High Tech Venture Capital Investment in a Small Transition ...
High Tech Venture Capital Investment in a Small
Transition Country: The Case of Hungary
László Szerb and Attila Varga
Faculty of Business and Economics
University of Pécs, Hungary
Acknowledgements: The authors would like to thank to the Hungarian Venture Capital and
Private Equity Association, its secretary István Lakos, to the venture capital representatives,
Ferenc Berszán, Péter Geszti, László Hradszky, Péter Fodor, and Benedek Lőrincz.
Hungary has started the change of the economic system from planned economy to market
economy in the late 1980s. In the first years of transition, GDP declined by around twenty
percent, unemployment increased from zero to fifteen percent, and inflation began to rise. At
the same time restructure of the economy started and liberalisation also helped to encourage
entrepreneurship. Since then one of the major problem of small and start-up businesses have
been the lack of financial resources. While government promoted new business creation in the
early years of transformation, this support disappeared by 1995. At the same time, the
financial system of Hungary began to improve by developing banking and credit institutions
and stock markets.
Since 1997, there has been a stable positive growth of the country mounting up to 5,2 percent
growth rate in 2000. This development was mainly due to large foreign companies well
equipped with capital and management knowledge. At the same time, small business growth
showed a declining trend that was turned only in 1999-2000. Small business debt financing
have been improving for the last two years, however, equity financing is still problematic.
As one of the solutions of equity financing, venture capital appeared first in the country in the
early 1990s, but played a minor role up to 1995. In the second half of the 1990s, besides the
Hungarian state, foreign venture capital funds and investors appeared and begun to dominate.
After the Russian crisis of 1998, foreign VC investment dropped and started to increase only
two years later. While up to 1998, food industry and manufacturing were the main targets of
investment, since then, the direction of investment turned to the new economy, following
Hungary seems to have an advantage in the internet and software business, therefore, most of
the VC companies and fund concentrate on these sectors. High tech ventures have appeared in
the portfolio of only a few VC companies, especially electronics and telecommunications,
software related computer technology, pharmaceutical. In some cases scientific instruments
have been the favourites. However, the amount of investment and the number of high tech VC
financed companies are by far of that of the Internet and software firms.
In the second part of this study we outline the Hungarian manufacturing sector and the change
of competitiveness. Over the last years, the importance of high technology firms has increased
but there is still a lag behind the leading nations as well as developed European Union
Section three shows the situation of innovation in Hungary. Despite Hungarian firms having
more and more innovative, novel innovations are missing. It is even more difficult to finance
the innovation especially in the start-up phase and in the small business sector. One of the
main limit of the development of the venture capital industry is the struggle of the domestic
stock market, Budapest Stock Exchange.
Section four highlights the role of government and institutions in supporting high technology
investments. Besides continuous government involvement in research and development,
innovation and new business creation, recent government programmes are not co-ordinated in
accordance of the needs of the National Innovation System and do not pay special attention to
high technology development.
Section 5 is the body of this study, analysing ten high tech projects financed by five venture
capital companies. There are detailed descriptions of venture capital companies, the investee
firms and the interaction between them.
Finally, in section 6 the paper concludes with a critical evaluation of the main findings of the
2. Manufacturing industry and competitiveness in Hungary1
2.1. Structural characteristics
Hungary is one of the most successful transition economies in East-Central Europe, due to
some historical factors (the country used to be the most liberalized one in the soviet block), its
good geographical location, a competitive work force and a relatively well-developed
infrastructure. The economy has been growing continuously since 1997 with a rate of three to
five percent. Unemployment rate has been decreasing to the currently six percent level and the
share of the public sector in GDP is only about ten percent. As the most attractive country for
foreign investors during the transition period, per-capita FDI was the highest in Hungary in
the East-Central European region during the 1990s. The number of active business entities is
currently about 1 million.
The overall economic structure of the country does not differ significantly from that of the EU
average as the respective shares of employment in the service sector, industry and agriculture
are 64 percent, 32 percent and 4 percent. Table 1 shows industrial employment in Hungary in
comparison to selected European countries. Although Hungary’s employment figure in
industry lies closest to smaller sized countries of the EU such as The Netherlands and
Belgium, the share of industrial employment in total employment resembles more to leading
manufacturing countries in the EU such as Italy and Germany (Borbély and Vanicsek 2001).
Table 1 Industrial employment in Hungary in comparison to selected European countries
Employment in industry Industrial employment
(in thousands) (in percentage of total employment)
Germany 12240 34.5
Italy 6348 31.7
France 5891 26.6
Spain 3796 29.9
The Netherlands 1548 22.9
Hungary 1196 31.9
Belgium 1057 27.5
Denmark 699 26.3
Source: Borbély and Vanicsek 2001, tables 6 and 13
The sectoral distribution of industrial production is shown in Table 2. The six leading sectors
are food and drinks, construction, electric power and public utilities, crude oil processing and
nuclear energy, transportation equipments and chemicals. In comparison to the six leading
industrial sectors in EU countries, the following observations can be made:
Research assistance provided by Kornélia Horváth is highly appreciated.
§ similar to the case of the EU countries, food and drinks is listed as the first sector in the
ranking list, however, its share for Hungary is one-third larger,
§ transportation equipments and chemicals are among the first six sectors in both Hungary
and the EU countries, although the respective weights of these sectors in Hungary are
smaller (i.e., the EU average is about 10 percent while for Hungary they are 7.9 percent
and 6.8 percent, respectively),
§ out of the first six sectors in the EU countries three also appears among the leading sectors
in Hungary (i.e., food and drink, transportation equipments and chemicals) whereas the
remaining three main sectors in the EU (i.e., machinery, communication equipments,
metal production equipments) are listed in the second third of the industrial sectors for
Table 2 Sectoral distribution of industrial production in Hungary, 1999
Industrial sector Production Share in total industrial Ranking
(million ECU) production (percentage)
Food and drinks 4806 14.53 1
Construction 3519 10.64 2
Electric power, gas and public utilities 2975 8.99 3
Crude oil processing and nuclear energy 2720 8.22 4
Transportation equipments 2625 7.94 5
Chemicals 2245 6.79 6
Other electric equipments 1829 5.53 7
Metal products 1369 4.14 8
Office machines sand computers 1346 4.07 9
Telecommunication devices 1225 3.70 10
Machinery 1205 3.64 11
Metal production equipments 943 2.85 12
Other mining 932 2.82 13
Plastic and rubber 833 2.52 14
Other nonferrous materials 770 2.33 15
Printing, publishing 530 1.60 16
Textiles 498 1.51 17
Clothes 497 1.50 18
Paper 469 1.42 19
Lumber 346 1.05 20
Instruments 277 0.84 21
Furniture 253 0.76 22
Water production, processing and distribution 211 0.64 23
Leather 195 0.59 24
Tobacco 169 0.51 25
Crude oil and natural gas 90 0.27 26
Other transportation equipments 90 0.27 27
Coal mining 74 0.22 28
Mining of ferrous materials 21 0.06 29
Waste recycling 19 0.06 30
Total 33081 100.00
Source: HCSO (1999)
manufa cturing p ro duc tion
3826 4 - 63808
7230 3 - 85129
8520 5 - 10278 1
1085 94 - 1587 86
2540 53 - 5944 86
Figure 1 The geographical distribution of manufacturing production in Hungary, 2000
Source: HCSO (2000b)
Out of the 30 industrial sectors, 22 belong to manufacturing representing 67 percent of
all industrial production. Manufacturing is heavily concentrated in the 8 sectors where
production value is above 1000 million ECU such as food and drinks, transportation
equipments, chemicals, electronics, metal products, office machines and computers,
telecommunication devices and machinery. These sectors represent 77 percent of
It is interesting to examine the geographic distribution of manufacturing production in
Hungary in Figure 1. As shown in the figure, manufacturing is heavily concentrated
spatially in the North-Western part of the country. Budapest, the capital of Hungary
provides alone one-fifth of total manufacturing production whereas together with the
counties in North Transdanubia (including Győr-Moson-Sopron, Vas, Fejér, Veszprém
and Komárom-Esztergon counties) this industrial region produces 64 percent of all the
manufacturing output of Hungary.
According to the latest issue of the World Competitiveness Yearbook (IMD 2002),
Hungary is the 28th most competitive nation in the world in 2002, directly preceded by
Israel, Malaysia and Korea and followed by the Czech Republic. Estonia is the only
former socialist country that has a higher competitiveness score than Hungary for the
year 2002. Another measure of the increasing competitiveness of Hungary is that
between 1993 and 1999 this country revealed the highest improvement in OECD
imports (Losoncz 2002). The most dynamically growing and as such the most
competitive industries are electronics, transportation equipments, instruments, wood
and paper production (Pula 1999).
Competitiveness of the Hungarian economy has improved significantly since the early
90s. What could be the main sources of this increase? Labor productivity is understood
as one of the major components of international competitiveness. It has increased in
Hungary by 50 percent between 1989 and 2000. This increase has at least two main
reasons (Losoncz 2002). The first is the dramatic decrease in employment during the
first part of the 1990s. Resulting both from the introduction of market mechanisms as
well as major structural changes in the economy, between 1990 and 2000 the decline
in the number of employed persons amounted to 1.2 million, accounting for a 24
percent decrease in total employment.
Improving productivity is also due to the dynamic flow of foreign direct investment (FDI) to
the country since 1989. By introducing more advanced technologies into production, FDI is a
significant source of productivity increase. The important role of FDI in the Hungarian
economy is also illustrated by the fact that besides that only 30,526 of the total of nearly 1
million registered Hungarian enterprises have some foreign interest, these about 30,000
foreign owned companies have a share of HUF 455 billion (i.e., over fifty percent of the total
amount of HUF 884 billion) of Hungarian investment (Fáth 2000). Another measure of the
significance of FDI for the Hungarian economy is that 67 percent of the industrial production
is being generated by foreign owned firms (Barta 1997). These firms account for 43 percent
of total employment in 1999 (Fáth 2000).
A large-scale study on the competitiveness of Hungarian companies (Chickán 1998) reveals
the fact that the top management also played a determining role in transforming firms’
organizational structure (Czakó 2001). The presence of a well-qualified yet relatively less
expensive work force is another source of an increase in international competitiveness
2.2. Relative importance of technological investment and high tech sectors
To empirically account for the “high technology” industry, three main approaches have been
developed in the literature (Varga 1998). High technology industry is measured as the set of
sectors with above-average ratio of R&D to sales; with higher than average percentage of
engineers and scientists in the labor force; with more than average number of innovations per
1,000 employees. Based on these criteria, the relatively high level of data aggregation for
manufacturing in Hungary allows us to consider the following, rather broad, sectors as high
tech in this study: Chemicals, Drugs, Electronics, Machinery, Transportation Equipments and
Instruments. The share of these six sectors in manufacturing has been dramatically increasing
since the mid-1990s. In 1996 high tech sectors took 47 percent of manufacturing output, while
this share increased to 64 percent by 2000. As shown in Figure 2, the main drivers behind this
increase are electronics and transportation equipments.
Share in manufacturing
1996 1997 1998 1999 2000
CHEMICALS ELECTRONICS TRANSP EQUIP MACHINERY
Figure 2 Share of high technology production in manufacturing, 1996-2000
Source: HCSO (1996, 1997, 1998, 1999, 2000a)
High technology industry concentrates geographically in four areas of Hungary. Budapest is
the center of software, R&D, internet applications, biotechnology and computer services,
North Western Transdanubia (concentrated around Győr) hosts automobile, engine and
related research activities, manufacturing in Central Transdanubia (with centers of Veszprém
and Székesfehérvár) focuses on electronics, light industry and computers while the region
around Szeged in the Southern Great Plain is a growing center of biotechnology.
An important source of high tech development is the dynamically growing small firm sector
in Hungary (Meixner 2001). Young high technology firms in the internet, telecommunications
and software fields are especially significant actors in this process. According to the recent
ranking of Fast 50 Companies in Central Europe by Deloitte & Touche, there three winners in
2002 are Hungarian ventures. Hungary overwhelmingly dominates in other parts of the rank:
there are seven in the best ten and altogether twenty firms are included in this select group of
50 (Deloitte & Touche 2002). In 2001, there were only 14 Hungarian ventures in the best 50.
The highest growing firm in the Central European region was a Hungarian company with a
growth rate of 1853 percent in 2001. Two other fast developing firms from the country were
also among the first ten in the ranking list (.(Deloitte & Touche 2001).
Besides the indigenous small firm sector, FDI also plays a determining role in the recent
growth of high technology industry in Hungary. The main portion (84 percent) of foreign
direct investment is related to high technology production or research activities: 66 percent in
machinery, 10 percent in chemicals and 8 percent in instruments. The contribution of
companies with foreign interest to research and development is also remarkable as about two-
third of the country’s total R&D expenditures are spent by this firm sector (Fáth 2000).
More than 40 of the world’s largest companies have established production or research
facilities in the country including IBM, Philips, GM, General Electric, Volkswagen-Audi,
Ford, Texas Instruments and Nokia, among others. FDI heavily concentrates geographically
in and around Budapest (18 percent in 1999) and in North Transdanubia (66 percent in 1999).
This spatial structure is mainly explained by accessibility, industrial traditions and the
availability of a qualified work force.
Several studies have pointed out that (resulting from the active involvement of foreign capital
in industrial investments) the Hungarian manufacturing sector shows a highly polarized, dual
structure (e.g., Barta 1997, Pula 1999). On one of the poles there is the group of firms
successfully integrated into international networks consisting of mainly multinational or
partly foreign-owned companies and their Hungarian suppliers dominantly in the automobile
and electronics industries. Many of the dynamically growing indigenous small high tech firms
in software, biotechnology, internet and telecommunications also belong to this group. This
sector generates about 60-70 percent of industrial growth and also it is the main driver of
Hungarian export activities. However, most of the Hungarian firms can be found on the other
pole. These firms represent a lower level of technology and a slower peace of growth while
this sector sells dominantly on the domestic market.
3. Technological change and corporate finance
As we can see from the previous section, Hungary’s competitiveness has increased over the
years of transition. As Losoncz (2002) noted the factors behind the increased productivity was
associated with declining employment as well as technological changes. Now, let’s focus on
the second factor. Technological changes are closely associated with technological
innovation, research & development (R&D) and investment to new machinery2. There have
been several papers analyzing innovation in Hungary.
In a comprehensive survey, Inzelt (1995) analyzed the innovation activity of 110 Hungarian
ventures in 1992. The data set was a sub-sample of a wide-range survey conducted by the
Central Statistical Office: out of the 3600 firms there were 478 (around twelve percent) who
reported some innovation activity, and out of this 110 filled out the questionnaire, mainly in
the large enterprise sector. At the early years of transition, the main focus of innovation was
quality improvement followed by the diversification of products and production. Fifty-six
percent of the ventures introduced new technology and seventy-five percent developed new
product. However, out of the new products, only twenty-five percent proved to be new
internationally. It was interesting that ventures spent half of the innovation budget R&D. The
most active technological research was noticed in the chemicals sector.
In a 1996 survey, Chikán et al (1997) reported that the competitiveness of Hungarian
enterprises improved compared to the first years of transition. However, technological as well
as product renewal of the enterprises were ”dramatically slow”, and the lack of innovation
was the most important barrier of further development. The survey was done at 325 ventures
that represented around ten percent of the Hungarian GDP. An improvement in innovation
activity was reported by Kiss (2000) who continued the Chikán research. Out of the three
hundred enterprises in the data set, thirty-six percent introduced new technology, but most of
these technologies were new only in Hungary. Most of the companies developed the available
technology significantly. Twelve percent of the ventures had own R&D unit. Most companies
preferred the technological development both in the time period 1993-1995 and 1996-1998.
Kiss reinforced the previous two studies’ result, that the most important aim of innovation
was product quality improvement.
Based on a regular survey of GKI that involved around 7-800 businesses, Papanek (2001)
examined innovation activities of different regions in Hungary between 1997-2000. He stated
We know that R&D is only one of the innovation activities, but it provides the basis for the other innovation
activities, like planning, engineering, new product introduction, investment to machinery etc (Papanek 2001)
that innovation activity of ventures in the sample increased, compared to previous time
periods: fifty percent introduced new technology and 63 percent of them entered the market
with new product. However, most of the companies wanted to increase their competitive
position by improved marketing efforts, and they paid less attention to intensive technological
development. It was not a surprise that most of the innovations were new only to the company
and internationally novel innovations were missing.
Table 3, below summarizes the main finding regarding innovation activity of Hungarian
enterprises based on various studies. We should note that the results are not comparable in
many respect (sample size, representetiveness, reliability, definition of innovation etc),
however, it is proper to see the tendency of improvement in the innovation activity over time.
Table 3: The innovation activity of Hungarian Enterprises 1990-2001
Time period Percentage of Sample size Reference
in innovation (%)
1990-1992 12 3600 Inzelt (1995)
1996-1998 36 320 Kiss (2000)
1997-1999 42 291 KSH (2000)*
1998-2000 50-63 7-800 Papanek (2001)
1998-2000 57 92 Inzelt – Szerb (2002)**
*The survey was done by the Hungarian Central Statistical Offfice: A feldolgozóipar innovációs tevékenysége
**Inzelt Annamária – Szerb László: A baranya megyei vállalkozások innovációja 1998-2000-ben, (Innovation at
Firms in baranya County 1998-2000) 2002 Working paper
There are two breakpoints in the innovation activity of Hungarian enterprises. First, foreign or
mixed ownership ventures were much more active than businesses owned only by Hungarians
in the manufacturing sector (A feldolgozóipar …2001). This fact corresponds to the growth
characteristics of Hungary large, foreign companies producing to foreign markets have been
the engine of development since 1997. Several surveys and studies noticed significant
differences in the innovation activities of small and large businesses. Innovation was much
lower in small businesses than in large enterprises. Sixty-four percent of the large enterprises
were involved in some kind of innovation activity, while only nineteen percent of the small
businesses, having less then fifty employees, innovated. The situation was even worst
regarding technological innovation: only twelve percent of small businesses renewed their
technology in contrast to the sixty-five percent of the large companies The backwardeness of
Hungarian innovation can be realized by an international comparison. In every size
categories, European Union businesses were more innovative. The lag was much larger in the
small business sector where the difference was twofold then in the large business category
where the deviation was only fifteen percent. (A feldolgozóipar…2001).
Most of the studies, cited above examined the main limiting factors of innovation. In the case
of Inzelt (1995) and Kiss (2000), the most crucial one was the lack of financial resources.
Papanek reported low domestic demand as No.1 limiting determinant, while financial
problems were listed second. Financial problems were much less severe in the large business
sector and amongst the most innovative firms.
In this section our primary focus is small- and medium sized (SME) sector financing.
Large, mainly foreign owned businesses have the necessary financial resources to grow
and to innovate. Small business growth and innovation has special problems. One of the
major difficulties of financing innovative small businesses is information opacity. In
dealing with this information problem, financial intermediaries that screen, contract and
monitor the businesses in which they invest, play a crucial role (Berger and Udell 1998).
World-wide, small and young businesses are financed more with owners’ equity than with
debt. Business angels and venture capital provide the primary equity financing for high
growth potential, entrepreneurial firms.
The differences between large companies and the SME sector can be seen in terms of
finance. While large, established businesses can find credits and loans relatively easily,
almost ninety percent of the SME sector is not even eligible to get a loan (Kállay 2000)
Table 4 provides some data on SME and large business debt financing. There has been a
real increase in outstanding bank credits of the whole enterprise sector. Since 1997,
however, the small business sector has had less than 5 percent of the credits. In contrast, in
1993, small firms had more than 12 percent of the loans. There are some signs that this
kind of negative tendency is turning around in 1999, and the share of loans below 20
million HUF (83 000 USD) for investment purposes was more than 50 percent (Waldner
2000). As Kállay (2000) reported, until 1998, only 12,7 percent of the enterprises in the
SME sector got some credits.
Table 4: Credits of the enterprise sector 1993-2000, end of the year
1993 1994 1995 1996 1997 1998 1999 2000
Outstanding bank credits of the
whole enterprise sector
(in million USD) 7 326 7 476 7 251 7 884 9 126 9 214 9 241 10 292
Outstanding bank credits of the
small business sector
(in million USD) 931 849 566 409 381 437 450 471
Ratio of outstanding bank
credits of the small business
sector (in percentage) 12,67 11,36 7,80 5,19 4,75 4,75 4,87 4,58
Calculation based on Hungarian National Bank Monthly Reports, 1994-2000, various issues
Improvement of the access to bank credits alone would not solve the financial difficulties
of the SME sector because the main problem has been under-capitalization (Apatini 1999).
The reasons for the lack of capital are not institutional but rather the lack of solvent
institutional investors. Even within the SME sector there have been huge differences:
Kőhegyi (1998) reported that only two percent of the businesses possessed about 48
percent of the capital of the SME sector where the number of employees was below 50.
Despite the fact that the development of financial intermediation is considered satisfactory,
there is a lack of SME specific banks and other financial institutions. Over the years there
have been several government initiatives aimed towards establishing an SME specific
banking system but all of these attempts have failed.
Stock market is one of the major sources of long term equity business financing. In Hungary,
there are a regular stock market at Budapest Stock Exchange (BSE) for some publicly listed
companies and an over the counter market. The BSE is an associated member of the
International Securities Market Association (ISMA), the Information Industry Association
(IIA) and other international organizations, giving an increased credibility, access to
information, control, and safety. However, the BSE is very small by international standards
and the dynamic development of the second part of the 1990s was broken by unfavorable
conditions. Over the last 1,5 –2 years the BUX has been stagnating discouraging potential
As Szerb and Ulbert (2002) pointed out, the companies in the BSE do not represent the top
Hungarian ventures. In 1998, out of the largest 50 Hungarian companies, only 9 were in the
BSE. Moreover, Hungarian companies have not relied on the BSE when they wanted to raise
capital. Over 10 years, the amount of capital raised on the BSE has been only $510 million, a
little bit more than 3 percent the market capitalization (about $15,7 billion in 2000). Some of
the companies, mainly with foreign ownership, obtained additional resources from the “parent
company” – abroad – and/or went to the banks for credit or raised capital privately. MATAV,
MOL and OPT, amongst the largest Hungarian companies have financed their growth from
retained earnings. Corporate bonds have not played an important role in the BUX.
Similar to the NASDAQ, there is another over the counter (OTC) market in Hungary. There is
no limit or requirement to being traded on this other OTC, but brokerage firms trade only a
few papers – e.g., compensation coupons and some bank shares - because of the high risk and
uncertainty. There are no official data available about the OTC turnover, but it is considered
to be unimportant in the Hungarian financial market. The market is very illiquid and neither
brokers nor investors like it.
4. Incentives and institutions supporting investment in new technologies
A country’s technological progress is closely related to innovation As Inzelt (2002) noted, the
weak point of innovation in developing and transitional countries is the improper distribution
of scientific knowledge. The innovative performance of a country depends on the whole
national innovation system that can be defined as a set of knowledge institutions who interact
with one other. In this complex system there are collaborative efforts and interaction with
other players like customers, suppliers, competitors, officials etc. Support for new technology,
innovation, regional development, and entrepreneurship exists also in Hungary, but the
interaction is not integrated.
In this part of the study, we focus on three issues. First, the bases of new technology, such as
investment and R&D support are analyzed. Second, new technology support by the state is
investigated. Third, entrepreneurship and new business creation, as the main source of
innovation is studied.
Table 5 shows the basic trends of investment R&D and registered inventions in the time
period of 1990-2000.
Table 5: Investment, R&D and inventions in Hungary 1990-2000
Volume R&D in GERD The percentage Number of
indices of million (R&D as the of state in R&D inventions
investment USD percentage of spending registered
1990 5638 mil. 533,2 1,60 53,7 1805
1991 87,7 362,2 1.20 .. 1349
1992 98,5 400,0 1,08 .. 1081
1993 102,5 383,5 1,06 .. 1143
1994 112,3 383,3 0,93 .. 941
1995 94,7 336,5 0,80 47,3 443
1996 105,2 301,6 0,67 44,7 344
1997 108,5 340,6 0,74 50,3 268
1998 112,7 332,0 0,70 49,6 551
1999 105,3 311,5 0,70 48,0 435
2000 107,4 351,3 0,80 45,3 330
Sources: Statistical Yearbook of Hungary, 1994-2001 various issues
Over the first years of transition, investment substantially declined. There was a parallel
movement of R&D both in terms of absolute value and as a percentage of GDP. After 1995,
investment began to rise not just in nominal but also in real terms, but R&D did not follow
this tendency exactly. The worst year was 1996, as a result of the re-balancing effect of
government deficit. In that year, R&D spending did not reach 0,7 percent of the GDP. Despite
some increased effort, government R&D expenditures has remained below one percent of the
GDP, an extremely low share by international standards. The OECD country average of R&D
expenditure in percentage of GDP was over two percent in the same time period, while it
appeared to be much higher in some newly emerging innovative countries like Finland (4-5
percent) (Csákvári and Kovács 2002). Similar tendencies can be noticed in other leading
transitional countries like Czech Republic and Poland.
The state proportion in R&D spending is an important determinant of the state involvement in
basic innovation. Over the years, from 1990 to 2000, the state proportion of R&D declined by
more than 8 percent, and the relative importance of private spending has increased. It can be
good from the viewpoint that R&D efforts that state support dependence decreases, but it is
bad because the absolute and relative spending on R&D is very low (the GERD is still below
one percent), showing that the situation could be improved by the increased involvement of
As a result of the declining trend in R&D, the number of registered invention decreased too.
In 1990, it was over 1 800, and by 2000, Hungarians registered only 330 inventions. At the
same time, foreigners increased registration. As a result of this two tendencies the dependence
of Hungary in terms of innovation capacity increased (Csákvári and Kovács 2002).
Nowadays the dominant government policy is changing from direct support to encouraging
innovation, initiatives and to shaping the business environment. Especially in Hungary, the
new science and technology (S&T) policy should move from the mission oriented position
toward influencing collaboration and integration amongst the three dominant players,
government-industry-universities. However, existing and recent government programmes are
only partially or not along this line. As Inzelt (2002) describes, recent priorities were to
stimulate business demand for R&D, to encourage technology transfer, to promote new
technology-devoted SMEs, and preserve and strengthen R&D capabilities.
Presently, there are several government programmes, and ways to support innovation,
technological development and investments. For example, twenty percent of R&D spending
can be deducted from company tax base, twelve percent of the investments in industrial parks
can also be deducted from the tax base. Foreign companies that set up a research laboratory
with over 30 researchers and invest over 500 million HUF can grant up to 25 percent of the
investment. Direct support of investment up to 25 percent of the project could be received
from the so called Széchenyi Plan, that was an ambitious development plan launched in 2000
by the previous government. Moreover, ventures can receive several types of state subsidies
and credits, that are not directly aimed at technological innovation but indirectly involve it.
Just to mentione a few: Development and Innovation Programme, Microcredit Programme for
small, early phase enterprises, Enterprise Promotion Programme, Regional Economic
Constructions Programme etc. Now, the new government wants to change the priorities in
accordance to the requirements of European Union accession
The effectiveness of direct government spending is questionable. In one of a rare studies in
this area, Futó (2001) examines the 57 government supported innovation projects in the SME
sector. Only 35 percent of the projects were in the high tech sector, other innovations realised
mainly in the low tech machinery and agriculture. Most of the firms aimed both product and
technology development. The support was positive mainly for the venture itself, however,
diffusion of innovation affected other players only partially, except co-operation with
partners and customers. Most of the ventures (56 percent) increased their revenues but the
effect on employment was mixed, and did not increase hiring significantly.
Several public and private institutions exist to support innovation and technological
development in Hungary. The Research and Development Division of the Ministry of
Education is the main managing and coordinating body of research and development
programmes of the government. Amongst others, one of its major aims is to stimulate
technological modernisation. The Hungarian Patent Office’s role is the protection of
intellectual property, the Hungarian Centre for Productivity Public Foundation was
established to implement technical development policy. Two major initiatives are technology
transfer programmes and the benchmarking services. Investment and trade development
institutions just related only partially to technological innovations. Hungarian Investment and
Trade Development Company (ITD-Hungary) stimulates investment, trade, and enterprise
development. Its operation includes maintenance of Euro-Info centres with purpose of
assisting SMEs in their preparation to EU accession. (State of small...2001)
Over the last few years, university research and research centres have been established to
overcome the weakest link in the Hungarian innovation, that is university industry co-
operation. The effect of the newly founded research centre at the Hungarian Technological
University on the knowledge economy was investigated by Dévai and Borsi (2000). The
initial results were positive regarding education, but unfortunately the industry relation of the
university did not improve significantly.
The are other institutions and organisations supporting new technology initiatives. Innovation
centres and incubators provide a solution for an increasing number of technology oriented
businesses start-ups, but they exist only in a few places like Budapest (INNOCENTRE),
Székesfehérvár and Győr.
One of a major private institution that supports technology related innovation is the
Hungarian Venture Capital and Private Equity Association. They issue a yearbook and a
quarterly newsletter to spread information and to assist mainly venture capitalists, business
angels and potential investee companies. Another world-wide organisation, First Tuesday is
also present in Hungary. First Tuesday is a meeting place for investors and business people in
high tech and new economy sectors.
Besides research and supporting institutions of technology and innovation we should also
discuss about business creation and entrepreneurship. Entrepreneurship is meant here in the
sense of Schumpeter, i.e., the creation of something new. Therefore, entrepreneurship is
closely linked to innovation. (Szerb and Ulbert 2002). The regular Global Entrepreneurship
Monitor (GEM) compares and investigates the effect of incumbent and newly founded
businesses on economic development. One of the major advances of the 2001 report is the
separation of opportunity and necessity entrepreneurship. The study observes a close
relationship between research and technological development (RTD) and opportunity
entrepreneurial activity. While in some sectors, large enterprises play a dominant role in
R&D, in some other sectors high tech start-ups dominate (Reynolds at al 2001). Therefore,
the support of new venture creation and opportunity entrepreneurship can be important for a
country’s growth, wealth creation and technological development.
Based on the 2001 GEM Report, Hungary ranked second in Europe in terms of Total
Entrepeneurial Activity3 as well as opportunity entrepreneurship, after Ireland and ranked
eights in the world. As opposed to the early years of economic transition when necessity
entrepreneurship was dominant, by 2001 almost 70 percent of young and incumbent
entrepreneurs claimed that they want to start a business because of good opportunities in the
economy. Regarding the entrepreneurial activity Hungary is more similar to other developed
nations in the European Union then developing countries.
For a country, not only the new business creation but also the survivability of the new
businesses can be important. Decreasing the mortality rate of new businesses can be an
important role of governmental and other institutions. As we presented in the previous
chapter, one of the major problems of Hungarian businesses is finance, both equity and
debt financing. Unfortunately, the recently launched government programs have not been
effective in supporting existing SMEs and have not promoted entrepreneurship and new
business creation (B.K. 2001).
Total Entrepreneurial Activity index is calculated as the percentage of the sample want to start a business
(incumbent entrepreneur) and having a business aged less than 42 month.
5. The Venture Capital Case Study
5.1 Background to the Venture Capital industry in Hungary
In Hungary, venture capital emerged first at the end of the 1980s, but did not play a major role
until the mid 1990’s. By 1996, the total investment of the 25 members of the Hungarian
Venture Capital Association (HVCA) exceeded 250 million USD, but only 52 percent of the
available capital was used. According to the Hungarian Venture Capital Association, by 1998
the available venture capital was about 1,2 billion USD and out of this 760 million was
effectively invested. Increased activity of foreign investors characterized the second part of
the 1990s: in 1995, domestic venture capital funds amounted to 70 percent of VC investment.
By 1998, foreign venture capitalist supplied about 350 million USD (46 percent) of venture
capital investment, and the Hungarian state (mainly via the Hungarian Development Bank,
HDB) supplied about one third of it. Domestic private investors had less than 25 percent of
the investment (Hungarian Venture Capital Association Yearbook 1999). Over the last three
years the domestic proportion of transactions have been stabilizing at around half of the deals
(Hungarian Venture Capital Association Yearbook 2001). Meanwhile, international deals
have increasing counting about a third of the total transactions. At the same time, Hungarian
venture capital funds (e.g. Corvinus) are more interested in foreign investments mainly in
neighboring countries like Romania, Slovakia and Ukraine.
The amount of the invested venture capital in Hungary is not known exactly. Halaska –
Kovács (1999) reported, that venture capitalists invested 300-500 million USD in Hungarian
businesses between 1995-1999. Increased activity was mainly due to foreign regional funds.
Karsai – Rácz (2000) claimed that by 2000, the invested venture capital exceeded 1 billion
USD. Another study (B.I. 2001) stated that total venture capital investment was about 800
million USD by the end of 2000 and this is about the same amount that the HVCA estimates
(Hungarian Venture Capital Association Yearbook 2000). If we add the 64 million USD
investment that happened in 2001 (Hungarian Venture Capital Association Yearbook 2001),
then the estimated total amount of venture capital investment was about 860-1000 million
USD, probably closer to the lower than the upper limit.
There is an even less reliable estimate that we can make regarding the number of companies
receiving venture capital injection. Over the last three years (1999-2001) there were 87 deals,
but many of them were second or third round investment to the same company. Based on
personal interviews with venture capital experts, the number of companies receiving venture
capital is about 200-450 up to 2002. We should note again, that there is no exact data
available regarding the above number.
Several studies (e.g. Ludányi 2001a, Karsai 1999) claimed that the Hungarian venture capital
market was the most attractive amongst transitional countries in the second half of the 1990s.
In 1996, the USD 350 million venture capital investment reached 0,8 percent in the Hungarian
GDP that was higher then in some developed or European Union counties. According to a
recent investigation by the Global Entrepreneurship Monitor (GEM) (Reynolds et al 2001)
research, the average of the 24 GEM country venture capital investment was about 0,5 percent
of the GDP, and was less than 0,1 percent of the GDP in the case of Hungary. If we compare
the results of the two different time period, we can conclude that relative to the other part of
the world, the venture capital market in Hungary has declined. In other words, the renewal of
the venture capital market, mainly in the US in the late 1990s, had a limited effect on the
Hungarian venture capital market. It can be seen, that positive world market events affect
Hungary with certain lag: 2000 was an exceptionally good year in Hungary. However, bad
events hit Hungary very quickly: the further development of the venture capital market was
halted by the collapse of the major new economy companies at the end of 2000.
In order to encourage new venture capital formation the Hungarian Parliament passed the
Venture Capital Act (VCA, Act XXXIV. of 1998), the first in the Central-Eastern European
region. Domestic companies and funds registered under the VCA have to be licensed by the
State Money and Capital Market Commission (SMCMA). The amount of subscribed capital
has to be over 500 million HUF (around 200 000 EURO), and the VCA describes the
documentation that is necessary to submit to the SMCMA, including the Deed of Foundation
and the Rules of Organisation and Operation. In exchange the VCA provides tax allowances
and potential collection of the funds from the public.
Unfortunately, over the three years there is only two companies receiving permission to
register under the VCA, but presently non of them operates under the VCA This data show
that the law has had a marginal effect on the Hungarian capital market. The main reason for
the fail of the VCA is associated with the strict rules on investment. Experts agree that the
VCA, in its present form, is over-regulated, and the rigid requirements do not compensate for
the tax allowances (Karsai –Rácz 2000, B.I. 2001)
5.2 Investment profile
Besides the regularly published yearbooks of the Hungarian Venture Capital Association,
there have been only a few major empirical studies about the role and the profile of venture
capital in Hungary: Karsai (1999), Lemák (2000) and Ludányi (2001a, 2001b). Before 1995,
the Hungarian state dominated in the venture capital industry, and the main type of transaction
was turnaround investment and MBOs. After 1995, foreign investors took the leading role.
Investigating the characteristics of venture capital investment in 1996-1997, Karsai (1999)
found that venture capital investments mostly concentrated on medium and large enterprises.
The average amount of investment was about two times more than the European Union
average (in 1996: 2,6 million ECU to 1,01 million ECU, in 1997 5,07 million ECU to 1,81
million ECU). Venture capitalists decreased the high risk by investing in larger companies.
Ninety percent of the total investment focused on the expansion phase (development capital).
Turnaround businesses constituted half of the financing and seed capital was completely zero.
Although, MBO played an important role before 1995, it presented only 4 percent of the
investment in 1999. Lemák (2000) reported that foreign regional funds became the main
venture capital investors in Hungary by 2000.
International capital movements highly influenced Hungarian venture capital investment. In
1997, capital withdrawal was higher than new investment. Before 1998, venture capitalists
were interested in services, machinery, food industry and information technology sectors.
Since 1999, interest in high tech enterprises, e.g., information technology, software firms,
telecommunication firms associated with internet and biotechnology type of businesses has
The following two tables present the main characteristics of venture capital investment in
terms of the amount of investment and the stage of investment in 2000-2001. We have exact
data on industry-wise investment only for 2000.
Figure 3: The Characteristics of Venture Capital Investment in Hungary, 2000-20014
60 50 50
3 5 2,2 2,3
Source: Based on Hungarian Venture Capital Association Yearbook 2001.
Figure 4: The Share of Venture Capital Investment by the amount and the number of
transactions in Hungary 2000
20% By invested capital
15% By number of transaction
Source: Based on Hungarian Venture Capital Association Yearbook 2001.
Traditional sectors include food, manufacturing, retailing, constructions, technology investments include
telecommunication, Internet, pharmaceutical, information technology, media and entertainment.
Following the world-wide tendencies, the Hungarian venture capital market has gone through
two major crisis. While the 1998 Russian crisis hit the venture capital sector badly, the
damage in 2000-2001 was not as severe as previously. The downturn both in terms of the
number of transactions and the invested capital was about 40 percent (Figure 3), but the early
stage technology investment showed noticeable resilience (Hungarian Venture Capital
Association Yearbook 2001). The average amount of investment of 2,2-2,3 million USD was
a little bit higher then in the previous years (around 2 million USD) in 2000-2001. However,
the typical investment was in the 0,5-1 million USD range. It also means that a few large
transactions constituted the majority of investments, while the vast majority of the deals were
much less then the average in terms of value.
The appearance of early stage investment was noticeable, being around 63 percent of the
transactions in 2000, and two-third in 2001, compared to 1996-1997 when it was zero.
Development capital losts its importance. There were only 17 and 3 deals in 2000 and 2001,
respectively. The appearance of buyouts in 2001 (5) was associated with the unsatisfactory
achievement and liquidity of the Budapest Stock Exchange (see later).
Figure 3 presents evidence about the sectoral changes of venture capital investment, that is the
dominance of the technology/high tech investment. Before 1998, only 7 percent of the
transactions happened in the technology sector, in year 2000, 70 percent of the transactions
were in the same sectors. After the collapse of the new economy companies in the American
stock markets, there was an adjustment in the Hungarian market too: traditional industries
gained back some space up to 50 percent from the new economy companies. Figure 2 gives a
detailed view about the share of industries in terms of the number of transactions and the
value in year 2000. There is an agreement amongst venture capitalists, that Hungarian
entrepreneurs are strong in software development, pharmaceuticals, biotechnology, and some
parts of laser application.
5.3 Exiting venture capital investment: The role of stock market and IPO
Since the venture capital market has only a few years history there are limited data about the
exits in Hungary. There is a common knowledge amongst experts that the progress of the VC
industry is strongly associated with the development of the stock market (see e.g. Mani and
Bartzokas 2002). Stock markets are important for venture capitalists since they provide a
perfect place for initial public offerings (IPO) for businesses that have gone through the
expansion phase and for venture capitalists who consider selling their ownership-share.
In general, Hungarian financial markets are relatively well developed having a good
infrastructure and a lot of further potential to develop. However, the stock market shows a
contradictory picture. Until now, the stock market played only a minor role when venture
capitalists sold their shares. There were only four IPOs: North American Bus Industries
(machinery), introduced by the First Hungarian Fund, Synergon (operation integration
systems) introduced by Advent the Hungarian Private Equity Fund, and, in the Vienna stock
market, E-PUB (software) introduced by Euroventures. After the successful premier in the
Frankfurt Neuer Markt, Graphisopft (software development) was introduced to the BSE in 16
May 2001. Professional investors bought Recognita (software development) and Elender
(Internet services) (Jön a kockázati tőke, 2000).
Despite continuous acquisitions, NABI, Synergon and Graphisoft have not used the stock
market to raise capital. Graphisoft is planning to increase is presence in Japan and the US,
Synergon aims to gain a regional market leading position. In both cases the companies relied
on retained earnings. NABI has relied on bank loans in its external growth financing in the
US and Great Britain.
The development of the BUX was broken in 1998 and in 2001 and by now even the
independent existence of the Budapest Stock Exchange is questioned. The capitalization of
the BSE is small, the annual turnover equals about the two days’ turnover of the 30 largest
companies traded in Frankfurt. Instead of new IPOs, companies are leaving the stock market
and this is definitely not a good news for venture capitalists that plan to sell their shares on the
BSE. The buyouts in 2001 were associated with the removal of these 5 companies from the
The limited use of the stock market as an exit route by the venture capitalist is also evidenced
in Karsai (1999). Between 1995 and 1998, IPOs constituted only seven percent of the exits
(four percent in terms of value), while trade sales amounted 57 percent (45 percent in terms of
value), and other methods (repurchase, and refinancing) mounted up to the remaining 36
percent (52 percent in terms of value). It is interesting that there was no involuntary exit in the
same time period – or the venture capitalist did not reveal them (Lemák 2000).
In another empirical study about Hungarian venture capital investments and investors,
Ludányi (2001b) claimed that the preferred exit method of most of the investors was trade
sale. On the contrary, state owned venture capital companies favoured to sell their shares to
the fellow owners, who were most of the times the entrepreneur itself (repurchase). During
the procedure of trade sale domestic venture capitalists strive to sell their shares fully.
Potential buyers are mainly domestic and foreign strategic investors who had no ownership in
the investee company before the exit. We have exact data on exits only for year 2000, when
out of the 10 exits 6 were trade sales, two IPOs and 2 other (repurchase, refinancing). There
were no reported involuntary exits.
As a consequence of the major problems of American new economy companies, investors of
the Internet and high tech sectors in Hungary have been trying to get rid of their investments.
However, under unfavourable conditions, the only way of exit is to sell the ownership back to
the entrepreneur, otherwise the venture capitalist has to write off the whole invested capital.
As a consequence, some Hungarian entrepreneurs had a very good chance to buy back fully or
partially the business at a very limited price (Elszállt a kedvük 2002). While it looks a
profitable deal for the entrepreneurs who could gain a lot in a short run, decreased activity of
future investors can hurt the development of the Hungarian new economy in a long run.
5.4. The selection and the profile of the interviewed venture capital companies
As presented earlier, the Hungarian venture capital market is relatively small: in 2000, there
were about 35 active venture capital funds and there were 25 VC members of the Hungarian
Venture Capital Association (HVCA). Table 6, below, shows some basic statistics about the
investment profile of these VC companies.
Table 6: The Investment Profile of the Full Members of the Hungarian Venture Capital
Number of Percentage of
companies companies (%)
Companies specificly interested in 14 56
new economy/high tech investment
Interested in early stage investment 9 36
Interested in development, 9 36
expansion type of investment
Foreign ownership 16 64
Hungarian ownership 4 16
Mixed (foreign, Hungarian) 5 20
New, economy/high-tech deals ~ 80 -
(estimated total number)
Number of new economy/high-tech ~ 50 -
companies receiving venture capital
Source: calculation based on Hungarian Venture Capital Association Yearbook 2001 and personal interviews
Table 6 prevails, that almost two-third of the companies were interested in high tech and/or
new economy investment. More then one-third of the VC companies (36 percent) favoured
early stage investment and the same number of companies preferred the development stage. In
terms of ownership, foreign or mixed companies dominated (84 percent). There were only 4
companies (16 percent) that had only domestic owners. Out of this 4 Hungarian companies
(funds) two were fully owned by the Hungarian State and the other two had domestic private
and institutional investors. Consequently, it was difficult to meet the selection criteria of the
study, i.e. half of the venture capital companies should have domestic owners. The Hungarian
Venture Capital Association gave assistance to select the venture capital and the investee
companies. Despite revealed preferences toward high tech, most of the venture capital
companies invested in the telecommunication sector and there were only a few interested in
other high tech sectors too. In addition, most of them just had only one investment in the high
tech sector. Therefore, besides the telecommunication sector, the selected five companies
represent the majority of the high tech venture capital investment in Hungary. There were
another two companies who were asked but refused to participate in the survey.
Table 7 shows the profile of the venture capital companies in our database. This table contains
information that is publicly available.
Table 7: The profile of the venture capital companies/funds 2001 (based only on publicly
3TS Venture Euroventures FastVentures Hungarian KFKI
Partners /ABN AMRO Innovative Investment
Year of 1998 1998 2000 1999 1998
Format of Company Ltd. Ltd. Ltd. Ltd.
Ownership Foreign Foreign Mixed Foreign Hungarian
Main owners 3i, Sitra, SET, ABN AMRO Private Hungarian – KFKI
/source of EBRD investors American Számítástech
capital Enterprise -nikai Rt,
Fund MAVA, HEP
Type of main Institutional Bank Private State Private
owner(s) (Regional individuals (country
Capital under EUR 66 m. Not limited USD 5.5 m USD 10 m Confidential
/ EUR 30m /confidential /USD 1,6 /USD 14 m
Minimum EUR 0,5 m EUR 1 m EUR 0,1 m USD 0,05 m No data
/maximum EUR 5 m EUR 10 m EUR 0,75 m USD 0,5 m USD 1 m
The number 3/4 6/6 5/3 2/4 4/3
Number of 6/10 5/4 8/8 3/7 10/6
Stage(s) of Seed, start-up, Start-up, early Start-up, early Seed, early Seed, early
financing early phase, stage, buyouts stage, stage stage
Industry IT, telecom, No specific New economy High-tech IT. Telecom,
preference(s) Internet preference sectors health, fitness
Number of 0 1 3 0 4
Source: Hungarian Venture Capital Association Yearbook 2001, http://www.hvca.hu
Because of business confidentiality, some of the data cannot be shown in identifiable form.
These sensitive data are the instruments of finance, the expected rate of return, the exiting
mechanism, and the strategy.
Establishment All of this funds were established after 1998 or later up to 2000. The
foundation was strongly associated with two events. First, due to the Russian crisis, some of
the venture capital investments lost completely that made venture capitalists very careful with
traditional industries. Second, the boom of the new economy sectors in the US and EU had a
positive effect on new venture capital company and fund establishment. Four out of the five
companies had a strong preference toward the new economy/high tech sectors.
Business format The venture capital companies prefer the limited liability company format
that is easier to establish then a company (limited by shares) and easier to maintain the close
relationship of the owners.
Ownership- regional focus Amongst the selected companies, all of the four main types of
ownership forms can be found. Institutional (regional and country funds), banks, private and
state ownership. The two largest venture capital companies are in foreign hands, and only one
of them had a clear Hungarian ownership. As it has been shown previously, this data set
represents the Hungarian venture capital market very well regarding ownership. The
ownership form is closely related to the regional focus. The three foreign companies also had
investments in other countries besides Hungary. 3TS had offices in Budapest, Prague and
Warsaw. Euroventures clearly prevailed its international regional strategy focus to Central
and Eastern Europe. Moreover, as a part of ABN AMRO Capital, Euroventures belong to an
international network having several offices all around the world from Chicago, London
Warsaw and Budapest, just mentioning only a few. Three out of ten investments of HITF
were in other Central Europen countries. The remaining two companies Fastventures and
KFKI had investments only in Hungary.
Within Hungary, all the five companies had the office in Budapest, the capital of Hungary.
Budapest and Pest county represents more then fifty percent of the GDP in Hungary. In terms
of Foreign Direct Investment (FDI) the share of the Budapest region is even larger, around
eighty percent. So, it is not a surprise that most of the venture capital investments especially
in the high tech sector goes to Budapest or Pest county. However, there are some venture
capital investments in the countryside: we should highlight Szeged, a major city close to the
Yugoslavian border, that looks to become an important centre in biotechnology.
There was only one change out of the five companies regarding ownership. Euroventures
initially was owned by the present management and was acquired by ABN AMRO: in 1999.
Since then the company is a part of ABN AMRO Capital, and the management has been
participating in venture capital as well as other private equity programmes of ABN AMRO.
Size – capital under management In terms of the size of the venture capital companies, there
is high variation: 3TS Venture and Euroventures/ABN AMRO Capital are large even by
international standards, while 2 companies are much smaller having USD 5-10 million capital
under management. We do not know the KFKI’s capital, but they already invested USD 14
million, most of their available capital, so the capital under management is around USD 15
million. The average size of the companies in our data set is much higher than it was a year
before: Ludányi (2001a) stated that capital under management in the range of USD 5-15
million was missing from the Hungarian market. The three, relatively small, venture capital
companies (Fasventures, HITF, KFKI) raised the capital considerable over a year showing
their interest toward further investments.
Size – investment The deals are in USD 0,05 - 5 million, with one exception of
Euroventures/ABN AMRO Capital except deals up to EUR 10 million. In the case of three
out of five companies, this range is much lower than the average investment in Hungary
before 1998 (more then USD 1 million). However, it should be noted that venture capital
companies are trying to invest rather close to the upper than to the lower limit.
Size – staff The average number of staff was 4 at the time of investment and also in 2002.
However, the venture capital companies that increased the number of companies in the
portfolio employed more expert while Fasventures’ staff decreased by two and KFKI’s by one
manager. The number of staff at the venture capital company was not known exactly because
of the varied participation of the owners. If there was a need – e.g. new companies, crisis,
expansion etc. – some of the founders spent more time at the venture capital company while
in the case of shrinking portfolio and tasks they were less active.
Out of the five companies, Euroventures had the largest staff but the smallest portfolio. The
reason of this fact was that the experts handle not only the Euroventures funds but also
participated in other equity businesses of the main owner, ABN AMRO. It was estimated that
about 2-3 persons dealt with venture capital investments.
The portfolio – industry and stage preference The number of portfolio companies varies from
3 to12 averaging at 6,8 in 2000 and 7 in 2002. While 3TS and HITF increased the number of
investee companies, KFKI’s porfolio become smaller. Euroventures replaced some of the
companies with others, but portfolio was the same in terms of the number of companies.
Euroventures’ portfolio has decreased by one, but they are launching new investments
We should note that the average investment is much lower at the companies that have larger
number of firms in their portfolio. There is also a potential overlap in the portfolios since
venture capital companies in the high tech frequently prefer co-investments in order to
decrease and spread risk.5 Similar to other high-tech/ new economy investors, our companies
prefer early stage and/or seed capital investments and except one, have a strong preference
toward the new economy sectors.
All of the five venture capital companies preferred minority ownership, one of them prefers
qualified minority (ownership over 33 percent). All of the companies use capital stock as a
main instrument of financing. Minority rights are protected by co-sale – mostly tag along -
rights and shares that have specific rights (preferred shares). Two of the companies refuse to
use ownership loans, and three of them rely on transferable bonds. It is commonly believed
that loans are not a proper way of financing firms by venture capitalists. Stock option plans
are used by one company, that is not a surprise considering the situation of the Hungarian
Exits – exit strategies Regarding exits, all of the five companies would prefer the stock market
(IPO) when they want to harvest the investment. However, the present situation of the
Budapest Stock Exchange (BSE) did not make IPOs attractive. As an alternative, one of the
companies tried to sell the ownership back to the entrepreneur (repurchase) the others
preferred professional strategic investors (trade sales). Since this later method was very time
consuming because of the limited number of potential buyers, venture capitalists were very
Co-investment or syndicate investment was not a preferred way by venture capitalists before 1998 (Ludányi
careful, and they rather postpone of or cancelled their new investment if they were not sure of
the exit conditions. Actual data on exits showed that there were two companies out of five
with a larger number of exits: Fastventures had 3 (and one partial) and KFKI had 4 exist. We
have no data on the exit method but it probably did not different what we had already stated
previously: trade sales and repurchase dominated while IPO was zero. At the same time
period, two other venture capital companies – 3TS Ventures and HITF - considerably
increased the number of portfolio companies. Therefore the number of investee companies did
not change in the data set between 2000-2002 It also means that different venture capitalists
exhibit different exit strategies:
· a group that waits with the exit for the proper and/or better time and does not want to get
rid of the investment in the case of crisis.
· another group exits much quicker and leaves the investee companies when there is no sign
of recovery in a short run (in a year)
Both strategies have advantages and disadvantages:. The insistence on the portfolio company
can cause problems if the situation becomes worse and the loss can be even larger, but
sometimes a considerable amount of extra investment is necessary even to keep the investee
company alive. On the other hand, the too rapid adjustment can result in a loss of a potentially
good investment. The reason behind the two strategies is the different expectations regarding
the recovery of the new economy. We have seen that some foreign new economy companies
have sold their Hungarian interests to be able to focus on solving domestic problems.
One of Euroventures fund was amongst a few in the region that finished a full circle of
venture capital with an average twenty percent yearly yield in 2000. As the company reported
(Regional Investment Strategies 2000) the majority of the portfolio of ten companies proved
to be successful businesses. Five out of this investee companies became a part of inter or
multinational companies, and two of them remain independent businesses under the new
ownership. There were two failures: as András Geszti reported, all the invested money –
around a million USD - to Alfagrafix was completely lost to the last penny (Csabai 2002)
Probably the remaining one investment were around the breakeven point.
Strategy – change of the strategy All of the venture capital companies were established under
favourable conditions in the new economy. When there was a boom in the high tech industry,
venture capitalist poured the money to the new sector companies much less carefully than
previously. However, this was only partially true in Hungary where foreign investors were
traditionally more risk averse then in other developed countries. Table 8 below, serves to
present the most important changes in venture capital investment pre- and after 1998. The
basis of comparison is based on Karsai (1999) who analysed the basic characteristics of
investment before 1998. Karsai’s finding are also compared to our venture capital company’s
Table 8: The characteristics of the venture capital investments pre 1998 and 2000-2001
Characteristics pre 1998 Characteristics 2001-2002
(Karsai’s result) ( data set)
Preferred sector Traditional New economy, high tech
Preferred phase Development capital (90 %) Early phase, seed
Ownership share Majority (53%) Minority
Type of investment Solo Syndicate is more preferred
Number of investments in the One More then one
Size of investee company Large Small
Average size of investment Large, over EUR 1M Smaller, around EUR 0,5M
Average time of investment Around a year 2-4 years
Investing in a risky sector in an early phase in a small business for longer time means much
more risk then developing a traditional, established, large company for a shorter time period.
Therefore, venture capitalists tried to decrease the risk by buying only minority ownership
and working together with other venture capital companies. Instead of investing one large
amount they preferred to give money in smaller portions, but more then once if the investee
company fulfils the expectations.
After the collapse of the new economy companies, three out of the five venture capital
companies changed its strategy. 3TS Ventures balanced its portfolio by moving toward larger
businesses that were not in the early stage of development. Fastventures refused to provide
seed capital and moved also toward more matured businesses. They also required more
committed owners and managers toward the development of the investee company. KFKI
moved also toward the development phase of investment. Euroventures and HITF did not
change the strategy. Ferenc Berszán (HITF) stated that they had had traditionally a
conservative investment policy. Due to careful selection they did not have major failures and
losses. Euroventures was a little bit different from the other venture capital companies since
initially they focused more on large, businesses in the development phase.
Deal flows There are high differences in terms of the number of deal flows. If we define
serious interest as submitting the business plan, then the deal flow ranges from around a
hundred to twenty-five. Two companies have around a hundred, one around eighty, one fifty
and one twenty-five offers in a year. The average offer is seventy Some of the venture capital
companies search more actively then the others. The search activity depends on several
conditions. We can see that companies are more active if they
· are younger,
· have a larger portfolio,
· want to increase the portfolio,
· specialise on certain sectors (e.g. biotechnology).
It is interesting, that the number of deal flows were not associated with the size of the capital
of the company. This was opposite to Ludányi (2001b), where institutional background as
well as the size of capital affected deal flows. The reason of the deviation could be that
Ludányi’s data set were different and included a wider variation of venture capital companies
not only in high tech sectors. Moreover, the above listed factors could also counterbalance the
effects of size. The yearly number of investments was pretty stable, except the foundation
period, averaging between two and three and independently from other characteristics.
It is interesting to analyse the kinds of efforts the venture capital company makes in order to
increase its deal flow. There were high variations amongst the examined companies regarding
the seal flow strategy. Table 9 below presents the type and the frequency of the deal flow
Table 9: The deal flow activities of the examined venture capital companies
Frequency (Nr.) Frequency (%)
Network of owners 5 100
Media 5 100
Conference, workshop 5 100
HVCA membership 5 100
Businessmen meetings 4 80
Internet, webpage 4 80
Consultant, outside agent 2 40
First Tuesday 2 40
Personal search 1 20
All of the companies agreed that “word of mouth” played an important marketing tool.
Moreover, the managers of the company had also a wide personal network. As a general
promotion tool, everybody tried to be in the news, mostly in the professional dailies and
journals. TV and radio news were much less frequent besides some major conferences – e.g.
HVCA yearly conference, and certain large investments. All of the five companies relied on
the owners’ network. Venture capitalists were frequently involved in conferences and
workshops. Two of the companies stated conferences as the most important place of meeting
with potential investee company representatives. HVCA membership had also a positive
effect on deal flows. Businessmen’s meetings were not mentioned but only by one company.
It was a surprise that one venture capital company did not have a webpage. Two companies
used outside agents, and First Tuesday events as an important meeting place was mentioned
by two companies. There was only one company, HITF that used all of the activities,
including the personal search for new deals. As they stated, competition had been increasing
that forced them to use a variety of tools in searching new deals. Moreover, in certain sectors,
biotechnology was emphasised, personal search was inevitable.
Rate of return There are variations regarding the expected rate of return. Three of the five
companies expect 25-30 percent rate of return, one 40-50 percent and one requires more then
50 percent returns on a yearly basis. These returns mean in terms of US dollars or in Euro. It
should be noted that there is no exact rate of return, venture capitalist consider various
conditions including industry, risk, market conditions etc. when they make the final decision
about the investment. Past internal rates of return are within the 25-30 percent range despite
some lost investments. This number is around the common international range.
Evaluation techniques Regarding evaluation of the potential investee companies, venture
capital companies use several methods: everybody relies on some comparative analysis
(industry, market, profit comparisons), four out of five use the traditional discounted cash
flow (DCF) method, one company mentioned replacement technique, and one company
considered potential selling price
Influence of the company The Hungarian venture capital market is small so every company
can be very important in certain respect. All of the five companies played a major role in high
technology venture capital investment in Hungary. 3TS was the first who specialised to the
high tech sector. Euroventures/ABN AMRO is the largest investor with major international
background and financial resources. Fastventures played a pioneering role in investing small,
early phase high risk projects. Amongst the venture capital companies, HITF invested below
USD 1 million first in the Hungarian market. KFKI was proud of its good reputation and its
major role in the Hungarian IT sector.
5.5. The selection and the profile of the investee companies in the data set
The estimated number of investee companies in the new economy segment is around 50,
most of them received venture capital more then once. Out of this 50 companies 10 were
selected to our database (Table 10). The choice of the investee companies in the data set was a
mixed procedure of media news and venture capital company suggestions limited by the
requirement that they should represent at least five high tech sectors.
Because of business confidentiality we do not provide the name of the company and its
connection to the venture capital firm. Despite of guaranteed privacy, some of the sensitive
data were not revealed exactly. However, table 5 makes it possible to have an inside view
about the Hungarian investments.
Unlike the case of venture capital companies, there had not been any research regarding the
investee firms in Hungary, so this is the first time when Hungarian investee company’s profile
are analysed. It is not a surprise since most of these data are confidential, this is the reason
why we have some missing boxes in table 5. The most sensitive questions were related to the
ownership share and the capitalisation of the investee firm.
It was given initially that eight technology sectors – aerospace, computing and office
equipment, electronics and telecommunication, electrical equipment, non electrical
equipment, scientific instruments, chemical and pharmaceutical – should be provided in the
analysis. The ten selected investee companies must have been represented at least five of the
above eight sectors. Since there is no aerospace sector in Hungary, only seven sectors
remained. It is not a surprise that three out of the ten companies are in the telecommunication,
and two of them are in the pharmaceutical sectors. The electrical equipment sector is
represented by two firms, and one company belongs to the non electrical equipment, one to
the computing and office equipment and one to the chemical sectors. However, we should
note that sometimes the company has mixed activities that make clear classification difficult.
This is the reason why we have sometimes two sectors in one box.
Capitalisation of the firms – if data are available – shows high variations. The upper range is
around USD 100 million, a Hungarian subsidiary of an international company. (The venture
capital investment was used to support the research activity in Hungary.) The lowest range is
company capitalisation of USD 2 million, that is a medium size company in Hungary.
Company 1 is probably larger than USD 5 million, and company 10 is probably below the
USD 2 million capital value. We have no estimate regarding companies 6 and 8.