“First Russian Search fund” LLC was established as the fund of funds or a platform / accelerator for search funds in Russia in end of July[redacted]And our first Search cohort started by the mid of August.

After a 3-4 months of search we are happy to share some observations regarding search in Russia which may be relevant for some other developing economies. And hopefully can be interesting to the community of searchers. It is the first thoughts and we will go on in the future.

1. On the size of the companies for acquisition. TOP-10 Russian banks and institutional investors (investment funds) typically look at companies with a size of 100 mln USD or higher for M&A. All the businesses bellow that size can be considered for private acquisition with relatively low competition. This gives you a chance to buy a significant business but also a challenge in future exit opportunities.

2. On visibility of EBITDA and taxation. Many businesses were established in the 1990-s by owners who never thought of selling their companies (first wave of Russian entrepreneurs). The consequences are that they are typically very entrepreneurial about maximization of short-term cashflows. First thing is profit tax optimization. They typically register a lot of self-employed entrepreneurs around the core company and have contracts to move out profits from core business through self-employed entrepreneurs. According to legislation profit tax difference between LLC and self-employed is 14% (LLC profit tax is higher). Thus be ready to 2 things:

a. You will need to explain to business owners that cashflows should be calculated in a way that profit tax is a bit higher for evaluation.

b. In the official Tax databases you will seldom find actual profits (EBITDA or Net profit) – it will often be around 0 as end-taxpayers are self-employed companies. To understand real profits you need to start due diligence. Good thing is that local banks are also ready to this situation and can provide lending based on “analytical EBITDA”.

3. On labor tax. Other optimization for business owners is Labor taxes. Many owners still have some wages paid unofficially. It means that your cashflow as new business owner will be different from cashflow of owners by the sum of labor taxes. And this can be significant. Fortunately this practice is not used by every company and some operate with fully transparent and official salaries. The inference of undeclared salaries is also two-fold

a. You need to explain to business owner that your cashflow will also assume official labor costs and increased taxation

b. You need to estimate and deal with a risk of previous tax reduction will be discovered by authorities. This risk you can quantify and manage.

Thus overall the market has good investment opportunities - many industries are growing 5%+ even in 2020, some industries are very fragmented and competition from institutional investors is low for Search fund typical size of businesses. But good investment will require some creativity in search and a bit of effort in the DD and deal closure.