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    High Tech Venture Capital Investment in a Small Transition ... High Tech Venture Capital Investment in a Small Transition ... Document Transcript

    • 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 October 2002 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.
    • 2
    • 3 1. Introduction 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 world-wide tendencies. 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 countries. 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.
    • 4 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 study. 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 (1999) 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: 1 Research assistance provided by Kornélia Horváth is highly appreciated.
    • 5 § 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 Hungary. 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)
    • 6 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 (million HUF) 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 manufacturing production. 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).
    • 7 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 (Losoncz 2002). 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.
    • 0.3 0.25 8 Share in manufacturing 0.2 0.15 0.1 0.05 0 1996 1997 1998 1999 2000 Year CHEMICALS ELECTRONICS TRANSP EQUIP MACHINERY DRUGS INSTRUMENTS 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.
    • 9 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 2 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)
    • 10 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 enterprises involved 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 Budapest, 2001 **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
    • 11 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
    • 12 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 investors. 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.
    • 13 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 % GDP) Previous year 100% 1990 5638 mil. 533,2 1,60 53,7 1805 USD 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 the state. 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
    • 14 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.
    • 15 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). 3 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.
    • 16 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
    • 17 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 been rising. 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.
    • 18 Figure 3: The Characteristics of Venture Capital Investment in Hungary, 2000-20014 120 103 100 80 71 64 60 50 50 47 40 30 28 29 20 17 20 3 5 2,2 2,3 0 0 ) s t t s ls ) ts SD en en l l SD ea ea a ou de tm stm d U d U uy es ge t of (m en (m ve fb nv sta r m in be t ro li en l op ta ly y um na be tm og pi el ar tio N um ev ca fe s ol ve di hn fd ro d N in ra ste ec ro be t ge ve ft of be um ra eo In e um ve N ar ar A Sh N Sh 2000 2001 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 35% 30% 25% 20% By invested capital 15% By number of transaction 10% 5% 0% gy t s n et en rie al lo io rn tic m no st at te in eu du ic ch In ta un ac in te er m m al nt n m ar io on ,e co Ph at i ti ea rm le ad ed Te fo Tr M In Source: Based on Hungarian Venture Capital Association Yearbook 2001. 4 Traditional sectors include food, manufacturing, retailing, constructions, technology investments include telecommunication, Internet, pharmaceutical, information technology, media and entertainment.
    • 19 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,
    • 20 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 BSE. 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.
    • 21 Table 6: The Investment Profile of the Full Members of the Hungarian Venture Capital Association 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 ownership New, economy/high-tech deals ~ 80 - (estimated total number) Number of new economy/high-tech ~ 50 - companies receiving venture capital (estimated number) 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.
    • 22 Table 7: The profile of the venture capital companies/funds 2001 (based only on publicly available data) 3TS Venture Euroventures FastVentures Hungarian KFKI Partners /ABN AMRO Innovative Investment Capital Technology Fund Year of 1998 1998 2000 1999 1998 establishment Format of Company Ltd. Ltd. Ltd. Ltd. business 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 fund) fund) Capital under EUR 66 m. Not limited USD 5.5 m USD 10 m Confidential management /confidential / EUR 30m /confidential /USD 1,6 /USD 14 m /invested capital 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 investment The number 3/4 6/6 5/3 2/4 4/3 of staff establishment/ 2002 Number of 6/10 5/4 8/8 3/7 10/6 portfolio companies 2001/2002 Stage(s) of Seed, start-up, Start-up, early Start-up, early Seed, early Seed, early financing early phase, stage, buyouts stage, stage stage development 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 reported exits since foundation 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.
    • 23 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.
    • 24 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 presently. 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 stock market. 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 5 Co-investment or syndicate investment was not a preferred way by venture capitalists before 1998 (Ludányi 2001b)
    • 25 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 characteristics.
    • 26 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 same company 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.
    • 27 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 activities. 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
    • 28 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.
    • 29 Table 10: The basic profile of the investee companies in the database Year of Profile/technology Total capital Ownership Invested Aim of Number of VC Number of establishment sector share of VC amount investment investment/ co- company Angel finance investors 1. 1998 Internet/ Not revealed Not revealed EUR 2,1m Regional 2/yes 3 Telecommunication /minority expansion 2. 1993 e-business ~ EUR 7 m. Minority EUR 2,65 m International 1/no 1 telecommunication (~ 40 percent) expansion 3. 1997 Medical-drug ~USD 35m Minority USD 0,4 m++ Research 4/yes 8 research/pharmaceutic (2-5 %) al, chemical 4. 1999 Chemical, Over Not revealed USD 0,46m Research 3/no 6 biotechnology USD 100 m* /minority 5. 1995 Laser technology Over Minority** USD 0,7 m Development, 2/no 4 /Non electrical USD 15 m USD 6 m+++ international equipment expansion 6. 1999 Biotechnology/ Not revealed Minority USD 0,2 m Market entry 1/yes 1 Pharmaceutical 7.*** 1998 Telecommunication USD 12 m Minority USD 1,3 m Domestic 2/no 1 (12 %) expansion 8. 2000 Computing and office Not revealed Minority USD 0,1m Strategy 1/no 1 equipment formulation 9. 1993 Electrical equipment, USD 2 m Minority Not revealed International 2/yes 1 telecommunication expansion 10+ 1989 Electrical equipment Not revealed Minority Not revealed International 1/no 1 (21%) expansion, *The Hungarian company is a subsidiary of a German parent company, the total capital belongs to the whole company. **The venture capital companies altogether have 65 percent ownership share in the company ***The use data are for the first investment, there is no data available regarding the second investment by the same company. + The company has been sold to a professional investor (trade sales). ++ The total investment was USD 11 million, that means altogether 32 percent venture capital share in the company. +++ The second round investment that was provided by a syndicate of four worth USD 6 million and 65 percent ownership share together. Only the first investment is included in the analysis.
    • 30 In all of the cases, venture capital companies gained minority ownership, ranging from 2 to 40 percent. The average amount of the investment was about USD 0,89 (EUR 1m), that was less then half of the average venture capital investment in years 2000 (average investment USD 2,1 m) – 2001 (average investment USD 2,3 m). It is not a surprise that the largest investment went to the most capital intensive telecommunication companies – USD 1,3 m, EUR 2,1 m, EUR 2,65 m . The other six known investments were below USD 1 million, and probably the remaining two company investments were also well below USD 1 million. Without telecommunication investment, the average money put in a company was about USD 372 000, less than 20 percent of the average investment in 2001. This lower average investment corresponds to the yearly data of the HVCA 2001 (Hungarian Venture Capital Association Yearbook 2002) that half of the transactions went to the high tech sector but they represent only 30 percent of the value of investments. There are several reasons of the low amount of venture capital investments in the high tech sector– especially if we compare to the US data where average investment was USD 7,5 m in the high tech sector (Karsai 2000): · Investors are very careful as they want to risk a low amount of money in one company, and they rather widen the portfolio of companies · Since most of the investments are in the early phase they require relatively less money · If we have a look at the other column of table 3, it can be seen that most of the companies receive venture capital more then once, only four out of the ten companies received VC money only once, and the average number of investments is 1,9. It means that venture capitalists put a limited amount to the company first, and if the results meet the expectations they are willing to provide more money. There is another way also that is related to the risk sharing strategy of the VC companies. Contrary to the pre 1998 deals, when most of the investments were made alone, 4 of the venture capital investments in the data set were syndicate ones. It is interesting to analyse why companies/entrepreneurs turn to venture capitalists and what do they expect from them? As it prevails from table 5, two companies wanted to continue research that related to the development of new drugs, medicine or molecules. Both companies in this area belong to an international parent and have research network. The search for venture capital was associated with the high expenses and high risk of failure of this type of research, as well as the limited money for R& D in Hungary. Another pharmaceutical firm that already had the product aimed to enter the market (seed capital). Company 8 had no clear strategy about the product and the company’s future and looked for help. In this case the most important problem was the market. In all the other six cases – independently from whether the investments were in the early or in the development phases – the investee companies were looking for expanding their business either domestically but mainly internationally/regionally. So beside the money, they expected the venture capitalist to provide help to search markets or provide actual connections to other buyers. The internationalisation of the high tech business is vital in a small, developing country like Hungary. On the one hand, the domestic market and consequently the number of potential buyers are very small. On the other hand the demand for high tech product is also limited because of the development stage of the country. Moreover, the quick exploitation of existing opportunities in the rapidly expanding high tech business is inevitable. Other earlier
    • 31 successful Hungarian high tech companies like Graphisoft and Synergon used the received venture capital to set up branch and/or selling offices in the USA and the European Union. It is well-known in the literature (e.g. Reynolds et al 2001) that not only formal venture capital but also informal business angel financing can be very important for high tech businesses. It is common thing in the US that the company starts with a relative low amount of angel money and then continues with a larger venture capital investment. In Hungary, business angels represent only 2,2 percent of the total population that is less then the world average and much less than the leading New Zealand and USA (around 6 percent). However, the importance of business angels can be noticed in Hungary: four out of the ten companies had received angel money before the venture capital participation. 5.6. The connection between the venture capitalist and the investee company: controlling and participating A distinguishing feature of the venture capital companies is to provide additional help to the investee company besides the money. The reason of the additional help is twofold. First, it provides a strong control over the company – much stronger than in the case of bank loans. Second, most of the companies are not properly managed. Leadership, management, marketing, financial planning, reporting, strategy focus etc. are frequently missing. Moreover, most of the times the investee companies want to expand the businesses. It means that the previous management techniques, even if they used to be perfect, cannot be applied anymore. The company has to deal with changes in sales, personnel, organisation, buyers/sellers connections etc. at the same time. Venture capitalists provide help to find the solution to manage growth. It can be believed that in a transitional country, like Hungary, entrepreneurs, potential venture capital investee companies have less experience in management and leadership than in other countries having longer history in the market economy. This fact was reinforced by venture capitalists: the lack of proper managerial skills is one of the main limits of further venture capital investments in Hungary. As a consequence of this less experienced management, venture capitalists can follow two practices. They select the investee companies much carefully than in other countries, and/or they engage more actively in the management. The second solution of more active participation could be more expensive in terms of costs that would increase the expected rate of return substantially. The risk is even larger if the company is in the early phase and the owner(s) have no managerial and business experience at all. We can find both of the selection strategies amongst our venture capital companies. Two of the companies focused more on the selection criteria and made no difference in managing a company in the early or development phase. However, they choose companies that have a time-tested management team. All the other venture capital companies made a difference in managing research, early phase, or developing companies. The earlier the investee company in the life cycle the more time is necessary for the venture capitalist to manage it successfully. While two venture capital companies requires quarterly, three expects monthly reports.
    • 33 Table 11: The characteristics of the connections between the venture capital and the investee companies Categories/companies A B C D E F G H J K Financial/strategic planning ++ + ++ + ++ ++ - ++ - ++ Controlling finance ++ ++ ++ ++ ++ ++ ++ ++ ++ ++ Controlling additional investment(s) + + ++ + ++ ++ - ++ - + Controlling leadership ++ ++ ++ ++ ++ ++ ++ ++ - ++ Following production/research - - - - - - ++ - ++ - Help to get additional financial + + + + + + + + + + resources/bank loan(s) Participating in leadership + + + + + + - + - + formulation Help in recruitment of key personnel - + + - + ++ - + - + Help to get/access to new - + ++ - + - - + - + technology Help in connection/network building ++ ++ ++ ++ ++ ++ ++ ++ - ++ Help to help to get out international ++ + + + ++ + ++ ++ ++ ++ market Participating in marketing strategy ++ - - - - - - + - - formulation The strength of the connection is noted by “+” “-“ signs. Strong participation/help ++, Occasional (semi-strong) participation/help +, No participation/help -
    • 34 When we asked the companies to estimate how much time they spent at the investee company, it proved to be difficult. There was an agreement that one venture capital manager can manage 2-4 projects. Besides Euroventures, who is less active in management, three out of the other four venture capital companies spent around a day in a week, and one passed a half day in a week or one day in every second week at an investee company. In the early phase of the investment, the connection between the venture capitalist and the investee company could be daily. In some cases, HITF requested the company to send daily cash-flow, 3TS participated in negotiations, Fastventures focused on avoiding crisis situations. In other cases, the venture capital company helped the investee company to set up the financial reporting system. The venture capitalist’s help is vital in the early phase when the investee company has no resources to finance a professional employee. If it was necessary for the investee firm to get a help that the venture capital manager could not provide than most of the companies relied on the owners. Some of the individual owners were actively participating in the management. Only one company noticed that they used outside experts, consultants, independent experts, head-hunters. We have already mentioned that Hungarian entrepreneurs possess less business skills then entrepreneurs in the developed countries. Three out of the five venture capital companies complained more or less about the lack of vital management skills and improper commitment toward the project. This was probably the reason why these venture capital companies began to move toward later phase and larger investments, where the management team had already had some experience and proof of survival capacity. More attention was given to the commitment of the entrepreneur both financially and non-financially (how much effort he wanted to take to the company). Table 11 provides the necessary information about the connection of the venture capital and the investee companies on a company basis. The first five categories – strategy formulation, financial control, investment control, leadership control and production/research control – are the most important tools for the venture capitalists to check the investee company. The other categories describe the type of help that the venture capital company provides to the investee firm. By examining the tools of control, table 11 reveals that venture capitalists practice both financial and leadership control. The close financial control, including the regular follow up of the investee company’s financial performance – sales, costs, financial ratios etc. -, and the participation in the additional investments are common. However, regularity does not mean a daily involvement, most frequently the monthly report is required. There are only two companies where venture capitalists do not participate in financial/strategic planning. The reason of that is that these companies are in the research phase, and actually there are no sales. However, as a substitute, venture capitalists have close look at the research procedure. In all the other eight cases, the investor is not participating in the production process. Authority over the leadership (management) is mainly practiced via the board of directors or regular assembly meetings. The magnitude of the authority, however, depends on the number of delegates of the venture capitalists in the board. Since most of the cases in our data set venture capitalists have minority shares it means that the entrepreneur/original owners have majority in the board. Despite the limited control over the management, personal conflicts are rare because venture capitalists have a close look at the management in the due diligence
    • 35 phase in the selection procedure. If they have any doubt about the personality, capability or skills of the management/owners, they will not invest in the business. This role of the venture capitalist is reinforced by the relatively weak/occasional participation in the leadership formulation. While control over the investee company serves the interest of the venture capitalist, the additional help provided by the investor can be vital from the viewpoint of the company. There are two factors where the companies in our survey receive considerable help from the venture capitalists. In the high tech sectors, network building and close personal contacts with other similar companies or potential buyers are inevitable. Hungarian venture capitalists assist to the investee firms to find the proper connection. As we have already noted, entering the foreign markets was overwhelmingly the most important reason of the companies’ search for venture capital. Based on table 11, it looks that venture capitalists fulfil the initial expectations of the investee firms and provide major help to get access to and, widen foreign relations. By far, the two most important desired direction of foreign relations were the USA and the European Union, mainly Germany. There were only one company that complained about the improper help of the venture capitalist in foreign relation building. It can happen that there is a need to get additional financial resources, mainly bank loans. In these cases, venture capitalists provide limited help and in most of the time they refuse to be a guarantor behind the bank loan. Sometimes they participate in finding key personnel, if they are missing from the investee company. In the case of company F, the venture capitalist carried out an extensive international search to find the proper expert. In half of the cases the venture capitalist helped the companies to find the proper technology or to develop their own one. However, technology was only vital at one telecommunication company. It also shows that the investee companies had possessed the necessary technology at the time of investment. Marketing is probably one of the weakest point of Hungarian businesses. While there are excellent ideas and creative persons, marketisation of the innovations are far from satisfactory. We believed initially that venture capitalist pay special attention to the marketing strategy of the investee company. However, this was true only in one case and there was another case when some marketing strategy participation of the venture capitalist could be noticed. 6. Conclusion Over the last three years, venture capital industry has been in haven and hell. The enormous boom in the American new economy had a crowding out effect on the world. While Europe followed US with a little lag, the influence on Hungary arrived even later in 2000. This is the main reason, why the collapse of the new economy companies in the USA did not have a major effect on Hungary: since the whole new economy constitutes only a little share in the Hungarian economy. The examined venture capital companies were established in the late 1990s – early 2000s with the aim to make high tech investments in Hungary. At the same time, existing venture capital companies turned more to new economy and early stage investment, following world-wide tendencies in VC investments. After the unexpectionally good year of 2000, venture capital investment decreased by 40 percent in 2001, however, the high tech sector preserved the dominant position in VC investment.
    • 36 It was presented in the case study, that venture capital companies became more carefully in selecting the investee firms, and followed the performance of the company in a more consistent way. Despite difficulties in comparing developed country venture capital companies’ behaviour to Hungarian ones, there are some variations. Even in hard times, some venture capitalists increased the number of portfolio companies while others tried to get rid of them. Some of the companies focus more on selecting a firm that has a proved management, others are more willing to teach the investee company managers, owners how to manage growth. Lack of managerial knowledge and commitment of the entrepreneur have been the main limits of further venture capital investments. Because of the problems in the small, local Budapest Stock Exchange, IPO, as a wishful exit route is not possible. Therefore trade sales played the primary role in the exit procedure. In some cases “pushed” repurchase technique could be noticed. Examining the available capital in the region it can be seen that it is still plenty of available money, but there is a lack of proper investments – as venture capitalists stated. The latest reports of Deloittle and Touche shows that Hungary is the most promising nation in the Central Eastern European region having high tech, fast growing companies that could be the potential target for venture capitalists. Due to high level of entrepreneurial activity, the number of innovative start-ups can increase too. It is also promising that the Hungarian economy grow at a rate double of that of the European Union. Moreover, the expected accession to the EU could also have a positive effect on the development of the Hungarian venture capital market. Hungary has done the most painful part of transition, by 2002 the country is definitely integrated into the globalised world economy. Now, the task for the government is to support European Union integration and further economic development. The economic policy should focus more on shaping favourable conditions for small and start-up businesses particularly in the high technology and fastest growing business sectors. References Apatini Kornélné (1999) Kis- és középvállalkozások finanszírozása, Közgazdasági és Jogi Könyvkiadó, Budapest. Barta, Györgyi (1997) Műszaki versenyképesség az átmeneti gazdaságban: külföldi és hazai vállalatok a magyar iparban (Technological competitiveness in a transition country: Foreign and domestic firms in the Hungarian industrial sector), Tér és Társadalom, 105-130 Berger, Allen – G. Udell (1998)The Economics of Small Business Finance: The Roles of Private Equity and Debt Markets in the Financial Growth Cycle, Journal of Banking and Finance 22 pp. 613-673 1998 B.I. (2001): Kockázatató tőke,Cégvezetés 2001 April, pp. 122-125 B.K. (2001) Változik a Széchenyi-terv, Cégvezetés 2001 October, pp.124-126 Borbély, Szilvia and Vanicsek, Mária (2001) Magyarország helye Európa gazdaságában (The place of Hungary in the European economy), Közgazdasági Szemle 48, pp.63-90
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