Acron Eyes Domestic Merger Amid Russia 101118 Basic Political DevelopmentsBln Investment Plan

From Russia with love and money

By John Gapper

Published: November 17 2010 22:09 | Last updated: November 17 2010 22:09

Yuri Milner is very popular among internet entrepreneurs. Mark Zuckerberg, founder of Facebook, encourages him to drop by and Mark Pincus, chief executive of Zynga, an online games company, regards him as a trusted adviser. Among Silicon Valley’s venture capitalists, feelings are decidedly cooler.

“He came on a night attack when everyone was asleep and while you might be full of admiration for his audacity and cunning in taking advantage of that moment, we’ve woken up now and he won’t be able to do it again,” says one Valley investing veteran about Mr Milner, chairman of Mail.ru, a Russian internet company that floated in London this month.

Mr Milner, who runs Digital Sky Technologies, the investment fund of Mail.ru, came up with a solution to the initial public offering drought that has afflicted venture capital funds and technology companies. He offers them a simple way to raise fresh money, and for their employees to sell shares, without going public.

His insight enabled DST to acquire nearly 10 per cent of Facebook and stakes in Zynga and Groupon, both premier league internet properties, at prices that are now bargains. He has shaken up late-stage technology investing and bruised the Valley’s elite.

The question is whether he is another Masayoshi Son of Softbank, the Japanese investor who rose to fame by acquiring stakes in Yahoo and other properties in the 1990s but flamed out in the dotcom crash, or an innovator who has changed the balance of power between investors and entrepreneurs for good.

My feeling is that, although Mr Milner’s coup was partly cyclical and partly a matter of first-mover advantage – the social media boom has produced some highly valued, fast-growing companies that want to remain private for as long as they can and he picked them adroitly in the wake of the financial crisis – it will have a long-term impact.

One reason for the VCs’ irritation (“You can hear the frustration in my voice,” says the veteran investor) is that Mr Milner has avoided playing the traditional role of a foreign investor who tries to break into Silicon Valley or Hollywood – that of the greater fool who takes the worst deal. Instead, he outmanoeuvred those who pride themselves on building the next Apple or Google.

Mr Milner’s trick was to spot that, as he told me last week at the Monaco Media Forum: “The company founder is charismatic and sees the future but some people just want to pay their mortgages and live a normal life.” In other words, visionaries such as Mr Zuckerberg are happy to be billionaires on paper and live in rented houses, while employees want to cash out.

Mr Milner responded by offering Facebook a deal in May last year: he would inject $200m in cash in return for a 2 per cent stake valuing the company at $10bn, and official approval to tender for the shares of employees at a lower valuation. He did not demand a seat on the board and was content to be “a servant” – to let Mr Zuckerberg keep on running things as he wished.

Both the $10bn valuation and the lack of control rights were much better than rival offers, but they have so far worked out extremely well – Facebook is now valued at $40bn. “If you select the best two or three high-velocity companies, pay 20 per cent more than anyone else and offer softer terms, you look like a genius,” says one venture investor.

There are obvious problems with replicating these early successes. One is that there are only a limited number of Facebooks and Zyngas around – his formula requires him to find high-growth companies that are heading for multi-billion dollar IPOs yet want time. He himself estimates that there are only 25 of these choice properties in the world, and he is not the only hunter out there.

A second difficulty is that it is a riskier business than Mr Milner has made it look so far. The IPO market for all but outstanding tech companies such as Google has been slow for years and companies often sell for less than venture valuations. Slide, a social media company, was valued at $500m in a 2008 venture deal but Google bought it for only $230m this summer.

“Some companies have raised money at huge valuations in early rounds and don’t want to go public and suffer huge dilutions,” says Tracy Lefteroff, a partner of PwC. Investors that match Mr Milner’s terms on second-tier properties could get burned while he goes down in history as, as Josh Lerner, a Harvard professor, puts it, “an idiosyncratic reflection of the times”.

But I doubt whether it will be that easy for Silicon Valley’s investors to get rid of him. Tensions between entrepreneurs and investors are as old as the hills and the founders of some companies left money on the table when investors pushed to exit. Mr Milner points out that, at their peak valuations, Google was worth 10 times, Ebay 108 times and Yahoo 379 times the IPO price.

Until now, the founders of such elite enterprises have struggled to resist the wishes of venture funds, but the deals pioneered by Mr Milner – and already mimicked by Elevation Partners in a recent financing of Yelp – give them greater power. They can keep employees happy while retaining control.

This may gall early-stage investors who have invested both money and precious expertise only to have a late-stage Russian bargain hunter outbid them, but that’s life. Mr Milner has broken into the club and he will be hard to dislodge.

john.gapper@ft.com