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. Last Updated: 07/27/2016

Three Little Businesses That Could

NIZHNY NOVGOROD -- In Russia on the whole, the growth of small and medium-sized businesses has been sluggish. Although the official number of small enterprises in the country jumped from 280,000 in 1991 to around 850,000 in 1993, the figures have leveled off since then to around 890,000 in 1995, according to figures from the Organization for Economic Cooperation and Development.

As of 1994, according to a report by the European Bank for Reconstruction and Development, 10 percent of Russia's population was employed by small and medium-sized enterprises, roughly defined as those with fewer than 100 to 150 employees. That compares to 76 percent in the U.K. and 53 percent in the United States, and, closer to home, 45 percent in Estonia and 23 percent in Poland.

Most economists agree that the role of small business needs to grow if Russia is to take off, but small business people themselves list high and complicated taxes, fear of the mafia and the high price of raising capital as the main obstacles to beginning a healthy enterprise.

The region of Nizhny Novgorod with its progressive local government is as likely a place as any for a rebirth. Boris Nemtsov, the region's reformist governor has granted small businesses local tax relief, which in some cases can amount to a 30 percent reduction on the total tax burden.

The rebirth may already have begun. The EBRD is looking eagerly for signs of growth, and has begun channeling money to small business through two programs. Nizhny Novgorod has one of the EBRD's Small Enterprise Equity Funds, or SEEFs, that gives technical assistance and, most importantly, capital through a $5 million EBRD venture capital fund administered by SEEF. In addition, small businesses in the Nizhny Novgorod region can get capital from a group of local banks, accredited to channel low-interest loans from a separate $300 million EBRD fund that covers the whole of Russia.

Overseeing the process is Eric Johnson, a Stanford MBA graduate, who has invested $1.1 million of the SEEF fund in about 10 different companies, and expects to invest in about 30 to 35 companies by 1998. Following are three of the EBRD project's success stories.

Rag trade to fashion plates

Natalia Loginova and Vladimir Petukhov are a classic example of the transition many Russians are now making from small-scale traders of imported goods to local manufacturer.

The two entrepreneurs returned to Nizhny Novgorod from Moscow in 1993 with respective doctoral degrees in law and economics, but quickly realized they couldn't live off the meager salaries of professors. Both driven by the same ambition but lacking any experience of business, they abandoned teaching and started small-scale trading in clothes and shoes.

"We started really out of necessity, and events led into the clothing business," said Petukhov.

In 1992, they started Oka, a trading company that bought French, Belgian, German and British clothes and shoes from distributors at local trade fairs and sold them to stores in the Nizhny Novgorod region.

Far from being embarrassed by these humble origins, Johnson of the EBRD said that the legacy of small-scale trading provided Oka with close ties to the local market.

In fact, many small businesses like Oka, he said, started first by engaging in trade before starting production and that "they usually bring the knowledge of the market and its players into their own company."

Indeed, Loginova and Petukhov reckoned they could gain a huge advantage on the local market by producing clothing in Russia. But the problem was finding a local supplier. They started off ordering clothing from a large local Soviet-era factory called Dom Modeli, which had a good range of clothing designs but was short of cash, and entrepreneurial and distribution expertise.

Borrowing $10,000 in rubles from a local bank, Oka put in an order with Dom Modeli. They were lucky: The clothes, which were considerably cheaper than imported fashions, sold very quickly to local stores and in Moscow as well.

"We knew it was a big risk, but our idea proved to be right," said Loginova.

But the relationship with Dom Modeli only lasted six months.The Soviet-built factory couldn't produce less than 3,000 pieces of any one model, which didn't allow the company the flexibility to produce a diversified collection for each season.

"We needed a flexible production unit, so that it could respond quickly to the capricious winds of fashion," Loginova said.

They severed their ties with Dom Modeli, hired its designers and opened two small workshops, upgrading one existing facility and building another one from scratch. This, of course, took additional capital.

Loginova and Petukhov had financed their first order from Dom Modeli out of their own savings plus the $10,000 credit. The local banker was a personal friend, and he was willing to finance the purchase of the new workshops as well, Petukhov explained. But by 1995, they were looking around for more capital to expand their company's operations.

With this need for serious long-term financing, Oka started to look around for something more serious than their friend's bank. They found the EBRD.

While Russian banks were lending funds at interest rates of 30 percent to 35 percent on the dollar, the EBRD was lending at between 18 percent and 20 percent. "We applied for the loans because they offered better rates," Petukhov said. An added consideration was that the EBRD would lend in dollars, and Oka was convinced that at the start of 1995 the ruble was about to appreciate and dollar lending would be cheap. They were right.

In the spring of 1995, they received their first $100,000 hard-currency loan from the EBRD, which allowed them to speed their expansion and invest more in production and quality fabrics and materials.

Although they have already paid back some money, in total they have received $400,000 from the EBRD over the past two years in loans and equity capital. They will launch their new label, Verley, and are about to begin an advertising campaign.

At the moment, the company seems to be speeding ahead. "The production of the latest quarter already equals last year's overall output," Petukhov said.

The company now has 150 employees with an average salary of a $100 a month, but Petukhov hopes that will rise along with profits. Customers are spread across several cities in Russia, and beyond: Oka also sells its wares to a Swedish wholesale company and England's Littlewoods, which has just opened an office in St. Petersburg.

"For the next two months, we can't take any more orders," Petukhov said.

In an ironic twist, Loginova says that one clear sign of their success is that imitations of their labels are now sold in Moscow, one of their main distribution points. "It is not just Chanel suits that have to cope with knock-offs," she said.

A textbook example

Leonid Groisman's current baby is his growing business, which involves the printing of high-quality color labels for Russian consumer-goods companies. His small company prints labels for everything from baby food to champagne and beer, and ships them to businesses in Moscow and other cities, as well as in his home town of Nizhny.

But Groisman has been a master of adapting to a changing market, developing his company, Dekom, into five separate small businesses in printing, publishing, design, wholesaling and retailing. His philosophy: Try anything, and see if it works.

Groisman spent his younger, Soviet years working as a teacher, radio engineer and textbook writer before he decided to start his own business in 1991. He was writing a book on desktop publishing -- at that time an almost unknown field in Russia -- when he had the idea of creating a high-quality printing house.

Like many Russian small businesses then, he was reluctant to approach local banks for money to start his business. His main concern was that taking out a loan could compromise his new business' security. Groisman said he suspected that many banks leaked information on their clients to local protection rackets.

"At the time, one could not rely on banks to keep a company's financial situation confidential," he said.

Yevgeny Maksakov, a project manager at Nizhegorodsky Bankirsky Dom, a participant in the EBRD loan scheme, said many small businesses still liked to get financing from "friends," since it involved less paperwork.

But he warned that it also had risks; borrowers from private lenders faced "certain misfortunes if they didn't respect the terms of the loan."

So Groisman turned to a local bank where he knew a number of employees, and borrowed $50,000, which he and his brother used in order to buy machinery and paper and set up a printing shop where they could make letterhead, business cards and flyers for private companies that were beginning to appear.

He was well ahead of the curve then, and he still has only a couple of real competitors in Nizhny. "We were one of the first private publishers in Russia. Our license number is 30," he said.

"The market for printing in 1991 to 1992 was very wide," he said. "Nobody [else] was printing full-color posters or high-quality books."

Groisman then used his printing skills to branch out into publishing books. Some of which were flops, others hits. He published a few thousand telephone directories and 50,000 European travel guides; both projects fell into the flop category.

But he had a hunch that the Russian public wanted modern foreign literature. Success came with his publication of a translation of a novel "Le Roi Vert," or "The Green King," by French writer Jean-Loup Sulitzer, which sold 200,000 copies in 1992.

Later, he began a third business, opening a retail store in Nizhny Novgorod, marketing his printing services and selling his publications and other printed material. He has also opened wholesale and designing branches.

Groisman said splitting his company, which now employs 130 people, into five separate business divisions has helped to systematize business. "It's makes it easier to split our budget, to pay taxes and to see which one is more profitable," he said.

By 1994, Groisman was looking to finance a major expansion to upgrade his printing facilities and buy better quality materials. That is when he turned to the EBRD loan program.

Groisman said he has so far received $110,000 from the program, through two local banks. About $50,000 of that has gone into buying a high-definition computerized color printer, with the other $60,000 going to the publishing division, for buying the rights to use posters and works of English-language fiction.

Groisman says after he received the EBRD loan -- which took seven months of negotiations to secure -- his sales doubled in six months. "It was good luck that we got the money from the EBRD. But it was complicated and difficult to show that we would spend the money in the right way."

The EBRD has also taken, through SEEF, an equity stake of an undisclosed amount in Dekom, which Groisman said he accepts largely because his outside partner does not interfere. But his main goal is to buy the bank out and retain his entrepreneurial independence.

Paving a way to success

Until last year when he was the operator of a small jewelry business, Denis Labuza said that when he saw scores of new dachas, offices and banks springing up in Nizhny Novgorod, he wanted to get in on the boom.

His inspiration came at a local trade fair, where Labuza met a Ukrainian company selling the technology to make outdoor tiles. Compared to the drab concrete slabs that were the only outdoor paving available in town then, he said, these patterned, ocher- and sand-colored tiles were a delight.

"It's just like Swiss watches: Our tiles are better because they are hand-made," said the former jeweler.

While many in Russia complain of the difficulties of turning a good idea into good business, Labuza snapped up the Ukrainian technology and quickly put it to work.

At the start of this year, his new company, Klass, took up residence in a workshop located in a corner of a massive 12-hectare industrial site that was, until recently, the giant Salyut arms-components factory. His company employs from 60 to 80 people, depending upon demand.

"I didn't have a problem either finding a place, or getting a license, because I have friends in the administration," said Labuza.

By using his contacts, Labuza was able to get permits quickly. By agreeing to locate in the Salyut factory, he also won an exemption from all local taxes.

For the local government, the logic behind the tax break is that it provides an incentive for businesses to move into city property that what would otherwise lie empty and unrented. But it took a lot of negotiating between Labuza and the local tax authorities to make the exemption happen.

"They have good relations with the tax inspectors because they worked closely together clarifying their status," said the EBRD's Johnson.

The tile business has grown quickly in its first nine months. In March, Labuza sold barely 200 square meters of tiles. By the end of August, he had sold 10,000. With prices ranging from $10 to $13 per square meter, turnover is more than $100,000 so far in 1996.

Labuza says he still holds a monopoly for quality outdoor tiles in Nizhny Novgorod, and that he may even be able to raise his prices.

In addition to taking out advertising spots on local TV -- in which he did not divulge his company's telephone number, he said, as he was already flooded with orders -- Labuza gets free publicity by having his work figure prominently in a number of public projects. Labuza's tiles now decorate Nizhny Novgorod's state university and a pedestrian street in front of the historic Nizhegorodskaya Yarmarka exhibition hall.

So far this massive growth has been funded largely from Labuza's savings, but he is about to receive $80,000 in loan and equity capital from the EBRD. The EBRD approached him, no doubt attracted by his handiwork.

Johnson of the EBRD said he was impressed by the speed with which Labuza is able to find local contracts. "They quickly got in touch with the administration people who supervise the city's construction projects," he said.

Labuza, like most Russian small businessmen, was counting on raising additional financing from friends. But he said he has decided to work with the EBRD partly because their interest rates are lower, but mostly because he wanted some business expertise to go with his big plans.

The EBRD is helping him with ideas on expanding his product line -- he is looking to move into high-quality ceramics -- and also in improving management and accounting.

Surveying the disused arms factory around his modest workshop, Labuza expressed expansion plans that are, well, less than modest. "One day this will all be mine," he said.