Part of Azorim High-Tech park in Kiryat Arie industrial area, Petah-Tikva, Israel. More and more Russians are investing in Israeli startups. Photo: Gellerj.

JNS.org – The venture investment boom in Russia, which began 4-5 years ago, has contributed to a series of events including the rise of e-commerce, the Yandex and Mail.ru IPOs (initial public offerings), increased government support of the venture capital industry, and the success of the Russian venture capital funds such as Almaz, Runet, and DST. Three years ago, Forbes magazine ranked businessman Alisher Usmanov as the richest person in Russia, attributing his wealth to his investments in Facebook, Twitter, and the Mail.ru Group. Thereafter, several other Russian business oligarchs formed their own corporate funds, such as DST.

There are about 50 classic venture-capital funds in Russia. Stagnation of the domestic stock market and the real estate market, as well as the move toward investment in information technology (IT), contributed to the influx of these funds. Through propaganda and the distribution of grants and tax incentives, the Russian government promoted the formation of many start-ups. The majority of new investments were directed to e-commerce—including hundreds of millions of dollars invested in Yandex, the main supplier of traffic in e-commerce. There was also significant investment in technology and innovation start-ups, which should ultimately provide good return on investment for venture-capital funds.

At the same time, Russia has many talented engineers, but few serious entrepreneurs. Technology start-ups have been able to develop their products, but are helpless in dealing with the market’s realities. It’s important to consider the curse of the big market. Due to the fact that 140 million people live in Russia, the domestic market initially seems appealing. In reality, however, most niche products can earn no more than a few million dollars.

Over time, the managing partners of Russian venture capital funds realized the minimal chances of good outputs due to the problems of deteriorating political and economic conditions in Russia, and the pathological inability of local entrepreneurs to create truly international projects. Additionally, there are almost no strategists willing to buy start-ups in Russia. Trying to find a solution, Russian funds looked to the United States. But with the exception of three successful funds (DST, Runet, TMT), all others were not competitive, partly because the U.S. is too far from Russia. In Europe, meanwhile, there were no suitable breakthrough start-ups for the Russian funds to partner with.

That’s where Israel, the so-called “start-up nation,” comes in. There are a million Russian-speaking Israelis, and over time many Israeli-Russian and Israeli-Ukrainian projects have attracted the attention of venture investors from Russia. But about two years ago, the Russian-Israeli start-up investment relationship rose to a new level due to various factors. Disappointment in Russian start-ups and major investment opportunities forced domestic funds to focus on markets outside of Russia. Several multi-billion dollar sales of Israeli start-ups attracted international attention. For Russians, the logistics for entering the Israeli market are manageable. You can fly to Israel, attend several meetings, and return to Russia all in one day. Once you’re in Israel, all of the start-ups in the country are essentially located within a 31-mile radius surrounding Ben-Gurion Airport.

The tiny domestic market forces any Israeli technology start-up to focus on the global market. That is very possibly the main secret to the success of Israeli start-ups. The path for Israeli entrepreneurs begins at the university level, followed by Unit 8200 of the Israeli military’s intelligence corps, and then a job with an international corporation—almost all of whom have R&D centers in Israel. Then, you launch your start-up at age 40, with considerable experience. By comparison, the average Russian entrepreneur is 15 years younger.

The entry price of the Israeli start-up company is almost indistinguishable from the same cost in Russia. As such, the attractiveness of the Israeli start-up market has grown in direct proportion to the decline of the attractiveness of the Russian market. Russian venture capital funds have started to work very actively in Israel. I don’t have definitive statistics, but it seems to me that 30 percent of the venture capital money in our country was directed to Israeli start-ups in 2014.

It is still too early to draw conclusions about the success of Russian funds in Israel. The investment cycle is in the middle of its process, and current statistics on investment in Israel will not be very different from the Russian venture capital industry as a whole, but we can certainly expect high-profile success stories in 2-3 years.

At the end of 2014, oil prices fell sharply—and everything in Russia depends on price of oil. Russia’s national currency (the ruble) has depreciated by double its original value, and a financial crisis has begun in early 2015 as oil prices continue to fall and drag the ruble down. While Israeli start-ups grow in value, Russia’s domestic market is struggling, meaning that export-oriented start-ups will be the focus of Russian venture capital funds.

Nevertheless, I expect that at some point in 2015, Russian funds will again focus on the domestic market. Funds in Israel, the U.S., and Europe will help Russian start-ups perform better in the global market. Alliances between Israeli and Russian start-ups will be generated. The best engineers from Russia may team with product managers from Israel—with the help of Russian venture capital funds. Ultimately, this relationship will be beneficial for all parties involved.

Alex Chachava is the managing partner at LETA Capital, a corporate boutique venture fund founded by LETA Group, an Eastern European technology holding company with more than $100 million in revenue. The LETA Capital fund supports innovative high tech start-up companies at their seed or early growth stage. In 2014, LETA Capital invested in the Israeli mobile sports application company 365Scores. Alex is also the co-founder at LETA, one of the largest Eastern European technology companies. Since 2005, Alex has been a head of the Eastern European devision of ESET, a pioneer in the anti-virus industry with its award-winning NOD32 technology.