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.

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.