World Law Group member firms recently collaborated on a Global Venture Capital Guide that covers more than 30 jurisdictions on investment approval processes, typical investment sectors and investment structures on Venture Capital deals (and more!).
The guide does not claim to be comprehensive, and laws in this area are quickly evolving. In particular, it does not replace professional and detailed legal advice, as facts and circumstances vary on a case-by-case basis and country-specific regulations may change.
This chapter covers Russia. View the full guide.
1) In your jurisdiction, which sectors do venture capital funds typically invest in?
Some of the main sectors attracting venture capital in Russia are IT and AI, educational technologies (EdTech), financial technologies (FinTech), logistics and transportation, e-commerce, food technologies (FoodTech), and others.
Currently the “hot topic” of venture capital investments in Russia are companies developing innovative technologies in AI/ML, SaaS, FinTech and EdTech.
2) Do venture capital funds require any approvals before investing in your jurisdiction?
Generally, no third-party or regulatory consents are specifically required for investment by venture capital funds (please see responses to questions 3 and 4 below for exceptions).
3) Are there any legal limitations to an offshore venture capital fund acquiring control or influencing the business, operations, or governance of an investee entity?
Prior governmental approval is required for an offshore venture capital fund acquiring control or influencing the business, operations or governance of an investee entity in certain business sectors (which are, however, rarely targets of venture capital investment). These business sectors, for instance, include aviation, nuclear and military industry, major mass media business, development of subsoil fields of federal significance and others (the “strategic” sectors).
Moreover, Russian law provides for further restrictions in relation to the strategic sectors. For example, only a Russian citizen may be appointed as the CEO of an entity carrying out aviation activities; foreign investors cannot directly own shares in the charter capital of an entity carrying out mass media activities, etc.
4) Would an investor be required to undertake an antitrust analysis prior to investment? When would such a requirement be triggered?
It is always advisable to conduct a preliminary antitrust analysis prior to an investment into a Russian company. The need to clear the investment with the antitrust authorities might be triggered, if the turnover or asset-based thresholds applicable to the companies and groups involved are met, by, for example:
· the acquisition of more than 25%, 50 % or 75 % of the voting shares in a Russian joint-stock company, or more than one-third, one-half or two-thirds of the participatory interests in a Russian limited liability company;
· the acquisition of direct or indirect rights to determine the business activities of a Russian company (including those based on voting arrangements or agreements such as the shareholders’ agreements providing for additional voting rights) or to act as its executive body; and
· the execution of a shareholders’ agreement or a similar arrangement, to the extent the venture fund may be recognized as a competitor of the target or any of the shareholders.
5) What are the preferred structures for investment in venture capital deals? What are the primary drivers for each of these structures?
Most commonly, the venture capital funds (often formed in foreign tax favorable jurisdictions, such as Cyprus, BVI or Luxemburg) acquire shares of the Russian investee company or establish a NewCo for the purposes of the investment together with the founders/strategic investors.
Less frequently used are the options of conclusion of the ordinary (investment) partnership agreement with a Russian party and conclusion of the fiduciary property management agreement with Russian party. The transfer of funds to “contract based” venture capital funds is not subject to additional taxation. This is one of the key advantages of these forms of venture capital deals. Nevertheless, they significantly restrict the change of parties and fund management. Due to that reason the “corporate” form of investment is more frequently used in Russia.
Currently (as of August 2020), the Russian Parliament is also considering a law on the regulation of convertible loans (convertible notes). If the law is adopted, this tool will also be available for venture capital investment.
6) Is there any restriction on rights available to venture capital investors in public companies?
Public companies are strictly regulated under Russian law, however, there are no specific regulations concerning acquisition of a stake in a public company by a venture capital investor. Certain restrictions (e.g., prohibition on disposal of shares, voting arrangements etc.) can be included in a shareholders’ agreement between the investor and the founders/other shareholders.
Venture capital investors rarely invest in, or end up, following an IPO, in a public company, since these are often state-controlled and, if a start-up ends up going through an IPO, it is usually done through international — rather than domestic —capital markets.
7) What protections are generally available to venture capital investors in your jurisdiction?
The most common way of protecting the investor is agreeing to a shareholders’ agreement, including a put option with a guaranteed return for the investor upon exit.
Further, Russian law provides for some general guarantees for foreign investors in certain instances, e.g., preferential regimes for distribution of profits, guarantee against adverse changes in the Russian legislation, etc.
Additionally, a venture capital investor and the investee company may provide for the application of foreign law and international arbitration in the transaction documents (subject to a “foreign element” in the deal).
8) Is warranty and indemnity insurance common in your jurisdiction? Are there any legal or practical challenges associated with obtaining such insurance?
The warranty and indemnity insurance market for Russian venture capital deals is still at quite an early stage of its development, and it is yet to be seen to what extent the relevant insurance product will be driven by any peculiarities of the sector in which the target business operates.
9) What are common exit mechanisms adopted in venture capital transactions, and what, if any, are the risks or challenges associated with such exits?
The exit mechanisms depend on the structure of the venture capital deal.
When investing into Russian businesses, venture capital funds usually negotiate a guaranteed “exit plan” from the business within three to seven years from the date of the investment. The investors are normally free to sell their shares to a third party after expiration of a certain lock-up period and may even have the right to drag along the founders, subject to the founders’ ROFO/ROFR. The contractual exit plan is also often facilitated by a put option right of the investor, subject to the triggers to be commercially agreed upon between the parties. The option agreements under both Russian and foreign law (most commonly, English or Singaporean law) are also possible.
With respect to Russian limited liability companies (the most common legal form in Russia), the main challenge connected to such an exit is the potential blocking of the enforcement of the option agreement by the notary or the other side. To avoid such issues, option agreements and the relevant triggers for enforcement are carefully negotiated with a Russian notary who plays a crucial role in the share transfer enforcement.
10) Do investors typically opt for a public market exit via an IPO? Are there any specific public market challenges that need to be addressed?
In Russia, exits through an IPO are a rare occasion due to the complexity of the procedure and the adverse economic and political conditions (e.g., economic sanctions). Usually, the investors prefer to exit through a sale to the founders or third parties (please also see the response to question 9).
Moreover, as mentioned above, Russian companies prefer foreign stock exchanges for the purposes of conducting an IPO.
Want to Learn More?
The objective of this publication is to serve as a Q&A-style multi-jurisdictional guide to venture capital law in countries where WLG member firms have offices. The guide intends to provide a high level overview of the venture capital market, including key sectors, preferred investment structures, regulatory approval requirements, limitations on acquisition of control in portfolio companies, restrictions on investment, investor protection, and exits; and hopes to provide readers the benefit of the shared global knowledge and local insights among the WLG member firms.