BackDmitry Chikhachev | The need for a home run in portfolio
The Russian venture capitalist on why careful due diligence before committing capital is the key to being a successful VC firm
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Singapore: Moscow-based venture capital (VC) firm Runa Capital has only one company from South-East Asia in its nearly 45-strong tech portfolio—something co-founder and managing partner Dmitry Chikhachev would like to change with its new fund.
Runa Capital’s second vehicle, termed Runa-II, achieved its first close of $49 million towards the end of 2014, and the next close, due this month, will take the fund to around $70 million, with the final close, targeted at $150 million, planned by the year-end, the 42-year-old Chikhachev said in an interview.
The Russian VC firm’s links to Singapore extend beyond its investments in Technosoft, a leading cloud business solutions provider for medium-to-large businesses in the Asia-Pacific.
The idea of Runa Capital took shape in 2009 when Chikhachev ran into his close friend and classmate, Serguei Beloussov, currently the chief executive of Singapore-based back-up and data recovery software vendor Acronis.
They had known each other since childhood, having been together in school and also at the Moscow Institute of Physics and Technology. In 2008, Beloussov quit Acronis, a company he had founded, following a conflict with the management on a possible listing. It was at this juncture, with Beloussov back in Moscow, that they discussed the idea of setting up a venture capital firm.
“I thought it was an exciting idea to start a venture capital fund. By then Serguei (Beloussov) had been in the software business for over a decade, while I had experience in building greenfield projects and doing M&A (merger and acquisition) deals and in growing businesses," Chikhachev said.
But launching a VC firm was no easy business. Chikhachev recalled that despite the duo touting complementary expertise in software, deal making and expanding businesses, as well as their entrepreneurial experiences, and also leveraging their connections, investors were hard to come by.
Chikhachev and Beloussov then roped in another of their university mate—Ilya Zubarev—who was now largely London-based, as another co-founder and partner, and the three put in around $30 million in addition to raising capital from family and friends.
Chikhachev said that it was this initial corpus that played a part in convincing the other investors to pitch in and join Runa Fund-1.
“We got some investment bankers in London—from Goldman Sachs, UBS and others—to make personal investments," he said.
After completing his masters in applied mathematics and physics from the Moscow Institute of Physics and Technology, Chikhachev started his career as a human resource partner with LM Ericsson International AB, and was with the Swedish multinational provider of communications technology and services from 1997 till 2002.
He then went back to school and completed his MBA from the American Institute of Business and Economics, and joined Ritzio Entertainment Group, one of the top gaming operators in eastern Europe, in 2004 as head of international business development. Chikhachev said he expanded Ritzio’s global business from nearly zero to $75 million in revenue, including that from an acquisition.
In 2007, when an arm of this company was spun off into a separate entity called UVENCO, Chikhachev was made its chief executive. He expanded its business from zero to $25 million during his two-year stint. This company, he said, continues to be the largest manufacturer of vending machines in Russia. Along with this role, he was also a partner and project execution director in private equity firm QWAN Management Partners, from 2006-2008.
It was at this juncture that Beloussov and he planned and set up Runa Capital, and the VC firm eventually closed its first fund at $135 million in April 2012.
Runa Capital-1 made its first investment in June 2010 in a firm known as Jelastic. Within months of closing its first fund, Runa also got its first exit when one of its portfolio companies, ThinkGrid, a cloud platform in UK, was acquired by Colt Telecom, and the deal also led to a 4.6X return on investment.
Since then, the first vehicle has seen over 35 additional investments, including five seed investments, with 1.6x gross unrealized return on investment (RoI) on the overall portfolio, in addition to four exits worth $16 million with 3.6x total RoI.
The presentation adds that Runa could make as much as $446 million in exiting some 10 investments from its first fund.
Runa has also made as many as six investments from its second vehicle that was launched in June 2014.
“For Runa Capital, our initial idea was to focus on Russian start-ups; but very soon, we realized it was not productive as software and technology are international. Making distinctions by countries is counterproductive," Chikhachev said.
In 2013, Beloussov returned to Acronis as chief executive.
Despite the success, Chikhachev admits running the first fund had been a learning experience for the team, and adds that some of their investments have gone dead.
“The first lesson from our Fund-1 was to become much more accurate about seed investment. We realized that seed investment is not our piece of cake. We may be not so good in making decisions. Second, we decided not to consider companies in e-commerce business—this is not a software business, but just business with some software in it. Same is true for many other businesses, for example, online travel, taxi booking apps—they may be very successful, but this is not our core competence. That was a result of a mistake as we made an investment in online travel. We also decided not to invest in gadgets and in companies which are not solving any painful problems. We are focusing on software that solves painful problems for consumers," he said.
For instance, Runa initially invested $800,000 in online travel booking website Travelmenu, along with a $1 million follow-up investment in 2012-2013, eventually resulting in $1.8million being written off. Here, Runa co-invested with Almaz and relied on the latter’s due diligence, and it then tried to fix the business, increasing exposure, before being forced to write off the investment. Similarly, it also invested in talkbits, a mobile app that allows voice-sharing, pumping in $800,000 initially in 2010, and $1.3 million in follow-on investment over 2011-2013, resulting in $2.1million being written off in 2013.
“We also had technical type of learnings on being very accurate on doing due diligence on the founders of the business. We try not to throw good money after bad money. In our first few investments, we basically made this mistake," Chikhachev added.
According to Chikhachev, the key to being a successful VC firm was to invest in companies that were in sectors that one is familiar with, and doing careful due diligence before committing capital.
“We picked software because we know software. You need a home run in your portfolio. Successful VCs make a big part of their returns from a very small number of deals," Chikhachev said.
He was also non-committal on investing in India and China, the largest markets in Asia, from Runa Fund-II.
“China is still a big question mark for many people. It is the largest market, but a very tricky one. It is self-sufficient—there are a lot of Chinese start-ups for the Chinese market, and making a Chinese start-up successful internationally, or making a European start-up successful in China is still very challenging. The situation is getting better and better, but it will take a few more years for it to get integrated into the global ecosystem."
“India is more open, English-speaking, although monetization level is not so high. We have seen some Indian start-ups. A lot of IT (information technology) outsourcing is done to India and outsourcing is the first step to creating a start-up ecosystem. We may do co-investments with local funds to grow our competence, like we did in fund-1 for Europe, Israel and US," he added.
Edited excerpts from an interview:
Singapore has been closely studying the success of Israel’s start-up ecosystem, and has been trying to replicate it. As someone who travels to Israel frequently, and had invested in start-ups there, why has that country been so successful? What is your take?
The Israelis are also asked this all the time. There are several factors in their success—first, their quality of education is very good. Next, it is a country of immigrants, and the level of immigrations is mostly higher than the locals. Immigrants happen to be more adventurous. It is told as a joke, but it is also partly true that the Israeli innovation boom is due to two million Russian Jews migrating there in the 1990s after the collapse of the Soviet Union.
Of the two million Jews that left Russia to Israel, a quarter of them have PhD degrees across different professions. The culture of Israel is that they are bold and ready to challenge authorities, and this is the problem of Asia, that they don’t question authorities. Finally, Israeli innovation and tech start-ups are heavily supported by the government not only directly, but also indirectly, as a lot of their innovation comes from the military. Israel is famous for its start-ups in security and hardware, and this clearly is the spin-off from its military.
A lot of your existing investments are in Europe. Why has Europe fallen behind when it comes to tech start-ups?
Several things are holding Europe back—historically, they are very fragmented—even though the EU (European Union) market is the same size of the US market. Many startups in Europe tend to have a local vision and strategy. This is changing as EU integration gets stronger. Second, VC in Europe was scarce when compared with the US, till recently. US funds were not investing in early-stage European start-ups—they wait for them to grow. Overall, the potential is very high.
Europe produces the same number of computer science graduates as the US. In the US, from 2010 to 2013, the number of seed deals grew from $500 million to $2 billion, but in Europe, over the same period of time, the growth was from $130 million to $780 million. Because of the fragmentation of Europe, it is hard to call any place the Silicon Valley of Europe, but several smaller start-up cities are emerging like London and Berlin.
As a VC firm, what do you bring to the table for start-ups, apart from capital?
There are four areas where we can add value. We have great experience in software development. We can help start-ups to build a good software product—many start-ups are good in prototyping and ideating, but to build a solid software product is challenging. Second, we do what every VC does—to help with business development, make the right introductions, to find the right partner, and using our networks internationally in the software industry, we can help start-ups find shortcuts to growth. Third, we can help with structuring the company, and when they scale, we can help with opening offices outside their respective countries, hiring people internationally, filing patents, helping with legal and tax perspectives. Many start-ups fail to hire great people—they don’t know where to find them, how to select them and how to convince them to join the company. Finally, we can help them find the next round of funding after Series A for our portfolio companies.
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