Tapping Into Russia's Regions

Investing in Russia is hard enough and risky enough to begin with, even in Moscow and St. Petersburg, which have a relatively well-developed financial and physical infrastructure. Picking winners among the myriad small enterprises now mushrooming in Russia's regions can be an even more challenging -- and at times frustrating -- task.


Yet for foreign investors, projects in the regions without big-city glitter offer a more direct and reliable way of tapping into the natural and intellectual resources of the country. For Russia itself, such grass-roots business development is essential for its transformation into a proper market economy.


The Small Enterprise Equity Fund (SEEF) in Nizhny Novgorod is a $5 million venture capital fund sponsored by the European Bank for Reconstruction and Development to promote the development of private Russian small business through direct investment in the equity capital of enterprises.


We have been working since January 1995 and have completed to date four investments totaling $335,000 and three commitments for an aggregate additional $570,000.


Loosely defined, "small businesses" for us are companies with less than 200 employees and annual revenue less than $1.5 million. In practice our target companies have turned out to be organizations which were started by a few individuals in response to market demand for products and services.


Unfortunately, no former state enterprise has made the second cut primarily because those we have talked to still believe that production is more important than marketing, i.e., if only a product will be manufactured, then "they [the buyers] will come."


Any private start-up business could not afford this misconception and survive, and they also do not carry the extra baggage of the welfare program costs that the former state enterprises do.


We have noticed that the serious entrepreneur gets started on his business without waiting for the large outside investment; the less serious ones have a tendency to throw out proposals like spaghetti against a wall to see which will stick -- as long as they are taking the risks with someone else's money.


Of course, we have seen our share of schemes whose proponents may yet prove to be geniuses, and we the plodders. For example, the scientist who wanted us to support the research and development of an infrared measuring device for inclusion in a space station; or the prototype development and production of a more efficient windmill propeller for energy production despite no windmill farm in proximity.


One company wants to produce a chemical that coagulates the impurities in wastewater. Naturally everyone wants cleaner water. We asked what market exists for this chemical and were told that there are 86 factories in the region that need water treatment. Unfortunately the next question is still unanswered: "How many are ready, willing and able to buy?"


One company owner dropped in our office with a seemingly enticing story. Profitable company, 26 subsidiaries making and selling leather goods. Prospects dimmed when we learned within a month that he was in jail for allegedly setting his partner's car on fire. Many a neighborhood -- and business -- would be wonderful were it not for the people.


The serious Russian business owner who has built something from nothing is usually obsessed with controlling the company and extremely concerned about buying back any equity portion he may sell to our fund.


The Russian owner's greatest fear is losing his business to an outside investor, and SEEF's greatest fear is purchasing equity on commercial terms that without dividends would effectively become an interest-free loan.


Many times we have heard Russian businessmen describe an image of a foreign investor who they expect to passively wait while the owner does all the work and then drop by to check the books and collect dividends.


A sensible strategy, however, is to develop an active, close relationship by helping not only with finance, but also in developing contacts for sales, suppliers and technical assistance. In other words, doing all that a good partner can do.


It is a practical fact that the "smallness" part of small business provides less margin for error and less time to correct mistakes when they occur and still survive. On the other hand, in small business it is easier to recognize beforehand on whom success depends.


The SEEF's preferred strategy is to back companies that produce basic products and services for which there is an assured market: A construction materials distributor, a small computer company and an animation studio are among the projects receiving our backing.


Another investment is supporting three former nuclear engineers who left their former employment making bombs and now produce and market high-quality cottage cheese and hot dogs for the Russian version of Los Alamos, the closed city, Arzamas-16. Which is better for the world?


Many investment professionals believe it is impossible for a small business fund to be profitable: Million-dollar investments in bigger institutions are the ticket, they say, whereas SEEF's limit is $200,000 per investment. Yet yearly growth rates of many new businesses in the Nizhegorodskaya Oblast are often over 100 percent, a reflection of Russia's entrepreneurial spirit and new practical ideas appearing in today's small businesses.


By finding good Russian business people, investing in them, and then acting like a real partner in the company to help it grow, investors and entrepreneurs alike can see positive and significant returns. Soon these companies will become mid-size and new models of Russia's success in adapting to a market economy.





John McGuire is the Chief Investment Officer of the Small Enterprise Equity Fund based in Nizhny Novgorod. Soap Box is a weekly forum for opinion on business issues in Russia. The Moscow Times welcomes submissions; please call the Business Desk at 257-3741.