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  • 1. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 Proceedings Contents Page Executive Summary 2 Introduction and Background 5 Current State of Private Equity and Venture Capital in the EU and in 7 Central and Eastern Europe The Importance of the Financial Services Action Plan and Development 10 of Financial Services Action Plan (FSAP) and the Development of Financial Services and Capital Markets Access to Finance and its Importance for Entrepreneurship 13 Issues relating to Entrepreneurial Environments 15 Page 1 of 16
  • 2. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 Executive Summary The development of private equity and venture capital – the business of building businesses, as with all industries, is dependent on the prevailing fiscal and regulatory environment. On the eve of accession, Central & Eastern European (CEE) countries face a unique situation where large amounts of new legislation need to be adopted by their formal accession in June 2004. It is vital that, during this short process, counter-productive legislation is not adopted and that regulatory measures are taken to foster and expand growth in entrepreneurship and the development of successful businesses funded by private equity and venture capital. The capital Central & Eastern European Policy Meeting underlined the importance of creating a favourable environment for private equity and venture capital in the region. The policy makers promised an open door for consultation, while practitioners set out the programme for change. Addresses by representatives of European Institutions made the case for private equity and venture capital as an engine of economic growth. A range of panel discussions centred on the following topics:  The current private equity and venture capital environment within the European Union and particularly Central and Eastern Europe  Access to finance and the impact on entrepreneurship, including future developments such as the Basel II Capital Adequacy discussions  The FSAP (Financial Services Action Plan) and the development of financial services and capital markets in Europe (pension funds, prospectus issues, patents)  Issues relating to the entrepreneurial environment, including tax and consumer policy and corporate governance The power of private capital to transform businesses and economies is one that the emerging markets of Central and Eastern Europe would do well to harness. Companies backed by private equity or venture capital grow quicker than others, create jobs and Page 2 of 16
  • 3. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 increase GDP. But private equity investments in Central and Eastern Europe are still very much behind Western levels. But it is not just about the hard numbers of economic development. Venture-backed companies also tend to embrace more rigorous standards of corporate governance, readying them for the spotlight of the public markets. Robert Manz, Partner at Enterprise Investors in Central Europe said that, “private and venture capital funds have an economic agenda, which is not just about providing money. It is about building businesses.” He added: “Private equity is a conduit for fast implementation of regulation in non-quoted companies.” There is still much work to be done. In most of the region, pension funds are still unable to invest in the asset class. Fund structures are clumsy, forcing investors into off-shore vehicles. The cultural obstacles are also significant and there is a large role for education to play in the encouragement of a more entrepreneurial, risk-taking society. As Prof. Dr. Dr. Ann-Kristin Achleitner, Professor in Entrepreneurial Finance at the Technische Universität München, said: “There are other forms of finance, but you will not have a sustainable environment for entrepreneurship without a strong environment for venture capital.” The signs are encouraging. The policy meeting was the first, timely step towards a continuous dialogue between the practitioners, their national associations and the policy makers. And platforms like this meeting provide opportunities to compare best practice and to benchmark progress. Here, the role of the national venture capital associations, working with EVCA, is crucial in disseminating information to venture capitalists and their portfolio and feeding their responses back to the policy makers at a national and supra-national level. And the time is right for the region. Just one third of the EU’s Financial Services Action Plan has actually been already been adopted by existing EU Member States. The accession states can still influence the shape of the framework that will legislate private equity and venture capital in a new and expanded Europe in the future. Mr Timo Summa, Director at the Enterprise Directorate Generale of the European Commission, in his keynote address Page 3 of 16
  • 4. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 said: “The accession countries have a skilled workforce with a strong entrepreneurial spirit, and they can teach a trick or two to the current Member States. Europe needs their entrepreneurial dynamism and we will make everything possible to remove obstacles. But,” he added, “the accession countries need to fulfil their part of the bargain. They have to apply the full body of European law, and in this context, I particularly would like to emphasise the need for functioning financial markets – in other words, the need to implement the Financial Services Action Plan and the Risk Capital Action Plan.” The objective and associated benefits are in sight in the marathon to create a private equity favourable regime in Western Europe. Runners from Central and Eastern Europe are joining the race, but through the exploitation of this opportunity, in efficiently prioritising the adoption of EU policy, they may still set a record time. Page 4 of 16
  • 5. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 Intro and background Welcome to the Central and Eastern European Policy meeting, organised for policy makers at both EU and regional level, to discuss the challenges and policy issues related to operating a private equity fund in Central and Eastern Europe on the eve of accession to the European Union. The objective has been to raise awareness of the importance of private equity and venture capital in the local economy; to provide information on history and trends in Central and Eastern Europe and above all, to highlight the fiscal and regulatory challenges and issues impacting this industry. It is also hoped that contacts are encouraged between the accession states and EU officials and in those terms the meeting is already a success. Why is private equity important? Private equity and venture capital practitioners are partners with entrepreneurs and share in their risks and their rewards. The industry covers all the phases of a company’s growth. By its nature private equity investing is limited in time, taking a company from A to B and to exit. Private equity firms make their money from capital growth, by growing the businesses that they invest in. It is hence no surprise that private equity and venture-backed firms grow quicker than others. Growing businesses develop innovative technologies, create jobs and build GDP. They are, in short, engines for economic development, important in developed markets, critical to transition economies. But venture capitalists do not just provide finance, they add value. Private equity and venture capital practitioners spend a lot of time working with portfolio companies. The economic and social impact of venture capital is profound. In an EVCA survey of 700 seed, start-up and expansion stage portfolio companies, 95% said their firms would not have existed or would have developed more slowly. It is a compelling figure. Concerning later stage firms, the perception is that a buyout involves restructuring and employee numbers go down. But in an overwhelming majority of cases, as a similar study reported, the level of employment went up. Page 5 of 16
  • 6. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 Private equity also allows large corporations to restructure by divesting non-core businesses without destroying value. But the story is in its infancy in Central and Eastern Europe. One of the Central and Eastern Europe region’s biggest problems is that private equity is not as important in the economy as it should be. In order to raise private equity and venture capital funds a high proportion of the money has to be imported. Equally, the region’s capital markets are immature and as a result, exiting an investment is much harder. Exits happen, but they are not happening enough. What can public policy do to help? Typically it can create the right environment for entrepreneurs and private equity practitioners. There are tax, cultural and educational issues. The European Union’s Risk Capital Action Plan is an excellent road map, which identifies the barriers that need to be overcome in order to converge and harmonise the risk capital markets of Europe to create a more favourable and homogeneous environment. Page 6 of 16
  • 7. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 Current State of Private Equity and Venture Capital in the EU and in Central and Eastern Europe Francis Carpenter, Chief Executive, European Investment Fund Presentation Kurt Geiger, Business Group Director, EBRD Presentation Pierre Mellinger, President and Chief Executive, AIG - CET Capital Management (Poland) SP.ZO.O Presentation If it were a school report, an assessment of the Central & Eastern European private equity and venture capital market would read something like: “Excellent progress, could do better.” Yesterday’s centrally-planned economies are making short work of catching up, but regulators and legislators could do more to help the market. Two of the EIF’s explicit aims are to address financing gaps in less-developed markets and to promote balanced VC markets in Europe. Two aims with particular resonance in the current environment for accession states. Francis Carpenter, Chief Executive of European Investment Fund comments, “The Central and Eastern European private equity and venture capital market is not helped by the general gloomy environment. Private equity funds investing in accession countries present a risk class dilemma to US investors, who have deserted the market since 2001. The emerging market brand is not as popular as it used to be.” European investors, however, can take a different view than those in the US because they are closer and part of the same union. Carpenter explains: “We can distinguish between the peculiarities of different markets, because we are used to that.” The main question is how are we going to fill the funding gap? From a public side, on behalf of the EIF Carpenter assures that “We’ll have to progressively make an effort, the European Investment Fund the EBRD working together.” Part of the answer is timing. Valuable market opportunities will appear following accession and these will attract investors. Private equity and venture capital investing in accession states is risky but not necessarily riskier, because the individual states have made such huge progress catching up. The risks are just different. Page 7 of 16
  • 8. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 But managers need also to break out of the CEE label and broaden the investment focus. The EIF’s intention is to help, but not just by providing capital. Its role is also to introduce EU best industry practice for terms and conditions, fund governance and structure. It is developing EIF operations in the accession states, establishing joint ventures and a loan guarantee business. Carpenter says: “We’re developing an advisory business. The idea is that we have a unique experience and we are offering the benefit of that in advice.” EBRD has been investing in the region since 1992. It has invested some €1.5bn in 85 or so funds. EBRD’s analysis of their own investments so far shows an encouraging gross IRR of 26%. Kurt Geiger, Business Group Director, Financial Institutions at EBRD, says the benefits go beyond the merely financial. He says: “Private equity is an instrument and a financial intermediary that supports and develops the culture of private enterprise and it is an important catalyst in Central and Eastern Europe.” Private equity builds institutions and develops skills and so far, the industry has done a good job of job of balancing the introduction of technology and skills and the education of local players. And of course, there is nothing more compelling than a successful, local businessman to encourage others. The pity is that there is a constant shortage if equity in the region. Governments can help by creating an environment where it is easy to do business and to do it transparently. That means cutting the bureaucracy and improving the regulatory environment for both entrepreneurs and investors in private equity funds. Geiger says: “This will lead to employment, prosperity and the snowball will just keep rolling, getting bigger and bigger.” And it can get even better, as long as practitioners know what the issues are and can lobby the legislators and regulators effectively. Geiger highlights two regulatory examples, which could improve the entrepreneurial environment 1. faster procedural laws for bankruptcies and 2. an allowance for banks to write-off difficult or bad loans. What Geiger does not want to see is government subsidising start-ups: “If you have too much subsidy up front, the entrepreneur starts to think what business do I start to get the subsidy? It is more important to create the environment.” And once the transition is Page 8 of 16
  • 9. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 complete then the EBRD’s ideal is to fade away: “We look to the market to take us out,” Geiger says. Pierre Mellinger, President and Chief Executive of AIG, says: “There was a one-off opportunity after the fall of the Berlin wall.” There remains a huge opportunity. But the economic environment is as tough as ever and in accession to the EU adds further challenges. Investment from within is restricted too. Mellinger adds: “Pension fund reform is largely incomplete and when it is, as in Poland, it does not allow for investment in the unquoted sector.” But the market is having difficulties on both the supply-side (i.e. private equity and venture capital houses and investors in the fund) and the demand-side (i.e. entrepreneurs) of the market. Mellinger says one of the toughest challenges is the relatively limited level of private equity experience. He says: “It took 500 interviews to assemble a team of 17,” when Mellinger embarked on setting up a local fund. And too often after doing two deals people thought they knew it all. Secondly, fund structures are at a critical stage. There is a danger that the fund is taxed at every level. Other difficulties, according to Mellinger are: “privatisations that take too long and bankruptcy procedures that run on interminably. Debt availability is limited and capital markets are undeveloped.“ For Mellinger, the key to unlocking the CEE countries’ economies is in their own hands: “Local experience is key. Bad practitioners will go. The fittest will survive. If the systemic issues are addressed, this will sustain growth better than any EU programme.” The effective prioritisation of policy adoption will help develop and facilitate investment in the private equity market by long-term capital sources, further the formation of private equity and venture capital funds and promote an entrepreneurial environment. Page 9 of 16
  • 10. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 The Importance of the Financial Services Action Plan and Development of Financial Services Action Plan (FSAP) and the Development of Financial Services and Capital Markets David Wright, Director of Financial Markets EC DG Internal Market Graham Bishop, Consultant, GrahamBishop.com Presentation Robert Manz, Partner, Enterprise Investors Presentation The Accession States are trying to jump onto a racing train; it has pulled out of the station and is gathering speed. How they board this train is vital in pursuing the objectives of the associated benefits of EU membership. David Wright, Director of Financial Markets at the European Commission (EC) DG Internal Market, made clear that the development of a single financial market is one of the most ambitious journeys ever undertaken. He says: “It’s important to put things in perspective. We are trying to create a single capital market. We have a single currency, but not a single capital market. We’re trying to break down those barriers.” The benefits are many: GDP growth, cost of capital will come down by 50bps, innovation will increase, venture capital will become more available and Europe will be a stronger economy. Risk capital has always been a part of the internal market plan: Wright says: “Unless we can fund small companies, making them big in a rapid timescale, then Europe will be in trouble. The rate of turnover in the main indices is accelerating, so it is essential we help smaller companies to develop.” Much progress has been made, a Europe-wide patent, the pension funds directive, the prospectus directive are all moves in the right direction. Work on insolvency and bankruptcy has not kept pace, Wright says, but it is in the EC’s thinking. Concerning the risk capital initiatives and the impending deadline of the EC Risk Capital Action Plan, Wright says: “Nothing is finished; nothing is final. We need to take stock in 2003. What are the priorities? What should we drive forward, up till 2010? My plea to you is to help us to define a new way forward.” “A third of the Financial Services Action Plan (FSAP) measures are not yet completed. Central & Eastern European policy makers can have some influence on the FSAP processes to maximise domestic Page 10 of 16
  • 11. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 economic benefits. The private equity & venture capital community in Central & Eastern Europe is ready to work with you.” The train’s ultimate destination is negotiable. Robert Manz, Partner at Enterprise Investors, says: “A third of the Financial Services Action Plan (FSAP) measures are not yet completed. Central & Eastern European policy makers can have some influence on the FSAP processes to maximise domestic economic benefits. The private equity & venture capital community in Central & Eastern Europe is ready to work with you.” For governments in Central and Eastern Europe, it is important to note that private equity practitioners can have a real impact on the implementation of the FSAP. Robert Manz underlines: “Private equity is a conduit for the fast implementation of regulation in unquoted companies.” What is vital to understand is that as well as the short time frame in which to adopt EU law, the Financial Services Action Plan itself is also moving very fast. Graham Bishop, Consultant, says: “The Accession States are trying to jump on a train that is accelerating in a revolutionary way. Regulators need to be flexible in this fast moving situation, so we don’t cramp markets.” In this short timeframe, Central & Eastern European policy makers can benefit from the recommendations of the existing EC Risk Capital Action Plan and use it to prioritise accordingly. This plan is intended to eliminate remaining regulatory and administrative barriers at both European Community and national levels, which impair the full development of risk capital markets in Europe. The elimination of these barriers will play a major role in the creation and development of SMEs and are therefore important to foster economic growth and job creation. In efficiently prioritising EU law, care should be taken, as not all regulatory developments could hold positive consequences for the industry. More work need to be done on Basel II, which looks at capital adequacy and may compel banks, one of the industry’s main sources of capital, to reassess their involvement in the asset class, both as a source of funds and as a source of debt for later stage buyout financing. Basel II has a particular resonance for the accession states because there are almost no local capital sources. The regions’ banks and insurance companies need encouragement to invest in the asset class, not disincentives. The train is speeding up, however the time is right for policy makers exploit the potential of adopting EU law effectively in order to improve the environment in which a healthy private Page 11 of 16
  • 12. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 equity and venture capital market can flourish and bring with it, its associated economic benefits of growth and employment. Page 12 of 16
  • 13. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 Access to Finance and its Importance for Entrepreneurship Ann-Kirstin Achleitner, Professor in Entrepreneurial Finance, Technische Universität München Presentation John K Thompson, Financial Counsellor, OECD Presentation Michael White, Managing Director, 3TS Venture Partners AG Presentation Money makes the world go round and no less so for the would-be entrepreneur. But it is not the only element even if it seems that way. Prof. Dr. Dr. Ann-Kirstin Achleitner, Professor in Entrepreneurial Finance at the Technische Universität München, says: “Access to venture capital has a major impact on a company and on the economy. Active financing is the major factor in the success of a start-up. There are other forms of finance, but you will not have a sustainable environment for entrepreneurship without a strong environment for venture capital.” But if finance is the most important factor behind a success story, the lack of it is always the cause of failure. Or at least so it appears to the entrepreneur. Achleitner says “Financing is necessary, but not sufficient. It is not enough to throw ever more money at the issue. Finance is always the first reason for failure. But in a lot of cases it is actually just the venture capitalist doing its job of effective due diligence. But what the entrepreneur sees is just that they did not get the money.” The non-financial contribution a good venture capitalist will make can also add value alongside the money they bring to a deal. Achleitner says: “It is not just about access to finance; it is about access to intelligent finance. An intelligent Euro is not just a Euro.” John Thomson, Financial Counsellor at the OECD, emphasises other essentials for a flourishing entrepreneurial climate. He says: “Countries with high levels of entrepreneurship are all non-EU. To a certain degree it’s cultural. This is important but so too is the tax and legislative framework.” Accession states also face a particular cultural barrier to entrepreneurial progress. Thomson says: “Some transition economies, where science was done in research institutes and labs, may lack ways of taking commercial value from a new idea.” Page 13 of 16
  • 14. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 Thomson too believes money alone may not be the answer. He says: “One of the ways that government can participate is by supporting informal equity: less with finance and more with the infrastructure to support the flow of information. Who has business plans; who is available for coaching?” But where state funds are available, as well as advice and information, another set of problems arise. Michael White, Managing Director of 3TS Venture Partners says “2003, going into 2004, you are going to see a radical increase of funding, and most of it through two great programmes. How it will be absorbed?” The suspicion is also that public money is free money and might be squandered on projects, which the private funds would have rejected. White says: “Government money needs to be managed very carefully, especially how it is partnered with private sector money, because if it fails then it is a double failure.” Public money should have a specific purpose and it should only be available be for a defined period of time. When its job is done, it should go. Achleitner believes: “Ideally public money should be anti-cyclical. It must be in before private money and it should be there when private money goes away.” This point is particularly relevant in the current economic slowdown. Thomson concludes: “We’ are in a period where the market is not thriving and we’re waiting to see what will happen next. It may not be any different.” Page 14 of 16
  • 15. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 Issues relating to Entrepreneurial Environments Hans Martens, Chief Executive Officer, The European Policy Centre Presentation Rudy Aernoudt, Deputy Head of Cabinet Minister Kubla, Chief Economist Détaché, EC - DG Enterprise Presentation Nick Fletcher, Managing Partner, Clifford Chance Pünder Warsaw Presentation “Reach for the stars, you won’t end with a handful of dirt” is the mantra for everyone striving to improve the entrepreneurial culture of Europe, new and old. Work has been in progress for some time in Western Europe and as the bar is raised, so the accession states have to work harder, faster and more concertedly. Alongside the legislative mandate of the Financial Services Action Plan (FSAP), the Lisbon process -begun in 2002- aims to get Europe working smarter. Its goal is to make Europe the most competitive knowledge-based economy in the world by 2010. Hans Martens, Chief Executive of the European Policy Centre, says: “The Lisbon process reminds me of when Kennedy said the US would put a man on the moon. It was a goal, but they did put a man on the moon.” The Lisbon process’ target may be rooted in this world, but is still ambitious. It looks to employ a minimum of legislation, promoting co-ordination, benchmarking and best practice. Martens says: “If the benchmarking is done regularly, countries could look to the best performers and adopt the best practice.” Accession states are joining and already are involved in the benchmarking. In the spirit of mutual learning, the Belgium example was presented by Rudy Aernoudt, Deputy Head of Cabinet Minister Kubla. Belgium is working hard to create the best environment for private equity and venture capital. Aernoudt believes that there are anomalies when the market is left entirely to its own devices: “Looking at pooled return figures, the more risk you take, the less your return. The market doesn’t function – this is the perverted risk-return relationship that hits the supply-side, especially seed capital.” Belgian entrepreneurs tend to look to venture capital, only after that have exhausted every other funding avenue. Aernoudt believes in measures to stimulate both the supply of and demand for venture capital. He says: “Investor readiness is about training and showing people that venture capitalists are not so bad. The lesson is not to neglect the demand side, because it is as important, if not more as putting money in the market.” Page 15 of 16
  • 16. Central & Eastern European Policy Meeting Fostering Value Creation in EU Accession Countries 7-8 April 2003 What can be done? An integrated approach to finance helps the entrepreneur to know what type of financing he needs and when he needs it. Not all money is the same: friends, families, banks, venture capitalists, all have their agendas. What is the optimal financing combination? Another approach is to create platforms - conferences and symposia - to encourage mutual understanding between different financial players. The Private Privak, a special purpose vehicle based on the principle for fiscal transparency, soon to be enacted into Belgian law, is widely considered to be one of Europe’s best fund structures. But as Arenoudt observes: “If you want to encourage people to start businesses you have to change mentalities. And you have to work on the whole population.” The Aunt Agaathe scheme attempts to link private money and affection with fiscal incentives for direct investments in young companies. Looking more directly at the accession states, Nick Fletcher, a Managing Partner at Clifford Chance in Warsaw, wonders whether they had not got a rough deal. High regulatory barriers and an excessive and arbitrary bureaucracy have been made worse by the increased burdens of EU accession. But it is also a question of perception, Fletcher says, “and a perception of bureaucracy depends on where you’re coming from. You don’t know bureaucracy until you have tried to buy a mobile phone in France.” In the accession states, waves of legislation to cope with the transition to a market economy have extended the reach of the law, but the machinery for enforcement is weak. Fletcher says: “In nearly all cases the regulatory burden has increased since 1995.” But Czech reforms to ease the judiciary’s burden and raise its standing, point the way forward for all accession states. Page 16 of 16