Time for stronger disincentives for those on the take

The RF State Duma is considering President Medvedev’s bill making a bribe-taker/giver liable to fines of 100 times higher than the bribe itself. A great move in corruption-plagued Russia, on the face of it, but is it going to make a difference?

Whether or not Russia will be able to vanquish the high level of corruption it faces is an extremely important issue. A lot of people today wonder how to reduce graft in this country and what mechanisms can be used to eliminate these types of practices and make Russia more attractive for foreign investors.

My opinion is that before we answer the question how we need to understand why Russia has suffered from so much corruption historically. What are the root causes of this? It’s very important for Russia to understand those and only through that to then create new laws which will reduce graft.

To my mind, one of the main root causes of corruption is that Russia has been a classic, top-down, centralized commodity economy for nearly its entire existence. In this type of economy, a certain legal structure has been developed, which historically protects those owning resources of the economy and enshrines the latter’s position above the law, making the rest of the population live below the law.

Therefore, one has to address the entire concept of law. I’d like to draw a parallel with protection of intellectual property.

The innovation-driven economies have extremely high penalties regarding IP fraud. For example, in the United States you can see very tiny small companies or individual entrepreneurs suing large global companies and literally winning billions of dollars in the IP lawsuits. If you look at other strong innovation clusters such as Israel, Finland or Singapore, they have very tough laws protecting IP, too. The penalties they have could bankrupt the largest companies in the planet.

But with China or other emerging markets, one of the basic problems they have is that the penalties are very low, and for someone to break the law and have a very small fine is not enough of a disincentive. According to some articles I’ve read, the largest fine ever paid for breaking IP laws in Russia is 125,000 euros.

I would 100% agree with new laws coming out that will increase the fines that people involved in corruption will have to pay. The very concept of what bribe givers and takers deserve has to be dramatically reviewed. In this light, the new proposal by President Medvedev is in line with what disincentives for people who act in such a way should be.

Societies behave according to the laws that are passed. If laws are weak, people will take advantage of those laws and act on their own behalf. If laws are strong, then society can be guided by those laws and this, in effect, increases the trust between individual parties. Likewise, if the institutions that guide a free-market economy and a democracy are weak, a system cannon work as efficiently as systems with stronger incentives for positive actions and disincentives against negative actions.

The law is the instrument that society agrees to use to regulate itself. This is the bottom line. If society as a whole wants to create a market economy with strong democratic institutions, then the people responsible for setting laws must develop and write those laws correctly, implementing them on the ground, on a daily basis, at the local and national levels.

This is a critical aspect Russia is going through now. In the U.S., for example, the legal system has been evolving over the past 200 years; Russia has only had 20 years for that. It’s very small amount of time, and it’s understandable that people writing laws in Russia very often have no business experience. So, how can they understand the implication of a law?

The first thing is to start putting in the basic structure of commercial law. The next step is to start building the body of case studies of how that law works, with example of where it works properly and where it fails. Lawyers, prosecutors and judges will begin to build the body of experience so that if a law is written badly, it will show itself with many negative examples which society rejects.

And in the end, laws that don’t work will not properly motivate people. If people are not properly motivated, they will not follow the actions that the government wants people to do, like investing in innovation. If laws are correct, innovation and investment will follow.

So, will Russia always suffer from high levels of corruption? No. I believe that by choosing the path of increasing the strength of laws, the disincentives to cheat and the incentives to do things properly, and by shifting the economy away from trading and more toward investing in technology and innovation, a critical mass of an effort to change Russia as a system will be created. This will support the ability for people to negotiate in a fair way, and when they suffer from some inequities they have a way to address those.

When people trust the law, they will enter into legal contracts and they will do business. If they don’t trust the law, then everything has to be done secretly and in a corrupt way. So, by strengthening laws against bribery you strengthen the system. Each law is like a brick laying a foundation for a new system.

Standards vs. creativity?

Russia has gotten carried away lately with heated debates regarding new educational standards for high schools. This is understandable; what and how our kids will be taught concerns each and every one of us, and molds this country’s future capacity. It is an important determinant that economic growth hinges upon, as skilled workforce is as prized an asset globally as Russia’s commodities.

Each camp has its own pros and cons arguments. When I listened to them, as a former schoolteacher I first tended to side with those who are worried about the new standards. But it dawned upon me then: why do schools need federal educational standards at all? We have a Centralized Testing system of exams that lists a minimal number of subjects to study; why not allow each school to teach a select number of subjects outside the list to an extent the school deems necessary? The authors of the new standards want multiple-choice alternatives for schools; so, the above option would provide a student and his parents with a choice of a school to go to. The reformers’ opponents advocate classical approaches to education; with what I just said there will surely be schools that cherish traditions.

I went on thinking and asked myself: why does such a vast and multi-culture country as Russia have to have so many various standards? Why not grant the regions permission to levy or abolish their own taxes (keeping the federal taxes intact, of course)? Why not let each region think of how to raise budget revenue while presenting itself as investor-friendly?

Or: why does almost every Russian company set January 1 as the beginning of a fiscal year? It is so inconvenient to prepare for a holiday season, do shopping, etc. and at the same time think of planning and reporting. Most international corporations start their fiscal year on April 1 or July 1, and they do fine…

There is a whole raft of standards, both written and verbal, which we hardly ever analyze. But if we bother to do so, we will understand that preserving all of them makes little sense. And as we do, then we’ll be more confident saying that Russia’s competitive advantage is not only well-educated but also unorthodoxly thinking and creative people.

A centrifugal force of Russia’s innovation

It seems to me there’s a growing critical mass of different individual catalysts that are themselves initiating new innovation-stimulating projects.

Many of these are emanating from Moscow out to the regions. Look at the project GreenField, look at StartUp Point or Start in Garage. There’s a lot of new types of people that are emerging, who feel there’s an opportunity for Russia to develop this new innovation economy. They are actively starting to go out of Moscow and participating in regional conferences, regional innovation conventions, i-Camps, various Seliger types of programs that are bringing these young people together.

Just as you can see around the world, young people networking through new media, though Facebook, LinkedIn or alternative social networks are starting to collect themselves into groups. They are starting to begin to support one another. This is a critical phase because when all entrepreneurs view each other as competition they don’t help each other. And as young entrepreneurs realize that they are in a common cause and need to support one another sharing experience, networks and contacts, these things begin to build a critical mass.

Why are such areas as Silicon Valley successful as innovation clusters? Because of the liquidity of movement of people going from a year or two in one company to another company, and every step on the way they are building their personal networks. This is what creates a critical mass of an innovation cluster.

Up to this point in history Russia’s market economy began with ‘Big Bang’ of privatization back in the early 1990s. The people that took over many of the companies were ‘red directors’ or government officials—just people who had no prior experience in the market economy.

So, absolutely everything that happened in Russia’s evolvement in the last 20 years is more or less understandable. There were no ‘smart money’ business angels here; everything had to be developed from scratch. Corporations were bought and large-scale industries were privatized into a very small number of people’s hands.

But today the people who are in their twenties have a completely different mindset. They had 20 years of a different education, of different upbringing, of parents who themselves are first-generation entrepreneurs and worked in the world in a different way and viewed life in a different way than previous generations.

So, these young people—just as in Egypt, the Philippines, America, the Middle East or Thailand—form themselves into their own individual independent social networks. And that’s exactly what’s beginning to happen in Russia. What I can see is that many of the leaders of this effort are coming from Moscow out to the regions.

That’s my main point. They have found that the networks they built in Moscow are extremely valuable, and they can see that it’s in their own self-interest to go out into the regions to find new partners, alliances and representatives to expand their own businesses, networks and experience. So, more and more young people from Moscow who are real leaders in this new generation are bringing in their new brands and new products.

People like Yevgeny Savin with UNOVA Media, like Elena Masolova with AdVenture, Renat Garipov with GreenField, and with StartUp Point, the BIT competition, etc.—the list is growing day by day. Future Russia and the Bortnik Fund’s U.M.N.I.K are other programs. These support programs which the Russian government initially created are now spreading down to a next layer of people.

And this is the critical phase. My view is that the next five years are going to see a massive increase in liquidity of young people going around to the regions. As transportation and infrastructure improve, as lower-cost hotels are established, it will be easier for people to take a speed train from Moscow to Nizhny Novgorod or St. Pete; easier to take a flight to Samara or to the new beautiful airport in Ekaterinburg. It’s easier when you can go and stay in low-cost two- or three-star hotels. So, as this infrastructure develops more and more people will reach out to try and expand their own business and their own networks into the regions.

Marchmont is encouraging that now for more than five years. We’re trying to support these types of programs because what we’d like to see is a critical mass of these types of people developing their own businesses. We realize what role that will have in the development of Russia’s IT sector. And not only IT, by the way.

We firmly believe in the huge potential for Russia’s nanotechnology, biotechnology, energy-efficiency, automotive components. We see huge potential in Russia’s advanced sciences.

IT is an extremely important sector, really moving this world forward right now. IT has a lower cost of entry; it has a shorter investment horizon; it’s easier to develop an IT project compared to developing the new generation of metal which may require millions of dollars worth of equipment for testing. Developing new medicines per day can only be done by the largest global multinationals that have deep pockets to invest in clinical trial testing. So, a lot of these types of more advanced technologies are very difficult for new young Russian entrepreneurs and innovators to deal with; therefore IT is a natural pool for people to jump into and develop.

That’s absolutely logical and absolutely correct. I however really feel that Russia has potential to develop new medicines, new generations of metals, alternative energy sources, life sciences, and so on. I think that as these entrepreneurs become more established in the regions, they will eventually begin to help their friends in laboratories, universities and R&D centers develop their business in other more advanced scientific spheres.

Marchmont wants to position itself exactly as helper in developing that growth in other technologies emanating from Russian regions.

So, am I optimistic about the development of Russia’s regions?

Absolutely.

Am I optimistic about the development of Russia as a leader in the innovation sphere?

Absolutely.

Do we see the opportunity for creating wealth, generating value and really improving the living standards of the Russian population through this?

Absolutely.

One of the key things we want to see is when parents talk about their children they do it with pride that their children are entrepreneurs and innovators. A good friend of mine in Moscow was recently talking about the fact that for her it was very important to know that the children of her friends are creating new real things that improve life in Russia. For her it was very important to know that it’s not just about exporting the top technology to the United States or wherever—it’s about innovating the way we live here, and improving the quality of life here.

And I believe that this trend that Moscow people go out to the regions is simply going to extend the process of increasing efficiency, modernization, and the quality of life by having better ranges of products. Having a better range of products results from having better infrastructure for cold storage, refrigeration, transport. All of these things are innovations which Russians can develop here, and develop companies to provide these innovations and services inside of Russia. I think this process starts in Moscow and is going to accelerate and spread throughout the country.

Taking stock of your potential investment

One of the pitfalls in VC financing is erroneous perceptions that investors develop when analyzing entrepreneurs. Not completely erroneous, of course, but rather vague and ungrounded.

Unfortunately, sticking labels on people has always been a tendency. Those labels are a ‘summary’ of what a person has done and still does, and others tend to build upon those their ‘forecasts’ about how the person will act in future. Assuming that an entrepreneur’s past flaws will not necessarily repeat in future is routinely ignored. Analyzers simply take an occurrence and develop their long-term perceptions of other people based on that occurrence.

Sticking an ‘honesty’ label is a classic, I think. We use our prior observations to say if a person is honest or dishonest, thus alleging that the person will be such in all of his future moves.

It’s not so easy to determine whether or not an entrepreneur will act honestly; each step could be interpreted differently, depending on what circumstances preceded it. An investor looks into the past and analyzes how an entrepreneur was evaluated before, but in most instances the investor lacks current data to see if the entrepreneur is honest enough now.

Even with the data aplenty, you can’t fully rely on their truthfulness. According to much research, there’s a major flaw in testing people for honesty, as all of us have at least once done something, for which we can be called dishonest, but does that mean we all want to do other dishonest things in future?

Such traits as perseverance, aggressiveness, inclination to dependence or submission and others are as hard to determine as honesty. While some other traits of an entrepreneur’s character may be just irrelevant.

So, how to take stock of an entrepreneur?

When we assess a person, we set for him standards that we expect from him or adhere to ourselves.

We develop ideas we expect people to act upon, based on prior experience.

When assessing we do not weigh all pros and cons in everything a person does. We respond spontaneously and are oftentimes dependent on our intuition. Intuition is a skill that can hardly be studied and which we typically use unconsciously. We always tend to subconsciously weigh up other people’s doings as ‘correct’ or ‘incorrect,’ and we do not ask ourselves what our assumption is based on.

There are two major approaches to evaluating an entrepreneur that are still valid: analytical and psychological.

The analytical approach is used when an investor completes his study of an entrepreneur (recommendations received, credit reports scrutinized, etc.), and comes down to the investor getting answers to the below questions:

• How will the entrepreneur treat the investor and his company?

• Does the entrepreneur have the traits of character that one should have in this particular business field to achieve success?

• Do the entrepreneur’s traits match those that ensure a successful business?

The psychological approach provides no answers to why people act in a certain manner and not otherwise. The approach helps figure what a person is capable of. With this approach an analyzer purposes to frame a ‘pared-down model’ of the person under scrutiny to predict his reactions in various situations rather than reasons for the person’s action.

You may request the person to undergo some tests (not the best option, I believe), or you may ask him to tell you his life story. Encourage him, and he will eagerly give you an account of his family, achievements, business experience or what he thinks of important aspects of life. It takes asking open questions and be able to listen. A good listener will hear many things he’s interested in reveal themselves unsolicited in a conversation. What questions are worth asking?

First of all, about intellectual efficiency. An investor should try to compare this manager with others he has ever met to see if this new one is part of the investor’s top list (5% of the best). Can the person learn fast? Can he think in conceptual terms? Can he work with numbers fast and accurately? Is he equally skilled in expressing ideas verbally and in writing? Can he make impromptu decisions or does he only stick to plan?

Secondly, about his business approaches and styles. Can he prioritize things or doesn’t know what to start from? Is he impetuous or prudent in decision-making? What strategy does he prefer? Is he reserved or quick-tempered? Sure-footed or easy to stray with the wind? How does he react to force-majeure? Are his goals realistic?

And thirdly, about his personal relationships. What type of relationship does he prefer with his bosses? Is he sincere, stubborn, loyal, responsible? How does he prefer to build relationships with inferiors? Does he feel his responsibility?

A VC investor doesn’t have to have a psychologist on staff to be able to screen an entrepreneur’s personal qualities. Learning some psychological techniques and applying them in work would do.

What do VC investors expect from entrepreneurs?

Personal characteristics:

• High efficiency

• High risk assessment capabilities

• Ability to convince

• Detail-oriented performance

• Psychological compatibility

Entrepreneurial experience:

• Knowledge of the market

• Business records

• Leadership

• Reputation

I recommend that as you analyze an entrepreneur you put down five things you liked and another five things you didn’t like. If a ‘like’ list is shorter than that of “dislike’—do not invest in such a person. When you detect negative traits think how you would act in his shoes. Sometimes, when interacting with your entrepreneur, you might come across things that may prima facie seem negative. If you do not delve deeper and make a no-investment decision, it might turn out that you have missed a terrific investment opportunity.

As an investor you have to consider everything. And make the right decision.

Out of the flu: a famous deadly foe unlooked-for

Russia’s still reeling from the global economic meltdown and its aftermath, but another foe is already taking out domestic businesses. In 59 Russian regions accounting for more than 60% of this country’s population, flu and acute respiratory viral infections have topped the permissible maximum levels.

You may think that the above doesn’t belong here and the crisis and flu just can’t be compared. I disagree; both recessions and outbreaks of diseases are external factors that adversely affect the Russian economy.

Lots of my business partners have been frustrating me lately with plans derailed, promises undelivered and deadlines pushed back, explaining that their responsible staff were sick. It’s a delayed-action mine for thousands of businesses in Russia.

Unlike the economic recession that is typically not very easy to predict (but still requires preparations for), the outbreak of flu and other acute respiratory viral diseases always coincides with winter—a season one doesn’t have a tough time forecasting. Why didn’t most of Russian entities take preventive measures?

Vaccination is a measure but doesn’t work 100%. But why then not let staff work from home in a web-based mode? Well, it’s true that some employers disfavor any remote kind of operations as they fear employees might leak commercial secrets to outsiders. Here’s an important nuance, however. With a company’s ability to introduce one innovative solution after another, thus developing fast enough to always outperform competitors, will such a company ever need the very notion of ‘commercial secrets’ in the first place?