Crowdfunding Is Not an F-word

This op-ed by Victoria Silchenko, founder and CEO of the U.S.-based Metropole Capital Group and a member of Marchmont's Advisory Board, was first published at Huffington Post.

What is the five-letter word sure to strike fear into the hearts of investors everywhere? Fraud.

But what I can't understand is why this particular f-word keeps being associated with equity crowdfunding. Sure, the involvement of large crowds statistically does increase the probability of a fraud in any industry. The National Retail Federation, for example, reports that 4.6 percent of holiday returns are fraudulent and cost retailers billions of dollars every year; an estimated $8.9 billion to return fraud will be lost by the retailers this year alone. Another example with rather limited number of people involved: a hedge fund industry with its non-transparent investment vehicles -- one of which happened to be managed by Bernie Madoff.

Historically, "every positive value has its price in negative terms. The genius of Einstein leads to Hiroshima," wrote Pablo Picasso, known for his wit and wisdom. And theories about an "efficient" economic outcome require many assumptions -- there is only groping in the dark.

So the big question is -- why do we keep hearing "fraud" about an as yet nonexistent industry? Just Google "fraud crowdfunding" and you can find that:

Experts are concerned that crowdfunding as a means of selling securities allows for more abuse and increases the potential for fraud... Experts are concerned that the internet will be used to cheat individuals out of their money by asking them to fund illegitimate businesses.

I suddenly feel a sense of deja-vu -- I heard angry warnings about PayPal, eBay and Wikipedia in the old days that could be summed up in the "Who Let the Dogs Out?" rap.

So, let's keep in mind that equity crowdfunding (or crowdfund investing) is not operational and not legitimate in the United States yet and for those who are growing comfortable with the concept, there are three essential facts to remember:

1. The equity crowdfunding regulations are tight.

The Senate has already added a substantial number of filing, disclosure and registration requirements that should make it harder for illegitimate businesses to get in the game. One major restriction imposed on equity crowdfunding is that the crowdfunding portals must be registered with the SEC and receive the license of a broker-dealer. Another safeguard tool is that companies seeking equity crowdfunding should disclosure a considerable amount of information, including financial statements and prior year tax returns. Finally, the companies are restricted to raise not more than $1,000,000 per year; for a round of over $500,000 audited financials are required.

2. The investment risks are limited.

The equity crowdfunding law limits private investments to 5 percent for individuals with annual income of less than $100,000 and 10 percent for those who make over $100,000. The United States isn't going to become like Russia of 1998 when people invested everything they had and ended up losing their life savings.

3. The world is small -- and visible.

The UK, Australia, and the Netherlands have all implemented an equity-based crowdfunding model and so far the world hasn't heard about one single case of fraud. I asked a colleague of mine, Simon Dixon, the founder of Bank To The Future (the equity-based crowdfunding platform in the UK endorsed by Richard Branson) why there are only 12 companies listed on their platform and he revealed that they spend a lot of time screening companies and making sure that they are "investment ready."

After all -- this is a new industry in the era of an unprecedented power of social media and equity crowdfunding portals want to be known for healthy business and healthy deals.

The story with equity based crowdfunding goes back to April 5th, 2012 when President Obama signed the Jumpstart Our Business Startups Act (JOBS Act) into law which contains a crowdfunding provision that allows entrepreneurs to raise small amounts of first round capital from the public. The U.S. Securities and Exchange Commission (SEC) had 270 days to issue rules before equity crowdfunding becomes legitimate but has failed to meet the deadline although admirably managed to create on-line forum to involve the public to assist with the decision. Mary Schapiro officially steps down as the head of the SEC on December 14, 2012 leaving everyone to wonder if the regulation will be ready in 2013. Or ever.

By the way, interestingly the American Gaming Association (AGA) launched on December 3 its own campaign urging the U.S. Congress to legalize online poker . I am wondering what their timeline looks like. May I just add that the amount lost gambling by Americans has a pretty significant impact on household finances already -- a chart from The Economist shows the USA has around $375 in losses per year per adult.

The fact above tells me one thing -- people don't care about probability when they have a freedom of choice. And when it comes to equity crowdfunding, I have a sense that it is not about fraud -- it is about changes. And who likes the changes? Not the old financial world. The new law would empower everyone with a right to invest regardless of his/her economic class breaking the old rule when only people with an annual income of at least $200K are allowed into the club.

Equity crowdfunding presents an attractive proposition for people who can choose to back up the project they believe in and attain a sense of pride at becoming a shareholder and making a difference even with a tiny amount of capital. I bet it is more rewarding than gambling.

Then again, with crowdfund investing entrepreneurs and innovators will no longer be limited to conventional financing sources and are inspired with the possibility of being heard and supported by the community -- here's where Facebook comes in handy.

While the future of the new industry is in the hands of SEC, there is something hopeful hanging in the air. Crowdfund investing won't be the death of the financial world -- instead, it may just be its savior.

What innovators and investors want to find in each other

Looking for an investor that understands you

I think the most important aspect for an innovator who’s looking for investors is to find a ‘smart money’ investor. That means, finding an investors who has experience in exactly your field.

Maybe it’s your technology; maybe it’s your segment of the market; maybe it’s your scientific background. The key thing is to find an investor who has empathy for what the innovator is doing, and has a personal interest. Angel level investors invest based on their instincts, on intuition. They base their decisions on the person and on what types of chemistry reaction they have with that person—unlike early-stage venture capitalists that invest based on objective assessment of risks, how to mitigate the risk and how to maximize potential returns. The process for a venture capital investor is to assess the business plan, the financial model, the integrity of intellectual property, the integrity of market research, the strength of a competitive analysis and all of these factors that require objectivity.

Then the valuation of a company can be assessed. The valuation will have some sort of range. Once the venture capitalist has a range of valuation then he can negotiate with the innovator. The buyer wants to buy cheaply and the seller wants to sell expensively. But in a situation of a pre-seed stage project where you have a technology idea or brand new fundamental science which may be revolutionary or even disruptive, it’s highly important for the innovator to feel comfortable with the angel investor, and know and feel that the angel investor is going to be there to help him. The valuation at this stage of project development is going to be very low, much lower than the innovator probably feels the technology is worth. There has to be real understanding between the innovator and the investor. The value that the angel investor will provide will absolutely change the financial dynamics and structure and the future valuation of the company. Therefore it has to be a smart investor, someone who has wise understanding of that sector. And the only thing that will push the innovator to agree is that same intuitive feeling that this is the right partner to work with. Looking for investors is extremely important. Innovators should look at the type of people, at what types of projects they have been involved in, what success stories the investor can point to, and so forth.

Looking for an innovator that is not a lone wolf

Investors have lots of choices. Most angel investors look at numbers, many numbers every week; they get invited to a lot of different projects. As an angel investor I’m looking at five or ten or twenty different projects per month through my networking activities and speeches, presentations, blogs, chatrooms, email correspondence, LinkedIn, Odnoklassniki and many other forums. Sometimes I receive two-three projects every day. And 99% of the material that I receive I’m rejecting because I think, “No, it’s not really for me.” Maybe I don’t have enough experience in that sector; maybe I don’t have the understanding of that geography or that market; maybe I feel that the team presented is not exactly the team that I can work with.

What I’m looking for in an investment team is that there’s not a single innovator but there is a real team. Why am I looking for the team? Because a team has already understood how to compromise. If I’m dealing with one single scientist that means this person is trying to do everything himself; he hasn’t had to compromise, and maybe if he has had arguments with partners, the partners have left him. From my standpoint, it’s extremely important to have three, four or five members of the team. That’s already a very important indicator for me that this is a group I can work with. I need the scientific leader but I need to make sure that the scientific leader or the project initiator has already brought other people into the project, which believe in him or her and believe in that project in the same way as the innovator believes in that project. To me, this is an indicator that the innovator has been able to sell the idea to someone else. If he’s alone, I almost always reject the project.

What the innovator has to understand about the angel investor is that the angel investor is someone searching for the next Google. What am I looking for? I’m looking to change the world. I believe that technology can be used to solve global problems and improve the human condition. So, I want to invest in things related to global warming, methods to purify water, etc. These are not necessarily idealistic goals on my part, but I believe that these types of disruptive technologies will create extreme value. A lot of business angel investors are motivated by improving the world.

Usually business angels are people who have already had two or more big successful projects. They’ve developed companies, they’ve sold them, they organized the public issuance of shares of their companies. Usually those things took place when they were in their late forties. And then they are looking for other projects to do. They typically work 24/7. Most angel investors I know never plan on retirement, never think of the day they will lie on the beach and do nothing because that would be boring. That’s what’s interesting in life, and life is short.

So, innovators have to understand the motivation of the angels: why are they doing what they are doing? The wealthy people with a lot of money in the bank can go to restaurants and take their families to some exotic trips. Business angels also do something like that periodically, but mostly they want to be changing the world. And they are looking for that type of disruptive technology which exactly would achieve that. Angels mostly look for people like themselves, for people with fire in their eyes.

They typically form a portfolio of 10-20 or sometimes, as a friend of mine in California, Frank Peters, told me, up to 30 projects. Some of the projects might not succeed, but a few of them might succeed beyond your wildest dream. And that’s the dream of every angel investor.

The investor and the innovator should understand the psychology of one another. For the innovator, the project might be something he’s spent 10-15 years of his life on; it’s something he believes in deep to his soul, something he wants to achieve as a major goal in life. If the angel provides some sort of advice which says to completely change the technology that may not be easily received information. The angel has to be sensitive that for the innovator, the project is his baby. It’s important that angel investors have a lot of experience and understanding of how to present themselves and their ideas to innovators; and innovators should be prepared that the angel investors are going to be strong-willed and they are going to push them. The ideal combination is when the two forces push each other forward, when none is completely dominant over the other, but both try to achieve the maximum valuation of the project.

For the innovator, it’s important to understand what he’s good at. I had a conversation recently with a man who’s been working for 15 years on his innovation project. It has to do with supercomputers. The man worked on this with a very small team, leading almost every aspect. I asked him, “Who created the marketing plan?” He proudly pronounced, “I did it himself.” I asked, “Who created the financial plan?” He proudly announced that he’d done it himself. Who created the idea itself? – he did it himself. And he has one programmer.

It’s a little bit scary for an angel investor to see that one seems to be completely self-reliant and does not really need a lot of people. When I suggested to him that maybe he should change his strategy, he absolutely refused. To me, this is a very dangerous kind of project to take on because what you want to find is a person who understands his limitations and weaknesses and feels the need to bring someone else like an angel investor into the project that could complement him and work on a commercialization strategy.

I explained to that innovator the example of my uncle’s business angel club which he created 40 years ago in Chicago. My uncle together with seven of his friends worked with professors from University of Chicago, North-Western University and some other universities in the mid-West. Once a month they would gather together. I explained to that innovator that those professors understood they were not CEOs of companies—they were start-up artists, they were creative innovators that would work on a project for six months or a year, develop it, and then hand it over to the people who could commercialize that project. And my uncle’s friends would take on the projects at a certain stage, hire accountants, marketers, the CEO, and they’d develop a team which could present all of the information to the venture capitalists, different VC funds in Chicago and the mid-West. What made this so successful in Chicago is that the professors understood themselves that they couldn’t do that alone and that they didn’t want to be the CEOs of their companies. They wanted to continue to work on technology, which is what the innovator should focus on. And the business people should focus on what they do well.

I was received with a look of shock. “Well, I’m not going to let anyone run this company; I’ve developed it from the start!” …In fact, he didn’t want to get advice on commercialization; he didn’t want to listen to anyone else. And what may happen unfortunately is that this project may not survive because in this day and age the professor sitting, say, in Siberia is probably having competitors in three other cities around the world working on exactly the same topic. And those other innovators may have a different view; they may believe that the speed to the market is the critical aspect of success. Those who wait may lose the market. If you try and do everything yourself the project may not succeed not because of its technology or whether it’s superior or inferior to any other technology, but simply because someone else beats you to the market as he understood they need professional management, they need professional venture capital, and they need to move into a new level of production and patenting and licensing and prototyping.

If I can understand that the innovator is not willing to get advice, for me this project is not interesting to work on. I want to work on a project where people need my influence and experience.

Why Crowdfunding Is The Next Big Thing: Let's Talk Numbers

This op-ed by Victoria Silchenko, founder and CEO of the U.S.-based Metropole Capital Group, was first published at Huffington Post. 

Stephen Hawking once said: "I don't think the human race will survive the next thousand years, unless we spread into space." Bold statement. But as I've been working on organizing the upcoming Next Generation and Global CrowdFunding Forum which is set to be on November 16th here in Los Angeles, I've been asking myself the similarly dramatic question: can we, as entrepreneurs in desperate need of capital, survive the next ten years unless we spread into crowds?

A Global Entrepreneurship Monitor (GEM) study revealed that out of the $51 billion invested in start-ups by individuals in 2010, only $9.4 billion was committed by angel investors (formal investors) while the bulk of capital, $41.6 billion (81%), came from friends and family. What about VCs? Let's look at the data from the National Venture Capital Association (NVCA): in 2010, venture capitalists invested approximately $22 billion into about 2,750 companies, 36% of which received funding for the first time.

Now let's compare the numbers: in 2010 we had $41.6 billion coming from friends and family, aka "informal" investors, fearlessly backing up start-ups and only $22 billion from the VCs committing to both: start-ups and established business. Are you thinking what I'm thinking?

More recent data from GEM confirms that in 2011, 4.8% of the U.S. population personally provided funds for new businesses while only 1% of the population was represented by formal or accredited investors (must have an annual income of at least $200K or over $1 million in liquid net worth) along with venture capitalists. Alas, the last were not much of a help to the majority of entrepreneurs - 95% of business plans received by the accredited investors and VCs were rejected.

From my frequent talks with VCs, I've collected even more astonishing numbers - on average a VC reviews 2,000 business plans annually while choosing to invest in just 3-5 ventures per year. So, your probability of getting funded by a VC is 0.2%. On the flip side, one of the VCs told me that he has to raise capital himself most of the time and is often sad to let the company go - moreover, he wouldn't be surprised to find out that his "rejected portfolio" would perform better than the acquired one. What? Does it mean that we might miss the next Mark Zuckerberg? And who holds the cash anyway - money that might have been invested in the emerging ventures otherwise?

The enlightening answer has arrived from the Federal Reserve. It turns out that large U.S. corporations currently hold about $1.73tn (50% more than they held in 2007) and banks keep in their reserves an estimated $1.5tn in excess. Realistically speaking, can we expect such cash hoarding to be unleashed any time soon with a goal of rescuing small businesses under the premise "too small to fail because nobody will notice anyway"? You get the point.

Needless to say, entrepreneurs in the U.S. are waiting with their hands up for the SEC to arrive with new solicitation and general legislation rules that would allow them selling shares over the Internet utilizing the equity- based crowdfunding model. Yet, some of them have already employed an altruistic or reward-based crowdfunding model which is operational today. If you are a small business owner or have a creative project, chances are you are familiar with Kickstarter ,IndieGoGo or GoFundMe - crowdfunding platforms with the investment proposals spanning from film makers to innovators offering non-financial incentives for micro-sponsors. Furthermore, last week Lockitron released a crowdfunding software under an open source license and launched Selfstarter - a ground-breaking platform which would allow inventors to set up their own crowdfunding campaigns.

Interestingly, the long awaited crowdfunding model where micro-investors take an equity part in the company, has been already operational in the UK for over two years, in Australia for seven, and recently was legalized in Italy by the Monti government. My Italian friend commented after that legislation: "I must say that this is a time I am proud to be an Italian!"

Overall, according to Crowdsoursing.org, the company that does an admirable job tracking the industry numbers and trends, the crowdfunding platforms raised $1.5 billion in 2011 - still a tiny number in global terms but the growth is impressive: 72% from $854 million in 2010 and almost a triple jump from the $530 million raised in 2009. The study forecasts further growth which is expected to be almost doubled this year reaching $2.8 billion globally.

What's next? Well, I am sure that SEC with the help of the two most active groups in the industry Crowdfund Intermediary Regulatory Advocates and the Crowdfunding Professionals Association will frame the legislation just right remembering that the initial goal of crowdfunding has been to simplify access to untapped capital for the entrepreneurs and innovators, not complicate it. Quoting Stephen Hawking once again, "The idea of 10 dimensions might sound exciting, but they would cause real problems if you forget where you parked your car."

How blood analysis ended up checking shampoo for authenticity

Once again, I think about the fundamental gap between an idea and a project. Typically in Russia, this gap is hard to fulfill because the innovators creating the ideas have very little interaction with specific venture managers. What Russia really needs is a new cadre of venture managers. These would be young entrepreneurs which have one leg in the science world (maybe they have their first degree or Master’s degree in some particular science), and their second leg in the field of business where they’ve worked for some years.

In talking to a lot of scientists, they have for years received subsidies from government ministries for their work in specific R&D sectors with little indication of where those technologies should be applied, and with little influence from any business sphere which would say how the project needs to be developed in order to adapt to markets.

There are many examples of a business angel coming across a technology project, looking at it from a business standpoint, and seeing that the innovator has no idea how to commercialize it. I have an example on my mind where a Moscow R&D institute was creating a blood analysis mechanism to check if blood has any particular virus or disease (by cross-checking a new drop of blood and an original sample).

As this is a very cheap mechanism, the institute found few markets in the United States for such a product because many doctors wouldn’t really have an interest to sell that service—they were already making a lot of money from conducting a variety of expensive tests for different diseases. The institute in Moscow had little traction in trying to commercialize this.

An angel investor, however, took a look at this technology and asked, “If you can analyze blood, can you analyze any other liquids?” And they said, “Sure, why not?” They hadn’t thought about it but yeah, if you could analyze blood you could analyze something else.

He asked them, “Could you analyze shampoo?” They thought it a crazy idea: why would anyone use this test to check shampoo? But he asked again, “Can this test analyze shampoo and cross-check any sample today of shampoo compared to an original sample of shampoo?” They replied, “Well, absolutely, and you could see if this is the same formula of shampoo or not.”

Basically what the angel investor discovered was that this was a cheap mechanism for checking if a household liquid like shampoo was an original product or a copy, because any deviation from the original formula would be picked up by this device. So this became a quality control device having nothing to do with medical purposes.

The scientists themselves were shocked at this application but, in fact, they made money; and selling a license for this product brought money to the institute enabling scientists to continue their efforts. So everyone ended up happy; the angel investor found the markets and found the way to license this, and the scientists received further additional revenues for themselves.

So this is just one example of where business angels can help fill the gap between an idea and real business project. What Russian business leaders and community leaders and public service leaders need to focus on is how to replicate this process, and how to build those types of mechanisms to cross-check the commercial application for any given technology. The scientists themselves will not necessarily have any understanding of how to commercially develop their products or what markets may exist at all for their ideas.  Business people may have an entirely different perspective.

Fundamental science gives us breakthroughs. Without it we can’t really advance ourselves in the field of communications, computer processing, supercomputer technology, artificial intelligence, biotech, etc. The problem is that scientists are following their own god instincts and their own methodologies in developing their theories and ideas of cross-checking theory against reality. But business people need to be part of that process, so they could look at those scientific ideas and then pick a part of what they think could be used within business.

VIDEO (Rus.): Kendrick White talking to the participants of a New Eurasia Foundation training program, Moscow

(1 min. 38 sec.)

 “We originally invested in Speech Technology $700,000 and then made a profit of $12m,” Kendrick talks of his prior experience of investing in IT projects with Quadriga, a European fund. 

Russia may jerk two steps forward and one step back—but hardly to a halt

More thoughts on Russia’s innovation development patterns in the wake of my prior posting from a couple of weeks ago…

Russia, in the last twenty years, has gone through fundamental transformation—from the commodity-driven economy to having now a strong national interest in developing the innovation-driven economy. We’re not there yet; there’s a lot of work to do. But there’s a critical mass of people that say Russia has no choice but to develop the innovation-driven economy.

The economy model based on commodities cannot work. The level of volatility is simply too high in such an economy for any government or culture to survive the ups and downs. If the global economy is on upward momentum, and oil prices are high, Russia does great; everybody’s just in a very wonderful mood. But if the global economy turns down, Russia may turn down three times worse than the rest of the world.

In this type of up and down momentum, and lack of stability in the foundations of the economic structure, Russian investors have had very short time horizons. They are worried about inflation, volatility; they’re worried of whether the government will change too abruptly. And all those worries create high levels of risk. Those risk levels make barriers for investors to think long-term.

That’s what has to change. And it’s changing. Russia’s developing fundamental basics of a structure to support innovation development at the grassroots—at the individual innovation leaders’ level—through education programs, through Eureka programs, through US-Russia Foundation programs. These types of programs to support fundamental law and civil society and institutional structures of democracy are critical for Russia’s long-term development.

All the people that I know in private enterprise and innovation entrepreneurship understand it well. And the people at the top who I’ve talked to also believe and understand this. But one must remember there’s a lot of people in the middle that have no vested interest in this future—people that thrive in chaos and ‘gray’ markets, and do well on corruption and kickbacks. They are not very interested in the type of society which is fully transparent and stable and long-term growth oriented.

Society is divided in Russia, and any observer of this country has to understand this.

There’re those who are for the process going forward; these are the young generation, innovators, entrepreneurs, doctors, lawyers—the professionals. They want to see a new society.

But there’s an older generation, and there’s an entrenched generation of bureaucrats and security service people that don’t really want to see the system change.

The situation isn’t clear-cut in Russia. The people have not decided as a strong majority, “This is what we want to do.” But we have to be on the side of the young generation that wants to move forward. The older generation wants stability and is prepared to sacrifice freedoms and human rights in order to have that stability. But young people, as in all cultures, are ready to risk it all in order to get more freedoms.

That’s what we have to support. I think that’s what we are supporting. And I think that’s what the world has to support in Russia. We shouldn’t take a critical eye and just condemn Russia that it’s not working out. It is working out. We’ve gone through twenty years of an extremely complex and difficult transitionary process. But the world has to realize that Russia needs to go through twenty more years.

We have to be patient with Russia; we have to work with Russia; we have to help Russia through this; we have to help its young generation. We have to understand that there are those in society that do not support what we’re doing. And they don’t want to support that because it’s against their interests. People that make a lot of money through non-transparent transactions don’t want the light of day shed on their work. We have to accept that that is reality in Russia that we have to deal with. But the people I work with, and the people I’ve met and been close to over the last twenty years, understand this and support the move forward.

I encourage any observer of Russia to really look at the situation with clear eyes, not rose-colored glasses, and not cynical glasses either. It’s easy to look at Russia and criticize; it’s easy to look at Pussy Riot like scandals and think, “Oh, Russia’s judicial system is just a mess!” Well, there are problems, but there are problems all across society. There are bright spots, however. There are lots of arbitration suits which are decided in favor of the Western investors; there are even those that uphold IP and trademark rights (take a look at a recent interesting one, with a Swiss watchmaker, Longines, awarded damages from a Russian delinquent online store in a trademark infringement suit). One must look at the overall picture and draw broad conclusions.

Russia is moving in a certain direction. It’s not negative. It’s two steps forward and one step back. It’s easy to point out the steps backward; but one should not forget we are making steps forward.

I remember when there were lines for bread and sausages in Russia; and it was chaos and hyper-inflation. Those times are long gone. Today, we live in a different world. Today, we’re talking about nuances, “How much freedom do innovators have? What type of tax incentives do business angels have to invest and risk their money in high technology?”

These are the real debates we’re facing today. And those are serious and need level-headed assessments on how to change the legal structure in Russia. Because in the end, it’s all about the rules of the game, and what rules we set for ourselves in developing this innovation economy in Russia. This comes back to the rule of law; this comes back to the judiciary and political structure. What we need to be focused on is helping Russia develop a proper set of rules to motivate and guide investors to make the right decisions, to make the decisions to invest in Russia.

That means that the government needs to consider that those investors have lots of alternatives in this world. They can invest in derivatives, or currencies, and speculate in any part of the world they want. So, if Russia wants investors to invest in this country, it has to create conditions that attract investors into this economy. And not only foreign investors but Russian investors.

This is what Russia has to face over the next five years. And I believe the next five years is the single most critical period we ever faced. Because if Russia continues to lose three or four hundred thousand young innovators, its ‘brain trust’ that now leaves Russia, this will be a catastrophe for this country. The top leadership and the elites in Russia understand that. So what we have to do is help Russia develop the right policy which will stimulate domestic young innovators to stay in the country and to work and develop their businesses.                

Part V: Scaling Up Investment—Finance the Startup of Start-up Communities

Thomas Nastas presents the concluding part of his insightful study on Russian and international start-up communities.

In Part V, subjects discussed:

1.)   For Entrepreneurs—What are You Selling to Investors?

2.)   For Investors—Let’s Be Realistic

3.)   For Governments/Development Finance Institutions—Atypical Leadership Needed

4.)   Concluding Remarks

Last time in Part IV, the Quest for Growth, I discussed:

1.)   Clonentrepreneurship or Alternative Paths to the Start-up of Start-up Communities?

2.)   Change the Culture & Amazing Things Happen

The take-away from Part IV.

Clonentrepreneurs sensitize local investors to the rewards of investing in technology since clones match the behavior of local investors to risk. As results are achieved and money is made by all, investors open up to new investment opportunities a bit more adventuresome and innovative—disruptive vs. cloning.

Cloning and Clonentrepreneurship is one strategy to impact the DNA of local investors in emerging countries to spark the startup of start-up communities, but of course others exist.

What are the other actions which each you can take to achieve your objectives and fuel the startup of start-up communities?

For Entrepreneurs—What Are You Selling to Investors?

Entrepreneurs raising money too often attempt to shape investor risk behavior to their investment opportunity. Instead, shape your business model to match the needs of not only your customers but investors too.  Think creatively to find the solution which your customers will pay for—no matter how little the revenue is per customer—to craft your business model to match investors’ DNA to risk.  Design your business model and its execution to systematically attack each of their fears to early stage tech deals.

Once you have this business model executed with paying customers, approach investors by ‘selling risk, then opportunity,’ i.e., demonstrate how you’ve eliminated risk in each of the four categories to prove your great investment opportunity. Once you raise money, execute yes but also pay forward in your start-up community; be the role model to other entrepreneurs, teach/mentor them in the solutions which you executed to overcome the fears of local investors in emerging markets.

For Local Investors—Let’s Be Realistic

Rarely will Western clones match the big returns as your investments in telecomm, real estate, construction, food/beverages, fast moving consumer goods, wholesaling and retailing have performed.  Yet as the economy in your country progresses and incomes grow, populations and enterprises open their pocketbooks to products and services which better match changing needs.

In the Chinese online travel industry for example, Ctrip and eLong have millions of registered users. Entrepreneurs seeking money to compete against them is risky and uncertain; however opportunities exist for unorthodox business models. For example, Chinese company Qunar is a travel search engine for online travel services. It aggregates travel information like air tickets, hotels and holiday offerings so Chinese consumers can make better and more informed travel decisions. Qunar serves the evolving needs of consumers and achieves success by approaching the market differently by making competitors—its partners.

Tell entrepreneurs your needs for business models which generate revenues in the immediate term; postpone your demands for immediate profits and cash distributions. Be creative in deal structuring and flexible to valuations since tech business models scale better across customers and geographies to justify higher prices paid vs. investments in brick and mortar.

Structure the investment agreement to align and incentivize entrepreneurs to your attitudes and behaviors to risk.  Oh, how does that work? An example:

American investor financings typically include an equity option plan for founders and employees.  In some emerging countries, legislation permits the issuing of equity options to management of start-ups. When permissible, distribute equity shares based on revenues realized vs. traditional metrics like length of time served in the company or # of users engaged. If legislation does not permit this action, structure the investment agreement as equity earn-ins held in escrow with shares issued when agreed-upon metrics are achieved.

For Governments/Development Finance Institutions—Atypical Leadership Needed

Governments and their finance institutions conceive venture initiatives to catalyze venture funds, to finance the startup of start-up communities.  Frequently these funds are modeled to the program called Yozma, the Israel Government’s fund-of?funds.

Yozma was capitalized with $100 million; $80 million which financed new VC funds with $20 million for direct investment into Israeli tech SMEs.  It invested $8 million into a private VC fund with a minimum of $12 million/fund invested by Israeli and foreign venture capitalists. Yozma financed ten VC funds with a total capitalization exceeding $200 million. These funds went on to finance innovative companies and spur the development of the high tech SME and VC industry in Israel, where one did not exist before. Fast forward 10 years and the 10 funds supported by Yozma were managing over $3+billion with the VC industry in Israel managing $10+billion.

Yozma-type schemes offer economic incentives to induce investment and build learning experiences in seed and early stage tech investing such as:

1.)   Commit up to 49% of the capital to the creation of a new VC fund

2.)   Offer preferential returns to investors

3.)   Take 1st losses on failed investments

4.)   Cap financial returns to the Government so as to boost profits to investors

5.)   Subsidize management fees &/or pay the costs of investment due diligence

6.)   Allow private investors to ‘buy-out’ the Government’s equity, usually within the 1st five years of fund operation, at cost + a bank interest rate of return

Yozma worked exceedingly well in Israel and a few industrial nations. But results in China, Russia, Chile, and other emerging countries has not been so spectacular; local investors didn’t respond in the #s or volume of investments in the seed and early stage sector as expected and targeted by sponsoring governments.

Hmmmm. Reality sets-in as staffers scramble for new solutions and a chair before the music stops.  “Let’s try something different.”

When domestic capital does not change its risk behavior to seed/early stage tech, government staffers work vigorously to create a new class of investor—angels—since their risk behavior better matches the profile of entrepreneurial ventures. While angel investors are welcome in all countries, developing this community takes years to accomplish with multiple false starts and entrepreneurs seeking money now going unfunded.

“Hmmmm—let’s rethink what the initiatives should be.”

Plenty of money exists in the pocketbooks of local investors in emerging markets to finance start-ups for a start-up community to emerge.  What’s required is the unlocking and mobilizing of local capital for investment in technology, 1st time entrepreneurs and early stage tech SMEs. Certainly encouraging a cloning strategy in the entrepreneurial community is one solution to unleashing local capital as the successes of Russian clonentrepreneurs proved.

Another solution is to think forward—design venture schemes which better match local investors’ behavior to risk and the mentoring of local investors in early stage tech investment. Include in this mentoring ‘show & tell’ sessions of other financing solutions: royalty based or technology performance financing schemes, i.e., capital invested in technology SMEs with investment returns generated from the cost savings and/or revenue enhancement earned by customers.

What else might you do, say with founders and management teams?

Organize a mentoring program; get them the mentors they need to ‘shape’ early stage tech business models to the risk attitudes & behaviors of local investors + ‘sell risk, then opportunity.’ Until investors can understand and ‘buy’ the risk in start-ups & early stage SMEs in the emerging markets, little capital will flow to them.

But what can you do if you seek to do something more ambitious, i.e., generate knowledge creation to disrupt industries and attract local investors for the needed finance?  Deal flow funds are one solution to attack both needs.

Deal flow funds finance entrepreneurs and SMEs executing to a single technology, product or service platform, technical challenges that require new thinking in science and engineering to accomplish.  What might be an example of technical challenges in need of solutions?  Take a look at these slides which tell this story.

A ‘deal flow’ fund finances technology development and commercialization.  And in Russia for example, development of the Shtokman field is a national priority of the Russian Government, not only because of its wealth potential but also the promise of new economic prosperity to the Russia Far North.  The linking of technology to a country’s national priority helps assure local financiers that innovators deploying the tech have a market and paying customers.  It’s this matching of tech solutions to customers which harmonize the risk behavior of local investors to the risks of start-ups and early stage SMEs.

Concluding Remarks

Emerging markets face huge obstacles in finding talent, capital, knowledge, and yes, the business models which match the risk appetite of local investors.

Clones are one solution to spark the startup of a start-up community since they generate the revenues which local investors demand as a precondition for investment.  As Clonentrepreneurs achieve success, it encourages others to try entrepreneurship too.  Some are a bit more venturesome and launch improvements to models cloned from the West.  Others do something different and inject their own notions of creativity by innovating new solutions layered on top of Western platforms like Russian beta-stage start-up ClipClock is doing to YouTube or IVI.ru is doing in the Russian video streaming industry.

And isn’t that what we want?

More entrepreneurs driving business and economic growth, irrespective of the business model or the platform technology. We all want more investment, more initiative and more conversation with more saying “I can do that” and “I can invest too.” Such actions generate the growth, the economic opportunities for citizens, and the prosperity that all countries, regions, cities and towns desperately seek.

You're welcome to send comments, opinions and questions directly to Tom at mailto:Tom@IVIpe.com . We also encourage you to visit his personal website.

The four questions Russia needs to ensure it has answers to

I found out recently that in a draft federal budget for 2013-2015, severe spending cuts are suggested, stripping science and state-sponsored R&D centers of part of their funding. A very untimely move, in my humble opinion. A lot has been done on Russia’s path to becoming a 21st century innovation-driven economy, and putting a brake on this process would be painful for the growing system. I asked myself, “Am I being delusional about the future of Russia’s innovation?” And here are my answers to this and other questions.

First: does Russia have an innovation culture? Historically, the answer is absolutely yes. Going back and looking throughout Russian history you can find extraordinary individuals such as Mendeleyev, Lobachevsky, Sikorsky and many others. If you look more into recent history, you’ll find people like Sergei Brin, David Yang, Alexander Galitsky; you’ll find leaders in today’s world that have really made their mark.

And if one were to really study many breakthrough innovations in fundamental sciences in the last hundred years he’d very often find, no matter where these innovations came from (US companies, French companies, Asian companies), that the root of the innovation came from a Russian immigrant.

So to answer the first question—does Russia have an innovation culture?—absolutely! There’s a history of advances in fundamental sciences coming from Russian scientists. And this is partly based on the inherent creativity of the Russian language combined with the fundamental basics of the education system which very early on tried to identify a student’s strong points and then funnel them into studying those topics he was really interested in and good at from an early age.

Russia has this fundamental science and innate creativity. I believe this is one of the fundamental competitive advantages for Russia in the 21st century as it struggles to develop its own innovation-driven economy and to diversify its economy away from oil and natural gas.

The second question would be: does Russia have the infrastructure to develop its innovation economy? What do I mean by infrastructure? I mean this: does Russia have the proper educational system, the proper equipment, and the proper ecosystems within its individual innovation clusters around the country? Is there infrastructure built into the system which could help commercialize technologies from the idea stage into working prototypes and on to companies which could approach and secure market positions in a competitive environment?

The answer to this question is that ten years ago Russia did not have this infrastructure. Russia was still struggling in an effort to create its own basic economic infrastructure in adapting to a market economy model from the commodity economy it had pursued for the previous thousand years. Ten years ago this infrastructure for innovation commercialization didn’t really exist.

I’d say that five years ago an effort was initiated to develop this infrastructure, and during the past five years substantial progress was made in developing it. I’m talking about techno-parks, business incubators, special economic zones; I’m talking about the very specific kinds of mechanisms that have been created, like the Russian Venture Company (RVC), Rusnano, or the Skolkovo Foundation. These basic government top-down led programs may have started out slowly but they have now effectively created the foundation on which Russia can build its infrastructure.

And it is building; and the initiatives are helping create the basis of operations for different innovators across the country. I’ve seen tremendous developments in such areas as Tomsk, Novosibirsk’s Academgorodok, a hub in Yekaterinburg and the Urals.

I’ve seen a lot of infrastructure be put into place and I see that that process is continuing and in fact accelerating. I’m not sure how long it will continue to accelerate because I’m not sure how the federal budgets will be able to sustain these efforts, but substantial progress has been made.

I’d say that also culturally and psychologically there’s much advancement and understanding about what the role of the government is in the process of fostering and developing an innovation economy.

For hundreds and hundreds of years Russia has followed the path of a top-down kind of vertically structured society where initiatives come from the top and are then implemented down below. Whereas in most modern-day innovation economies the emphasis is on what local entrepreneurs can do to initiate progress from the bottom up; to initiate ideas and let them percolate up to the top to where they can go to venture funds and strategic partners and so on.

Russia has made a lot of progress in understanding that this is in fact the bottom-up process. And the paradox for Russian government leaders is that it’s necessary for them to initiate this process from the top down but in the end the power would be held in the hands of those bringing their projects up.

The Russian Venture Company was approached about five years ago about creating a small pre-seed fund. Its managers had absolutely no interest in doing so because they felt it was more important to have large-scale funds to finance large-scale projects. When confronted with the idea that a large fund is going to do an average of ten to twenty million dollars per project when, in fact, innovators need much smaller amounts of money, this wasn’t really considered an issue five years ago.

Today, the progress that has been made by the Russian Venture Company is astonishing. The RVC has programs supporting individual entrepreneurs; there are seed funds, infrastructure funds, Venture Partner programs, programs to support business angel investors, etc.

All of these things have changed and developed in the last five years, which gives me great encouragement that Russia really is making strides in its development of not only its infrastructure but its understanding of what needs to be done to actually empower entrepreneurs so that they can develop themselves and their businesses.

If we look at other initiatives, just a couple of years ago Skolkovo was simply a Potemkin village; it wasn’t really operational. Today, this is a different story completely. I visited its space technology cluster recently and saw that there were over forty companies which were residents of this, and these were really advanced and interesting scientific projects. Through the use of grant financing Skolkovo is encouraging the commercialization of fundamental sciences.

So yes, Russia has created substantial infrastructure to support the development of a long-term shift to its innovation-driven economy.

The third question would be: does Russia have enough of a regional diversity within its innovation clusters to develop a real modern-day, 21st century innovation-driven economy? One can look at the United States and see that there’s a dozen innovation clusters which have developed in various parts of the country and are focused on specific different types of technology segments. It’s IT in Silicon Valley; genetics and biotechnology in Silicon Alley; New York is developing its own cluster; there’s Austin, Texas. In the U.S., there are numerous innovation clusters and they are developing and advancing and springing up.

And the strength of these individual innovation clusters—this is important to understand—lies in the horizontal collaboration and relationships between different types of innovation clusters. A good example could be seen recently with federal initiatives to work with private corporations and universities to develop solutions addressing Alzheimer’s. The collaborative efforts on both the horizontal and vertical levels have created tremendous progress in the fight against this disease.

Russia historically has had very strong vertical relationships but these vertical relationships result in the fact that individual universities see that their interest lies in obtaining additional subsidies through their relationships with the vertical counterparts in the Moscow ministries. And this has created a sort of competition so that within any individual innovation cluster individual universities have little motivation to collaborate between themselves because they see themselves competing for resources from Moscow. This is highly negative and needs to be changed.

Russia has huge potential because the diversity of its own innovation clusters is fantastic. Look at what the region of Tyumen is doing with the development of absolutely new advanced supercomputers, bringing in artificial intelligence technology; or at what Nizhny Novgorod is doing in search technologies and IT, or Obninsk with new molecules. And the real key to make the system effective is to find how these individual innovation clusters and the entrepreneurs developing and evolving within each cluster can begin to work together and collaborate, not only seeking federal funding and support from Moscow but also between themselves.

We all know that some projects now require different specialists to cover different aspects in order to help solve an overall complex problem. Developing new medicines to fight Alzheimer’s, for example, requires vastly different types of technology approaches to understand where the disease comes from, how to identify it, how to identify it early, how to deliver a solution to solve that problem, in what way to monitor and check the progress of therapies. So, the complex problems that need complex solutions require horizontal collaboration between different technology segments.

The idea of commercializing technology is not to just focus on one aspect of fundamental science but rather to look for the multifaceted solution that creates sellable products. In this regard, Russia still has a long way to go. There’s a major gap between the academic circles and fundamental science developments and specifically the business sectors which are used to a very short investment cycle and a short investment horizon.

So the basic answer to the question is yes, Russia has a wide diversity of innovation clusters but those are not cooperating or collaborating either within themselves or between themselves across the country. And this is the main challenge this country faces over the next five years: how to make each regional innovation cluster work itself as a local ecosystem and how to connect that local ecosystem to other broader regions across the country.

The fourth main question to ask is: does Russia have the financial infrastructure to develop its innovation economy? I’d say that this question is complex because 20 years ago Russia didn’t have any type of financial infrastructure for this. Ten years ago it started really to advance its private equity system and even to some degree venture capital.

Five years ago the venture capital system was really emerging and probably before the most recent crisis of 2008 Russia already had more than a hundred fund management, venture capital and private equity companies. Unfortunately, most of these sprang up in Moscow, and the reality is that many of the regional venture funds that were developing were not very successful. Those were based on a model whereby the fund managers were headquartered in Moscow and only had very limited presence in the region, so investments were made with little initial due diligence and very little or no follow-up. Therefore a lot of the venture funds in the country simply made bad investments and did not achieve positive returns.

This has all really begun to change now. Starting five years ago there was an effort to develop a network of business angel clubs across the country, and this started with some presentations that I made in Samara almost six years ago. Today, there are 12 different business angel clubs around the country; these business angel clubs have started to develop a new generation of Russian investor who is quite interested to support technology.

The problem is that today, most of these business angels are in their mid- to late forties and are still working on making their first or second million dollars. So they don’t really have the same psychology as the sixty- or seventy-year-old American business angels who already have many, many millions of dollars in the bank and have already a history of maybe ten or twenty or thirty different projects they’ve developed.

The type of experience that comes from developing multiple angel-level early pre-seed stage projects is invaluable, so therefore the role that angel investors play in more mature economies is such that they act as general mentors and coaches for young entrepreneurs helping them develop business strategies, commercialization strategies, business plans, financial models, and so forth. In Russia today, unfortunately, these business angels are not very active. Perhaps, they have an interest to invest in technology and support innovation but their experience level is not yet high enough to understand what role they really need to play.

This is changing, however. I believe that over the next five years the role of angel investors will become one of the most important roles in the country. According to Fast Lane Ventures, a venture accelerator in Moscow making IT projects, the fastest segment for growth in new investment for Russia over the next five years will be at the angel level, pre-seed and start-up stage levels. I expect a lot of changes to come in the next five years and for more and more money to be flowing in at the earliest stage of project development.

So, to answer the fourth question, I’d say that the infrastructure is developing rapidly and that over the next five years there’ll be great advances made in ensuring that this infrastructure really develops properly.

I have raised these four questions, and to each my personal answer is yes. On Russia’s path to being one of the world’s leading innovation economies in the 21st century, its deadliest foe would be putting all these advances on hold.

'I Went to See the VC and All I Got Was This Lousy T-Shirt'

Victoria Silchenko, founder and CEO of the U.S.-based Metropole Capital Group, feels the VC industry has been sort of limping over the past ten years or so. However, there are other ways--like business angels... The story was first published at Huffington Post. 

Is it just me or does everyone want to be a Venture Capitalist these days? I've been re-reading my latest LinkedIn "cold call" note that looked incredibly similar to a few dozen others I've received over the past few months:

"Hi Victoria -- I am seeking investors to start an investment fund. This fund will invest in startups and small businesses in a broad range of industries. If you are interested, please let me know."

These notes are arriving from the U.S., India, Russia and even Africa. I have no idea why I am on their list, nor why I am enthusiastically pitched by strangers at business events "off-line" -- before I even have a chance to disclose the fact that I am not a Russian oil tycoon. But I do know one thing -- it is tough to be on the "selling-side".

A friend of mine has been pitching his new venture unsuccessfully for over a year and ultimately grew a beard and gained weigh, just like Albert Gore did after losing the Presidential election. We, his friends who happen to be in the entrepreneurial and investment ECOSYSTEMS (excuse my French) all tried to help but at some point we had no bullets left (read: investment leads). So, I've decided to bring some enjoyment into his miserable existence and recently suggested that he should make and wear a t-shirt with some cool slogan, like the one I used as the title of this blog post or something even stronger, like: "I am raising capital for my venture. Can I show you my Deck?" (Yes, I meant Pitch Deck -- and what did you think?) OK, scratch the last one but seriously, can we ease the pain?

The results of recent Kaufman Foundation research stated that the VC industry has delivered poor results for over a decade. In fact, the returns from the public markets were practically similar to VC returns, and what is more, since 1997 less cash has been returned to investors than has been invested in VC. Of course, Groupon, Zynga or LinkedIn continue to inspire the "too-big-to-fail" minds, but the truth is that only 20 percent of VC funds outperformed public markets by more than three percent; and half of such VCs started to invest in mid 90s.

Still, the human working population it seems is divided by two -- those who are VCs and those who are not VCs (but would like to be even if they do not say so). The logic? Well, besides the fact that it is obviously sexy to be called part of the "Dragon's Den," "Shark Tank" or any similar epitome that our pop-culture fed us with, the infamous "2 and 20" formula (2 percent management fee on capital committed and 20 percent profit-sharing arrangement) always works. It's just simple math: if, let's say you have $10 million under management and don't produce any returns, you still are entitled to 2 percent of the management fee which is $200,000. And to the astonishing findings of the Kaufman folks, the average VC fund in the United States actually FAILS to return investor capital after fees.

There are a lot of talks and discussions lately about how to fix the broken VC (LP) investment model and it is my only hope that soon we all will witness an increased transparency and, very importantly -- a sensible alignment between VCs and entrepreneurs in a $15-20 billion (annually) VC fundraising industry.

Until then, before you starting to talk to a VC, make sure you know what the rules of the game are. Unless you are building a $30m + business, don't bother with VCs. If Friends & Family do not return your calls any more, angel investors might be an option. Remember that these days, angel investors most often invest at pre-money valuations between $1m and $2 m with an IRR projected 10-20 percent (VCs are looking for at least 20-40 percent and more).

But most importantly ask yourself who is my buyer and why is he/she going to pay for my product/services? The aspiration of searching for investors is important, but I've found that sometimes it can be disruptive to a steady search for customers.

Part IV: The Quest for Growth—the Startup of Start-up Communities

Thomas Nastas was in Silicon Valley, California, most of August, mentoring a large group of entrepreneurs from 36 countries in selecting, developing and shaping their business models to investors' behavior to risk. (By the way, he has promised to share with the Marchmont readers what experience he gained from the event.) That's why we had to wait a little bit for the continuation of his series of postings about Russian and international start-ups. But now Tom's back with us, and here's part 4 of his in-depth study. 



Subjects in this Part IV post include:

1.)   Clonentrepreneurship or Alternative Paths to the Startup of Start-up Communities?

2.)   Change the Culture & Amazing Things Happen

In Part III, the Power of Clones, subjects presented:

1.)   Drive Growth and Innovation in the Supply Chain

2.)   Sidestep the Obstacles that Impede Scaling Up

3.)   Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start-Up?

4.)   The Spread of Clonentrepreneurship

Read Part III here

Read Part II

Read Part I

Read Introduction to the series

The take-away from Part III:

Cloning and Clonentrepreneurship is belittled since many criticize it as being incremental and not creative, a waste of time, money and energy.  While cloning is neither gamechanging nor disruptive, the results it achieves to drive forward more entrepreneurship and investment validates its contribution to the startup of start-up communities around the world.

Given the contributions of clones to spark the startup of start-up communities, are they a panacea to growth? Do alternatives exist in the quest for growth? And what lessons can we apply from clones and Clonentrepreneurship to impact investor DNA for more seed and early stage investment?

Clonentrepreneurship or Alternative Paths to the Startup of Start-up Communities?

Brazil and China like Russia are large population countries with a growing middle class that is ripe for more consumer-facing clones, clonentrepreneurs and Clonentrepreneurship.  Certainly the selective transfer of some cloned business models to low-medium population countries like Costa Rica, Chile, Argentina, Kenya and Ghana have merit as consumers in these countries seek products and services to save money, to have more choice, to enrich the quality and joy in their lives with clonentrepreneurs, investors and Government all benefiting.

Clones are not the same. The ones with the best chances of survival in the emerging markets against the innovator globalizing are those which require localization for the domestic economy and not just for language(s) spoken: but product sourcing, logistics, payment systems, merchandising and other business practices to satisfy conditions on the ground and to comply with the huge number of local regulations that impact how e-commerce is transacted.

Cloning Western business models is only one direction for entrepreneurs and investors to pursue for profit.  Israeli entrepreneurs and venture investors took a different approach to create a start-up nation through the development and commercialization of disruptive and gamechanging technology for global markets, directly primary toward enterprises.

The Israeli Government pushed success forward through a variety of initiatives which sped Israeli tech to market including but not limited to the transfer of military technology to the private sector and its open door policy to immigrants (many were scientists from the Soviet Union). Other success factors include an Israeli industrial policy that funded R&D to create deal flow and the unplanned creation of entrepreneurs through military training in the ‘8–200’ intelligence unit.

Government policy makers and their sovereign wealth funds can catalyze the start-up communities in other ways.  Riches earned from oil and other natural resources funded Russian initiatives like the $10 billion Russian Corporation of Nanotechnology, the $1 billion dollar fund-of-funds called the Russian Venture Company and the Russian Government’s multi-billion dollar Skolkovo program—to seed development of gamechanging tech, investment and the creation of a new set of entrepreneurs.

While small population countries may not have the sovereign wealth of oil, natural assets like Costa Rico’s location to America creates advantages for its ICT entrepreneurs to scale its start-up community.  Costa Rican entrepreneur Manrique Ulloa Steinvorth of ieSoft created a consortium of companies (IT Innovation Group) to expand access to the US; “Instead of competing for the same opportunities, we get together and offer a whole solution. If a project needs ten developers and I only have five, I will search within the consortium for a partner that can provide the other five, and the company that brings the project will manage the project” he says.

Croatia is another small country with ambitions for more start-up communities.  Its location on the Mediterranean is an ideal spot to transform selected coastline into logistics, transportation and warehousing tech start-up centers to serve Central and East Europe. Investors and the Croatian Government might collaborate to co-create ‘deal flow funds’ which invest in the technologies required to transform this underutilized asset into wealth.

Entrepreneurs and venture investors ask me “Which path should we choose; the road of disruptive technology or Clonentrepreneurship (or something in between)?”

My answer is that it’s not an ‘either…or’ decision.  It’s a combination of all with the percentage blend influenced by:

1.)   Your natural and technology assets

2.)   The sources and amount of money you have or can raise for the execution of your business model

3.)   The types of investors in your country, their sources of capital and their behavior to risk

4.)   The time, patience and determination you and your investors have to continue in the face of disappointment, risk, false starts, failure and forces working for your demise.

As you execute, your specialties and expertise will shine to guide your footsteps forward.

In Russia and in other countries clonentrepreneurs are sensitizing local investors to the rewards and risks of investing in technology.  Over time expect that some investors whom financed clones will develop the confidence and risk appetite to selectively invest in technology that will be more innovative at first—disruptive later—vs. cloning.  These investors and entrepreneurs will be the ground-breakers that establish the precedence for investment in new thinking thereby attracting co-investors from around the world to their home country.

One never knows:  Perhaps the next Facebook-type success is hatching right now in some Russian laboratory?

Change the Culture & Amazing Things Happen

Is this actually possible?  Change the culture—investors’ DNA—for more seed and early stage investment, leading to the startup of start-up communities?

Yes it is, but to change the culture one must first impact it, with investors earning money to their requirements and tolerance for risk.

As I detailed in Part I, Russian entrepreneurs deployed business models which generated quick revenues after their market launch, solutions which matched the behavior and attitudes of Russia investors to risk.  Impacting the culture came about not through grand ambitions to create gamechanging technology but practical steps to generate immediate revenues and execute quickly.

So what are the small but meaningful steps you can take to impact the culture for more investment, entrepreneurship and innovation?

For Next Time, Part V:  Scaling Up Investment for More—Impact & Outcomes

In Part V, I answer this question and suggest initiatives for entrepreneurs, investors, Government staffers and investment officers at development finance institutions to ‘Scale Up Investment for More—Impact and Outcomes.’

You're welcome to send comments, opinions and questions directly to Tom at mailto:Tom@IVIpe.com . We also encourage you to visit his personal website.

Entrepreneurs of the World, Unite

With this high tech era paraphrase of an old Soviet rallying cry Victoria Silchenko, founder and CEO of the U.S.-based Metropole Capital Group, joins our Marchmont bloggers and raises an important question: is the start-up success rate of just 5% normal in the world that has an estimated 400 million entrepreneurs? The story was first posted at Huffington Post.

It was a wake-up call for me -- not that I was sleeping. In fact, it is three a.m. as I write this and I've just finished sending out emails as part of pitching and promoting an event that I am organizing here in Los Angeles -- the Global Entrepreneurial and CrowdFunding Forum. I am an entrepreneur helping other entrepreneurs and this forum is my very personal attempt to assemble and create a cross-border exchange of fundraising ideas among entrepreneurs and investors in a tough economy. BTW, the slogan I've arrived with might sound to you a bit "red": Entrepreneurs of the World, Unite, but hey, I am a native Russian and hope you have a sense of humor too.

But back to the "wake-up" -- well, I just read that according to a new study from the know-it-alls at Harvard, 95 percent of start-up businesses fail. That's ... a lot. Further findings come from the Global Entrepreneurship Monitor, which points out that the number of entrepreneurs around the word is growing at an astonishing rate and now numbers nearly 400 million across 54 countries. Fascinatingly, the intent to start businesses is highest in emerging economies and in some middle-stage developing economies like China, Chile and Brazil. Don't they read the Harvard Business Review too?

The fact that the success rate of "making it" is just 5% annoyingly stuck in my head and made me wonder. Are we all delusional for being inspired by the stories of Mark Zuckerberg, the legendary Steve Jobs or my personal hero Richard Branson? How many stories for the past two years do I know where success was a result of someone's dream come true, in other words, someone was able to take their idea to the level of business project and the business project to the stage of product or service which has a price tag on it? Let me think. The guy who was trying to find investors for his travel website idea has just moved to SF, landed a job at Google and seems quite happy (so is his wife). The young woman who was pitching her media company disappeared from my radar once she got married.

Myself? Well, just like any entrepreneur I am my own cheerleader, educator and self-founder. BTW, being a self-founder wasn't really on my business plan but my consulting business has proved that it is not a recession-proof business and the price of this discovery was equal to the price of my beautiful car. I did have a choice -- but would you give away to an "angel" investor 40 percent of your company for just a few thousands bucks? Me neither. And why are people who take away the junk piece of what you built for years called "angels" anyway? The interesting thing is that I wasn't even looking for an investor! So, keep in mind that "if-you-build-it-they-will-come" happens not only in movies.

I suspect that many of us entrepreneurs believe that through being an entrepreneur we can discover WHO we really are and what we HAVE doesn't really mater. Most of our aspirational moves are about the desire for dignity, freedom to make a choice and believe that we can change the word to a better place. We share and we bond together because we know -- we can lose with a high probability, but we can never lose enthusiasm. Yes, we are dreamers and we are artists painting a picture of success without having to pay tribute to the folks who see the world in black and white and don't recognize the colors. It is a struggle -- but we are in it together. There are 400 million of us. Entrepreneurs of the World, Unite!

Part III: The Power of Clones to Startup—Start-up Communities

More from Tom Nastas on Russia's start-up community. Please check out prior postings to read the beginning.

Subjects in this post include:

1.)   Drive Growth and Innovation in the Supply Chain

2.)   Sidestep the Obstacles that Impede Scaling Up—Investor Attitudes to Risk & Failure

3.)   Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start-Up?

4.)   The Spread of Clonentrepreneurship

Last time in Part II, Cultures of Risk—Financing the Startup of Start-up Communities, I discussed:

1.)   The Cultural Divide:  What Investors ‘Buy’

2.)   What Investors Fear

3.)   The Culture of Venture Capital:  Friend or Foe?

The take-away from Part II. Local investors in the emerging markets ‘buy’ risk by investing in the known and understandable. This explains why they finance business models of fast moving consumer goods, food and beverage, supermarkets, telecoms, light manufacturing and automotive components as examples. Investors finance such business models even at the seed and early stage of company development.

The reason investors invest as they do; markets and customers are a 100% guarantee in these sectors, even in greenfield projects, with the risks of investment in execution, not the risks of market existence and the uncertainties if the tech will work, will customers come and pay.

Clones copied, localized and pasted into emerging economies impact the DNA of investors to risk since many generate revenue quickly—overcoming the fears that investors have for early stage tech.  But impacting the behavior of investors to risk is not the only contribution of clones to the start-up of start-up communities.

Drive Growth and Innovation in the Supply Chain

Although clones look the same on the surface, one country to the next, there are multiple differences in execution.  Many clones require supply chain partners for them to work, yet many of these companies do not exist in emerging countries.  While outsourcing from delivery to call centers are common services for hire in the US and Europe, clones frequently build them themselves, in what I call ‘self-sourcing.’  In other cases, new supply chain entrepreneurs emerge to offer the services to make clones work.

Let’s examine three such innovations.

Logistics and delivery

Lack of effective and efficient delivery companies forced Ozon, the Russian clone of Amazon, to organize its own logistics operation for door-to-door delivery of goods to their customers in Moscow and St Petersburg plus the delivery to more than 2,000 pick-up points across the Russia Federation.  With this asset in place, Ozon offers delivery services to others as the market for online businesses grows in Russia.  Like Ozon, the discount shopping club KupiVIP delivers product with its self-owned fleet of 100 vans; it leases extra vans when capacity is short. Yes FedEx and DHL exist in Russia, but the cost for local delivery approaches $100, too expensive for a book costing $15 or a $40 pair of shoes.

Getting paid

65% of all transactions in Russia are paid for in cash.  Almost 90% of Ozon revenues ($300 million) are cash.  ATM’s that accept cash for payment are widely used in Russia, made by QIWI, a Russian innovator.  But a new complication develops in a cash economy. In Russia for example, customers regularly inspect the goods to confirm that what was ordered is actually in the box. 25% of all online orders are rejected by the buyer with no money trading hands in cash transactions, or a credit has to be made if payment was made through a QIWI terminal, another snag that required innovation for e-commerce clones to work in Russia (and other emerging market economies based on cash vs. credit or debit card transactions).

Call centers required to reassure online buyers

50% of Ctrip (Chinese online travel company) customers purchase tickets by phone as do large numbers of Russian customers of Ostrovok, a Russian online travel company.  Both Ctrip and Ostrovok operate self-owned call centers staffed with real live persons to reassure customers that their on-line orders are placed, accurate and confirmed.

Clearly what emerging markets lack in the sophistication of online shopping in the United States creates a sea of supply chain opportunities for more start-ups to service clones in the developing world.

Sidestep the Obstacles that Impede Scaling Up—Investor Attitudes to Risk & Failure

It’s great to talk about the need for failure, how great business models evolve from failed attempts and the need to encourage more failure. The question is who pays for this learning, and how recover from it? Investors not only in Russia, but other emerging markets label a failed entrepreneur a loser for life, never to raise money again with failure an embarrassment that frequently spills onto her or his family; such shame creates an environment where entrepreneurship is discouraged as a career path vs. a ‘safe’ job, e.g., working for Government, a state-owned enterprise or a multinational corporation.

Even more troublesome is another deep seated cultural attitude to failure in emerging market countries.

Failure = Fraud: we know this is not true, but that’s the verdict when entrepreneurs fail in emerging markets.

The attitude that failure equals fraud stems from ‘who pays for the cost of failure’ as failure in emerging markets means the promoter, the entrepreneur, and the team did not possess the competencies to overcome the challenges of development, or did not really understand all the requirements needed (or did not do all) for success. Yet we know that experimentation, trial and error, failure and pivoting are necessary to define the requirements for business model creation, making the path to progress unlikely in developing countries.

In the former Soviet republics, East Europe too, entrepreneurs and scientists have financial responsibility to repay money under failure; prosecution and jail-time are real possibilities.  Even more chilling are the threats of investors to entrepreneurs “You lost my money (equity), now you must pay the money back (i.e., the investment is equity if achieve success, debt if the venture fails!).”

The fears of investors, attitudes to failure and who pays for failure create a culture that makes early stage venture capital dicey in the emerging markets.  Such behavior discourages risk taking and incentivizes entrepreneurial commitments to proven business models for proven markets like fast moving consumer goods, retailing, wholesaling, telecoms, and yes, clones from Clonentrepreneurs.

But given the successes of clones to start an entrepreneurial revolution in a country, they are not without their critics.

The Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start-Up?

Given the successes of clones to satisfy the appetites of domestic customers and local money, they have their critics when taken to the extreme.  Sarah Lacy wrote an upbeat article in TechCrunch about copy-cat business models in China yet almost three years later levied stinging criticism at the Samwer Brothers with their rip-off of Fab.com called Bamarang.

Their newest clone for the Middle East Lazada is especially bold: I thought I had inadvertently landed on Amazon, that’s how closely Lazada resembles it.

Even Union Square venture capitalist and blogger Fred Wilson jumped into the frying pan with his opt on cloning start-ups.

Condemnation aside, one can’t argue with the quick and profitable financial successes of cloning.



Controversy intensifies when founders clone not just the idea, but every pixel of the start-up to make the clone an almost exact duplicate of the original as the Samwer Brothers did.

In Russia there are multiple groups creating and financing clones.  One of the most aggressive is Fast Lane Ventures which cloned Pinterest (PinMe), Quora (OdinOvet), Eventbrite (Eventmag), Airbnb (RentHome.ru) to name a few; their Zappos clone Sapato was acquired in 1Q2012, 18 months after launch for an approximately 2x return for investors including Fast Lane (plus Intel Capital, eVenture Capital, Kinnevik and Direct Group too).

The Spread of Clonentrepreneurship

Clonentrepreneurship is sweeping not only Russia, but all of Planet Earth.

Cloning has become a trusted way for more entrepreneurs to raise more money from more investors, thereby financing the future of their start-up communities, not only in the emerging world, but developed countries too as the explosion of car sharing clones demonstrates.

Zipcar was one of the first to execute Internet business models for the sharing of cars. Zipcar was not the innovator, but the imitator with Vancouver’s co-op called Modo operating for more than 15 years and the catalyst that helped communities and non-profits get car sharing started in several continents.  While it may not have started in the Internet space, Modo was one of the first to institutionalize collaborative sharing in the community.

So what is really being cloned, who is cloning what and to whom?

Is it car sharing or the collaboratively sharing of underused assets and transforming them into new business opportunities? If the later, clonentrepreneurs are hard at work around the world creating the next set of companies in the sharing space to take advantage of this social movement as these examples demonstrate:

ParkAtMyHouse.com—shared parking spaces
SkillShare.com & TaskRabbit.com—sharing of skills and chores
Murfie.com & Swap.com—collaboratively sharing of DVDs, books & video games
Snapgoods.com & Neighborhoods.net—sharing of ‘stuff’
I-Ella.com & Thredup.com—sharing of clothes & wearables
Sharedearth.com & Yardshare.com—the sharing of land for gardeners & land owners with capacity
Freecycle.com & ILoveFreegle.org—sharing of ‘stuff’ people no longer want/need
Given the contributions of clones to spark the startup of start-up communities, are they a panacea to growth? Do alternatives exist in the quest for growth? And what can actors in the start-up community do to impact investor DNA for more seed and early stage investment?

For Next Time—Part IV: The Quest for Growth

In Part IV, subjects I’ll discuss:

1.)   Clonentrepreneurship or Alternative Paths to the Start-up of Start-up Communities?

2.)   Change the Culture and Amazing Things Happen

You're welcome to send comments, opinions and questions directly to Tom at mailto:Tom@IVIpe.com . We also encourage you to visit his personal website.