The Peril and Promise of Investing in Russia

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The Kremlin allows participation only through joint ventures or minority stakes in these Russian companies. Such deals can be troubled: BP was ensnared in lawsuits and hounded by Russian tax and environmental authorities after a falling-out with local partners in its TNK-BP joint venture.

Buying Russian companies outright can be risky, too. One U.S. CEO recalls hastily backing away from a possible Russian acquisition after meeting the company's owner. The Russian company's books were awash in red ink. But the owner, arriving late for a scheduled lunch with the chief executive in London, apologized by explaining that he had been buying a Renoir painting. The affable Russian then chatted during the meal about his ultra-luxurious New York apartment. "It was clear that this company was being run for the enrichment of one person," says the American executive, who spoke on condition of anonymity. His company later decided to enter Russia without purchasing a local enterprise.

CULTURE OF CORRUPTION

Still another danger sign: the tangled structures of Russian firms. These are a legacy of 1990s-era laws that perversely encouraged Russian companies to establish legal headquarters in offshore havens such as Cyprus. Andrey Posdnyakov, a physicist in the Siberian city of Tomsk, co-founded Elecard Devices, a company that sells audio and video digital-compression technology. He says he registered the business offshore to avoid a tax that Russian authorities levy on local companies' sales to foreign customers. Theoretically, Elecard can obtain a refund of these taxes from the government. "But the procedure is so complicated, you never actually get a refund," says Posdnyakov. Now he has discovered that the offshore registration is a turnoff to potential investors, from whom he hopes to raise $8 million to expand his business over the next two years. Intel Capital, the venture capital arm of the IT giant, has invested in only six Russian companies. It has rejected Elecard and scores of others in Russia because of their complex structures. "We can't invest in companies that have even a slight shadow," says Intel's Konash.

Yet acquisitions can succeed, especially ones involving established Russian brands. In 1998, Unilever purchased a run-down Soviet-era margarine factory in Moscow, gutting the interior and installing new equipment imported from Western Europe. Since then it has snapped up other companies, including Russia's biggest ice cream maker, Inmarko, and the producer of the country's best-known ketchup brand, Baltimor. Nestlé and Danone have cut similar deals.

Corruption is still a problem, though, even when smart companies do their best to avoid it, and even in regions with a business-friendly reputation. An executive of one U.S. company operating in the St. Petersburg area says privately that payoffs are needed for routine tasks such as getting imported supplies cleared through customs. "We use customs brokers, and they build bribes into the invoice," this executive says.

Although many companies say they don't engage in such shady deals, refusing to bribe often complicates their work. Nycomed's Davidsen says setting up the pharmaceutical group's Russian factory will take two or three years longer than it would have in Western Europe, largely because the company has insisted on "100% compliance" with the law at every step of the process, from acquiring land to lining up suppliers to getting approvals from drug regulators.

Russia enacted new anticorruption legislation last year at President Medvedev's urging, but it probably won't make much difference. The law criminalizes only completed acts of bribery, not the act of demanding or offering bribes. Nor does it address widespread corruption in the judicial system.

But the lack of progress doesn't discourage veterans like Stuart Lawson, who worked for Citibank (C) in 11 countries and who now runs HSBC's Russian operations. He's still excited about the market. Russia, he says, offers "some of the most exciting opportunities and some of the finest human capital that I've ever run across."

Miriam Elder in Moscow

Matlack is BusinessWeek's Paris bureau chief.

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