IVCA Profile Q&A: David Kronfeld, Founder of JK&B Capital, on his Recent Trip to Russia, Meeting with Russian President Dmitry Medvedev

IVCA Profile Q&A: David Kronfeld, Founder of JK&B Capital, on his Recent Trip to Russia, Meeting with Russian President Dmitry Medvedev

July 7, 2010

CHICAGO - “ David Kronfeld, founder of JK&B Capital, has been at the forefront of this quandary recently when he participated in a delegation last month that sent 20 leaders from top VC firms to Russia. While there they met with business, legal, entrepreneurial and government officials, including the current Russian president, Dmitry Medvedev. The IVCA got the opportunity to interview Mr. Kronfeld, as he debriefed on his visit and analyzed the business prospects for private investments in high-growth companies in Russia today.

IVCA: What is the background of the initiative for this Russian trip?

David Kronfeld: This was an historical trip, a first-of-its-kind, sponsored at very high levels. It stems from a recognition that started all the way at the top of Russia, both with [former Russian President] Putin and [current President] Medvedev, giving it personal leadership. It started with the recognition that Russia is a rich country, but its economic success is from natural resources, oil, gas and agricultural. But from a technological standpoint, Russia is substantially behind developed countries. The leadership believes that Russia cannot be a successful country in the future without bridging this technological gap. With that conclusion, President Medvedev took it upon himself to start what he refers to as the - ˜Era of Innovation' for Russia. He wants to establish a culture of innovation and entrepreneurship in Russia.

Medvedev wants the private sector to advance this innovation culture, and he basically wants to replicate in Russia what happened in Silicon Valley, what happened in Israel and what is happening in China, India and Singapore. In Russia, he wants to create this through both culture and physical infrastructures.

IVCA: What was the purpose for inviting venture capitalists to this particular event?

DK: The trip had a dual purpose. First, to solicit whatever advice or observations we may have to help Russia transition into the cycle of innovation. And the other purpose was to convince us that Russia is a very attractive place, at this point, to make venture capital investments.

Russia recognizes that they do not have the venture capital know-how that we have. How do you take basic research and development, for example, and convert it into a commercialized product? Additionally, they need our involvement in terms of both expertise and capital.

IVCA: You expressed some specific goals that the Russian leadership had for these meetings. In your opinion, were those goals met?

DK: Yes, I believe so. There were several things that became very clear. First, Russia has taken substantial steps to do - “ from a public policy standpoint - “ what the country needed to make it more attractive for outside venture capital. The flow of capital is unburdened and tax rates are very low. Capital gains are at nine percent. Income tax is at thirteen percent. These public policies are better than what exists in China, for example. In China, there still are restrictions on who can own things in the country.

IVCA: One Russian fund advisor was quoted as saying, 'The members of the delegation are coming not just as investors but as role models.' What are the main lessons a group of VC funds from America can teach a business culture like Russia?

DK: I think Russia is a very strong country in terms of engineering, scientific talent and a very high standard of education. We've seen what Russians can do in Israel. Around a million and a half Russians emigrated to Israel, many were doctors, engineers, physicists, nuclear scientists, etc. As soon as they were put in an environment that fostered entrepreneurship they flourished. Those Russians are for the large part responsible for the increased technological innovation in Israel.

So what Russia can learn from us is that they have wonderful talent to do basic research. They don't have understanding - “ because everything was formerly owned by the government - “ of how to commercialize technology so it fits a market need. And how to build a company around that, and how to make it successful. This is a dimension that they don't have in-house right now, and they view this dimension as valuable. This is why they are looking for us to come in and do business with them.

IVCA: Given the current economic infrastructure in Russia, what are the great opportunities now, especially in your field of expertise in tech?

DK: The opportunities are considerable and across the board, but the business model that can best work, for American venture capital, is the exact same business model that we've seen work in Israel. You have the basic R&D in Russia, but then you create a company that can take the technology and sell it in global markets.

I believe that any entity in Russia can also find a market in Russia itself, that could be attractive. But the Russian market as a whole is not ready for a very sophisticated level of technology. However, there is a good lower tech potential for local markets. If it's high tech, it would have to be sold globally. Again, the business model that worked for Israel will probably be the best business model for Russia.

IVCA: You spoke of a less restrictive ownership and tax structure in Russia now. Do you see any other restrictions in Russia that might make outside venture capital difficult?

DK: There are no restrictions that I see on a governmental policy level. However, there are other issues that are not driven by policy. They are not minor and definitely need to be considered. First, just like in China, there is not a very good legal system in place. This can make you nervous. At the same time, they have a tremendous amount of bureaucracy and corruption at all levels. This is definitely a problem, in Russia it is even more prevalent than China.

In China, the common wisdom was to get around these problems you had to have very good contacts and local partners. This is true in Russia as well, not so much about the contacts, but you need a local partner who knows how to avoid the pitfalls.

The last thing is about what happened in the 1990s. Many people invested a lot of money in Russia and it turned very sour, with a lot of bad experiences. It was due mostly to an economic recession and crime, especially with the Russian mafia muscling in. I think some of those issues still linger. Some of the corruption is still very strong, so against that background even though the government is creating the right policies and is headed in the right direction, in the trenches it may work a little differently. The real challenge for the government is to ensure that these new policies translate to real behavior across the board.

IVCA: What are the age demographics of the current Russian tech entrepreneur? What generally did you find to be their backgrounds?

DK: What is being fostered now in Russia, from what we were able to determine, is what you would expect. Most of the tech entrepreneurship is centered around the internet, for simple reasons - “ it requires less - ˜brick and mortar', has very few barriers to entry and it doesn't matter physically where you are located. They actually created some very successful companies. The age of the guys who use the internet as a basis to launch companies is very young, similar to what you would find here. It's people who have just finished college or a little thereafter, between the ages of 25-30.

If it's not in the internet space, then the next level you see is in the typical well educated scientist, physicist and mathematician. They are older, with more knowledge and experience. But the people who really drive the concept of entrepreneurship and who have the drive to try something or take the risk are the younger generation. People who come out of the better universities, the universities that have a world reputation for quality. These entrepreneurs tend to come from the elite schools.

IVCA: You talked about the technological and economic aspirations of current Russian President Dmitry Medvedev in regard to meeting with your delegation. What was your impression of him as an individual?

DK: I was very impressed. He is young in spirit and vision. He is a very sharp guy, very engaging and very pragmatic. I was amazed by the level of pragmatism that I saw in how he viewed what he is trying to do, why he's trying to do it and the challenges he is facing.

IVCA: What are the main themes or conclusions that came out of these meetings?

DK: I think Russia is at an inflection point now. I believe that, over time, Russia will become a high technology center, just because they have the brain power, the creativity and now they have the government behind it. It's inconceivable to think that the country will not get there over time, the question is not if, but when.

In regard to - ˜when,' Russia is probably where China was five or six years ago. At that time, when we looked at China we saw all the problems, the difficulties and tended to shy away. Now everybody wants to be there. Those who were there early on had the first mover advantage. And I believe that in Russia today it is the same situation. Would I say go in and invest hundreds of millions of dollars in venture start-ups indiscriminately? I would place a very high caution on that. But do I believe there are ventures to cherry-pick that are wonderful opportunities and that to get in now to obtain a first mover advantage, so when the market grows, you grow with it is a good idea? The answer is yes. I've seen enough to convince me that this kind of a scenario might make a lot of sense.