Author: Martina Martinovičová
Source: Profit, 2.3.2009, no. 9, page 44
Does the recession mean the limitation of private equity investments or could they become a tool which will help companies during the period of the crisis? Could the state also assist companies with cash shortages by entering into private equity funds? Put simply, a private equity investment is a package of money which enters into a company under clearly defined conditions and assists it to expand. Therefore, like a bank loan, it represents new, fresh capital, but is provided by a private investor or fund instead of a bank. In return for the influx of new money, private equity investors require an ownership share in the company, participation in the management and the option of intervening in the company’s commercial plans. In crisis periods, these investors typically become especially more interested in small and medium-sized enterprises, because it is mainly these types of companies which have problems acquiring bank loans when the banks tighten up their loan conditions. Of course, the current form of the recession contains a strong hint of resistance to the share markets and investors are leaving them en masse. At the same time, the gate is also being shut to one of the possible culminations of this type of investment – the road to the entry of a company onto the stock exchange by means of an initial primary offering (IPO). On the other hand, the share market no longer offers many opportunities to achieve profit and as such the interest of the investors may overflow precisely into the area of private equity, because these investments are marked by the achievement of very reasonable profits – around twenty, forty or even more percent. Entry into the stock exchange is not the only possible way of completing investments and achieving profit. It is possible to sell a launched company equipped with capital to a new strategic investor. In the region of Central and Eastern Europe, approximately half the private equity investors have so far received their invested funds back by means of the sale of the company to a strategic investor and only one fifth of them terminated their investment by means of entry into the capital market. On the other hand, IPOs, which are generally considered to be a more profitable method of exit from this type of investment, were predominant in Western Europe and the USA. If private equity investors know that they can easily increase their investment by means of sales on the stock exchange, they will be more willing to invest their money in the country where this method is simple.
COMPANIES I FUNDS
Private equity investments may be at varying amounts (from five million up to billions of crowns); it depends on the investor’s orientation. Foreign private equity investors especially look for investments with a minimum size of around fifteen million EUR, i.e. approximately 4 billion crowns. Foreign private equity investors in the Czech Republic include, for example, the Polish company Enterprise Investors which bought a share in the company Grisoft in 2005, the Belgian company KBC Private Equity which took over the company Novaservis in 2006 or the company Warburg Pincus which purchased the second largest Czech internet portal, Centrum.cz, in December 2007. There are, however, also a number of Czech private equity subjects which admittedly have their domiciles abroad, but whose management or part thereof is Czech. Their investment targets involve companies in Central and Eastern Europe. Such companies are, for example, Petr Kellner’s PPF Group, the Czechoslovak Penta Investments Group or Arca Capital. However, the area of public equity investments is not only the domain of individual companies, but also of funds. Of course, there are not yet many which have focussed on this area. This involves approximately twelve unit trusts which do not include this specification in their names, so it is difficult to find them by name. And then there are the funds which are relatively new in the Czech capital market, they being funds of qualified investors which the Collective Investment Act “introduced” to the Czech market in 2006. However, not everybody can invest in these funds, of which there are now almost forty in the Czech Republic. The funds are only designated for so-called qualified investors who are precisely defined in the Act. This involves, for example, institutional investors, i.e. banks, insurance companies and insurance funds or individuals or businesspeople who issue a statutory declaration as to the fact that they have experience in the field, in which the fund invests.
THE STATE COULD PURCHASE VIA A FUND
However, the state is also a qualified investor. Could it support small and medium-sized enterprises by means of investments in the funds of qualified investors for private equity projects? For example, Pavel Makovec, the Chairman of the Board of Directors at Arca Capital CEE, a closed-end investment fund, is of the opinion that it could. In his opinion, the state support for small and medium-sized companies via these funds could function according to the following principle. The state would invest money in various funds which would reduce the risks of losses and increase the objectivity of the investments. The funds would then purchase shares in small and medium-sized enterprises which would give them the opportunity to develop and succeed in the period of the recession. In return for the provided capital, the funds would, of course, request participation in the management of the company and the option of intervening in its strategic goals. Thanks to the additional capital and restructuring measures, the companies would also more easily receive the bank loans which are necessary for further development. Once the fund achieved the required return, it would sell its share in the company and therefore the state would also realise its investment. It could divide the profit among the shareholders or invest it in another company. “In order for the state to have a better overview of its investments, the self-administrating investment funds could offer it an above-standard method of inspection in the form of a place on the Supervisory Board or by means of the establishment of a special inspection or program body,” said Makovec. “Apart from supporting the Czech economy in the time of recession, the funds of qualified investors may secure relatively good yields for the state, around 10 to 15 percent per year. Given a retroactive evaluation of the efficiency and yield of the individual governmental anti-crisis measures, the funds of qualified investors would probably finish among the top places,” said Pavel Makovec. However, the Manager of the Investment Section of Pioneer Investments, Petr Zajíc, is relatively sceptical with regard to this option. “I think that the state will not wish to enter into companies as a part owner, not even via the funds of qualified investors aimed at private equity,” said Zajíc. “The problem is that this type of fund was only established recently in the Czech Republic and we do not have any historical data or the corrections of any possible errors arising with the establishment of these funds. I personally think that the state is a terrible owner of almost anything and from a long-term perspective it should only hold truly strategic companies in its portfolio and even then preferably only golden shares and not a full majority, because there is the threat of the unsustainable removal of cash in the form of dividends”, estimated Jan Procházka, an analyst at the company Cyrrus. In his opinion, the idea is not bad, but the Czech experience with the funds of bad bank loans, the Consolidation Agency and so on unequivocally raises a warning finger. “The state will not be able manage it and a classic space will arise for the Czech “small scale theft” and corruption. Just the fact that everybody has to put up their hand for EU subsidies and that the best project on paper wins out over the actual best project is a financial tragedy,” added Procházka.
WHAT EXACTLY ARE THE FUNDS OF QUALIFIED INVESTORS
How do the aforementioned funds of “experts” work in the market? They invest the entrusted money in real estate, shares, bonds or private equity projects. “Investors also support the Czech business environment with investments in private equity projects. Their finances help small and medium-sized companies to develop and enable them to invest in new technologies or to enter into new markets,” said Makovec. The advantage of investing in these funds is the low tax rate which ensures a higher yield. This does, however, involve a long-term investment with higher amounts. As the name itself suggests, the securities of these funds are only designated for so-called qualified investors. By law, a fund may have a maximum of one hundred such investors and the lower limit for the investment of each investor is one million crowns. This is, however, only the minimum amount set by law and every fund may arbitrarily increase this in its statute. For example, the Arca Capital CEE fund has a minimum investment level of five million crowns. The equity of each fund must reach at least 50 million crowns within one year of the day of the receipt of the licence. The funds may be deposited for a maximum period of 10 years which cannot be extended. It is, however, possible to merge with a younger fund and thus extend the existence of the fund.
FIFTY MILLION WITHIN ONE YEAR
The funds are subject to strict inspections from the Czech National Bank. The law precisely defines what the fund may and may not invest in and the investment strategies must therefore be defined in great detail in the fund’s statute. Investors can choose between two types of these funds: unit trusts and investment funds. There are now five unit trusts and 13 investment funds, the number of which is constantly changing however, because the funds not only receive licences, but they also lose them. “This happens because the fund managers are unable to fulfil the legal requirement that the fund’s registered capital must be successfully increased to at least 50 million crowns within one year of the receipt of the licence,” explained Pavel Makovec. A unit trust may only be established by a licensed investment company which then administers the fund’s assets and sells investment certificates to the investors. A unit trust may be established in an open-end and closed-end form. An open-end fund does not have any limit to the number of issued investment certificates and its investment certificates may be bought back by the investment company at the request of their owner. In the case of close-end funds, the investment company does not buy back the investment certificates. Their investments are not settled until the unit trust is wound up.
