By Nina Joyce

Russia is a huge potential market for internet ventures but it is under-exploited because of a lack of investment capital. Internet ventures and the Russian government have made attempts to address this shortcoming. George Soros, the international financier, said that the Russian internet had great potential, and that he is ready to invest there.

Russia's venture capital industry is still in its fledgling stages. Tellingly, it is only recently that the term 'venture capital' became accepted legal terminology in Russia. The website, Monitoring.ru reports that there are now 6.6m people with internet access in Russia. This is a far cry from the estimated 70m users in the United States but analysts expect the number of Russian internet users to grow rapidly in the next few years.

Recent political and economic events in Russia have tempered the climate for venture capital investment. Russia's involvement in Chechnya is cited by the European Union as the reason it suspended a large portion of Russia's grant funding from the Technical Assistance programme for CIS countries (TACIS). The economic crisis of last year dampened foreign enthusiasm to exploit this huge emerging market.

Russia presents great obstacles to securing venture capital investment. Michael Zverev, co-head of Technology Banking at Trigon Capital, a Baltic investment bank, says that excessive taxation "sometimes forces companies to become less transparent, and take on potential tax liabilities". This lack of transparency can consequently "increase the risk and uncertainty for investors", he told FT.com. Mr Zverev also points the finger at Russia's "complex system of foreign investment regulation" as an obstacle to investing in Russia.

One major challenge in the Russian VC sector has been to secure venture capital funding from domestic sources. This problem is particularly prevalent in Russia and not found to the same degree in the Visegrad countries - Hungary, the Czech Republic and Poland. Aleksei Vlasov, former chairman of the Russian Venture Capital Association and present member of its administrative council, blames the underdevelopment of this sector of the economy. Evidence of this is the almost non-existent initial pubic offering market.

He also agrees with Mr Zverev in that current Russian legislation is not conducive to venture capital investment.

At a recent e-commerce conference in Moscow Andrew Volokitin, Russian deputy minister of communications and information, emphasised the underdevelopment of market relations and the lack of good legislation and said these were the principal hindrances to e-commerce in Russia. On the other hand, Russia has a good base in the field of information technologies, electronic banking technologies, and domestically developed information protection systems, said Mr Volokitin. However, Guennady Spirin, CEO of Ozon, said there was a persistent "prejudice in the Western marketplace against high-tech products made in Russia."

Aleksei Vlasov thinks that the low amount of available Russian-sourced VC funding will improve in the future. He says that structurally, the banks are the most prepared organisations to take this on, although reforms in pension fund legislation and mergers in the insurance sector could boost funds.

ichael Zverev from Trigon Capital says that Russian-sourced funding is already increasing. "Several players that are investing in the IT sector are operating with funds from Russian companies."

He said that a "broader awareness of the technology sector and the concept of venture investments" are a prerequisite for the VC industry in Russia. There also needs to be "legislation that allows tax-efficient structures for investment funds." Thirdly, there needs to be a more determined effort on the part of professional asset management institutions. They must "approach local investors, not only overseas investors".

The Russian government has taken a proactive role in addressing high-tech investment. It said that it would participate 30-50 per cent in venture capital funds that invest in technology businesses. The Ministry of Science and Technology announced plans to establish a venture finance fund worth $3.5m (E3.64m). Andrew Volokitin, also said that his ministry, the ministry of communications and information, the ministry of trade and ministry of finances have prepared a draft programme for development of electronic commerce. The programme, due to be submitted to the government next month, focuses on e-commerce legislation as well as creating an e-market infrastructure.

A discouraging sign for venture capitalism in Russia is the difficulty for the investor in exiting a VC process. There is no IPO market to speak of, and exacerbated by the recent economic crisis, market confidence in Russian companies is extremely low. The emerging high-tech companies, the prime Russian candidates for investment, have no affiliations with the big name companies and thereby suffer from a lack of name recognition.

What can be done to improve the level of investment in Russia? The country's new president Vladimir Putin uttered a plea during his trip to London for increased foreign investment in what he termed the "new Russia". He vowed to address the main obstacles to investment in the region. Firstly, companies should be unfettered by state interference. Secondly, the impact of heavy tax burdens should be reduced on business in Russia. And finally, there should be respect for private ownership of property. Michael Zverev would like to see a decrease in the tax burden on business and a "radical liberalisation of foreign direct investment". A "more active state protection of investor and shareholder rights would help a lot," he said.

A number of the top Russian websites has been bought this year by foreign investors. Among these is Russia's e-commerce portal Ozon based in St. Petersburg. United Financial Group (UFG), the investment bank, and Barings Vostok Capital Partners, a private equity investment fund, bought 51 per cent of Ozon for $3m. The two investors launched Ru-Net Holdings in March, a joint effort with initial, mostly western, capital of $20m. The company's aim is to invest in Russian internet ventures. The sale was assisted and underwritten by Trigon Capital.

The European Bank for Reconstruction and Development is the main player in Russian venture capital and sources of finance are strikingly different for Russian venture capital investments than for investments in western Europe. The Russian Venture Capital Association believes that the success of the EBRD will be a barometer for the future of foreign private investment in Russia. "Nevertheless, even under existing conditions we see substantial growth of investments and investor interest, especially in the technology sector," said Michael Zverev.



Deep in the game
Lack of available funds
Harder times ahead as party ends early
Companies in search of tomorrow's new ideas
Support for start-ups with the accent on technology



Ozon - this site is in Russian