Barriers to Innovation: Legal Constraints in the Venture Capital Market

Import substitution remains one of the key priorities of economic policy. The government is placing its focus on domestic startups capable of delivering innovative solutions and accelerating technological development. However, a significant number of young companies fail to move beyond the early stages: according to the Moscow Innovation Cluster, up to 60% of startups cease operations within their first years, failing to overcome the so-called “valley of death,” while around 80% face a crisis at the very beginning of their development.

One of the main reasons behind these statistics is the lack of financing. According to the Venture Eurasia 2025 report, the number of venture transactions in Russia decreased by 42% in 2025 compared to 2024. Investors are reluctant to take on high risks amid economic uncertainty, while restrictions on available financing instruments further reduce startups’ chances of survival and growth. Against this backdrop, it becomes clear that the key constraints on venture market development are related not only to the amount of available capital but also to legal barriers that directly affect deal structures and the speed of attracting investment.

Lack of SAFE (Simple Agreement for Future Equity) and KISS (Keep It Simple Security) equivalents

SAFE and KISS are popular legal instruments widely used in international venture practice that help early-stage startups raise capital quickly. They allow investors to provide funding without requiring an immediate company valuation, while equity conversion takes place upon the occurrence of certain events (for example, a new investment round or a business sale).

In Russia, investors are forced to choose between two imperfect alternatives: direct equity investment, which requires an immediate valuation of the company — something that is often highly uncertain at an early stage — or convertible loans, which create additional debt obligations for the startup.

Attempts to replicate SAFE structures through option agreements or convertible loans face the challenge of defining material terms of a future transaction that are unknown at the time the agreement is entered into.

The authorities have begun discussing the creation of SAFE-like instruments in Russia — including a grant mechanism that could be converted into an equity stake in a startup upon its successful development. Another proposed measure is to allow the procurement of products developed with federal budget support for a specific customer from a sole supplier, while prohibiting purchases of foreign alternatives.

The introduction of a new instrument would allow startups to attract investment faster and focus on product development.

Unanimous Consent Requirements in LLCs

Under Russian corporate law, a number of key corporate decisions in a limited liability company (LLC) require unanimous approval by all participants. These include, for example, increasing the authorized capital, limiting additional rights granted to all participants, imposing additional obligations on all participants, and terminating such obligations.

This creates a risk that decisions necessary to attract new financing rounds may be blocked. If minority shareholders are involved (in particular, business angels or employees holding an equity stake), they may effectively exercise a veto over the company’s development, reducing the startup’s investment attractiveness.

Resolving disputes with such minority participants may ultimately require court proceedings. For example, an entrepreneur holding an 80% stake in a company filed a claim seeking the exclusion of another participant holding a 20% stake.

The claim was based on the fact that the defendant had systematically avoided participating in general meetings of participants, depriving the company of the quorum required to make important business decisions.

The court ruled in favor of the claimant, stating that systematic failure to participate in general meetings without valid reasons constitutes an action (or inaction) that makes the company’s operations impossible or significantly complicates them.

The court also established and recorded that the defendant had been properly notified of the meetings (based on postal tracking reports), eliminating procedural obstacles to reviewing the case on its merits. The defendant failed to appear at the hearings and did not submit any objections, which the court considered an additional indication of their lack of interest in the company’s activities.

Restrictions of Investment Partnership Agreements (IPA)

Despite the introduction of the Investment Partnership Agreement (IPA) as an analogue of the limited partnership — a widely used structure for pooling capital in venture and private equity investments — systemic barriers remain.

For example, individuals cannot participate as parties to an IPA, and the term of an IPA is limited to 15 years. In addition, all actions involving the agreement require notarization, which effectively turns any amendment or adjustment of the document into a lengthy and burdensome process.

At the same time, at the end of 2025, the State Duma passed a bill in the first reading aimed at modernizing the investment partnership framework. If finally approved, the legislation will eliminate many existing barriers and make IPAs a more attractive instrument for investment transactions.

Lack of Effective Employee Stock Option Programs (ESOP)

Russian law does not currently provide a convenient and widely applicable mechanism for employee participation in company equity comparable to Western Employee Stock Ownership Plans (ESOPs).

In practice, companies are forced to rely on complex alternative structures, each of which has significant disadvantages.

These include either the issuance of an option by a founder in respect of their own equity stake, where one of the founders grants an employee the right to acquire part of their stake in the company in the future upon the occurrence of certain conditions (such as achieving KPIs, completing a certain period of employment, and other milestones), or the use of phantom options, where an employee does not receive an actual equity interest in the company but instead obtains the right to monetary compensation linked to the value of the equity stake or the company’s capitalization growth.

From a tax perspective, such compensation is generally treated as a bonus payment.

This approach is used, for example, by major Russian IT companies. Since 2007, Yandex has operated a long-term employee option program, which was extended again in 2025: the company’s board of directors approved a new employee share allocation worth RUB 15 billion through a private placement as part of its employee incentive program.

However, the absence of a legally established equivalent of a traditional ESOP in Russian law limits the ability of most companies to motivate and retain key employees through equity participation and creates an additional financial burden for startups.

Conclusion

The current challenges in startup financing are a consequence of an imperfect legal framework. However, the first steps toward reform have already been taken: the introduction of a SAFE-equivalent instrument is being discussed, and the investment partnership framework is being modernized.

The implementation of these and other measures would provide investors with more effective financing tools and give startups greater opportunities for rapid growth.

Under current conditions, the key success factor in attracting investment is not only access to capital but also a properly structured legal framework established at an early stage of the company’s development.

In practice, this means that startups need to carefully design their corporate structure from the outset, including the company’s charter documents and shareholders’ agreements, taking into account future financing rounds, and clearly defining decision-making mechanisms in order to prevent potential blocking by minority participants.

When using financing instruments currently available under Russian law — including convertible loans, option structures, or contractual arrangements — it is critical to define in detail the terms of future conversion and equity allocation.

This helps reduce legal uncertainty, accelerate transactions, and minimize the risks of corporate conflicts as the company grows.

Source: Business Secrets
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