investment returns generated from the cost savings and/or revenue enhancement earned by customers.

What else might you do, say with founders and management teams?

Organize a mentoring program; get them the mentors they need to ‘shape’ early stage tech business models to the risk attitudes & behaviors of local investors + ‘sell risk, then opportunity.’ Until investors can understand and ‘buy’ the risk in start-ups & early stage SMEs in the emerging markets, little capital will flow to them.

But what can you do if you seek to do something more ambitious, i.e., generate knowledge creation to disrupt industries and attract local investors for the needed finance?  Deal flow funds are one solution to attack both needs.

Deal flow funds finance entrepreneurs and SMEs executing to a single technology, product or service platform, technical challenges that require new thinking in science and engineering to accomplish.  What might be an example of technical challenges in need of solutions?  Take a look at these slides which tell this story.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

A ‘deal flow’ fund finances technology development and commercialization.  And in Russia for example, development of the Shtokman field is a national priority of the Russian Government, not only because of its wealth potential but also the promise of new economic prosperity to the Russia Far North.  The linking of technology to a country’s national priority helps assure local financiers that innovators deploying the tech have a market and paying customers.  It’s this matching of tech solutions to customers which harmonize the risk behavior of local investors to the risks of start-ups and early stage SMEs.

 

Concluding Remarks

Emerging markets face huge obstacles in finding talent, capital, knowledge, and yes, the business models which match the risk appetite of local investors.

Clones are one solution to spark the startup of a start-up community since they generate the revenues which local investors demand as a precondition for investment.  As Clonentrepreneurs achieve success, it encourages others to try entrepreneurship too.  Some are a bit more venturesome and launch improvements to models cloned from the West.  Others do something different and inject their own notions of creativity by innovating new solutions layered on top of Western platforms like Russian beta-stage start-up ClipClock is doing to YouTube or IVI.ru is doing in the Russian video streaming industry.

And isn’t that what we want?

More entrepreneurs driving business and economic growth, irrespective of the business model or the platform technology. We all want more investment, more initiative and more conversation with more saying “I can do that” and “I can invest too.” Such actions generate the growth, the economic opportunities for citizens, and the prosperity that all countries, regions, cities and towns desperately seek.

A Future Blog Series: Mobilize Local Capital to Finance Your Dreams

This is one of the topics I mentored 80 entrepreneurs from 36 countries—at Singularity University, located in the heart of Silicon Valley.  These entrepreneurs learned about exponential technologies to solve global challenges, and my job was to work with them—selecting ideas, developing and shaping business models to investors’ behavior to risk.

I was one of approximately 16 or so team project advisors selected from around the world to mentor these entrepreneurs at Singularity University, created by x-Prize Foundation founder/CEO Peter Diamandis and inventor, entrepreneur and futurist Ray Kurzweil.

Till then, be well and be lucky


[1] For explanation why Yozma worked great in Israel and not so well in emerging countries, see ‘The GoForward Plan to Scaling Up Innovation, page 4 (English). For my Russian readers, go to ‘The GoForward Plan to Scaling Up Innovation,’ by Thomas D. Nastas, June/July 2007, Russian edition, Harvard Business Review.  Hungarian readers go to October 2007 ‘Scaling-Up the Innovation Ecosystem,’ Hungarian edition, Harvard Business Review; Sept. 200. Spanish readers go to ‘Innovation for Growth,’ Latin America edition, Harvard Business Review

[2] For explanation, how local investors in emerging market typically behave-invest, when managing Yozma-type schemes, see slides 50-68, ‘Bridging the Valley of Death,’ presentation of Thomas Nastas to staff of the World Bank & IFC, 29 November 2011

About Me

I am a venture and private equity investor since 1986, financing university tech in Michigan with liquidity events including Neogen (NEOG: NASDAQ), AISI Inc. (acquired by ESI, ESIO: NASDAQ, USA) & Personal Bibliographic Systems (acquired by Thompson Financial, NYSE: TRI) as examples.  An entrepreneur myself, I left Michigan in 1992, created int’l and emerging market funds in Africa, Canada, Europe, Kazakhstan and Russia, for ROI & economic development, i.e., >$300 million invested to advance entrepreneurship, innovation and growth in int’l and emerging market countries.  I am past/current Independent Director, Board of Directors of eighteen (18) companies over the past 25 years, USA & international enterprises.

I can work with you in four ways.

1. As an investor advising LPs and GPs in your country for emerging market investment, create venture initiatives (+ raise capital). I invested my own capital + established and managed cash flow, venture, private equity and fund-of-funds as shown in the1st picture below. The 2nd picture shows the deal structures and strategies executed to localize money for investment in each country and to match local investors’ behavior to risk.

2.  As an advisor to Governments & development finance institutions.

  • Design & execute venture initiatives: My clients include Development Bank of Canada, European Commission, European Bank of Reconstruction & Development, IFC/World Bank, Russian Venture Company, Govts of Slovakia, Croatia and the US Govt’s USAID—create, startup, finance & execute:
    • Venture capital funds
    • Venture lending funds
    • Private equity funds
    • Royalty based & cash flow funds
    • Fund-of-funds
  • Design & execute grant schemes—to advance tech dev. thru commercialization:  With six other directors, I manage the $85 million technology commercialization project in Kazakhstan, making grants to finance and advance science from proof-of-concept thru 1stcommercialization.
    • We established the policies/procedures for grant investment, criteria, tender & selection process including all documentation for program execution
    • Selected & committed $22.5 million to 21 development stage SMEs and R&D groups in 2011 & 2012, average grant ?$1MM
    • I lead the creation of 1st technology commercialization office in Kazakhstan, to transfer Kazakhstan tech to market.  I established strategy, programs, key performance metrics, deliverables and all tasks for commercialization & execution-budget is $2.8 million, staffing of four international experts + five Kazaks.
  • Design & execute int’l—cross border tech transfer & commercialization initiatives:  Conceive programs and connect—Russian Corporation of Nanotechnology (Rusnano)—& int’l organizations
    • Created project to establish technology proof-of-concept tech dev. & commercialization program between Rusnano & tech transfer offices of US universities (e.g., Colorado, Utah & Michigan). I established the trust and confidence in the parties to negotiate & secure signed agreements

3.  As an entrepreneur mentoring founders & entrepreneurs as an Independent Director, member of the Board of Directors or member of the Advisory Committee.  I established legal entities, hired & managed staff in Africa, Canada, Europe, Kazakhstan and Russia, all costs of market entry and operation financed by me. Living, working and      investing in these counties—paying the bills too—developed in me the experiences to counsel:

  • Founders of mid-size companies, revenues to $100 million, solutions to integrate their firms into global markets, harmonize products/services & the organization for this global expansion, raise int’l capital and build the 2nd tier layer of management for execution
  • Entrepreneurs of early stage companies, my contributions include conceive/negotiate partnerships for 1st commercialization, raise 2nd round VC financing, ‘shape’ business models to the risk profile and behavior of local money in the country, mentor/counsel management team in growth & development

My other contributions to global entrepreneurship:

4.  As a thought leader & advocate of VC, entrepreneurship and innovation to solve global challenges, I conceive and deliver keynote talks and Master Classes to engage stakeholders with the ability, interest and resources to finance technology commercialization and early stage venture capital.  View my publictions which spread ideas—solutions to create more investment, innovation and entrepreneurship.

Let’s engage, how make an impact, make money and have fun. Contact me at Tom@IVIpe.com. Learn more at Scaling Up Innovation.

Links: Evolution of Runet (Russia Internet) & the Russia Tech Scene

Top 10 Web Start-up CEOs in Russia, 2011

Top 10 Russian Web Startups of 2011

Top 30 Russian Internet Companies (Forbes, 2011)

Top 10 start-ups of 2009

Top 10 Internet Entrepreneurs, 2009

Top 10 Internet CEOs in Russia

Top 10 Russian Venture Capital Internet Investors 2009

Top 10 Russian Web Startups, 2008

Top 10 Russian Web Apps & Sites, 2007

http://www.eddy.lt/2011/12/10-must-know-facts-about-russian.html#!/2011/12/10-must-know-facts-about-russian.html

http://goaleurope.com/2012/04/21/eastern-europe-weekly-news-from-eastern-europe-baltics-russia-ukraine-and-poland/

http://thenextweb.com/russia/2012/04/19/skolkovo-stimulating-russias-it-industry-by-spending-stupid-money-smartly/

http://thenextweb.com/russia/2012/04/20/already-europes-largest-internet-market-and-still-growing-astoundingly-fast-russia-by-the-numbers/

http://thenextweb.com/russia/

http://www.marchmontnews.com/Archive/News/18636.html

 

 

 

 

 

 

 

 

Part IV: The Quest for Growth—the Startup of Start-up Communities

(Nastas note to readers:  From 6-22 August I was in Silicon Valley, mentoring 80 entrepreneurs from 36 countries on selecting, developing and shaping their business models to investors’ behavior to risk as I discuss in this blog series.  I was one of approximately 15-16 team project advisors selected from around the world to serve in this capacity at Singularity University, created by x-Prize Foundation founder Peter Diamandis and futurist Ray Kurzweil.  Click on the icon below to view the presentation.

Subjects in this Part IV post include:

1.)   Clonentrepreneurship or Alternative Paths to the Startup of Start-up Communities?

2.)   Change the Culture & Amazing Things Happen

In Part III, the Power of Clones, subjects presented:

1.)   Drive Growth and Innovation in the Supply Chain

2.)   Sidestep the Obstacles that Impede Scaling Up

3.)   Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start-Up?

4.)   The Spread of Clonentrepreneurship

Read Part III here.

Read Part II

Read Part I

Read Introduction (to the series)

The ‘take-away from Part III.

Cloning and Clonentrepreneurship is belittled since many criticize it as being incremental and not creative, a waste of time, money and energy.  While cloning is neither gamechanging nor disruptive, the results it achieves to drive forward more entrepreneurship and investment validates its contribution to the startup of start-up communities around the world.

Given the contributions of clones to spark the startup of start-up communities, are they a panacea to growth? Do alternatives exist in the quest for growth? And what lessons can we apply from clones and Clonentrepreneurship to impact investor DNA for more seed and early stage investment?

Clonentrepreneurship or Alternative Paths to the Startup of Start-up Communities?

Brazil and China like Russia are large population countries with a growing middle class that is ripe for more consumer-facing clones, clonentrepreneurs and Clonentrepreneurship.  Certainly the selective transfer of some cloned business models to low-medium population countries like Costa Rica, Chile, Argentina, Kenya and Ghana have merit as consumers in these countries seek products and services to save money, to have more choice, to enrich the quality and joy in their lives with clonentrepreneurs, investors and Government all benefiting.

Clones are not the same. The ones with the best chances of survival in the emerging markets against the innovator globalizing are those which require localization for the domestic economy and not just for language(s) spoken: but product sourcing, logistics, payment systems, merchandising and other business practices to satisfy conditions on the ground and to comply with the huge number of local regulations that impact how e-commerce is transacted.[1]

Cloning Western business models is only one direction for entrepreneurs and investors to pursue for profit.  Israeli entrepreneurs and venture investors took a different approach to create a start-up nation through the development and commercialization of disruptive and gamechanging technology for global markets, directly primary toward enterprises.

The Israeli Government pushed success forward through a variety of initiatives which sped Israeli tech to market including but not limited to the transfer of military technology to the private sector and its open door policy to immigrants (many were scientists from the Soviet Union). Other success factors include an Israeli industrial policy that funded R&D to create deal flow and the unplanned creation of entrepreneurs through military training in the ‘8–200’ intelligence unit.[2]

Government policy makers and their sovereign wealth funds can catalyze the start-up communities in other ways.  Riches earned from oil and other natural resources funded Russian initiatives like the $10 billion Russian Corporation of Nanotechnology, the $1 billion dollar fund-of-funds called the Russian Venture Company and the Russian Government’s multi-billion dollar Skolkovo program—to seed development of gamechanging tech, investment and the creation of a new set of entrepreneurs.

While small population countries may not have the sovereign wealth of oil, natural assets like Costa Rico’s location to America creates advantages for its ICT entrepreneurs to scale its start-up community.  Costa Rican entrepreneur Manrique Ulloa Steinvorth of ieSoft created a consortium of companies (IT Innovation Group) to expand access to the US; “Instead of competing for the same opportunities, we get together and offer a whole solution. If a project needs ten developers and I only have five, I will search within the consortium for a partner that can provide the other five, and the company that brings the project will manage the project” he says.[3]

Croatia is another small country with ambitions for more start-up communities.  Its location on the Mediterranean is an ideal spot to transform selected coastline into logistics, transportation and warehousing tech start-up centers to serve Central and East Europe.[4]  Investors and the Croatian Government might collaborate to co-create ‘deal flow funds’ which invest in the technologies required to transform this underutilized asset into wealth.[5]

Entrepreneurs and venture investors ask me “Which path should we choose; the road of disruptive technology or Clonentrepreneurship (or something in between)?”

My answer is that it’s not an ‘either…or’ decision.  It’s a combination of all with the percentage blend influenced by:

1.)   Your natural and technology assets

2.)   The sources and amount of money you have or can raise for the execution of your business model

3.)   The types of investors in your country, their sources of capital and their behavior to risk

4.)   The time, patience and determination you and your investors have to continue in the face of disappointment, risk, false starts, failure and forces working for your demise.

As you execute, your specialties and expertise will shine to guide your footsteps forward.

In Russia and in other countries clonentrepreneurs are sensitizing local investors to the rewards and risks of investing in technology.  Over time expect that some investors whom financed clones will develop the confidence and risk appetite to selectively invest in technology that will be more innovative at first—disruptive later—vs. cloning.  These investors and entrepreneurs will be the ground-breakers that establish the precedence for investment in new thinking thereby attracting co-investors from around the world to their home country.

One never knows:  Perhaps the next Facebook-type success is hatching right now in some Russian laboratory?

Change the Culture & Amazing Things Happen

Is this actually possible?  Change the culture—investors’ DNA—for more seed and early stage investment, leading to the startup of start-up communities?

Yes it is, but to change the culture one must first impact it, with investors earning money to their requirements and tolerance for risk.

As I detailed in Part I, Russian entrepreneurs deployed business models which generated quick revenues after their market launch, solutions which matched the behavior and attitudes of Russia investors to risk.  Impacting the culture came about not through grand ambitions to create gamechanging technology but practical steps to generate immediate revenues and execute quickly.

So what are the small but meaningful steps you can take to impact the culture for more investment, entrepreneurship and innovation?

For Next Time, Part V:  Scaling Up Investment for More—Impact & Outcomes

In Part V, I answer this question and suggest initiatives for entrepreneurs, investors, Government staffers and investment officers at development finance institutions to ‘Scale Up Investment for More—Impact and Outcomes.’

Comments, opinions and questions are welcome here or send directly to me at Tom@IVIpe.com

Be well and be lucky.

Tom Nastas



[2] Source, ‘The GoForward Plan to Scaling Up Innovation,’ by Thomas D. Nastas, June/July 2007, Russian edition, Harvard Business Review (in Russian), in English.  See also October 2007 ‘Scaling-Up the Innovation Ecosystem,’ Hungarian edition, Harvard Business Review, (Hungarian); Sept. 2008, ‘Innovation for Growth,’ Latin America edition, Harvard Business Review (in Spanish)

[3] Source, Costa Rica’s Startups Fight Through Bureaucracy and Focus on Diversifying, by Patrick Haller, Part II: “Diversify or Die,” 15 November 2011

[4] Source ‘Creating a Venture Capital Industry in Croatia,’ report of Thomas Nastas to staff of the World Bank, 18 March 2011

[5] Source ‘Bridging the Valley of Death,’ slides 117-128, presentation of Thomas Nastas to staff of the World Bank & IFC, 29 November 2011

Part III: The Power of Clones to Startup—Start-up Communities

Subjects in this post include:

1.)   Drive Growth and Innovation in the Supply Chain

2.)   Sidestep the Obstacles that Impede Scaling Up—Investor Attitudes to Risk & Failure

3.)   Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start-Up?

4.)   The Spread of Clonentrepreneurship

Last time in Part II, Cultures of Risk—Financing the Startup of Start-up Communities, I discussed:

1.)   The Cultural Divide:  What Investors ‘Buy’

2.)   What Investors Fear

3.)   The Culture of Venture Capital:  Friend or Foe?

Read Part II

Read Part I

Read Introduction (to the series)

The ‘take-away from Part II. Local investors in the emerging markets ‘buy’ risk by investing in the known and understandable. This explains why they finance business models of fast moving consumer goods, food and beverage, supermarkets, telecoms, light manufacturing and automotive components as examples.  Investors finance such business models even at the seed and early stage of company development.

The reason investors invest as they do; markets and customers are a 100% guarantee in these sectors, even in greenfield projects, with the risks of investment in execution, not the risks of market existence and the uncertainties if the tech will work, will customers come and pay.

Clones copied, localized and pasted into emerging economies impact the DNA of investors to risk since many generate revenue quickly—overcoming the fears that investors have for early stage tech.  But impacting the behavior of investors to risk is not the only contribution of clones to the start-up of start-up communities.

Drive Growth and Innovation in the Supply Chain

Although clones look the same on the surface, one country to the next, there are multiple differences in execution.  Many clones require supply chain partners for them to work, yet many of these companies do not exist in emerging countries.  While outsourcing from delivery to call centers are common services for hire in the US and Europe, clones frequently build them themselves, in what I call ‘self-sourcing.’  In other cases, new supply chain entrepreneurs emerge to offer the services to make clones work.

Let’s examine three such innovations.

Logistics and delivery

Lack of effective and efficient delivery companies forced Ozon, the Russian clone of Amazon, to organize its own logistics operation for door-to-door delivery of goods to their customers in Moscow and St Petersburg plus the delivery to more than 2,000 pick-up points across the Russia Federation.  With this asset in place, Ozon offers delivery services to others as the market for online businesses grows in Russia.  Like Ozon, the discount shopping club KupiVIP delivers product with its self-owned fleet of 100 vans; it leases extra vans when capacity is short. Yes FedEx and DHL exist in Russia, but the cost for local delivery approaches $100, too expensive for a book costing $15 or a $40 pair of shoes.

Getting paid

65% of all transactions in Russia are paid for in cash.  Almost 90% of Ozon revenues ($300 million) are cash.  ATM’s that accept cash for payment are widely used in Russia, made by QIWI, a Russian innovator.  But a new complication develops in a cash economy. In Russia for example, customers regularly inspect the goods to confirm that what was ordered is actually in the box. 25% of all online orders are rejected by the buyer with no money trading hands in cash transactions, or a credit has to be made if payment was made through a QIWI terminal, another snag that required innovation for e-commerce clones to work in Russia (and other emerging market economies based on cash vs. credit or debit card transactions).

Call centers required to reassure online buyers

50% of Ctrip (Chinese online travel company) customers purchase tickets by phone as do large numbers of Russian customers of Ostrovok, a Russian online travel company.  Both Ctrip and Ostrovok operate self-owned call centers staffed with real live persons to reassure customers that their on-line orders are placed, accurate and confirmed.

Clearly what emerging markets lack in the sophistication of online shopping in the United States creates a sea of supply chain opportunities for more start-ups to service clones in the developing world.

Sidestep the Obstacles that Impede Scaling Up—Investor Attitudes to Risk & Failure

It’s great to talk about the need for failure, how great business models evolve from failed attempts and the need to encourage more failure. The question is who pays for this learning, and how recover from it? Investors not only in Russia, but other emerging markets label a failed entrepreneur a loser for life, never to raise money again with failure an embarrassment that frequently spills onto her or his family; such shame creates an environment where entrepreneurship is discouraged as a career path vs. a ‘safe’ job, e.g., working for Government, a state-owned enterprise or a multinational corporation.

Even more troublesome is another deep seated cultural attitude to failure in emerging market countries.

Failure = Fraud: we know this is not true, but that’s the verdict when entrepreneurs fail in emerging markets.

The attitude that failure equals fraud stems from ‘who pays for the cost of failure’ as failure in emerging markets means the promoter, the entrepreneur, and the team did not possess the competencies to overcome the challenges of development, or did not really understand all the requirements needed (or did not do all) for success. Yet we know that experimentation, trial and error, failure and pivoting are necessary to define the requirements for business model creation, making the path to progress unlikely in developing countries.

In the former Soviet republics, East Europe too, entrepreneurs and scientists have financial responsibility to repay money under failure; prosecution and jail-time are real possibilities.  Even more chilling are the threats of investors to entrepreneurs “You lost my money (equity), now you must pay the money back (i.e., the investment is equity if achieve success, debt if the venture fails!).”

The fears of investors, attitudes to failure and who pays for failure create a culture that makes early stage venture capital dicey in the emerging markets.  Such behavior discourages risk taking and incentivizes entrepreneurial commitments to proven business models for proven markets like fast moving consumer goods, retailing, wholesaling, telecoms, and yes, clones from Clonentrepreneurs.

But given the successes of clones to start an entrepreneurial revolution in a country, they are not without their critics.

The Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start-Up?

Given the successes of clones to satisfy the appetites of domestic customers and local money, they have their critics when taken to the extreme.  Sarah Lacy wrote an upbeat article in TechCrunch about copy-cat business models in China yet almost three years later levied stinging criticism at the Samwer Brothers with their rip-off of Fab.com called Bamarang.

Their newest clone for the Middle East Lazada is especially bold: I thought I had inadvertently landed on Amazon, that’s how closely Lazada resembles it.

Even Union Square venture capitalist and blogger Fred Wilson jumped into the frying pan with his opt on cloning start-ups.

Condemnation aside, one can’t argue with the quick and profitable financial successes of cloning.

Controversy intensifies when founders clone not just the idea, but every pixel of the start-up to make the clone an almost exact duplicate of the original as the Samwer Brothers did.

In Russia there are multiple groups creating and financing clones.  One of the most aggressive is Fast Lane Ventures which cloned Pinterest (PinMe), Quora (OdinOvet), Eventbrite (Eventmag), Airbnb (RentHome.ru) to name a few; their Zappos clone Sapato was acquired in 1Q2012, 18 months after launch for an approximately 2x return for investors including Fast Lane (plus Intel Capital, eVenture Capital, Kinnevik and Direct Group too).  

The Spread of Clonentrepreneurship

Clonentrepreneurship is sweeping not only Russia, but all of Planet Earth.

Cloning has become a trusted way for more entrepreneurs to raise more money from more investors, thereby financing the future of their start-up communities, not only in the emerging world, but developed countries too as the explosion of car sharing clones demonstrates.

Zipcar was one of the first to execute Internet business models for the sharing of cars.  Zipcar was not the innovator, but the imitator with Vancouver’s co-op called Modo operating for more than 15 years and the catalyst that helped communities and non-profits get car sharing started in several continents.  While it may not have started in the Internet space, Modo was one of the first to institutionalize collaborative sharing in the community.

So what is really being cloned, who is cloning what and to whom?

Is it car sharing or the collaboratively sharing of underused assets and transforming them into new business opportunities? If the later, clonentrepreneurs are hard at work around the world creating the next set of companies in the sharing space to take advantage of this social movement as these examples demonstrate:

  • ParkAtMyHouse.com—shared parking spaces
  • SkillShare.com & TaskRabbit.com—sharing of skills and chores
  • Murfie.com & Swap.com—collaboratively sharing of DVDs, books & video games
  • Snapgoods.com & Neighborhoods.net—sharing of ‘stuff’
  • I-Ella.com & Thredup.com—sharing of clothes & wearables
  • Sharedearth.com & Yardshare.com—the sharing of land for gardeners & land owners with capacity
  • Freecycle.com & ILoveFreegle.org—sharing of ‘stuff’ people no longer want/need

Given the contributions of clones to spark the startup of start-up communities, are they a panacea to growth? Do alternatives exist in the quest for growth? And what can actors in the start-up community do to impact investor DNA for more seed and early stage investment?

For Next Time—Part IV: The Quest for Growth

In Part IV, subjects I’ll discuss:

1.)   Clonentrepreneurship or Alternative Paths to the Start-up of Start-up Communities?

2.)   Change the Culture and Amazing Things Happen

Comments, opinions and questions are welcome here or send directly to me at Tom@IVIpe.com

Be well and be lucky.

Tom Nastas

 

 

 

 

 

Part II: The Cultures of Risk—Financing the Startup of Start-up Communities

Subjects in this post:

1.)   The Cultural Divide:  What Investors ‘Buy’

2.)   What Investors Fear

3.)   The Culture of Venture Capital:  Friend or Foe?

Last time in Part I, I discussed:

1.)   First, Three Definitions

2.)   The Russia Tech Scene

3.)   Growth in Russia

4.)   What Changed for Growth to Emerge

5.)   The Spark that Ignited the Start-up of Russia

Read Part I.

Read the Introduction to the series.

Summary from Part I:  Beginning about 2006, innovation became a priority of the Russian Government to diversify its economy from oil/gas with its multi-billion dollar investments in the Russian Venture Company and the Russian Corporation of Nanotechnology. Even with these investments, the needle of tech investment crept up ever so slowly in venture stage companies.

But everything changed beginning in the 2nd half of 2010; Russian entrepreneurs cloned US business models in Internet e-commerce, social and mobile with 20+ startups attracting more than $400 million in less than eighteen months through 2011.  For 2012 investment in start-ups and venture stage companies is estimated at between $800 million to $1 billion.

The ‘take-away. Russian entrepreneurs demonstrated that cloning established Western Internet business models and localizing them for the domestic market captures growth.  This was what domestic investors needed to open up their pocketbooks and spark the startup of Russia.

Ok, so, uhm—what’s so revolutionary about entrepreneurs cloning the ideas of others and investors financing start-up clones?

To answer this question, I discuss the culture of risk in the developing countries and how it impacts the behavior of local investors and their willingness to finance seed and early stage tech business models.  Then I contrast how their investment behavior differs from investors in the developed countries.

The Cultural Divide:  What Investors ‘Buy’

American tech and start-up entrepreneurs ‘sell opportunity’ to raise money. This works great in the United States since angel investors and venture capitalists are comfortable with risk, ambiguity and uncertainty, and willingly pay the costs of failure when business models don’t work, founders pivot and start-ups evolve into something different from entrepreneurs’ initial intentions.

Except for the very few, most local investors from Manila to Moscow and from Shanghai to San Paulo approach risk differently. Sure, opportunity is required for the financing of ventures.  But the risks of execution are more importance as the deciding factor since emerging market countries are opaque and with their lack of transparency—invisible risks and obstacles can cause even the most experienced investors to lose their entire investment:  Capital preservation drives financing decisions.

Consequently they buy ‘risk’ by investing in the known and understandable;  businesses and projects with markets and customers a 100% guarantee, where the risks of the investment are in the execution of building a factory or constructing a warehouse, creating a bank, establishing a chain of shops or restaurants as examples. These are the uncertainties they have dealt with as businessmen and investors, and have the experience to help entrepreneurs solve—avoid.

What Investors Fear

The risks of financing innovative firms, i.e., does a market exist, will customers buy, achieve promised performance—often technology based—are uncertainties too great for domestic investors in emerging markets since they add additional layers of risks to those of execution and involve a different sort of risk assessment—skills and experiences they frequently lack.

Clones overcome these fears since many generate revenues immediately, some from day #1, demonstrating that a market exists, the tech works, customers show up and pay.  With these risks behind the venture, the way forward is managing execution—risks that local money in emerging markets ‘buy:’  the tolerance of emerging markets investors for the US model of entrepreneurial experimentation, trial and error and the funding of pivots is zero.

Why is this so?  And how do we use this culture of investor risk-taking as our ally, to make amazing things happen; more entrepreneurship, more innovation and more investment for the start-up of start-up communities not only in Russia but throughout the emerging world from Chile to China, Kazakhstan to Kenya, India to Indonesia?

The Culture of Venture Capital:  Friend or Foe?

To obtain a deeper understanding why entrepreneurs and investors behave as they do in the emerging markets, we must look at an unlikely place to frame this discussion:  Silicon Valley.

 “Silicon Valley is the only place on Earth not trying to figure out how to become Silicon Valley.[1]

Silicon Valley’s greatest attribute is not its ability to finance the future and failure, but investors’ attitude to risk which shapes their risk taking, their acceptance of ambiguity and uncertainty to early stage tech deals, thereby attracting entrepreneurs with the wildest (and craziest) ideas.

This behavior to risk is exemplified by the 2-6-2 distribution of returns rule.[2]

For every ten investments made by investors, two fail with all money lost, six return the original investment + a low to modest rate of return, with the remaining two generating breathtaking profits (Facebook, Google, Apple, Cisco, Oracle, Instagram and Microsoft as examples). These ‘superwinners’ as they are called, produce the superior rates of financial return that compensate for losing investments and slightly profitable ones.[3]

Of course one never knows in advance which investments will be superwinners or also-rans. Since Silicon Valley investors know that statistically they’ll invest in their fair share of superwinners, they have the confidence to finance the wild and crazy, a few which become successes. Superwinners breed or attract others to launch start-ups.  As more entrepreneurs enter the market, the number of new companies financed increases with less time required by investors to make the investment decision. More choice is what investors need since for every one investment, 99 are rejected;[4]  to consummate ten investments (the 2-6-2) an investor needs to see 1000 opportunities.  More choice attracts more capital to the start-up community as other investors jump in to finance the next set of superwinners.  The start-up community prospects and perpetuates to a thriving ecosystem.

Many superwinners did not start on the path to greatness, and they only found it after experimenting with different business models until they hit the bulls-eye;  others started down a path only to change direction—pivot—to find what the market and customers would accept.  Silicon Valley investors willingly finance early failures since they know statistically, many pivot to success as Google, Instagram, Facebook, YouTube, PayPal and others did to achieve superwinning status. While it may seem counterintuitive, investors must finance failure since without them they are not taking enough risk.[5]

It’s this willingness to finance ambiguity and uncertainty that makes Silicon Valley—uhm—Silicon Valley.

The National Venture Capital Association (USA) estimates that in 2010 the US venture industry invested the equivalent of $3,945 per person living in the Silicon Valley area vs. $43 per person in the rest of the US, including other start-up communities like Boston and New York. That’s a 91:1 ratio.[6]

Go to my home state of Michigan and the number falls to $15 per person, a ratio of 263:1.[7] So the likelihood of a Detroit startup raising venture capital in Michigan is more difficult vs. Silicon Valley.

In Russia and other emerging market countries the amount of capital invested/population is even less than Michigan;  these regions lack the quality and quantity of deal flow that typifies the Valley and local investors are unwilling to fund experimentation, pivoting, trial and error in business model creation.  Since domestic investors buy the ‘risks’ of execution by investing in the known and understandable—businesses and projects with markets and customers a 100% guarantee (experimentation/pivoting not necessary)—the chances of superwinners being created and financed is remote:  Yet an increasing flow of future ‘superwinners’ is what’s required for local investors to invest in, and for a start-up community to crystalize.

That is until an event or series of events breaks this cycle to change the trajectory of the market.  In Russia it was the early and fast liquidity from the Groupon clone that demonstrated the merit of cloning Western business models plus the IPO of Mail.ru that minted the money for clone investment.  With the United States as the engine of start-up creation in the world, it was natural for Russians to copy, localize and paste clones into Russia, to capture the eyeballs and wallets of the Russian consumer. And then—the pocketbooks of investors too.

The chasm between the cultures of risk-taking by local investors in Russia and the risk of start-ups was crossed. Foes became friends. The start-up of Russia began. 

“But this is not the only contribution of clones to the startup of start-up communities.”

For Next Time—Part III:  The Power of Clones

In Part III, I discuss the multiplier effect in start-up creation that clones have in local market.  Clones do more than just build a local network of supply chain partners thereby increasing the # of startups for a startup community to emerge.  Their successes impact the DNA culture of investors to risk as they build new experiences in seed and early stage risk.  And they do so without taking the risks of opportunity that is normally associated with early stage companies since clones[8] demonstrate that a market exists, the tech works, customers ‘get it’ and pay.

Subjects in Part III:

1.)   Drive Growth and Innovation in the Supply Chain

2.)   Sidestep the Obstacles that Impede Scaling Up

3.)   Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start-Up?

4.)   Spread of Clonentrepreneurship

Comments, opinions and questions are welcome here or send directly to me at Tom@IVIpe.com.

Be well and be lucky.

Tom Nastas


[1]Quote from Robert Metcalfe, father of Ethernet, founder of 3Com, author, pundit & conference host

[2] Author’s note:  The 2-6-2 distribution of returns rule is a term to describe the distribution of investment returns in a venture capital or private equity portfolio. The 2-6-2 rule comes from data collected and reported on the industry’s financial performance over a 40 year period from Cambridge Associates, the National Venture Capital Association and the Small Business Administration (which tracks investments made through the Small Business Investment Corporation program of the US Government).

[3] Author’s note:  While the 2-6-2 distribution of returns is an industry average, individual funds will have a different distribution of financial performance, e.g., some might have a result of 4-4-2, others a 1-9-0, others a 0-7-3, etc. Approximately 2% of investments since the 1980s have produced 98% of the financial returns realized in the venture capital industry (USA)

[4] Author’s note:  A rule of thumb in the industry.  Naturally some firms will be in the flow of ‘better’ investment opportunities and able to transact the necessary number of investments with a lessor number of total deals evaluated

[7] Source: Ibid

[8] Certainly all clones are not alike.  Prudent, wisdom and understanding of the local market is required in the selection of which business models to copy, localize and paste into an emerging market

 

 

Part I: The Start-up of Russia. The Startup of Start-up Communities: The Power of Clones in Russia—& Beyond

Last time I introduced the questions as topics for answers in this five part post series:

1.)   What is the ‘spark’ that ignites the startup of start-up communities?

2.)   How does the ‘start-up’ of startup communities differ—emerging markets vs. developed countries?

3.)   Why is the US entrepreneurial model of experimentation, trial and error and pivoting a death sentence for entrepreneurs in the emerging markets? And what you can do about it.

4.)   How does the culture of risk and failure in emerging markets impact investor DNA—what they finance and what they won’t

5.)   What is Clonentrepreneurship, where is it spreading from and to, and why is it a model for more—innovation, startups, and venture investment?

Read the introduction here.

I conceived this series for StartUp Communities, the blog of venture investor Brad Feld (Foundry Group, Boulder, Colorado, co-founder of Tech Stars, blogger Feld Thoughts).

Subjects covered in this post include:

1.)   First—Three Definitions

2.)   The Russia Tech Scene

3.)   Growth in Russia

4.)   What Changed for Growth to Emerge

5.)   The Spark that Ignited the Start-up of Russia

First—Three Definitions

You might be unfamiliar with this phase ‘start-up community.’ So here’s a short intro to what it is and why it’s important to every country on Planet Earth.

A start-up community is a place where entrepreneurs with ideas come together to start new companies, and can actually find the money and the talent to get their start-ups financed, staffed and launched.  Most start-up communities offer appealing lifestyles, are cool places to live, to work, to have fun and do more—faster.  Over time as more and more start-ups are created and financed, an entrepreneurial ecosystem takes root with success begetting success leading to a thriving start-up community.

In the world of venture capital (VC), entrepreneurship and start-up creation, Silicon Valley is the quintessential start-up community in the United States, with the MIT/Boston area as #2.  The term start-up community can be attached to a country as Dan Senor and Saul Singer did in their 2009 book Start-Up Nation: how Israel became a start-up ecosystem with sixty-three publicly Israeli companies traded on the NASDAQ stock exchange in the United States, more than any other foreign country.

Start-up communities attract and breed entrepreneurs.  Entrepreneurship drives economic growth and development, new jobs and of course, wealth creation. It’s this prosperity that cities, states, regions and countries around Planet Earth are trying to create, attempting to replicate—duplicate, to get things going; for their survival and renewal, by inspiring wannabe entrepreneurs to take the leap into the unknown and supporting resident entrepreneurs.

I craft two other phrases in this series, Clonentrepreneurs and Clonentrepreneurship; words put together from Clone-Entrepreneurs and Clone-Entrepreneurship (but without the hyphen).

Clonentrepreneurs are entrepreneurs that clone a business idea or a business model of a company and implement it too, sometimes with improvements, sometimes not.  While the word clone may be a 21st century phenomena, clones have been around a long, long time.  Over the years these two companies have taken different paths to growth, but over 100 years ago it was “Coke or Pepsi?”

The Russia Tech Scene

Startup Genome recently published research on the most active start-up ecosystems around the world. It listed Moscow as #10.

It’s great to see Russia’s largest city rocket into this spot, given that in 2001 less than $100 million/year was invested in Russian seed and early stage tech vs. billions of dollars of private equity money invested in fast moving consumer goods, real estate, construction, wholesaling, retailing, natural resources and other sectors that lifted a post-Soviet economy into the 21st century.  Ten years ago only a handful of emerging growth tech companies existed in Russia including Yandex, Ozon, Mail.ru, Abbyy and Kaspersky to name five.  The first three served primarily the Russian speaking market, the last two—international customers around the world.

In the latter half of the decade, innovation became a priority of the Russian Government to diversify the economy from oil/gas with its investments in the Russian Venture Company (fund-of-funds with $1 billion under management) and the Russian Corporation of Nanotechnology (Rusnano, $10 billion under management, making fund, project and international investments in nanotech). Even with these efforts, the needle of tech investment crept up ever so slowly to $200 million ± 10% for seed and early stage investments in all sectors.

But everything changed in 2010; investment in seed, start-ups and early stage companies more than doubled from 2009 and in 2011, doubled 2010 results.  In 1Q 2012 the top Internet 10 investments raised over $80 million. Some pundits claim that investment will exceed $1 billion by end of 2012.

What caused this acceleration in investment in just two years, and what are the take-ways for your start-up community; to increase the # of start-ups in your country and entrepreneurs making the commitment to new projects, the amount and velocity of venture money invested with the ‘Scaling Up’ of entrepreneurship, risk-taking and innovation for more?

Growth in Russia

Certainly as the Russian economy rebounded from the lows of the global financial crisis, consumers and businesses were in the mood to spend. Russians increasing lived and breathed on-line with entrepreneurs serving up Internet models to capture their eyeballs and wallets.

Online video advertising in 2011 doubled to $37 million from $15 million, Russian contextual advertising jumped to $430 million in the first half of 2011, an increase of 60% from 2010, Russian Internet advertising clocked in at $1.4 billion, up 56% from 2010 with display (banner) advertising’s 2011 spend up 45% to $510 million from 2010.  GP Bullhound an investment bank based in the UK estimates that only 18% of the 53 million Russian internet users shop online, with online advertising consuming only 9% of Russian ad budgets.

All of this growth translated into increasing revenues for Internet and Web companies with Forbes.ru listing the top 30 Russian Internet companies by their 2011 sales.

Such growth attracts investors as honey lures bees.  But it’s the nature of the deal flow that better explains the huge jumps in VC investment in less than two years and the wave of new entrepreneurs doing start-ups.

What Changed for Growth to Emerge

2010 was a ‘tipping point’ for the start-up of Russia through two liquidity events and underlying forces in the country. First was the acquisition of the Russian Groupon clone called Darberry by Groupon.

From their formation in February 2010 to its purchase by Groupon in August 2010, Darberry showed the investment path for entrepreneurs and investors in Russia, business models with a real shot at attracting capital.  While a handful of clones existed in Russia, Darberry’s sale was a major inflection point for more Russian entrepreneurship.

The second event was the minting of a few billionaires and dozens of new millionaires from the IPO of Mail.ru (valuation—$5.71 billion, November 2010).  After this new wealth splurged on cars, clothes, homes and travel, it financed new start-ups.

Since these liquidity events, dozens of new start-ups raised hundreds of millions of dollars in 2010, 2011 & 1Q2012 with capital invested by new Russian funds formed to finance mainly e-commerce, social and gaming startup clones with US and European venture capitalists co-investing since they had experience with these business models in the West.

Prior to 2008 the Russian tech scene had no role models, no ‘mojo’ and little connection to the world other than oil/gas.  It was widely known that Russia had deep human talent in mathematics and the physical sciences, yet few knew the route to exploit these assets for commercial ventures.  Some took the path of outsourcing (India model) or system integration to build enterprises like Luxoft, IBS and TerraLink to name three.  A few others walked a different road like Acronis and Parallels:  creation of gamechanging technology for global customers (Israeli model) with R&D conducted in Russia and headquarters located in the United States.

Neither of these endeavors generated the velocity of new start-ups being formed nor an explosion of venture capital investment.  Yet if these were not the paths forward for the creation of a start-up community, then what was—since there was no clarity to what business models would capture the wallets of Russian customers and the cash of Russian investors?

The Spark that Ignited the Start-up of Russia

Certainly the creation of several dozen angel investors with tech experience was an impetus to the start-up of Russia as the market lacked ‘smart’ money. But that money has to find a home, and that’s where clones showed the way forward.

Darberry demonstrated that cloning established Western Internet business models and localizing them for the domestic market captures growth. While profits eluded Darberry, it scaled quickly with revenues multiplying exponentially day-by-day.  This was the signal that Russian investors needed to open their pocketbooks and finance the start-up of Russia.

From Sept. 2010-2011, 20+ new start-ups and development stage companies raised over $400 million.  Most are clones and a small sample of these seed and early stage companies which raised capital is shown below.

New capital continues to flow into clones.  KupiVIP (clone of USA shopping club Gilt Groupe, itself a clone of French deep discounter Vente-Privée) grew from launch (October 2008) to $200+ million revenue by 2011 with $65 million of new capital raised in 1Q 2012.  In May 2012, Avito.ru, the Russian clone of Craigslist raised a whopping $75 million.

Ok, so, uhm—what’s so revolutionary about entrepreneurs cloning the ideas of others and investors financing the start-up of clones?

For Next Time—Part II:  The Cultures of Risk

To answer this question I’ll examine how the cultures of risk—developed vs. developing countries—impact the DNA of investors and their willingness to finance seed and early stage tech business models, with some investors ‘buying’ opportunity while others ‘buy’ risk.  A preview of the subjects in Part II:

1.)   The Cultural Divide:  What Investors ‘Buy’

2.)   What Investors Fear

3.)   The Culture of Venture Capital:  Friend or Foe?

Comments, opinions and questions are welcome here or send directly to me at Tom@IVIpe.com.

Be well and be lucky.

INTRODUCTION: THE STARTUP OF START-UP COMMUNITIES; THE POWER OF CLONES IN RUSSIA—& BEYOND

What are the elements of a start-up community?  What can you do to startup a start-up community in your city, or help it do more—faster?

Venture investor Brad Feld (Foundry Group, Boulder, Colorado, co-founder of Tech Stars, blogger Feld Thoughts) writes about these subjects in his other blog StartUp Communities with his new book titled ‘Startup Communities: Building an Entrepreneurial Ecosystem in Your City,’ to be published in the fall of 2012.  You can read his first draft, outline here.

If you don’t know Brad, he was and remains the protagonist and instigator that transformed Boulder from a sleepy Rocky Mountain hippie town into one of the most vibrant entrepreneurial tech start-up communities in the United States.  It is his individual contributions to this success that makes Brad’s advice sought by investors, government policy makers and entrepreneurs from around the world.

Recently Brad accepted my offer—I contribute a post on the startup of Russia to StartUp Communities.  As I started writing, one subject led to another, with the result too much for one individual post.  Over the next few weeks I’ll upload the content as a series of posts for you:  the investor, the entrepreneur, the Government policy maker, staff of international development finance institutions.

In this series I answer five questions:

1.)   What is the ‘spark’ that ignited the start-up of Russia?

2.)   How does the ‘start-up’ of startup communities differ—emerging markets vs. developed countries?

3.)   Why is the US entrepreneurial model of experimentation, trial and error and pivoting a death sentence for entrepreneurs in the emerging markets?

4.)   How does the culture of risk and failure in emerging markets impact investor DNA—what they finance and what they won’t?

5.)   What is Clonentrepreneurship, where is it spreading from and to, and why is it a model for more—innovation, startups, and venture investment?

There is much happening in Russian cities like St Petersburg and Novosibirsk as two regional hubs of innovation and entrepreneurship.  Even so, I’m confining my discussion to Moscow since what we are seeing in the Russia capital is being replicated in other cities in the Russia Federation, only to a lesser degree.

Here’s a preview of the topics in each post.

PART I:  THE START-UP OF RUSSIA

  • First—Three Definitions
  • The Russia Tech Scene
  • Growth in Russia
  • What Changed for Growth to Emerge
  • The Spark that Ignited the Start-up of Russia

PART II: THE CULTURES OF RISK

  • The Cultural Divide:  What Investors ‘Buy’
  • What Investors Fear
  • The Culture of Venture Capital:  Friend or Foe?

PART III: THE POWER OF CLONES

  • Growth and Innovation in the Supply Chain
  • Sidestep the Obstacles that Impede Scaling Up
  • The Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start Up?
  • The Spread of Clonentrepreneurship

PART IV:  THE QUEST FOR GROWTH

  • Clonentrepreneurship or Alternative Paths to the Start-up of Start-up Communities?
  • Change the Culture to Make Amazing Things Happen

PART V:  SCALING UP INVESTMENT—FINANCE THE STARTUP OF START-UP COMMUNITIES

In this final post to the series I answer the question:  “What are the small but meaningful steps you can take to impact the culture to change the culture for more investment, entrepreneurship and innovation?”

  • For Entrepreneurs—What are You Selling to Investors?
  • For Investors—Let’s Be Realistic
  • For Governments/Development Finance Institutions—Atypical Leadership Needed
  •   Concluding Remarks
  • My Next Blog Series—Mobilize Local Capital to Finance Your Dreams
  • Links: Evolution of Runet (Russia Internet) & the Russia Tech Scene

I hope that these subjects will help you to ‘Scale Up,’ more entrepreneurship, more investment and more tech start-ups in your country, with Russia as one experience to learn from.

How might this happen you ask?

Frequently a mismatch exists in the business models that entrepreneurs launch in the emerging markets and what local investors finance.  Struggling to raise money, entrepreneurs label capital as risk adverse with investors blind to potential, seeking guarantees and sure things.  Investors respond that entrepreneurs of venture stage companies fail to transform potential into paying customers fast enough and in the volumes needed for the business to scale.  Add in their need to generate a rate of financial return required for their own survival, and it’s logical why local investors in the emerging world finance expansion stage companies.

This conflict spills into the public stage with Governments called to action.  They conceive and invest taxpayer money to catalyze an early stage tech venture capital industry to fill market voids.

What happens next is perplexing to the creators of these investment schemes.

These new funds have a mandate to invest in venture stage tech companies, but they behave differently in execution. They invest in tech, but at the growth stage of company development, not at the startup stage.

But what if seed and early stage business models exist with the revenue growth characteristics of expansion-stage companies?  If such business models do exist, what are they? Can they impact the DNA of local investors to risk and catalyze investment at the earliest stages of company formation?  And can they spark the start-up of a startup community? While such business models seem to be an illusion and counterintuitive to the natural evolution of market development, I explain in this series that such models do in fact exist in Russia—& beyond.

Subjects I discuss in Part I:

1.)   First—Three Definitions

2.)   The Russia Tech Scene

3.)   Growth in Russia

4.)   What Changed for Growth to Emerge

5.)   The Spark that Ignited the Start-up of Russia

Reactions & opinions welcome in the comments box or send directly to me at Tom@IVIpe.com.

Be well and be lucky.

Insider View, Twists & Turns in International Venture Capital

In January I delivered a lecture to MBA students, Ross School of Business at the University of Michigan. David Brophy, Director of the Office for the Study of Private Equity Finance & Associate Professor of Finance invited me to speak at his private equity class about my experiences in doing VC since 1986, with what he calls “Tom is 3 feet deep into VC, with mud on his boots.”

If you don’t know David you should, as he was the instrumental force in developing the venture capital and private equity industry in the State of Michigan. He was the creative force behind business plan competitions in the Midwest of the USA, in 1980, way before anyone in the world was thinking of bringing companies and investors together to mix, interact and network around this asset class we know as venture capital.  His event, called the Michigan Growth Capital Symposium is one of the longest running programs in the USA, in operation since 1980.

I quote from the Symposium’s web site, “Celebrating its 31st anniversary, the 2012 Michigan Growth Capital Symposium is the Midwest’s leading event for attracting the best investors from across the U.S. and showcasing high-quality investable companies. In the past decade alone, more than 300 companies have presented. About 70% of these have raised capital totaling more than $1.7 billion in investments and nearly 20% have realized successful exits. Video: MGCS Celebrates 30 Years

Year after year, the MGCS has brought greater awareness and opportunity to startups emerging from research departments of leading universities across the country. Over the past 10 years nearly a quarter of the presenting companies have been university-based spin-outs, raising capital totaling some $430 million in investments. About 70 percent (a total of 49 companies) have come from Michigan’s University Research Corridor institutions—U-M, Michigan State and Wayne State and one-fifth of these companies have realized successful exits.

MGCS is presented by the University of Michigan Zell Lurie Institute’s Center for Venture Capital & Private Equity Finance at the Ross School of Business in partnership with the Michigan Venture Capital Association.

I am grateful to David for his interest in me and his invitation to speak to his students.  David, thank you.

I’ve upload two icons.  Click on the 1st to view the PowerPoint. Click on the 2nd to view the video of the lecture.  If you watch the video, I suggest that you scroll to the eight (8) minute mark to start viewing.

As always, comments are welcome here, or write me directly at Tom@IVIpe.com