This article analyses the specifics of the development of the venture capital market in Russia under conditions of sanctions. The main reasons for the crisis phenomena in the venture capital market are investigated, and an assessment and forecast of its development in the context of sanctions and economic downturn is given.
Key words: venture capital, venture investments, sanctions, politics
For the past several years leaders in Russia were arguing whether we should move away from being a resource-based economy. Now, more attention is being paid to stimulating innovations in economy (development, implementation, and use of scientific and technological advances).
Greater efficiency of production through innovative technologies creates conditions for competitive advantage of Russian products among domestic and foreign markets [4]. Commercialization of innovative developments is a complex and risky process, which requires years of financial investment and professional development to bring new products to the market. In addition, we should say that venture capitalists are the ones, who invest the necessary funds on an interest-free and non-repayable basis in return for a stake in the company.
The relevance of the study is determined by the fact that the sanctions imposed against Russia have made the existing problems in the real and financial sectors even worse, than they once were, and now it is even harder for Russia to build up new economy of innovations, as many new challenges are now on the horizon.
Russia’s economy is now in yet another crisis after the COVID-19 and is in the phase of initial recovery after a noticeable decline, against the background of political disagreements between Russia, on the one hand, and the USA and European Union, on the other. Now we can say mutually beneficial bilateral economic relations have been suspended, at least partly.
The uncertainty caused by geopolitical tensions and sanctions had a shocking impact on the Russian economy in 2014 and contributed to increased macroeconomic instability and a significant slowdown in growth. The situation only became worse in 2022.
In recent years we may have seen a great number of negative effects as dramatic changes in the Central Bank key rate. Experts say that it is strongly connected with the introduction of sanctions and restrictions on access to cheap foreign loans for some of Russian banks, rising prices for products of companies operating with foreign capital associated with the ban on investment by Russian companies from the European Union, instability of gas and oil prices, and increases in prices for consumer goods.
Any investments made in companies, based in Russian Federation, at this stage are a great support to Russian economy. These investments might help to recover economy of Russia sooner. Although venture business in Russia has recently been gaining momentum, and, in fact, rose by a lot in 2021, the prospects, and problems of venture capital funds in Russia are needed to be researched, and thus, the subject of this study.
Venture Capital (VC) is a form of private equity and a type of financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. Investors, usually investment banks or other financial institution, seek to undertake risky projects, usually of an innovative nature, for the purpose of making a profit. Usually venture capital funds are set up. Funds are created and managed by professional investors — venture capitalists [8].
Venture capital business started to be shaped by the government in the US in 1953. This is the year, in which the U. S. Small Business Administration (SBA) was founded. However, the philosophy and idea of creating some agency, that would help small businesses to flourish, began to arise years earlier in a number of other agencies, mainly as a response to the crisis, caused by the Great Depression [5]. The SBA (Small Business Administration) adopted a special law on investment in small business. The government started lending to small businesses on preferential terms. If the SBA approved a project, the government provided a soft loan for it. The credit was then also approved by the SBA [4].
Venture capital investments are very risky, so venture capitalists should carefully consider every detail, every step they take, weigh all pros and cons, whether they should invest their money or not. In most cases, these funds invested in new startups simply do not pay off, which often leads to large losses, or even to bankruptcy [3]. We should also say, the risks in venture capital entrepreneurship come from the fact, that products, which are developed and sold by startups are new. So, that is why it is impossible to predict with high accuracy, how consumers will react to a brand-new product or service, what they will buy and what will not [7].
In such a case, the investor must have excellent knowledge and intuition, as well as market trends today and be able to predict and foresee consumer behavior in the nearest future. Otherwise, “the invisible hand of the market” will come into force, which will show that if one of two participants of the market relations turned out to be more successful, considered all possible options of investments, foresaw all risks, and chose the winning project and got a bigger profit, the other capitalist, however, will suffer great losses. Such a problem has been encountered by many investors who point out that when investing in such risky projects it is worth considering the Pareto Principle (20x80) which states that only 20 % of our investments bring 80 % of our profit. Based on this principle, one should choose not one but several startups to invest, thereby diversifying the risks [4].
However, it should be noted that despite the huge risks of not getting a return on investment, this type of activity is a necessity for the economy as it makes a tremendous contribution to the development of small and medium-sized businesses, promotes the development of entirely new technologies and sustains progress, which has a significant impact on the state of economic development. Venture capital, combining different forms of capital (equity, loan, and entrepreneurial capital), mediates economic relations between investors and companies in need of financing [2]. The assessment of the essence, functions and characteristics of venture capital allows us to consider it as a kind of financial capital.
This kind of financial capital forms a specific investment factor — a resource in social reproduction, which has a predominant focus of action on the intensification of scientific, technological and innovation activity, combining high risks and uncertainty of the market trends with high returns on funds invested in new or developing firms [1]. The venture capital market consists of several segments — the main one is institutional venture capital. Professional financial intermediaries operate in this market, the purpose of which is raising funds from financial institutions such as NPFs, commercial banks and insurance companies. For this purpose, venture capital funds are created and managed by professional investors — venture capitalists [5].
A study of the experience of venture business development abroad reveals that most of the countries with lagging economies undergoing transformation have made huge leaps, evolved, and emerged as a leading technology and economic powerhouse thanks to venture business, which has attracted large amounts of capital. The most prominent examples of such countries include Singapore, Japan, South Korea, and Israel. These states, unlike Russia, do not have large territories, rich natural resources, or a large population, but they are in many ways ahead of our country in terms of their economic development and in the development of innovations. The need to transform the Russian economy into a post-industrial stage has been a pressing issue for economists for the past decades [7].
The growth in investment was caused by several factors. Firstly, this trend can be seen as a distinctive characteristic of the global venture capital market. According to Crunchbase, the venture capital market is now growing by about 90 % annually. Secondly, for the second year in a row, the volume of investment in startups by the Russian corporate sector has doubled. This year, it reached the RUB 11.5 billion mark.
Economic trends always depend on geopolitics and social events, happening in the country and in the whole world. That is why all the predictions made for 2022 have become irrelevant. In the year 2021, deals with foreign and corporate investors as well as private funds showed the greatest growth. Foreign investors even surpassed Russian venture capitalists in terms of investments: 44 billion rubles against 40 billion rubles. At the same time, state funds, were investing less actively. In 2021 there were only 29 deals totaling 2.3 billion rubles, compared to 3.9 billion rubles in 2020 [9].
The pool of investors is now limited to startups from Russia. It is very likely that the government will try to invest more money in new and young companies to substitute imported pro. Also, there will be more private investors in Russia because many businessmen have lost the opportunity to invest their money in real estate and other property abroad. Most likely, investors will pay special attention to startups that are already operating and have a profit, rather than to projects with a good long-term perspective.
Startups that will be able to replace foreign software, applications and services with their Russian counterparts will now be in demand. There will also be a need for projects that will solve the problem of finding suppliers and different ways of making the process of logistics cost-effective.
A specific feature of venture capital financing in Russia is the predominant role of the government. This is because Russia's high-tech complex was formed based on the legacy of the centrally planned economy of the USSR. At that time, the government was making emphasis on the development of the military-industrial complex.
In 21 st century, as time has changed, government has begun to support the IT startups. Since 2022, taxes have been abolished. This fact may help to create many IT companies in Russian Federation, which will drive the economy of the country. Especially now, when companies are leaving Russia, the threshold for entering the market has fallen. Western companies have suspended cooperation with Russia, freeing up a niche. Therefore, the state is now in need of specialists in the field of cybersecurity. New startups will take the place of the companies that have left Russian market and will develop [4].
We think that it is safe to say, Russian venture capital market will continue to grow, but the challenge for any investor now is to choose the right partner and startup to invest into. Right decisions will help to build up the capital. Now, venture capitalists in a short time, to provide people with something they have suddenly lost, and to build their business on it.
The venture capital market cannot exist in isolation from the country's economy and politics. It reflects all positive and negative trends that are taking place in the context of economic sanctions, imposed by the West and the economy’s downturn.
The number of foreign investments has dropped significantly, but new ways have opened, regarding import substitution. Russia still has enough potential to form a new economy, which align with requirements of today’s world.
Crisis in Russian Federation may certainly help its economy to grow if we will be able to use it right. They usually stimulate entrepreneurs to create new projects because, when unemployment and living standards are rising, entrepreneurs start looking for new opportunities for survival and become more open to new ventures. The announced import substitution policy aims at revitalizing domestic production and making it more competitive in the future. Innovative projects, which will make production more in-demand and competitive, could be a catalyst for economic development.
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