18. June 2018

"Development should be in Eastern Europe, Manufacturing in China and Business in San Francisco" - Part 2

Part 1 was all about tech trends, market projections, and features that make a product successful!

Part 2 turns the focus now on the investor side. Vitaly hints where corporate venture funds invest their money and defines the rules one has to play by in Silicon Valley

THE SERIAL ENTREPRENEUR AND VENTURE INVESTOR Vitaly Golomb moved with his parents from Odessa to the US at the age of 8. He started working in technology companies in his youth and started venture investments in 2010. As Managing Director of the IEG Investment Banking Group in California, Golomb knows the venture market on both sides of the Atlantic first hand. He invests in startups from Russia, Ukraine, and other CIS countries, helping them to move to Silicon Valley and complete the Series A (often several tens of millions of dollars).

Vitaly Golomb told Inc. which markets (apart from the obvious industries such as AI, medtech and blockchain) expect explosive growth, what is to be feared if a corporate venture fund wants to invest in you and why the ideal startup lives in three countries.

About Corporate Venture Funds

"Investments and acquisitions are two completely different approaches with their own strategy and framework."

- Vitaly Golomb, Photo Boris Zharkov

Today, 30% of venture capital investments are made by companies - either directly into startups or by investing in venture funds. More than a thousand companies around the world have their own corporate venture funds - that is almost four times more than ten years ago. Of those, about 20% behave much like institutional venture capital funds with the goal of earning high returns and are quite independent of their parent companies.

For a large company like HP, which generates over $52 billion a year in revenue, even a large exit is not as important as informing the corporate strategy. Because of this, most companies invest in startups to get the inside track to the latest technologies. When I was at HP, I invested in The Virtual Reality Fund (VR Fund). Virtual reality is a very important category for a computer company like HP because it has the potential of changing the definition of computing in the near future. It was very important to follow this market, so HP invested in a fund that invests in startups at the seed stage - earlier than a company the size of HP could typically invest directly. Strategically, this deal gave various product groups access to some of the best up-and-coming technologies in this category.

Companies rarely invest in startups to buy them later: If a company buys a startup for a relatively small amount after having invested in it, it is likely a failed investment. Usually, investments and acquisitions are two completely different projects with their own strategic rationale and framework.

Institutional venture capital funds have the same goal as the startup - to develop the company, to grow and sell or go public. Corporate funds have a different goal. They want to expand their market by somehow using their relationship with the startup. For this reason, investment is often made alongside a partnership or joint venture. This can take the form of joint product development or the company using the startups’ technology to develop its own products.

Your exit options can be severely limited if you are careless when taking corporate venture money. When a company representative sits on the startup’s board of directors, it is unlikely that their competitors will be interested in working with this startup even if they really need the product. This is often true of competitors wanting to buy the startup. Therefore you must carefully manage potential corporate investors and their level of involvement with your startup.

You should not give corporate investors special terms you wouldn’t to institutional venture funds. Otherwise, you risk losing independence. There are some conditions you should not agree to, for example, ROFR (rights of first refusal, when the corporation has the right to buy the startup first if it gets an offer from a competing company.) Corporations will often want to have this right but this can be highly disadvantageous to the startup. If they insist on this condition, I would typically recommend walking away.

On Silicon Valley Rules

Silicon Valley is a series of concentric social circles - the inner circle is extremely hard to penetrate. This is why it is extremely difficult for a startup to move to San Francisco right away - it takes a substantial amount of money plus a year or two of networking to be taken seriously. At the seed investment level, there is no product, no customers, only really the team - and if the team doesn’t have a track record, what am I investing in? The right pre-seed investor can be very helpful in the startup ready to go to the next step:

Silicon Valley is the right next step when you have a functioning business and want to bring your product to the global market. You can use your local market as a lab - to understand what problem the product is solving, who the customer is and if they are willing to pay. After you are convinced there is demand for the product and you can make a profit, come to Silicon Valley to put down the gas pedal and scale the business globally. Many come to Silicon Valley as tourists and try to raise money here - this doesn’t work. Some come with an immature business, bring their whole family and the success of a startup becomes secondary. This is dishonest and unfair towards their investors.

"For a startup to move its business to San Francisco at seeding investment level can be very difficult"

Vitaly Golomb, Photo Boris Zharkov

Any company moving to the Valley from another country needs a local CEO or a key member on the team. This is the essential element to meeting the right people and developing relationships with them.

You need to set aside 60% of your seed round for marketing experiments and finding experienced team members who can plug-in and sell. There is no magic or special talent required, the ability to communicate effectively and sell is mostly a matter of experience.

Being the only investor in a startup is often a big mistake. This would mean that for some reason the open market does not want to invest in this company.

Large venture capital funds from the Valley don’t have the need to take on the additional risk of investing in foreign startups, but there are those who specialize in local markets. On the one hand, in Silicon Valley you are already in the middle of the Startup Olympus - the best companies from around the world come here. If I'm a local venture capitalist on Sandhill Road, why should I go anywhere? If I’m tapped into the right networks, the best will come to me. On the other hand, if I happen to know a foreign market and invest in an undervalued company and provide the immense value of helping them move to Silicon Valley, the company will become much more valuable and I will see a bigger return on my investment.

In California, there is no negative attitude or bias towards immigrants from Russia - though questions can only be raised for cybersecurity startups. Russian engineers have earned a lot of respect in Silicon Valley. In a place where half of the population are immigrants anyways, people can usually take geopolitics out of the equation. Of course, if the startup is in cybersecurity, customer and investor due diligence may be more invasive. Has the company taken money from the Russian government, does it transmit any information to Russia and if it is completely privately-held and independent. The same can be said for companies from China.

The ideal combination for an Eastern European startup is software development in Eastern Europe, manufacturing in China and business and in San Francisco. Petcube (one of the brightest stars of the Ukrainian startup ecosystem) is a good example of this. They have 12 people in their San Francisco HQ, engineering (half of the company) in Kyiv, and four in China.

The complete interview was originally published in Inc Russia in May 2018.