Private Equity Investments in SMEs: SEAF Experience in the Balkans

1
Private Equity Investments in SMEs SEAF
Experience in the Balkans
Vladimir Pesevski Director General SEAF
Macedonia Belgrade, October 2003
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What is Private Equity

• Its additional money invested by an outside
  investor in exchange for additional ownership in
  a given company
• The investor is not an individual, but an
  institution called Private Equity Investment Fund
• Its not a grant, its not a loan, the Fund is
  not a bank
• The Fund takes a higher risk than the bank,
  targeting for higher returns (typically above 30
  on compounded basis)
• Most PE Funds are focused on larger companies or
  high growth industries such as IT and
  biotechnology (venture capital)
• After certain period of time (3-5 years), the
  Fund will sell its ownership in a given company,
  either to a strategic partner, to the public via
  stock markets, or back to the management of the
  company

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Who is SEAF?

• SEAF - Small Enterprise Assistance Funds is an
  international private equity fund manager
  specalized in SME financing in difficult regions
  (Eastern Europe, Russia, Asia, South America)
• Close to 200 million under management, by the
  end of 2003 to be over 300 million
• Investors include both IFIs and private capital
• In the region has investment funds in Croatia,
  Romania, Macedonia, Bulgaria
• In the region, shareholder in the leading
  Croatian ISP, leading Croatian cable TV, leading
  Romanian software developer, leading Bulgarian
  ice cream producer, etc
• Activities are under way to start operation in
  Serbia and Montenegro, hopefully in the first
  half of 2004

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SEAF in Macedonia

• In Macedonia operation started in 1998, funded by
  USAID, EBRD, IFC and DEG
• Investment limits 200,000 to 1,000,000 per
  company
• Typically a Minority Shareholder (25-49),
  although we take majority position as well
• Active partner provides technical assistance to
  help company development, heavily involved in
  making key business decisions
• Exit 3 to 7 years sale to other partners,
  strategic investor
• Target IRR gt 30

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Business background in Macedonia

• Small country (population c.2m.) - small market
  low purchasing power (GDP/capita lt 2,000) -
  enclosed thinking due to regional instability /
  sanctions / restrictive visa regime with western
  countries
• High unemployment officially close to 40
• Fewer Large/Medium enterprises - 591 v. 31,204
  small (lt 20 employees)
• Privatization not completely successful - Started
  1994 - many companies sold to the workers -
  foreign investment in major utilities or
  companies with monopolistic market position (e.g.
  Telecom, Oil Refinery, Cement factory), not
  resulting in expansion, increased exports and
  transfer of knowledge, but merely transfer of
  ownership
• Stock exchange market not functioning, IPOs do
  not exist and probably will never exist

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Business background in Macedonia

• Poor legal / regulatory environment
• incoherent, contradictory and imperfectly
  understood legal system
• lack of solid legal counsel
• inconsistent / selective enforcement (including
  political interference as well as administrative
  problems)
• many changes to follow, following the
  recommendations of EU
• Lack of transparency
• incomplete and inaccurate accounting (IAS adopted
  but not implemented)
• widespread tax evasion (somewhat reduced through
  VAT)
• inadequate corporate governance
• uncertainty of property ownership
• active gray economy
• distrust of banks
• political connections seen as necessary for
  obtaining government contracts
• Poor Banking sector
• obtaining loans is difficult and tedious process
• interest rates relatively high (14-22 per annum)
  
• production is viewed as more risky than trading
• generally, real estate is needed as collateral

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Business background in Macedonia

• Balkan instability - potential strategic
  investors cautious
• Reluctance to accept an equity partner
• Many businessmen prefer loan financing (despite
  high interest cost collateral requirement)
• fear restriction and loss of control (despite tax
  benefits / reduced interference risk if foreign
  financial partner)
• Ambitions restricted just to the local market
• Lack of good quality business ideas
• business plans poorly developed (marketing not
  understood as a concept)
• proposals tend to be opportunistic / imitative
  rather than strategic in outlook
• no basic culture of industrial entrepreneurship
  (most successful businessmen have foreign
  experience)
• may be consequence of small enclosed market
• need to develop means for Macedonian businessmen
  to obtain practical experience of Western
  business methods (i.e. learn how to identify and
  exploit opportunities)

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SEAF Experience

• The Fund went through two difficult years (Kosovo
  crisis in 1999 and in-country crisis in 2001)
• Kosovo crisis brought the level of investment
  almost to zero, took the businessmen focus out of
  business, resulting in anti-west sentiment in the
  country
• In-country stability crisis in 2001 changed the
  consumer spending pattern, exhausted the budget
  and resulted in severe GDP decline
• The effect on the pipeline of new investments and
  existing portfolio was very negative, proving
  that the country risk is high, and making
  Macedonia not attractive place for equity
  investment
• During the life of the fund, many regulations,
  laws and taxes have been changed, greatly
  affecting the operations of the local companies
  thus making the planning very difficult and
  unreliable
• The widespread corruption and nepotism made life
  very difficult for honest businessmen and
  investors
• Yet the performance of the portfolio companies
  was satisfactory, with some of them highly
  exceeding expectations. The key success factor
  was finding companies with good management.

9
SEAF Experience

• Despite the difficulties SEAF has made 15
  investments, out of which 13 are active at the
  moment
• The list of active investments include

• Pilko, the only fresh chicken producer in the
  country
• Nasto, local dairy with a well established brand
• Planet Press, publisher of several leading
  magazines
• On.net, a well known ISP
• Magnolija, children clothing retailer
• Medium Export, an exporter of lamb, paprika and
  other Macedonian products
• Gica, the leading local egg producer

• Dnevnik, the leading daily newspaper
• Tinex, the leading local supermarket chain
• Login Systems, distributor of Microsoft and other
  leading brands
• Fonko, the leading local HVAC company
• Mako Market, one of the largest FMCG distributors
• Datapons, a medium size printing company

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Some Benefits to SMEs from SEAF

• Tax benefits due to the foreign ownership
  (reduced corporate income tax, customs, any other
  by the local regulations)
• Consulting services from experienced experts
• Assistance in obtaining additional financing
  (banks, grants, etc.)
• Training programs for the company management and
  sourcing additional management skills
• Additional financial advise in day-to-day
  operation
• Support in the analysis and participation in the
  key business decisions
• Network of SEAF throughout the world and
  experience from similar investments

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Recommendations to the Government

• SME sector is where most of the new jobs will be
  created, but dont full yourself that they will
  solve the problem of the Serbian economy.
  Paretos 8020 rules applies even here. You need
  big companies in order to be successful, and many
  SMEs to support them.
• Use combination of donors and government money
  to create programs for transfer of knowledge and
  know how. Local professors rarely have the
  knowledge, experience and motivation to do it.
• The highest priority on long run should be to
  improve education. Install system for checking
  the quality of the education.
• Simplify the taxation, but dont change taxes
  every day. Foreign investors want stability so
  they can plan on medium to long term basis.
  Improve the laws, and especially their
  enforcement.
• Dont buy every idea that international
  donors/experts sell. Its true that they dont
  fully understand the local environment and the
  first thing they want is their fees. But many of
  them do have the knowledge and experience that
  could be used and transferred locally. Do not
  reject the opportunity to work with them and
  tailor their support to the country needs. Create
  win-win situation.
• Spend time in recruiting local talent even for
  the government. Face it, the best people are not
  members of the political parties nor they will
  ever be (at least in Macedonian parties). But
  due to their self interest to live and work in a
  better country, many of them are willing to help.
  Utilize them.

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Recommendations to the Entrepreneurs

• Partnership in the business could be very
  beneficial. The most successful companies are
  not owned by a single individual. Find the right
  partner(s) and define the partnership terms in
  detail.
• Think whether you really want a foreign partner.
  Think what will make your company attractive to
  someone else, or to you if you want to buy it.
  Are you willing to give up control, truly report
  revenues and earnings, honestly discuss future
  plans together.
• Surround yourself with talented people with lots
  of energy, willing to learn and adopt. Spend time
  in recruiting local talent. Although scarce it
  exists
• Think medium to long term. Avoid political
  involvement.
• CAPEX is not enough. Invest in people, respect
  them and delegate responsibility.
• Be transparent and pay taxes. Do audits. On long
  run the payoff will be much greater than hiding
  the profits. Low profits will rarely attract
  foreign investors.
• Accept the fact that you dont know everything
  and that you will never know everything, even in
  your own business. Use outside help.
• Think regionally. In three to five years, even
  the Serbian market will be dominated by regional
  players. Being the best company in your small
  city (and small country) will be far from enough.
  The best in the region (which will be associated
  with the best in the world) will be the winners.
  Do you see yourself as one of them?