PRIVATE EQUITY FUNDS

AND VALUE CREATION OF THEIR

PORTFOLIO COMPANIES
Marek Panfil

(2005)
Holds an Economics Ph.D. in Management; Senior Lecturer at the Small Business
Department of the Warsaw School of Economics (SGH) in Warsaw. Co-organizer of
the Postgraduate Studies in Value-based Management of the SGH between 1999-
2005. Between 1997-2003 he collaborated with a consulting agency, PONT Sp z o.o.
He specializes in business valuation, analysis of investment profitability, acquisition
of structural funds and company value management.
He is an author of over a dozen business plans and around 30 papers of corporate
finance.
As a lecturer, he collaborates with such organizations as UNIDO, Centrum Edukacji
Sp z o.o. in Płock, Lower Silesian Baking School.

(2015)

Marek Panfil, Ph.D., Internal Audit Manager at KGHM International Ltd. in

Vancouver in Canada (since October 2014); from 1997 to 2014 Senior Lecturer at
the Institute of Value Management at the Warsaw School of Economics; from 2005 to
2014 Director of Postgraduate Studies Business Valuation; alumni of International
Faculty Program at IESE Business School in Barcelona (June 2010); visiting scholar
at Stern School of Business, New York University (July-December 2012). Consultant
of companies in such areas as value based management, private equity, business
valuation. Author and co-author of several dozen publications, the latest one include:
Wycena spółek z WIG30. Metody, przykłady, M.Panfil, A.Szablewski (eds.), Poltext,
Warsaw, 2014. E-mail: [email protected]
.

Warsaw, 2005
 CONTENTS

FOREWORD ........................................................................... Error! Bookmark not defined.

INTRODUCTION ...................................................................................................................... 4
I. PRIVATE EQUITY – SOURCES OF DEVELOPMENT AND ECONOMIC ROLE ..... 6
1. PRIVATE EQUITY  DEFINITIONS .............................................................................. 6
2. ORIGINS OF PRIVATE EQUITY .................................................................................. 13
3. THE ECONOMIC ROLE OF PRIVATE EQUITY ........................................................ 17
II. PRIVATE EQUITY FUNDS IN THE USA AND EUROPE – A COMPARATIVE
ANALYSIS .............................................................................................................................. 28
1. PRIVATE EQUITY FUNDS IN THE USA ................................................................ 28
2. PRIVATE EQUITY FUNDS IN EUROPE ..................................................................... 49
III. SELECTED LEGAL AND ECONOMIC ASPECTS OF THE ACTIVITY OF
PRIVATE EQUITY FUNDS ................................................................................................... 65
1. CYCLICAL NATURE OF PRIVATE EQUITY INVESTMENTS ............................ 65
2. PRIVATE EQUITY FUNDS OPERATING AS INVESTMENT COMPANIES IN
THE FORM OF LIMITED PARTNERSHIPS .................................................................... 67
3. RELATIONSHIP BETWEEN PRIVATE EQUITY FUNDS AND PORTFOLIO
COMPANIES ....................................................................................................................... 72
4. RELATIONSHIP BETWEEN PRIVATE EQUITY FUNDS AND CAPITAL
PROVIDERS ........................................................................................................................ 79
5. RISK AND RATES OF RETURN .................................................................................. 81
6. DISINVESTMENT STRATEGIES OF PRIVATE EQUITY FUNDS ........................... 83
IV. MANAGEMENT CAPITAL AS A SOURCE OF INCREASE IN THE VALUE OF
PORTFOLIO COMPANIES .................................................................................................... 85
1. CONCEPT OF MANAGEMENT CAPITAL OFFERED BY PRIVATE EQUITY
FUNDS ................................................................................................................................. 85
2. TYPES OF PRIVATE EQUITY FUNDS FROM THE POINT OF VIEW OF THEIR
INVOLVEMENT IN PORTFOLIO COMPANIES ............................................................ 86
3. TYPES OF MANAGEMENT CAPITAL .................................................................... 87
4. COMPARISON OF COMPANIES WITH AND WITHOUT VENTURE CAPITAL 92
5. ATTRIBUTES OF PRIVATE EQUITY FUNDS ....................................................... 93
6. PROBLEMS RELATED TO ADDING VALUE TO COMPANIES BY PRIVATE
EQUITY FUNDS ................................................................................................................. 94
7. ADDITIONAL BENEFITS OFFERED BY PRIVATE EQUITY FUNDS IN
POLAND: ANALYSIS OF QUESTIONNAIRE STUDY RESULTS ................................ 95
V. STRATEGIES FOR INCREASING PORTFOLIO COMPANIES’ VALUE BY
PRIVATE EQUITY FUNDS ................................................................................................. 104
1. CONCLUSIONS FROM VALUE-BASED MANAGEMENT THEORY ............... 104
2. CREATING PORTFOLIO COMPANIES’ VALUE BY PRIVATE EQUITY FUNDS
107
2.1. CASE STUDY METHODOLOGY ...................................................................... 107
2.2. CHARACTERISTICS OF PRIVATE EQUITY FUNDS MANAGED BY
ENTERPRISE INVESTORS SP Z O.O.................................................................... 109
2.3. POLFA KUTNO S.A. VALUE GROWTH STRATEGY BY EI FUNDS..... 111
 2.4. STOMIL SANOK S.A. VALUE GROWTH STRATEGY BY EI FUNDS ... 127
2.5. ELDORADO S.A. VALUE GROWTH STRATEGY BY EI FUNDS............... 139
2.6. GRUPA KĘTY S.A. VALUE GROWTH STRATEGY BY EI FUNDS ............... 148
2.7. COLLECTIVE SPECIFICATION OF CASE STUDIES .............................. 158
VI. PRIVATE EQUITY FUNDS IN POLAND – THEIR CURRENT STATUS AND
FUTURE DEVELOPMENT .................................................................................................. 163
1. EVOLUTION OF PRIVATE EQUITY FUNDS IN POLAND SINCE 1990 ........... 163
2. PRIVATE EQUITY FUNDS IN POLAND................................................................... 166
3. SOURCES OF MONEY FOR THE FUNDS ................................................................ 172
4. FUNDS’ INVESTMENTS ............................................................................................. 173
5. WAYS OF FUNDS’ DISINVESTMENTS ................................................................... 174
6. POSSIBILITIES OF CREATING PRIVATE EQUITY FUNDS IN VIEW OF THE
POLISH LAW .................................................................................................................... 175
6.1. THE ACT ON INVESTMENT FUNDS .............................................................. 175
6.2. ACT ON NATIONAL INVESTMENT FUNDS (NFI) ........................................ 177
6.3. CODE OF COMMERCIAL COMPANIES AND PARTNERSHIPS ............... 178
6.4 CONCLUSIONS FROM THE ANALYSIS OF LEGAL FORMS FROM THE
POINT OF VIEW OF PE FUNDS .............................................................................. 180
7. CAPITAL MARKET DEVELOPMENT STRATEGY IN POLAND - AGENDA
WARSAW CITY 2010 ...................................................................................................... 180
8. BARRIERS TO PE DEVELOPMENT IN POLAND ............................................... 181
9. SUGGESTED INSTITUTIONAL, LEGAL AND ORGANIZATIONAL CHANGES
IN POLAND ...................................................................................................................... 182
CONCLUSION ...................................................................................................................... 192
LIST OF TABLES, DIAGRAMS, FIGURES AND CHARTS ............................................. 196
BIBLIOGRAPHY .................................................................................................................. 201
ANNEX .................................................................................................................................. 209
SCHEDULE 1: 30 most influential private equity deals in history ................................... 209
SCHEDULE 2 .................................................................................................................... 211
European companies: private equity receipients. Case study. ........................................... 211
SCHEDULE 3 .................................................................................................................... 215
Venture capital industry lifecycle in USA and Israel ......................................................... 215
SCHEDULE 4 .................................................................................................................... 218
DEFINITION OF INDUSTRIES BENEFITING FROM VENTURE CAPITAL IN THE
USA .................................................................................................................................... 218
SCHEDULE 5 .................................................................................................................... 220
OVER-THE-COUNTER MARKETS IN OECD COUNTRIES ....................................... 220
SCHEDULE 6 .................................................................................................................... 222
Examples of completed private equity investments in Central and Eastern Europe .......... 222
INTRODUCTION

Over the last three decades, private equity funds (PE funds in short) have
become a very important source of new innovative solutions at enterprises and a
source of wealth in developed economies (especially in the USA and UK). They are
also playing an increasingly important role in developing economies all over the
world, also in Poland.
Private equity funds act as financial intermediaries that manage the cash
entrusted to them by institutional investors (such as pension funds, insurance
companies as well as banks and universities). The investment partners of such funds
allocate the capital in companies with a potential of above-average internal rate of
return.
At present, in mature economies, private equity is the most important
alternative source of financing for small- and medium-sized enterprises with a high
growth potential (especially at early stages of development), which other traditional
financial institutions, such as banks or lending institutions, see as entities charged
with a too-high investment risk.
PE funds are also playing an increasingly active role in MBO/MBI transactions.
The popularity of such transactions has grown especially since 2000, when many PE
funds made losses on investments in new on-line companies and shifted their focus
to less risky undertakings.
Apart from equity, such funds offer their portfolio companies some added-
value (management capital) to enhances their competitiveness on the local and
supraregional market and boost their market value.
The value of private equity investments represents a small portion of the GDP
(in 2002: 0.95% in Israel; 0.62% in UK; 0.60% in USA; 0.28% in Europe), but the
market for such investments is important, as it creates a chain of mutual
dependencies. Owing to the well-developed private equity investment market, the
knowledge market is thriving and the economy is becoming more and more
innovative. The companies supported by PE funds become creators of new
technologies, new industries (such as biotechnology, semi-conductors, ICT) as well
as new jobs with above-average salaries. Hence, they affect the growth of local
economies and, eventually, the economic growth of the country (GDP growth).
Private equity funds also exert substantial influence on the development of
stock exchanges, facilitating Initial Public Offerings (IPOs) of their portfolio
companies. Sales of stock to exit the funds have enabled new, dynamic companies
with global reach to become listed. In the past thirty years such companies as 3
Com, Amgen, AMD, Compaq, Cisco, Federal Express, Genentech, Intel or Sun
Microsystems have benefited from private equity at early and later stages of
development.
Globally, there are currently over 30 national associations of private equity and
venture capital investors, including the Polish Private Equity and Venture Capital
Association (PSIK).
 In 2003 the value of private equity investments in the USA closed at EUR 49.1
1
billion (including EUR 16.3 billion or 37.2% of the so-called venture capital
investments at early stages of company development).
The value of private equity investments in Europe amounted to EUR 27 billion
(including EUR 8.4 billion or 31.1% of the so-called venture capital investments at
early stages of company development) in 2003.
The first private equity fund in Poland, the Polish-American Entreprise Fund,
was opened in 1990. Since that time, the number of such funds has grown to over 60
and is still rising. PE funds registered abroad (e.g. in the USA in Delaware or on the
British Jersey Isle) are managed by management companies (e.g. Enterprise
Investors Sp. z o.o. manages five funds). There around 35 such management
companies in Poland.
Between 1989-2003 PE funds acquired ca. EUR 5 billion, and most of their
investment capital comes from foreign institutional investors. The funds invested
around EUR 2.2 billion in over 600 companies in Poland (which represents 3% of the
value of Foreign Direct Investments in Poland until 20032) and EUR 2.1 billion in
companies in other CEE countries, i.e. the Czech Republic, Slovakia, Hungary,
Romania. In 2003 the value of private equity investments in Poland amounted to
EUR 133 million (of which EUR 57.6 million went to the so-called venture capital
investments at early stages of company development). Private equity investments
represented ca. 0.074% of the Polish GDP in 2003.
Private equity funds play a very important role in Poland, supporting
companies that undergo dynamic growth and are in need of capital injections. The
companies that have acquired private equity offer jobs to thousands of employees,
although they should not be seen as an unemployment remedy.
However, these funds are reluctant to invest in undertakings at early
development stages and the minimum investment sum reaches EUR (or USD) 3
million, although there are funds where that value starts at EUR 1 million or even
EUR 0.1 million. Both in Poland and elsewhere there is the so-called equity gap,
meaning that there is an access barrier to equity for small- and medium-sized
enterprises which are otherwise ready to expand.
Just as in other developed economies, the MBO/MBI market in Poland is
growing rapidly, financed by PE funds. The funds prefer MBO financing due to
economies of scale, which are related to commission-based remuneration of the fund
managers, depending on the value of the capital under management and the level of
risk of the undertaking.
Some of the companies that have acquired private equity in Poland and can
boast tremendous success include: Polfa Kutno S.A., Lukas S.A., ComputerLand
S.A., Euronet S.A.,@entertainment SA, HTL Sp. z o.o., Town & City S.A., Eldorado
S.A.

1
Average weighted exchange rate of the National Bank of Poland in 2003: EUR 1.00 = USD 0.884873
2
Accrding to the Polish Agency for Foreign Investments, FDIs had amounted to ca. USD 72 billion by 2003
 I. PRIVATE EQUITY – SOURCES OF DEVELOPMENT
AND ECONOMIC ROLE

1. PRIVATE EQUITY  DEFINITIONS

Foreign literature in the field often uses the terms “venture capital” or “private
equity”3. National associations of venture capital and private equity investors4 even
have those expressions in their names. In Polish literature, the English expressions
are often used, without their Polish equivalents5.
In this book the author refers to some Polish expressions, such as:
a. capital invested at early stages of company development for venture
capital or VC;
b. high-risk capital covering all stages of company development
(including venture capital) is private equity or PE.

1.1. VENTURE CAPITAL – CAPITAL INVESTED AT EARLY STAGES OF COMPANY

DEVELOPMENT

The term "venture capital” has various meanings, especially the word “venture”.
According to an English-Polish commercial dictionary6 it can mean: “a risk, business
undertaking, contribution to an undertaking, transaction, business, speculation or
goods sent abroad at the supplier's risk”. Hence, "venture" capital may be seen as
equivalent to "risk capital7", "speculative capital", "high risk capital”8 or "capital
invested in risky transactions".
The Oxford Dictionary of Business9 provides the following definition of risk
capital: “Capital invested in a project in which there is a substantial element of risk,
typically a new or expanding business. The capital is has the form of share capital
(shares, stocks in share capital) and not loan capital".
The difficulties with interpreting the term “venture capital” go beyond linguistic
considerations. Literature of the field presents different approaches to this issue,
depending on the stage of development of the given venture capital market. For
instance, P.A. Samuelson interprets “venture capital” as the funds (cash) made
available for the execution of highly risky projects10. Such general formulation
encourages us to a place the origins of contemporary high-risk companies in the
period of the Industrial Revolution, in the then formed partnerships between persons
with an idea or a technology and those with the necessary capital to finance the

3
E.g. Lerner J., Hardymon F., Venture capital and Private Equity. A Casebook., John Wiley & Sons, Inc., 2002
4
E.g.. European Private Equity & Venture Capital Association
5
E.g. Sieradzan P., Sobańska K., Inwestycje private equity/ venture capital, Key Text, Warsaw, 2004;
6
Słownik handlowy angielsko-polski, PWE, Warsaw 1991
7
Węcławski J., Venture capital. Nowy instrument finansowania przedsiębiorstw, PWN, Warsaw 1997
8
Wrzesiński M., Charakterystyka szczególnych form finansowania przedsiębiorstwa 7.2.2 [in:] Finanse
przedsiębiorstwa, ed. J.Szczepański, L.Szyszko, PWE, 2003
9
Oxford Dictionary of Business, 1996
10
Samuelson P.A., W.D.Nordhaus: Economics, New York 1985
project11 . In a narrower sense, “venture capital” is defined as the capital invested in
highly risky undertakings in the field of high-tech small- and medium-sized
enterprises.12
Jerzy Węcławski defines venture capital as “own funds contributed for a
limited period of time by third-party investors to small- and medium-sized enterprises
with an innovative product, production method or services which have not been
verified by the market and thus pose a high risk of investment failure, but at the same
time, if the undertaking supported by the investors ends with success, they will
ensure a significant growth in the value of invested capital, which is locked-in through
sale of shares”.13
According to Piotr Tamowicz from the Research Institute for Market Economy,
venture capital is mid-term and long-term capital invested in securities such as
shares (or quasi-shares) or stocks in non-listed enterprises with the intention to
redeem the shares or stocks at a later date in order to withdraw the invested capital
and lock in gains, the main source of which is the growth in the enterprise’s value 14.
According to the Polish Private Equity and Venture Capital Association,
venture capital refers to investments made at early stages of company development
aimed at starting-up or expanding the given enterprise.15
The American National Venture Capital Association defines venture capital as
the cash provided by specialist managers to young, fast-developing companies with
a high growth potential16. The funds’ investment partners:
 invest in equity securities;
 help the companies to develop new products and services;
 are actively engaged in company management;
 bear some risk in exchange for a high rate of return on capital;
 are devoted to a long-term investment horizon.

The website of NVCA17 specifies that some investors refer to venture capital and
MBO/MBI transactions as private equity. Others use the term private equity only with
regard to MBOs/MBIs.
The European Private Equity and Venture Capital Association describes
venture capital as an element of private equity referring to capital investments in
companies at such stages as seed, start-up and expansion.18
This book will use the following definition of venture capital:
Venture Capital refers to investments (usually made through specialist legal
vehicles19 called venture capital funds, acting as financial intermediaries) in share

11
Venture Capital jako źródło finansowania inwestycji dla MŚP, Sygma Sp. z o.o. – paper for the 3rd National
SME Conference, Warsaw16-17.06.1998
12
Cleifie Ch.C., Venture Capital in Europe. [in:] Venture Capital Markets for Regeneration of Industry. J.M.
Gibb, Amsterdam 1984
13
Węcławski J.,Venture capital. Nowy instrument finansowania przedsiębiorstw, PWN, Warsaw, 1997, p. 17
14
Tamowicz P., Fundusze inwestycyjne typu Venture Capital. „Transformacja Gospodarki”, 60/1995, IBnGR,
Gdańsk 1995, p.3
15
www.ppea.org.pl
16
Definition after www.nvca.com
17
www.nvca.com
18
EVCA Yearbook 2004, p. 293
capital of private (non-listed) enterprises at early stages of their development, such
as seed, start-up or expansion. Venture capital investments are included under
private equity investments, which have a broader meaning. Apart from equity, VC
funds contribute management capital to the portfolio company, which should result in
value growth.

1.2. PRIVATE EQUITY – CAPITAL CHARGED WITH HIGH RISK

According to P.A.Gompers and J.Lerner, two American scholars studying the

market for private equity investments, the boundary between venture capital and
private equity investments is not clear20. The authors believe that venture capital
funds deal mainly in equity or equity-linked investments addressed to young, high-
growth companies. On the other hand, many venture capital funds occasionally use
various private equity investments.
Literature of the field and specialist literature have increasingly used a broader
term: “private equity. The names of national associations of this type of investors
include the terms “venture capital” and “private equity”, such as the above-mentioned
European Private Equity and Venture Capital Association. Venture capital is one of
the segments of private equity, although these two terms may also be used
interchangeably.
D.Gladstone and L.Gladstone also describe venture capital as one of the
segments of private equity investments21. Apart from venture capital they also list
MBO/MBI and mezzanine financing.
Just as the EVCA, the Polish Association treats venture capital as an element
of private equity22.
According to PSIK, private equity includes investments on the non-public
capital market aimed at generating mid-term and long-term gains on capital value
growth. Capital from PE/VC investments may be used to develop new products and
technologies, increase the working capital, acquire companies or improve and
strengthen the balance sheets.
K.Sobańska and P.Sieradzan23 define private equity as mid-term and long-
term share investments, usually on the non-public market, combined with
management support to the enterprise, which have the potential of above-average
value growth within the timeframe specified by the investor.
In this book the following definition of private equity has been adopted:

19
The limited partnership is the most common organizational and legal form in the USA (also existing in the UK
and Sweden), sharing some features with limited partnership under Polish law, i.e. spółka komandytowa.
20
Gompers P.A., Lerner J., The Venture Capital Cycle, The MIT Press, 1999, p. 3
21
Gladstone D., Gladstone L., Venture Capital Handbook: An Entrepreneur’s Guide to Raising Venture Capital,
Financial Times Prentice Hall, Londyn-Nowy Jork, 2001, p. 5
22
www.psik.org.pl /new/slowniczek.php
23
Sobańska K., Sieradzan P., Inwestycje Private Equity / Venture Capital, KeyText, Warsaw 2004, p. 13
Private equity refers to investments (usually made through specialist legal vehicles24
called private equity funds, acting as financial intermediaries) at all stages of
development of non-listed enterprises in order to boost their value and obtain above-
average capital gains. Private equity investors also contribute management capital
(depending on the company’s needs), which may be an important value growth
generator for the company.
The spectrum of investments of a PE fund may be very broad, covering
funding on different stages of enterprise financing.
Private equity investments include:
a. Seed capital;
b. Start-up capital;
c. Capital enabling financial enterprises to reach a level of production that
guarantees them profitability, with a relatively stable market position;
d. Capital used to finance the company’s expansion extension of its activity,
acquisition of new sale markets;
e. Capital for financing mergers or distribution of the company’s shares on the
market;
f. Rescue capital, recovery capital or turnaround capital to save the company
from insolvency;
g. Capital used to finance undertakings aimed at acquiring the company from its
previous owners by a group of the company’s or third-party managers
(management buy-outs, MBO or management buy-in, MBI);
h. Capital used to privatize state-owned enterprises;
i. Capital to withdraw company shares from public trading (delisting);
j. Capital used for bridge financing;
k. Capital used for M&A financing and Buy & Build Strategies;
l. Mezzanine – financing of undertakings with the use of equity-linked securities
(mainly convertible bonds warrants or preferential shares25).

In this book we use the term “private equity funds” or “PE funds” for private equity
funds and the term “venture capital funds” or “VC funds” for funds investing at early
stages of company development26. VC or PE funds acting as financial intermediaries
are legal (investment) vehicles, depending on the applicable regulations in the given
country. The most common organizational and legal form of VC/PE funds in the world
is the aforementioned limited partnership. Other common forms include corporations,
partnerships and various funds. A typical private equity fund is headed by the
managing partner(s), followed by investment directors (managers) and investment
analysts.
24
The limited partnership is the most common organizational and legal form in the USA (existing also in the UK
and Sweden), sharing some features with limited partnership under Polish law, i.e. spółka komandytowa.
25
K.Sobańska, P.Sieradzan, ibidem, p. 236 point out that the structure of preference shares in the Polish law is
different from the structure used in many other countries.
26
We should mention the draft Act on the National Capital Fund adopted by the Council of Ministers on 11 th
September 2004. The Act defines a capital fund as a legal person or organizational unit without legal entity
whose scope of activities covers only making investments.
 Some funds specialize only in venture capital investments (VC funds), others
only in MBOs (buyout funds) or mezzanine financing (mezzanine funds). There is
also a large group of funds which do not focus on any specific PE segment.

1.3. THE NATURE OF PRIVATE EQUITY INVESTMENTS AT SUBSEQUENT STAGES

OF COMPANY DEVELOPMENT

At early stages of company development, to which “classical” venture capital is

addressed, there is a new undertaking, a new product or service, or a new market
approach. At this stage the business is owned by its founders. The company has no
credit worthiness, usually generates negative investment cash flows (new
investments in the purchase of fixed assets, licenses and patents) and negative
operating cash flows. Sale revenues are usually low and the financial result is
negative (see Chart 1). Financing is mainly of the equity-type (sale of shares or
stocks to the VC fund), although also equity-linked financing is possible (e.g. shares
in share capital and a short-term loan from the fund). In a classical situation VC
financing is provided in tranches, so that the company receives e.g. USD 1 million in
the first round, USD 5 million in the second and USD 10 million in the third round 27.At
this stage the cash from a VC fund flows mainly to high-tech sectors, such as
biotechnology, medicine, ICT, but in practice any sector is taken into account by the
fund’s managers. Investments at early development stages are charged with a very
high risk (mainly due to the business model), but the fund receives a reward in the
form of a high rate of return.
At the next stage of expansion, the company has survived on the market for at
least several years, has a tested business model and experienced managers. The
sale revenues and level of cash are growing; net profits are starting to appear (see
Chart 1.1). The need for more capital results from continued market, territory and
product expansion or competitor take-overs. At this stage VC fund and PE funds may
offer equity financing (purchase of shares, stocks) or equity-linked financing (e.g.
purchase of bonds convertible to shares). A company with some credit worthiness
may apply for third-party financing. The risk of financing the company remains high,
mainly due to the management’s compliance with the business plan.
At the next stage the model company is a mature business, generating net
profits and positive cash flows, with a stable market position. If a private equity fund
has already invested in that company, in may be interested in withdrawing the capital
to lock in gains. The company’s current owners or managers as well as new PE
funds may repurchase the stake from the investor.
On the other hand, the company may need additional bridge financing to generate
even higher financial results before it is listed. At this stage of development the
company may use all sources of equity, third-party or equity-linked financing. PE
funds will be interested in companies with positive cash flows (see Chart 1.1),

27
In the Polish context the companies see the value of USD (or EUR) 3 -5 million as a certain minimum below
which they will not allocate capital in the new business, although there are cases where the limit equals USD 0.1
million (MCI Management S.A.) or USD 0.5 million (Renaissance Partners).
generated fairly regularly throughout the year (low seasonality). The risk is linked
mainly with the financing structure and not the business model. The possibility of
further expansion is the key to generating attractive rates of return on the investment.

Chart 1.1 Life cycle of a typical company funded with private equity

Sale revenues
PLN million

Maturity
MBO/MBI
Bridge financing before
Expansion stock exchange lisitng

Operating cash flows

Early stage

Net profit

Time

Source: own work

1.4. TYPES OF PRIVATE EQUITY INVESTMENTS IN THE USA AND EUROPE

NVCA distinguishes four stages of development of undertakings financed by
VC funds:
 early stage financing, covering seed capital, start-up capital and other early
stages;
 expansion;
 later stage financing, later stage, bridge financing, open market;
 acquisitions and buyouts: acquisition financing, leveraged buyout (LBO)
financing, turnaround financing; 28

28
Kornasiewicz A., Venture capital w krajach rozwiniętych i w Polsce, CeDeWu, Warsaw 2004, p. 26 [after:]
NVCA Yearbook 2001, Thomson Financial / Venture Economics, Airlington, 2001, p. 117
Table 1.1 below contains a detailed description of subsequent stages of business
development.
Table 1.1
Characteristics of business development stages
Business development Stage description
stages
1. Early stage financing
Seed capital A relatively low sum of capital provided to the inventor or
entrepreneur so that he can develop the business concept and
become eligible for start-up financing. At this stage financing
can cover product development, market research, recruitment of
management, development of the business plan.
Start-up capital At this stage the capital is addressed to companies at an early
stage of development and may cover the initial marketing
campaign. The portfolio companies can be under formation or
have operated for a year or less, and have not sold their
products or services yet. At that stage companies have usually
carried out market research, employed key managers,
developed a business plan and are ready to launch commercial
activities.
Other early stages They cover the financing of valuation increase, the size or price
of one share of companies whose products/services are under
development or already available on the market.
2. Expansion financing This stage concerns the financing of current capital needed for
the company’s early development (increase in receivables and
inventories). At that stage the company may but does not have
to finance its investment expenses on expansion of its factory,
marketing costs, current assets, development of an enhanced
product. The role of PE funds evolves from operational support
to strategic consulting.
3. Later development stage financing
Later stage Companies with a stable level of growth. Most companies at this
stage are profitable. They have positive cash flows.
Bridge financing This is the stage when the company intends to list its shares on
a stock exchange in some 6 to 12 months. Very often bridge
financing can be refinanced from the income derived from the
public offering. It may also take the form of restructuring the
shares of the main shareholders who resell their shares.
Restructuring may also occur when shareholders who have
invested at earlier stages of development wish to reduce or
redeem their positions. Restructuring can also be motivated by
changes in the management board. The shares held by the
previous management board members and their relatives are
repurchased so that their supply is reduced upon the company’s
initial offering.
Open market At this stage the company's shares, which have been admitted
 to public trading, are purchased.
4. Acquisition and buy-out financing
Acquisition financing The capital is provided to finance the acquisition of another
company. This also includes mezzanine financing through
subordinated debt and bridge loans used in LBOs and
acquisition financing. NVCA includes such transactions in its
aggregated data on venture capital, if such transactions are
financed by VC funds.
MBO/LBO financing The capital provided at this stage enables the management to
purchase a production line or an entire enterprise (at any
development stage) from a non-listed (or listed) company. Such
transactions often cover private (also family-owned) enterprises.
NVCA includes such transactions in its aggregated data on
venture capital, if such transactions are financed by VC funds.
Turnaround financing Financing companies that plan deep restructuring or efficiency
improvement process, despite financial problems. This also
refers to financing directed at restructuring the company’s
equity.
Source: based on Kornasiewicz A., Venture capital w krajach rozwiniętych i w Polsce, CeDeWu,
Warsaw, 2004, p. 29-31
In Europe, EVCA uses a classification of investments which is similar to that of NVCA
and is maintained for statistical purposes. It provides for the following stages:
 Seed – seed capital;
 Startup– start-up capital, other early stages;
 Expansion – expansion, bridge financing, turnaround;
For the sake of comparison, the above stages are defined as venture capital
investments.
 Replacement capital – secondary purchase, capital conversion, refinancing
bank debt;
 Buyouts – MBOs, MBIs, venture purchase of quoted shares29.

2. ORIGINS OF PRIVATE EQUITY

Currently, the role of private equity in the financing of high-growth companies

is widely appreciated around the world. In the last thirty years, many companies,
such as 3 Com, Amgen, AMD, Compaq, Cisco, Federal Express, Genentech, Intel,
Sun Microsystems and Lotus, have been founded with the help of PE funds. Globally,
there are over 30 national associations of private equity and venture capital
investors, including the Polish Association of Private Equity and Venture Capital
Investors (PSIK).
The origins of venture capital date back less than 70 years. However, in a
broader sense, the expression “private equity" has existed for thousands of years.
The history of global economic development provides us with many examples of

29
EVCA Yearbook 2004, June 2004, p. 294
financing innovative or highly risky investments. The capital provider was motivated
by the prospects of multiplying the invested funds. Oversees merchant trips may
serve as an example here. In the 15th century the role of a private equity investor was
played by the Spanish Queen Isabela I of Castile, who financed the sea voyages of
Christopher Columbus to India. The Queen expected high incomes from the
voyages, by far exceeding her expenses. The income directly affected the economic
and political position of Spain in Europe, so the Queen was ready to bear the high
risk of the voyages.
The requirement for capital to finance innovations became more evident in the
19th century in the context of the Industrial Revolution in Western Europe and in the
USA30. The innovative ideas of manufacturers were usually capital-consuming. The
main capital providers included bankers and wealthy merchant families. Banks were
the first institutional capital investors supporting innovative enterprises. Seeing as
many banks operated as single-person enterprises or partnerships at that time, their
investments were charged with high risk. Gradually, to spread the investment risk,
banks began creating subsidiaries which acquired shares in companies (e.g. Societe
Generale established such an investment vehicle in Belgium in 1822).
Until WWII both the government and the government agencies were devoted
to financing such companies, and informal investors (today referred to as “business
angels”) were the main sources of capital. Generally, looking at the history of private
banking, those banks were not keen on lending money to newly-founded companies
due to high risk and lack of credit securities.

2.1. DEVELOPMENT OF PRIVATE EQUITY IN THE USA

After WWII the USA saw the emergence of intermediaries specializing in
investing in high-growth enterprises. For instance, wealthy families, such as the
Mellons, the Phipps, the Rockefellers and the Whitneys, founded their agencies in
New York and employed experienced managers to look for attractive investment
opportunities, i.e. small niche companies with a high growth potential. They were the
first, family-owned private equity funds. Each of those funds has changed its
organizational structured, but some of them have survived until this day, such as
Rockefeller (Venrock), Whitney (J.H.Whitney) and Pipps (Bessemer Ventures).
Traditionally located on the East Coast, PE funds evolved gradually, taking the
form of highly professional institutions. At that time the PE funds had shifted their
focus from New York and Boston on the East Coast to the Silicon Valley in California.
Until mid-1980s a typical American PE fund had its headquarters in the Silicon Valley
and invested mainly in electronic companies, and lesser amounts in companies using
biomedical technologies. Currently, apart from the Silicon Valley, there are two key
areas of concentration of private equity in the USA: New York and Boston.
After 1946 the USA experienced a continued growth in supply of private
equity. After the Potsdam Conference the Allies quickly went their separate ways and
the USA engaged in an arms race with the Soviet Union. This meant that it had to
gain technological advantage over its competitor, and this required devoting
substantial financial means to scientific research and implementation of inventions
and innovations. Not all projects were executed under government research

30
Węcławski J., Venture capital. Nowy instrument finansowania przedsiębiorstw, PWN Warsaw 1997
schemes. Many small private companies developed promising undertakings and
needed capital to implement them. Their small size, short history and lack of financial
stability often prevented them from obtaining bank loans, so their only option was to
increase their equity through sale of shares or stocks.
In the USA, the American Research and Development Corporation from
Boston, founded in 1946 by the president of the Massachusetts Institute of
Technology (Karl Compton), a Harvard Business School professor (George F.Doriot)
and local entrepreneurs, was an important undertaking. Doriot encouraged many
HBS students to study investment strategies. Later, many of them became partners
in private equity funds. Seeing as institutional investors were not interested in capital
contributions to the ARD, the Corporation was structured as a mixed closed-end fund
addressed mainly to private investors. The organization had two primary aims:
 injecting young, high-tech companies focusing on the arms sector with capital,
and
 facilitating the execution of an undertaking, by providing professional
management support.
The greatest success of the corporation was its investment in Digital
Equipment Corporation. In 1958 ARD invested USD 100 thousand in the
establishment of a new computer company (77% of its shares were purchased for
USD 70 thousand and the rest was offered as a loan). After DEC’s market success
and listing of its shares, the company’s market capitalization increased to USD 350
million in 1971. Ten years after ARD’s foundation a few more PE funds were created,
operating as closed-end funds.
The role of the US government in the development of private equity
investments was mostly indirect. The US government pursued a monetary and fiscal
policy ensuring low inflation, stable public finances and a stable USD exchange rate.
Reductions of the capital gains tax for natural persons also had a positive effect on
the availability of equity. For instance, in 1978 the US Congress decreased CGT from
35% to 28%.
The US Department of Labor adopted the Prudent Man Rule in 1979, pursuant
to which pension fund managers could invest free cash (from 5% to 10% of the
fund’s asset portfolio) in non-listed companies. This increased the value of engaged
capital flowing into VC funds from USD 68.2 million in 1977 to USD 978.1 million in
1978 (1987 prices in USD). Another reduction of the CGT came in 1981 and resulted
in yet another inflow of cash to VC funds, up from USD 961.4 million to USD 5.1
billion in 1981. In the 1980s the value of cash acquired by VC funds oscillated
between USD 2 billion and USD 5 billion. After a decline to USD 1.3 billion in 1991
there came a period of dynamic growth, with a peak in 2000, closing with USD 107.2
billion.
The Nasdaq Securities Market, opened in New York in 1971, became the
perfect location for disinvestments of PE funds. The market was strongly regulated
as regulations were introduced to protect investor funds, but this also contributed to
market transparency and lower investment risk.
Another important aspect of private equity development in the USA has been
the eagerness of the private sector to invest in university research projects. The
advantages of those investments were derived by the investors, the inventors and
the universities involved. Graduates of exact sciences, such as electronics, computer
studies, biotechnology etc. are a measurable outcome of those investments. Those
scientific undertakings led to the emergence of qualified staff and innovations, and
some project participants became founders of PE funds. American universities such
as MIT, Stanford, UC Berkeley play an important role here.
The Small Business Investment Act of 1958 was the most important, direct
contribution of the US government to the development of private equity investments.
It provided for the establishment of Small Business Investment Companies.
The Act was somewhat complicated, but it was an important element of PE
development. It adopted the principle of maximizing the share of private equity in the
SBIC scheme. The main aim of the program was to support active private equity
funds with public capital.31

2.2. DEVELOPMENT OF PRIVATE EQUITY IN EUROPE

In Europe, the private equity market began developing in the 1960s, first in the
UK, and then on the continent. The pioneer of VC funds on the British market was
the Industrial and Commercial Finance Corporation established by the five largest
commercial banks and the Bank of England in 1945, which provided high-growth
companies with capital in exchange for shares or stocks. The ICFC has survived until
this day as Investors in Industry Group PLC.
Until mid-1990s private equity was a rarity in Europe, especially in comparison
with the abundance of start-up capital in the USA. Therefore, venture capital did not
play a major role in financing young high-growth companies at that time. Until then,
the policy promoting venture capital in the EU had been wrong, says Thomas
Lawton32. It neglected the key aim, the development and expansion of small- and
medium-sized enterprises by eliminating the equity gap. National governments of EU
member states and the European Commission itself concentrated on the
development of business-friendly infrastructure and not on supporting the leaders of
economic growth – the growth companies or sectors.
After the Maastricht Treaty of 1992, EU reports and drafts of the European
Commission managed to combine economic competitiveness with low
unemployment33. The European Commission underlined that there was a clear
connection between venture capital and employment, arguing that “growing risk
capital in the EU, leading to the development of pan-European VC markets, plays a
special role in job creation across the EU34”.
T.Lawton35 points out that private equity investment markets are necessary for
facilitating the access of small- and medium-sized enterprises to funding across
Europe. They reduce the dependency of small-companies on short-term loans, i.e.
overdrafts – a practice, which, according to Aernoudt36, is twice as common in the EU

31
The SBIC is described in more detail in Chapter II Item 1.8.3
32
Lawton T., Missing the target: assessing the role of government in bridging the European equity gap and
enhancing economic growth, Venture Capital 2002, vol. 4 no. 1, p. 7-23
33
CEC, Action Plan for Innovation in Europe: Innovation for Growth and Development, White Paper COM (96),
589, 20, listopad 1996 oraz CEC, Seed Capital, a Pilot Action of the European Commision: Progress Report
(Bruksela DG XXIII) 1998
34
CEC, Risk Capital: a key to job creation in the European Union, Luxemburg, Office for Publications of the
European Community, 1998
35
Lawton T., Missing the target: assessing the role of government in bridging the European equity gap and
enhancing economic growth, Venture Capital 2002, vol. 4 no. 1, p. 7-23
36
Aernoudt A., European policy towards venture capital: myth or reality?Venture Capital 1999 no. 1/1, p. 47-58
as it is in the USA and which increases the level of equity financing in Europe. This,
in turn, creates jobs and stimulates economic growth37.
In 2000 Elliot Posner38 stressed that the sector of high-growth high-tech small-
and medium-sized enterprises in Western Europe developed in late 1990s, financed
largely by private equity funds. Growth of PE investments in Europe was coupled
with a growing number of IPOs on new stock exchanges, addressed to new, high-
growth companies. Access to those markets is closely related to expanding activity of
VC funds, as it enables investors to sell their shares. At the end of 2000 there were
over 30 high-tech companies listed on Neuer Markt in Frankfurt, ca. 140 companies
on Nouveau Marche in Paris and ca. 430 companies on the Alternative Investment
Market in London. Similar markets were opened in other EU countries, such as
Nuovo Mercato in Milan and Nuevo Mercado in Madrid. The companies acquired
over EUR 22 billion on the new markets through IPOs. After March 2000 there was a
strong adjustment of share prices due to instability on global markets. This led to a
decline in capitalization of the new markets and fewer IPOs, which also reduced the
number of VC investments. However, the emerging private equity investment market
in Europe, though still small in comparison to the USA, is past the early stage. It has
its own group of specialist investment managers, lawyers and private equity
investment advisors.
Private equity in Europe evolved at a time of turmoil on the European financial
markets after introduction of EUR, mounting competition pressures, growth in M&A
activity, structural changes to address global economic challenges.
The major private equity investment centers in Europe are located in the UK
(London), France (Paris) and Israel39.

3. THE ECONOMIC ROLE OF PRIVATE EQUITY

The global market for private equity investments has developed considerably
since 1989, recording its peak dynamics between 1995 and 2000. Chart 1.2 presents
the development of private equity across the world and Chart 1.3 depicts the
development of private equity in the three largest regions (North America40, Western
Europe41, and Asia-Pacific42).

37
Westall, Cowling, Agenda for Growth (Londyn IPPR), 1999
38
Unpublished doctoral thesis w UC Berkeley, materiał niepublikowany
39
Annex 3 presents the development cycle of VC investments in Israel as compared with the US market.
40
USA and Canada
41
UK, France, Germant, Italy, Netherlands, Belgium, Switzerland, Sweden, Spain,
42
Hongkong, China, Japan, South Korea., Singapur, Australia, Taiwan, India
Chart 1.2

Global private equity – invested and acquired

300
250
200
USD billion 150
100
50
0
199 199 199 199 199 200 200 200
5 6 7 8 9 0 1 2
Kapitał zainwestowany 41 53 59 90 159 206 103 102
Kapitał pozyskany 44 52 108 132 152 250 165 88

[x: Invested PE, Acquired PE]

Source: Price Waterhouse Coopers, data for 1998-2002 come from Global Private Equity 2003, data
for 1995-1997 come from Global Private Equity 2001, www pwcmoneytree.com.

Chart 1.3 presents the three largest regions, which together represent almost 95-
96%.

Chart 1.3
Private equity (acquired and invested) in North America, Western Europe and
Asia-Pacific
200.0
180.0
160.0
140.0
120.0
100.0
80.0
60.0
40.0
20.0
0.0
1995 1997 1998 1999 2000 2001 2002
Ameryka Pn. Kapitał
21.0 41.5 63.5 120.1 152.0 66.3 64.3
zainwestowany
Ameryka Pn. Kapitał pozyskany 31.0 74.8 95.9 103.6 180.5 117.5 57.0
Europa Zach. Kapitał
6.0 10.9 16.2 26.8 32.0 21.5 25.8
zainwestowany
Europa Zach. Kapitał pozyskany 6.0 22.6 22.8 27.1 43.7 34.0 26.0
Azja - Pacyfik Kapitał
6.0 4.6 4.9 9.1 12.3 11.2 9.0
zainwestowany
Azja - Pacyfik Kapitał pozyskany 7.0 5.9 7.4 16.6 17.9 9.9 3.0
[North America, invested PE
North America, acquired PE
Western Europe, invested PE
Western Europe, acquired PE
Asia-Pacific, invested PE
Asia-Pacific, acquired PE]

Source: Price Waterhouse Coopers, data for 1998-2002 come from Global Private Equity 2003, data
for 1995,1997 come from Global Private Equity 2001, www.pwcmoneytree.com

The value of acquired capital increased from USD 44 billion in 1995 to USD 250
billion in 2000, dropping again to USD 88 billion in 2002. The highest growth and
decline dynamics of the value of acquired private equity occurred in North America,
where the financing grew from USD 31 billion in 1995 to USD 181 billion in 2000, and
then to USD 57 billion in 2002.

For over thirty years the private equity market has played an important role in the US
economy in the development of innovations and wealth creation. It has played a
significant role in developed and developing economies around the world 43. It is
very difficult to measure the impact of private equity on the economic growth in most
countries, as this type of capital constitutes a very small portion of the GDP. Table
1.2 presents the share of selected categories, such the value of PE investments,
market capitalization, R&D expenditure in GDP in 20 countries.

Table 1.2
Share of PE investments, market capitalization, R&D expenditure in GDP in 20
countries.
GDP PE % Market % GDP R&D %
in investments GDP capitalizatio expendit GDP
2002 in 2002 n in 2002 ure in
2001
USD
USD billion USD billion billion
0.600
1 USA 10446 62.68 % 11055.57 105.84% 294.58 2.82%
0.616
2 UK 1555 9.58 % 1800.66 115.80% 29.55 1.90%
0.390
3 France 1419 5.53 % 1476.00 104.02% 31.22 2.20%
0.209
4 Italy 1186 2.48 % 477.08 40.23% 12.69 1.07%
0.060
5 Japan 3996 2.38 % 2095.52 52.44% 123.48 3.09%
0.119
6 Germany 1987 2.37 % 686.01 34.52% 49.48 2.49%
0.416
7 South Korea 469 1.95 % 215.66 45.98% 13.88 2.96%
0.389
8 Netherlands 419 1.63 % 695.00 165.87% 8.13 1.94%
43
Gompers P.A., Lerner J. ,The Money of Invention, Harvard Business School, 2001
 0.215
9 Canada 729 1.57 % 570.22 78.22% 14.14 1.94%
0.584
10 Sweden 238 1.39 % 179.12 75.26% 10.16 4.27%
0.308
11 Australia 393 1.21 % 380.09 96.72% 6.01 1.53%
0.228
12 India 460 1.05 % 242.84 52.79% 2.30* 0.50%
0.951
13 Israel 103 0.98 % 40.77 39.58% 2.80* 2.72%
0.141
14 Spain 654 0.92 % 461.56 70.57% 6.28 0.96%
0.460
15 Hong Kong 163 0.75 % 463.05 284.08% 0.35* 0.21%
0.324
16 Indonesia 173 0.56 % 30.07 17.38% 0.48** 0.65%
0.326
17 Finland 132 0.43 % 138.83 105.17% 4.48 3.39%
0.356
18 South Africa 104 0.37 % 116.54 112.06% 0.72 0.69%
0.028
19 China 1237 0.35 % 463.09 37.44% 60.00 4.85%
0.138
20 Belgium 247 0.34 % 185.00 74.90% 4.84 1.96%
* 1999, ** 1996
Own presentation on the basis of:
1. GDP value  Institute of International Management World Competitiveness 2003
2. VC value – PricewaterhouseCoopers, www.pwcmoneytree.com
3. Market capitalization, World Federation of Exchanges www.world-exchanges.org apart from France,
Netherlands, Belgium (Euronext data)
4. R&D expenditure  www.oecd.org

Israel with an index of 0.951% (index of PE investments’ share in GDP) ranked first
in 2002, followed by the UK and USA (see Table 1.3). Schedule 3 in the Annex
presents the life cycle of the VC market in Israel as compared with the USA.

Table 1.3
Ranking: share of PE investments, market capitalization, R&D expenditure in
GDP in 20 countries.
No. Country PE Ranking Market Ranking R&D Ranking
investments capitalization expenditure
in 2002 as % as % GDP as % GDP
GDP

1 Israel 0.951% 1 39.58% 17 2.72% 7

2 UK 0.616% 2 115.80% 3 1.90% 13
 3 USA 0.600% 3 105.84% 5 2.82% 6
4 Sweden 0.584% 4 75.26% 10 4.27% 2
5 Hong Kong 0.460% 5 284.08% 1 0.21% 20
6 South Korea 0.416% 6 45.98% 15 2.96% 5
7 France 0.390% 7 104.02% 7 2.20% 9
8 Netherlands 0.389% 8 165.87% 2 1.94% 11
9 South Africa 0.356% 9 112.06% 4 0.69% 17
10 Finland 0.326% 10 105.17% 6 3.39% 3
11 Indonesia 0.324% 11 17.38% 20 0.65% 18
12 Australia 0.308% 12 96.72% 8 1.53% 14
13 India 0.228% 13 52.79% 13 0.50% 19
14 Canada 0.215% 14 78.22% 9 1.94% 11
15 Italy 0.209% 15 40.23% 16 1.07% 15
16 Spain 0.141% 16 70.57% 12 0.96% 16
17 Belgium 0.138% 17 74.90% 11 1.96% 10
18 Germany 0.119% 18 34.52% 19 2.49% 8
19 Japan 0.060% 19 52.44% 14 3.09% 4
20 China 0.028% 20 37.44% 18 4.85% 1
Source: see above.

The greatest advantages of private equity come in the form of innovations, defined
after Schumpeter, which contribute not only to the emergence of new companies, but
also – and most importantly – to the emergence of new industries. It is also difficult to
estimate private equity because the companies financed by PE funds would have
developed without their capital engagement, by reinvesting net profits. However,
without a strong capital injection from PE funds, the technological inventions
implemented as such companies would have evolved at a much lower rate.
One can ask: how do we measure the impact of private equity investments on
economic growth? On the one hand, we can measure the impact of PE on new job
creation, broken down into various industries.
However, we can only measure the companies who have gone public, because
access to information on unlisted companies is very limited and so far there are no
summary lists with their financial indicators.
Investments in companies that are entering the stock market ensure higher rates of
return than companies purchased by or remaining in private hands. PE funds have
been very successful at listing their portfolio companies (introducing their shares to
the stock exchange). The following Chart 1.4 presents the history of IPOs for
companies that were beneficiaries of private equity in 1972-2003 in the USA.
Chart 1.4
Number of new stock exchange companies with venture capital

300
260
250
225
204
200
Mumber of IPOs

151
150 129 126
109 114 115
93 100
100 80
75
55 52 51
50
42 44 46 41
18 20 24 29
2 9 4 0 8 5 7 5
0

Year

Source: Securities Data Company, NVCA

On the American stock exchange there are shares of many companies that have
acquired some private equity in their history. They include such companies as Intel,
Cisco Systems, Federal Express. For instance, in 1999 a venture capital fund
Kleiner, Perkins, Caufield, Byers44 announced that the market value of its portfolio
companies had amounted to USD 657 billion at the opening of the fund in 1973, the
companies' revenues had totaled USD 93 billion, while the total employment had
been 252 thousand persons and the total value of investments had reached ca. USD
2 billion45. It is hard to extrapolate on the basis of the KPCB fund, which is considered
a VC fund that has achieved the greatest success worldwide. However, the
cumulated impact of over 600 portfolio companies of VC funds in the USA has a
considerable impact on such a large economy as the US economy.
In 1982 an entity called General Accounting Office (GAO) in the USA studied
the impact of VC investments on the US economy. Extrapolating the performance of
72 public companies operating in 1979 which had obtained venture capital (1332 VC
funds were active at that time), GAO forecast that employment would have increased
by 522 thousand to 2.54 million persons, depending on the annualized company
growth dynamics. NVCA46 studies carried out in the USA by DR-WEFA in 2001
showed that companies with VC in the USA generated 4.3 million jobs and USD 736
million in revenues in 2000. Out of every 9 jobs in 2000, one was created by a
venture capital recipient.

44
The Fund’s website: www.kpcb.com
45
Kenney M., Han K., Tanaka S, Scattering Geese: The Venture Capital Industries of East Asia. A Report to the
World Bank. Brie Working Papers 146, September 17, 2002
46
NVCA, “New Study Documents 4,3 Million Jobs and $736 Billion in Annual Revenues Created by Venture
Capital Investments” (2.05.2001)
 Another DRI-WEFA study47 of venture capital in the USA, published in 2002,
showed that between 1970-2000 VC funds had invested USD 273.3 billion in 16,278
companies in all 50 American states. The recipients of venture capital employed 7.6
million people and generated almost USD 1.3 trillion in sale revenues in 2000, or
5.9% of the total US workforce at that time and 13.1 of American GDP (see Table
1.4).

Table 1.4
Impact of venture capital investments on sales and employment in the USA
between 1970-2000
US state Cumulative VC Sales of VC recipient Employment at VC
investments between companies in 2000 in recipient
1970-2000, in USD USD million companies in 2000
million
California 108 810 207 616 1 415 748
Massachusetts 25 986 48 848 381 433
Texas 17 189 158 183 676 158
New York 16 070 65 848 369 314
Colorado 9 881 14 565 62 971
New Jersey 9 138 38 151 260 114
Washington 7 383 75 392 263 585
Virginia 7 215 35 689 207 777
Pennsylvania 7 187 58 037 424 652
Georgia 6 435 62 797 338 188
Total in the 273 300 1 300 000 7 600 000
USA
Source: J.Metzger, Ch.Brooks, „Three Decades of Venture Capital Investment Yields 7,6 mln Jobs
and 1,3 Trillion In Revenue” NVCA (22.10.2001), www.nvca.com

Studies show that VC recipients were characterized by:

 twice as high sales,
 thrice as high amount of paid federal taxes,
 twice as high exports and thrice as high R&D investments per USD 1000 in
assets,
In comparison to companies that have not used VC funding.
According to the authors, each USD 36 thousand in VC investments
generated one new job.
The experience of the US market suggests that jobs created by high-growth
companies using venture capital are characterized by a higher value (high
specialization) and above-average salaries48.

47
Taylor J., Brooks Ch., Hodge A. “DRI-WEFA Study Identifies Venture Capital as a Key Factor Powering US
Economic Growth” – report findings published at www.nvca.com dated 26.06.2002.
48
Lawton T., Missing the target: assessing the role of government in bridging the European equity gap and
enhancing economic growth, Venture Capital 2002, vol. 4 no. 1
 A study by British Venture Capital Associations (BVCA) in 1999 revealed that
revenues of PE-funded companies had grown by 24% or thrice as fast as those of
FTSE 100 companies and 70% faster than FTSE 250 companies. It was estimated
that 2 million Brits or 10% of workforce at that time was employed by portfolio
companies of PE funds.
Mason and Harrison49 argue that venture capital is the driving force promoting
innovations, economic development and employment, as it facilitates the
establishment and development of small, high-growth companies. Many other
structural factors are used, such as an effective transfer of technologies, seeds, FDI.
Private equity is not a remedy, but a key to success. In recognition of that fact at the
EU-level, entrepreneurship has become one of the four pillars of EU policies aimed at
counteracting unemployment, as confirmed at the Luxembourg summit, which
highlighted the special need to broaden the access to venture capital, mainly by
improving the operating conditions on private equity markets.
Private equity is creating jobs and wealth. EVCA and Coopers and Lybrand
conducted a study among 500 companies which had acquired private equity and
compared the results of that study with the performance of the TOP 500 as
presented by Financial Times. The study showed that employment at VC recipient
companies grew at an annual rate of 15% between 1991-1995, and ca. 60% of the
respondents stated that the entry of their venture capital investor positively affected
new job generation. Four in every five companies confirmed that without venture
capital injections their business would not exist or would have developed at a much
slower rate.
In 1998 the European Roundtable of Industrialists, an influential group
composed of experienced businessmen, also recognized that there was a link
between venture capital, competitiveness and job creation. They believe that fast
access to private equity on reasonable terms and in due time is crucial to companies'
success and innovation.
EVCA studies also revealed that venture capital recipient companies recorded
a higher rate of return on sales, R&D expenditure and job creation than companies
without such capital between 1990-199550 . The updated study from 2002 proved that
PE funds had invested EUR 9.8 billion in 8,684 portfolio companies in 2002. Ca. 1/3
of the value of that investment was addressed to companies at early stages of
development. Results of further studies from June 2002 showed that 95% out of
100% of the portfolio companies would not have survived on the market or developed
without the venture capital investments.51
Therefore, another question arises: To what extent do private equity funds
influence the level or company or sector innovation?
P.Gompers and J.Lerner 52 highlight two directions of reasoning. First, venture capital
funds search for innovative solutions and introduce them to the market, not affecting
the level of innovation, but only facilitate access to the sale market. Second, the
ability of venture capital funds to offer capital to companies at different stages of
development enables entrepreneurs to focus on new technologies.
49
Masson C.M., Harrison R.T.,Public policy and the development of the informal venture capital market 1999,
[w:] Cowling K. (ed.), Industrial Policy in Europe oraz Masson C.M., Harrison R.T., Financing
entrepreneurship: venture capital and regional development 1999 [in:] Martin R.L. (ed.), Money and the space
economy, Wiley, Chichester
50
Survey entitled “Economic Impact of Venture Capital in Europe”, www.evca.com
51
“Survey of the Economic and Social Impact of Venture Capital in Europe”, www.evca.com, 22.06.2002.
52
Por. P.A. Gompers, J.Lerner, The Money of Invention, Harvard Business School, 2001, p. 74
Unlike sales, market value, or number of employees, innovation level is difficult to
measure. However, the number of patent applications is one of the measures that
seem to be helpful in the evaluation of innovations in a given economy, region or
company.
Table 1.5 presents the venture capital investment index in relation to R&D
expenditure at US manufacturing companies.

Table 1.5
Venture capital investment index in relation to R&D expenditure at US
manufacturing companies
Venture capital stages
Year All (%) Early (%)
1965 0.05 0.02
1970 0.38 0.24
1980 1.30 0.80
1985 2.92 1.42
1990 2.40 1.11
1995 2.80 1.42
1996 3.29 2.06
1997 5.73 2.99
1998 8.08 3.32
1999 11.06 5.01
Own presentation based on: P.A. Gompers, J.Lerner, The Money of Invention, Harvard Business
School, 2001, p. 76
and S.Kortum & J.Lerner, Assessing the Contribution of Venture Capital to Innovation, Rand Journal
of Economics 31, Winter 2000, 674-692

While the share of venture capital investments in R&D expenditure is not high, the
very fact that it grew between 1965-1999 should be noted here. For all venture
capital stages the index grew from 0.05 in 1965 to 11.6 in 1999 (i.e. 200 times), while
in the case of early stages it increased from 0.02 in 1965 to 5.01 in 1999 (or 250
times).
Companies financed with venture capital in the USA became the creators of
new technologies, such as:
 biotechnology (e.g. Genentech, Amgen)
 semiconductors,
 data base software (Oracle)
 the Internet (Netscape, Yahoo!, AOL, Amazon.com, Cisco Systems),
 computer processors (Intel)
 minicomputers (Compaq, Apple Computer),
 disc stations
 data communication.

Another question could be asked: how can we assess the impact of private
equity investments on the economic growth of particular regions?
In specific areas, particularly in the Silicon Valley in California and Boston’s
Route 128 venture capital is an important element of what Bahrami and Evans53

53
Bahrami H., Evans S., “Flexible Re-cycling and High-technology Entrepreneurship” [in:] Kenney M. (ed.)
Understanding Sillicon Valley: The Anatomy of an Innovative Region, Stanford University Press, 2000
describe as an internal ecosystem. According to P.Gompers and J.Lerner 54, the
economic transformation in those two regions was possible due to venture capital
funding.
Between 1978-1999 California acquired the highest sum of venture capital of all US
states. The value of venture capital investments amounted to USD 19 million in 1978
and closed with USD 34.9 billion in 1999, shared by 397 venture capital funds. Those
figures represented, respectively: ca. 30% of the total sum of venture capital invested
in the USA and ca. 31% of the number of funds. After California, Massachusetts and
New York also had a large share in the total value of acquired venture capital.
Together those three states constituted 63% of the total number of funds and 68% of
the total sum of venture capital acquired in that period, and were the three main
venture capital centers in the USA. The value of venture capital investments in the
Silicon Valley and Route 128 grew due to close ties with university research centers
(MIT, Stanford) and high-tech companies. The universities delivered many innovative
solutions. Further on, the success of such enterprises as Fairchild Semiconductor in
the Silicon Valey and Digital Equipment Corporation in Route 128 acted as an
incentive for other potential entrepreneurs and provided tangible proof that the new
business model can be successful.

When analyzing the impact of private equity investments one should also mention the
industries that support PE-funded companies. These are: consulting and law firms
specializing in capital acquisition and the investment aspects of private equity
allocation processes, such as Wilson Sonsini Goodrich & Rosami in the Silicon Valey
and Testa, Hurwitz & Thibault in Boston.
Schedule 1 in the Annex presents the thirty most influential private equity
transactions (according to private equity fund managers) in the world, of which:
a. 10 were related to management buyouts (9 – LBO, 1- MBO), 8 to venture capital
financing, 4 to acquisition financing, 3 to privatization and company acquisition,
and 1 to each turnaround and PIPE (private equity in public investment);
b. 14 transactions took place in the USA, 9 in the UK and one in each of the
following countries: Argentina, Switzerland, Italy, Bulgaria, Canada, Japan and
Germany55.

Summary
In this chapter we have tried to present various definitions of private equity (as
high-risk capital) and venture capital (invested at early stages of company
development). It is assumed that venture capital is an element of private equity.
Then, we presented the premises for private equity evolution in the USA and
Europe. The history of this type of investments has just over 70 years, but in a
broader meaning private equity investments have existed for centuries. The market
for PE investments is one of the youngest segments of the capital market.
The most important aspects of the development of the private equity market in
the USA include:
54
Gompers P., Lerner J., The Money of Invention, Harvard Business School, 2001, p. 79
55
Private Equity International, 26.06.2004r., The 30 most influential private equity deals
a. making it possible for pension funds to invest in unlisted companies;
b. reducing the capital gains tax in the particularly difficult period for the private
equity market, i.e. at the turn of the 1970s-1980s;
c. launching of the OTC market for securities in New York (NASDAQ) in 1971, which
enabled PE funds to exit many investments by selling the shares of their portfolio
companies through IPOs;
d. willingness of the private sector to invest in university research projects. Those
projects produced qualified employees and innovations, and some of the
participants even became founders of PE funds. American universities such as
MIT, Stanford or UC Berkeley play an important role here.
e. introducing the Small Business Investment Act of 1958 which provided for the
establishment of Small Business Investment Companies.
f. government spending on defense and space exploration in the 1960s, which
stimulated the demand among PE funds for companies from those sectors.
In Europe, the private equity market began developing in the 1960s, first in the UK
and then on the continent. Until mid-1990s private equity was rare in Europe. Venture
capital did not play an important role in financing young high-growth companies then.
In the next part we tried to describe the economic importance of private equity in
mature market economies.
The results from literature studies are as follows:
a. private equity funds are an important driver of innovation and wealth creation in
developed economies;
b. the first five countries with the highest % share of PE investments in the GDP in
2002 were Israel, UK, USA, Sweden and Honk Kong.
c. private equity funds contribute to the emergence of new companies, jobs and
industries (biotechnology, semiconductors, ICT, software). While private equity is
not a remedy for unemployment, it may be a key factor of success;
d. private equity recipient companies are developing faster than their counterparts
without such funding;
e. the jobs created by thriving companies financed with private equity are more
specialized and offer above-average salaries;
f. private equity financing was used to transform two economic regions in the USA:
the Silicon Valley in California and Boston’s Route 128.
At the end of the first chapter we also presented the determinants of demand and
supply on the venture capital market in the USA. Venture capital demand is affected
by:
a. offered rate of return on investments in portfolio companies;
b. government decisions (such as implementation of the SBIC Act, making it
possible for pension funds to invest in PE funds and no capital gains tax on profits
of pension funds from PE investments);
c. new technological solutions (microprocessors, Internet, biotechnology,
nanotechnology).
II. PRIVATE EQUITY FUNDS IN THE USA AND EUROPE –
A COMPARATIVE ANALYSIS
The comparative analysis of private equity fund performance in the USA and Europe
was conducted on the basis of study results by Venture Economics56, a branch of
Thomson Financial.
Venture Economics prepares statistical analyses for NVCA and EVCA, which may
facilitate comparisons between those two markets57.

1. PRIVATE EQUITY FUNDS IN THE USA

1.1 ACQUIRED AND INVESTED CAPITAL OF VENTURE CAPITAL / BUYOUT

FUNDS

The statistical category of private equity at Venture Economics includes: venture

capital funds, buyout funds, mezzanine funds and funds financing special situations.
As figures concerning mezzanine funds and special situation funds are not available,
in this book we assume that private equity is the sum total of venture capital and
buyouts.
The development of the US private equity market between 1990 and 2003 can
be divided into two stages: A growth phase until 2000 and a decline phase from 2001
to 2003.
Between 1990-2000 the US private equity market experienced a robust
growth, measured in terms of the value of acquired58 and invested59 capital of PE
funds (see Chart 2.1).
The value of acquired private equity increased from USD 13 billion in 1990 to USD
196.8 billion in 2000, while invested private equity grew from USD 15.2 billion in 1990
to USD 173.8 billion in 2000. Specifically, between 1997-2000 there was excess
supply of private equity, i.e. an excess of acquired private equity over invested
private equity, which amounted to, respectively: USD 30.7 billion in 1997, USD 49.3
billion in 1998, USD 28.6 billion in 1999, USD 23.0 billion in 2000. Institutional
investors were interested in financial assets of the private equity type because of the
attractive rates of return on equity (see Table 2.3).

56
Thomson Venture Economics, Jesse Reyes, Vice President, Benchmarking Private Equity in Today’s
Environment, 10.09.2003, www.ventureeconomics.com
57
Comparative analysis in the USA has developed as follows: 1988 – the first Venture Capital Performance
Report; 1989 - NVCA Valuation Guidelines; 1990 - Investment Benchmarks Report: Venture Capital; 1994 –
Investment Benchmarks Report: Buyouts
At present the reports on venture capital, buyouts, private equity in Europe and the USA are published
annually, and the data has been updated on a quarterly basis since 1991.
Comparative analysis in Europe has developed as follows: 1990 - EVCA Venture Capital Valuation Guidelines;
1993 - EVCA Performance Measurement Principles; 1994 - Bannock Consulting - BVCA Performance
Measurement Study; 1995 - Bannock Consulting - BVCA Performance Update; 1996 - Bannock Consulting -
European Commission European Performance Pilot Study; 1997 - Venture Economics / Bannock: European
Private Equity
58
Acquired PE (capital) is the amount declared by the limited partners, which the limited partners are willing to
invested in limited partnerships.
59
Invested PE (capital) is the amount actually spent by the funds to purchase shares/stocks in portfolio
companies.
 From 2011 onwards the value of acquired and invested PE declined. In 2001
the funds managed to acquire private equity of USD 102.5 billion, of which they
invested USD 92.7 billion. Acquired private equity amounted to USD 54.6 billion and
invested private equity amounted to USD 57.8 billion in 2002, and USD 45.8 billion
and USD 49.5 billion in 2003, respectively. The deficiency in invested private equity
in 2002 and 2003 was covered with funds not invested in previous years.

Chart 2.1
Private equity acquired and invested by the funds between 1990-2003

USD billion
250.0

200.0

150.0

100.0

50.0

0.0
199 199 199 199 199 199 199 199 199 199 200 200 200 200
0 1 2 3 4 5 6 7 8 9 0 1 2 3
PE zainwestowany 15.2 8.5 13.5 14.1 20.0 24.4 34.9 40.2 60.8 104.4 173.8 92.7 57.8 49.5
PE pozyskany 13.0 9.5 18.0 21.8 32.4 42.9 48.6 70.9 110.2 133.0 196.8 102.5 54.6 45.8

[x: invested PE; acquired PE]

Source: Own work on the basis of: Jesse Reyes, Vice-president of Thomson Venture Economics,
presentation of Private Equity Performance 2004, The Coming Shakeout on the basis of database
VentureXpert Thomson Venture Economics and The Money Tree Survey conducted by
PricewaterhouseCoopers/Thomson Venture Economics/ NVCA of 19/07/2004.

Between 1990-1998 acquired PE for buyout financing represented from 70% to 82%
of private equity value, while between 1999-2001 it dropped to 54.8% in 1999, 45.5%
in 2000 and 63.5% in 2001, for the benefit of venture capital. Between 2002-2003 the
share of buyout capital rose again to ca. 84% of private equity value (see Chart 2.2).
Chart 2.2

Acquired and invested PE between 1990-2003, broken down into buyouts

and venture capital
100%
90%
80%
70%
60%
50%
40%
USD billion 30%
20%
10%
0%
199 199 199 199 199 199 199 199 199 199 200 200 200 200
0 1 2 3 4 5 6 7 8 9 0 1 2 3
Buyouts pozyskany 9.5 7.5 12.6 17.8 24.6 32.8 37.2 52.4 79.4 73.0 89.6 65.0 45.7 38.8
VC pozyskany 3.5 2.0 5.4 4.0 7.8 10.2 11.4 18.5 30.7 60.1 107. 37.4 8.9 7.0

[x: acquired buyouts, acquired VC]

Source: see above.

When analyzing Chart 2.3 we see that the value of venture capital investments
exceeded the value of invested buyouts only in 1999 and especially in 2000.

Chart 2.3
Invested PE between 1990-2003 broken down into buyouts and venture
capital

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
USD billion 0%
199 199 199 199 199 199 199 199 199 199 200 200 200 200
0 1 2 3 4 5 6 7 8 9 0 1 2 3
Buyouts zainwestowany 12.3 6.2 9.9 10.2 15.8 16.8 23.4 25.4 39.6 50.0 68.0 52.0 36.5 31.0
VC zainwestowany 2.9 2.3 3.6 3.9 4.2 7.6 11.5 14.8 21.2 54.4 105. 40.7 21.2 18.4

[x: invested buyouts, invested VC]

Source: See above
1.2. PROFILE OF VENTURE CAPITAL / BUYOUT FUNDS

1.2.1. Venture capital funds

Table 2.1. presents venture capital funds in 1997 and six years later, i.e. in 2003.
Comparing 1997 with 2003 we see that60:
a. The number of operating venture capital funds grew by ca. 121%, i.e. from 885
to 1,954;
b. The number of portfolio companies managed by those funds grew almost by
100%, i.e. from 515 to 1,027;
c. The group of employees of private equity funds grew by ca. 120%, i.e. from
4,914 to 10,833 persons;
d. The value of total capital managed by those funds grew by ca. 289%, i.e. from
USD 64.6 billion to USD 251.4 billion and the value of capital engaged by the
investment managers of those funds increased from USD 13 million in 1997 to
USD 23 million in 2003;;
e. The average size of a portfolio company of venture capital funds grew by ca.
82%, measured in terms of the value of sale revenues i.e. from USD 135.3
million in 1997 to USD 245.7 million in 2003;;
f. The average size of the fund in terms of invested capital value grew by ca. 10%
from USD 94 million in 1997 to USD 103.5 million in 2003;
g. The number of companies in the first financing stages (rounds) dropped from 61
companies in 1997 to 38 companies in 2003;
h. The value of the largest fund (measured in terms of invested capital value)
dropped from USD 1.158 billion in 1997 to USD 1.1 billion in 2003;

60
Source: Jesse Reyes, Vicepresident of Thomson Venture Economics, presentation entitled Private Equity
Performance 2004, The Coming Shakeout on the basis of the VentureXpert Thomson Venture Economics
database
Table 2.1.
Comparison of venture capital funds in 1997 and 2003 in the USA
Specification 1997 2003
Number of portfolio companies / 515 / 885 1027 / 1954
number of funds
Professionals 4 914 10 833
Total capital managed by the USD 64.6 billion USD 251.4 billion
funds of which: USD 13 of which: USD 23 million is
million is professional professional capital
capital
Average company size (in terms USD 135.3 million USD 245.7 million
of sale revenues)
USD 94.0 million USD 103.5 million
Average fund size (in terms of
invested capital)
61 38
Number of first financing rounds
USD 1158 million USD 1100 million
Largest fund (in terms of invested
capital value)
Source: Jesse Reyes, Vice-president of Thomson Venture Economics, presentation entitled Private
Equity Performance 2004, The Coming Shakeout on the basis of database VentureXpert Thomson
Venture Economics and The Money Tree Survey conducted by PricewaterhouseCoopers/Thomson
Venture Economics/ NVCA.

Chart 2.4 confirms that 1992-2000 was a period of exceptional growth of venture
capital funds. In the record year of 2000 as many as 410 new funds of an average
size of USD 203 million (value of acquired capital) were launched, then a decline was
recorded. 246 new funds of an average size of USD 136 million were launched in
2001, and only 85 funds (of a size of USD 117 million) in 2002 and 54 new funds (of
an average size of USD 130 million) in 2003.
Chart 2.4
Average size of venture capital funds in the USA in USD million

450 250
400
350 200
Liczba funduszy
300
Średnia wielkość 150
250
200
100
150
100 50
50
0 0
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Fund launching year

[Liczba funduszy = Number of funds; średnia wielkość = Average size]

Source: See above

1.2.2. Buyout funds

Table 2.2 contains a comparison of buyout funds in 1997 and 2003. Comparing 1997
with 2003 we can see that61:
a. The number of operating buyout funds grew by ca. 57%, i.e. from 637 to 998;
b. The number of portfolio companies managed by those funds grew almost by ca.
38%, i.e. from 404 to 557;
c. The group of employees of those funds grew by ca. 82%, i.e. from 3,158 to
5,757 persons;
d. The value of total capital managed by those funds grew by ca. 140%, i.e. from
USD 187.2 billion to USD 449.8 billion and the value of capital engaged by the
investment managers of those funds from USD 59 million in 1997 to USD 77
million in 2003;;
e. The average size of a portfolio company of buyout funds grew by ca. 66%,
measured in terms of the value of sale revenues i.e. from USD 486.2 million in
1997 to USD 807.5 million in 2003;
f. The average size of the fund in terms of invested capital value declined by ca.
30% from USD 500.2 million in 1997 to USD 352.1 million in 2003;
g. The number of companies in the first financing stages (rounds) grew from 19
companies in 1997 to 36 companies in 2003;

61
Source: Jesse Reyes, Vicepresident of Thomson Venture Economics, presentation entitled Private Equity
Performance 2004, The Coming Shakeout on the basis of the VentureXpert Thomson Venture Economics
database
h. The value of the largest fund (measured in terms of invested capital value)
dropped from USD 6.0 billion in 1997 to USD 5.3 billion in 2003;

Table 2.2
Comparison of buyout funds in 1997 and 2003 in the USA
Specification 1997 2003
Number of portfolio companies / number 404 / 637 557 / 998
of funds
Professionals 3 158 5 757
Total capital managed by the funds USD 187.2 billion USD 449.8 billion
of which: USD 59 of which: USD 77 million is
million is professional professional capital
capital
Average company size (in terms of sale USD 486.2 million USD 807.5 million
revenues)
USD 500.2 million USD 352.1 million
Average fund size (in terms of invested
capital)
19 36
Number of first financing rounds
USD 6011.6 million USD 5300 million
Largest fund (in terms of invested capital
value)
Source: Jesse Reyes, Vice-president of Thomson Venture Economics, presentation entitled Private
Equity Performance 2004, The Coming Shakeout on the basis of database VentureXpert Thomson
Venture Economics and The Money Tree Survey conducted by PricewaterhouseCoopers/Thomson
Venture Economics/ NVCA

1998 was a record year in the history of buyout funds (see Chart 2.5) because of the
largest number of newly launched funds (167, with an average size of USD 531
million of acquired capital). Since 2000 the number of new buyout funds has declined
systematically, although the average fund size grew markedly in 2003 (ca. USD 923
million).
Chart 2.5
Average size of buyout funds in the USA in USD million

180 1000
160 900
140 Liczba funduszy 800
120 Średnia wielkość 700
600
100
500
80
400
60 300
40 200
20 100
0 0
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Fund launching year

[Liczba funduszy = Number of funds; średnia wielkość = Average size]

Source: See above

1.3. MEASUREMENT OF FUND PORTFOLIO VALUE

1.3.1. Average value of venture capital fund / buyout fund portfolio

The average value of venture capital fund portfolio in the USA oscillated between
USD 15-42 million between 1980-1998. 1999 and 2000 were two record years: The
average value of fund portfolio was USD 101 million in 1999 and USD 96 million in
2000, and then a decline was recorded: to USD 70 million in 2001, USD 55 million in
2002 and USD 54 million in 2003 (see Chart 2.6).

Chart 2.6
Average venture capital fund size in the USA (in USD million)

120
101
96
100
80 70

60 55 54
40 41 38 42
40 30 30 34 35 36 35
27 28 30
22 24 23 24
15 19
20
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

Source: See above

The average value of buyout funds rose between 1980 (USD 11 million) and 1985
(ca. USD 95 million), then oscillated between USD 100 and 200 million in the period
1986-1991, then between USD 200 and 300 million in the period 1992-1999, then
reached an all-times high of USD 317 million in 2000, next oscillating at around USD
300 million between 2001-2003 (see Chart 2.2).

Chart 2.7
Average value of buyouts portfolio in the USA (in USD million)

350 317
290 295
300 280

250 209 218

203 200
200 171
143
150 95 115
87
100
48
50 31 34
11
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Source: See above

1.3.2. Changes in portfolio valuation over time

When analyzing the annual percentage changes in the average valuation of venture
capital fund and buyout fund portfolios created between 1969-2003 (see Chart 2.8),
we should point to the positive dynamics between 1992-2000, with special emphasis
on 168% in 1999 for venture capital fund portfolios. Between 2001-2003 the changes
in valuation of venture capital fund portfolios were negative, and for buyout portfolios
they were negative in 2001-2002, and the trend turned upward in 2003.
Chart 2.8
Annual percentage changes in average weighted portfolio valuation
for venture capital and buyout funds created between 1969-2003 in
the USA

200.0
150.0
100.0
50.0
0.0
-50.0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Venture 11.8 18.5 12.2 38.7 30.4 23.6 22.8 168.0 33.6 -27.3 -25.8 -6.9
Buyouts 9.6 29.1 12.4 15.1 24.1 20.4 13.9 24.6 2.8 -11.1 -5.3 8.2

Source: See above

1.4. FINANCIAL BENEFITS FOR INVESTORS

1.4.1. Value benefits

Chart 2.9 presents the inflow of cash into venture capital and buyout funds from
limited partners in the period between 1990-2003. 2000 was a record year, when the
investors obtained USD 78.6 billion (including USD 56.3 billion from venture capital
funds). The level of cash returned to investors by venture capital funds dropped to
USD 9.4 billion in 2001, to USD 6.3 billion in 2002 and USD 5.7 billion in 2003.

Chart 2.9
Financial benefits for limited partners in US venture capital and buyout funds
measured in USD million

90000
80000 Buyouts
70000
60000 Venture
50000
40000
30000
20000
10000
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Buyouts 3253 2392 3478 8160 7069 11376 17805 15072 19844 19190 22264 20184 17663 24500
Venture 1546 2659 3160 4344 4463 6968 10663 12005 8433 19791 56336 9429 6276 5700

Source: See above

1.4.2. Return on investments in private equity funds in the USA

Chart 2.10 presents the cumulative IRR on investments in venture capital funds,
which were launched in particular years and/or had acquired a capital tranche from
investors for the first time. The all-time high in IRR was generated in 1996, while in
1999 annual IRRs were negative, with the historic low in 2002. : -31%.

Chart 2.10
Cumulative IRR for venture capital funds created between 1980-2002 in the USA (“vintage year”)

100
89

80
63
60 52

38 41
40 32 31
28 30
19 19 17
20 11 13 14
8 10
5 6

-20
-22 -20
-26
-40 -31

Source: See above

The negative IRR for venture capital and buyout funds between 1998-2003
results from the so-called J-curve. At the beginning of their operation the fund
generating profits, the IRR gradually grows. Only after 3 to 5 years of operation
can the success of the fund’s investments be assessed. The period is shorter
for buyouts than for venture capital funds.62

The annual cumulative IRR for buyout funds (see Chart 2.11) was highest in 1985,
between 1998-1999 it turned negative (-3.2% and -3.6%, respectively). An
exceptionally negative value in the analyzed period was recorded in 2002: -23.8%.

62
Private Equity & Venture Capital Glossary. Entrepreneurship Education Course. EVCA, Belgium 2002, p. 12
Chart 2.11
Annual cumulative IRR for buyout funds created between 1980-2002 in the USA (“vintage
year”)

70

60 57.3

50

40 36.8

30 26.0
21.3 21.0 19.1
16.1 17.6
20 13.2 12.1 13.9
9.9
10 6.8 6.9
4.6 3.6
1.2
0
1980-83

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002
-10
-3.2 -3.6
-20

-30 -23.8

Source: See above

Chart 2.12 presents the five-year rate of return on investments for venture capital and
buyout funds for all private equity investments and the stock exchange index S&P
(Standard & Poor’s).
Between 1980-1983 venture capital funds generated a rate of return higher than for
other investments, the buyout funds fared best between 1984-1993, while the highest
five-year IRR has been generated by venture capital funds since 1994.

Chart 2.12
5-year IRR (%) for venture capital buyout funds against private equity funds
and S&P 500 Index

60.0 Venture capital razem Buyouts razem

Private Equity razem S&P 500

50.0
40.0
30.0
20.0
10.0
0.0
1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-10.0

[Total venture capital; Total buyouts; Total private equity; S&P 500]
Source: See above

Table 2.3 presents rates of return for funds created between 1969-2003 in particular
private equity segments in the USA (PEPI = Private Equity Performance Index).
Table 2.3
Pooled IRR63 for US private equity funds for the period until 31 December 2003
All funds created between 1969-2003 (PEPI)
3 5 10 20
Type of fund 1 year years years years years
Seed Stage VC -4.7 -11.6 -1.7 17.9 10.6
Early Stage VC -7.1 -23.7 58.3 38.4 19.9
Balanced VC 11 -13.9 19.4 20.4 13.3
Later Stage VC 25.4 -18.8 3.5 17 13.8
Total VC 8.1 -18.9 22.8 25.5 15.5
Small Buyouts 5.7 -2.7 0.8 8.9 26.3
(Medium Buyouts)
5.4 -3.1 5.9 9 17.7
Large Buyouts 17.6 -3.8 2.7 9.5 13.5
Mega Buyouts 29 -1.4 1.7 6.7 8.5
Total buyouts 24.1 -2.1 2.2 7.8 12.4
Mezzanine 5.7 1.1 5.6 7.3 9.6
Total private equity 18.3 -7.0 6.8 12.7 13.6
Source: Thomson Venture Economics

Generally, in the 20-year horizon private equity funds produced a rate of return of
13.6%, of which the venture capital funds alone generated 15.5%, the buyouts –
12.4% and mezzanine funds only 9.6%.

As far as individual funds are concerned, the highest pooled IRR was
generated by small buyouts (26.3%), then early stage VC (19.9%) and medium
buyouts (17.7%).
In the 10-year and 5-year horizon venture capital funds had an advantage,
with a rate of return of 25.5% and 22.8%, respectively.
In the 3-year horizon the situation changed; venture capital funds recorded
high losses on investments and generated IRR of: -18.9% against -2.1% for buyout
funds and for 1.1% mezzanine funds.
In annual terms the rate of return was highest for buyout funds (24.4%), then
8.1% for venture capital funds and 5.7% for mezzanine funds.
Further on, due to lack of available data on buyout funds, there is an analysis
of venture capital fund performance concerning investment value and their recipient
industries.

63
Pooled IRR – aggregated Internal Rate of Return calculated jointly for all funds covered by the survey. Cash
flows from each fund are added together, just as the values of their assets, and treated as if pertaining to one fund
(after Sobańska K., Sieradzan P., ibidem)
1.5. VENTURE CAPITAL INVESTMENST – STAGES AND VOLUMES

In the following part of this Chapter we will analyze only venture capital
investments (as full data is unavailable), which represent one of the segments of
private equity investments.
As mentioned before, the value of US venture capital investments has fallen
steadily since 2001, reaching USD 18.4 billion in 2003.
Between 1995-2003 the funds investing in portfolio companies at the
expansion stage had the highest share in the value of venture capital investments
(42.8% - 57.1%), followed by funds investing in early stage companies (22.2% -
25.9%) – see Table 2.4.).

Table 2.4.
Venture capital investments by stages (in %)
1995 1996 1997 1998 2000 1999 2001 2002 2003
Startup/Seed64 17.3 13.2 8.9 8.5 2.9 6.1 1.9 17.3 13.2
65
Early Stage 23.4 24.7 23.6 25.9 24.5 22.2 22.5 23.4 24.7
66
Expansion 42.8 47.1 51.6 50.0 57.1 55.7 56.6 42.8 47.1
67
Later Stage 16.5 15.1 15.8 15.6 15.4 16.0 19.0 16.5 15.1
Other 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
100. 100. 100. 100. 100. 100. 100. 100. 100.
Total in % 0 0 0 0 0 0 0 0 0
105.
Total in USD billion 7.6 11.5 14.8 21.2 54.4 8 40.7 21.2 18.4
Source: author’s presentation on the basis of the study by PricewaterhouseCoopers/Thomson Venture
Economics/National Venture Capital Association (www.pwcmoneytree.com)

Just as in the case of most investments, the number of transactions has been falling
since 2001, down to 2,808 transactions in 2003 (see Table 2.5). Transactions
concerning expansion company investments held the highest share (37.5% - 53.6%
between 1995-2003), followed by early stage companies (26.8% - 35.7%).

64
Startup/Seed – the company has a business idea or a new product concept, however it does not generate
attractive operating cashflows, usually it has existed for no more than 18 months
65
Early stage – the company is testing its product/service or conducting pilot studies. In some cases the
product/service may be already on the market. The company may generate sale revenues. Company age: up to 3
years.
66
Expansion – the product/service is already on the market, the company has some sales growth dynamics, but
does not need to generate profits. Age: over 3 years.
67
Later stage – the product/service is generally available on the market. The company is generating growing sale
revenues, it has positive cashflows. Its sales may be profitable.
Table 2.5.
Number of venture capital investments by stages (in %)
1995 1996 1997 1998 1999 2000 2001 2002 2003
Startup/Seed 23.6 19.4 16.4 18.4 14.4 8.3 5.5 4.9 6.4
Early Stage 27.5 29.5 27.8 27.1 30.6 35.7 28.2 27.9 26.8
Expansion 37.5 39.7 44.8 43.1 44.8 46.8 53.1 53.6 48.6
Later Stage 11.4 11.3 10.9 11.3 10.3 9.2 13.2 13.6 18.1
Other 0.1 0.1 0.1 0.1 0.0 0.0 0.0 0.0 0.0
Total in % 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Total number 1 868 2 610 3 182 3 688 5 600 8 056 4 604 3 030 2 808
Source: author’s presentation on the basis of the study by PricewaterhouseCoopers/Thomson Venture
Economics/National Venture Capital Association (www.pwcmoneytree.com)

1.6 VENTURE CAPITAL INVESTMENT RECIPIENTS

The three key sectors, which together represent ca. 50% of invested VC in the
USA, are: software, biotechnology and telecommunications.
Between 1995-2003 software companies68 were the top recipients of venture
capital (see Table 2.6). Their share in the total value of invested VC amounted on
average to ca. 20% each year.
The share of biotechnology69 in invested VC has grown steadily for several
years, up to 18.7% in 2003.
The share of telecommunications70 in the value of invested VC has declined
year-in-year, down from 17.1% in 2000 to 11.3% in 2003.
The annex at the end of the book (Schedule 4) contains definitions of all
recipient sectors of venture capital in the USA.
Table 2.6.
Venture capital investment recipients in the USA (in %)
Sector 1995 1996 1997 1998 1999 2000 2001 2002 2003
Biotechnology 10.8 10.4 9.9 7.2 4.0 4.0 7.8 13.9 18.7
Business products and services 2.7 3.3 2.8 3.5 6.5 5.8 3.3 2.9 3.5
Computers and peripheral
devices 5.4 4.2 3.4 2.5 2.0 2.9 2.9 3.4 3.5
Consumer products and
services 8.0 4.4 4.9 3.3 5.0 3.3 1.7 1.2 1.2
Electronics / instruments 2.0 2.3 2.5 1.5 0.6 0.8 1.0 1.2 2.2
Financial services 2.4 2.8 1.7 4.4 3.9 4.1 3.5 2.3 2.5
Medical services 5.4 6.1 5.8 4.7 2.9 1.5 1.7 2.0 1.2
Energy 7.9 4.8 5.7 6.6 3.3 2.3 2.9 4.0 3.7
IT services 2.4 4.0 4.3 5.5 7.9 8.6 6.6 5.4 4.0

68
Software is represented by IT software manufacturers for business and private consumers, i.e. operating
systems, graphic, educational programmes or games. Also specialist software for the banking sector, industry,
forwarding companies, etc.
69
The sector concerns technologies promoting drug and treatment development. Biotechnology for humans,
animals, industry – products and services. The sector also includes bioreceptors, pharmaceutical equipment.
70
Companies focusing on data and voice transmission, Fixed-line and mobile telephony.
Media and entertainment 4.9 9.0 6.6 8.4 12.1 10.0 5.8 3.5 3.4
Medical instruments and
equipment 9.2 5.5 6.7 5.5 2.6 2.4 4.9 8.7 8.3
Network and equipment 4.4 5.5 6.7 7.0 8.1 10.5 14.2 10.6 8.9
Retail / distribution 2.9 4.6 2.1 2.7 5.8 3.4 1.4 0.8 0.6
Semiconductors 2.7 2.1 3.5 2.9 2.2 3.2 4.5 5.9 6.5
Software 14.5 19.9 22.1 20.0 17.5 20.0 22.0 21.2 20.3
Telecommunications 13.2 11.0 11.1 13.8 15.3 17.1 15.4 12.8 11.3
Other 1.1 0.1 0.2 0.4 0.3 0.2 0.4 0.1 0.3
Total in % 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Total in USD billion 7.6 11.5 14.8 21.2 54.4 105.8 40.7 21.2 18.4
Source: author’s presentation on the basis of the study by PricewaterhouseCoopers/Thomson Venture
Economics/National Venture Capital Association (www.pwcmoneytree.com)

As far as the number of transactions is concerned, the top sectors in 1995 included
software (396 transactions), medical instruments and equipment (187 transactions)
and biotechnology (173 transactions). The three leading sectors in 2003 included
software (755 transactions), biotechnology (319 transactions) and
telecommunications (263 transactions) – see Table 2.7.

Table 2.7.
Number of venture capital investments by sectors
Sector 1995 1996 1997 1998 1999 2000 2001 2002 2003
Biotechnology 173 231 251 275 264 330 302 281 319
Business products and
services 50 69 102 156 368 576 229 127 114
Computers and
peripherals 115 124 147 121 143 242 148 100 110
Consumer products and
services 119 134 155 165 289 292 129 72 52
Electronics / instruments 54 56 63 75 61 83 68 56 65
Financial services 42 71 94 122 192 355 157 82 72
Healthcare services 67 125 133 155 171 181 105 74 64
Energy 143 166 227 190 209 245 202 136 122
IT services 60 120 157 208 447 694 338 175 148
Media and entertainment 127 165 203 239 656 940 356 142 119
Medical instruments and
equipment 187 224 269 288 289 302 268 215 219
Networks and equipment 78 124 148 219 270 478 341 208 181
Retail / distribution 48 71 89 110 251 297 96 49 43
Semiconductors 55 57 95 90 122 212 157 140 148
Software 396 649 759 908 1 290 1 865 1 119 842 755
Telecommunications 146 217 279 349 555 944 566 328 263
Other 8 7 11 18 23 20 23 3 14
Total 1 868 2 610 3 182 3 688 5 600 8 056 4 604 3 030 2 808
Source: author’s presentation on the basis of the study by PricewaterhouseCoopers/Thomson Venture
Economics/National Venture Capital Association (www.pwcmoneytree.com)

1.7. DISINVESTMENTS
Since 1996, the sale of portfolio companies through IPOs has been the most popular
exit strategy for venture capital funds in the USA. There were 280 IPOs in 1996 and
only 145 companies were sold through trade sales. There were 29 IPOs and 336
trade sales in 2003 (see Chart 2.13).

Chart 2.13
Number of disinvestments (IPO, trade sale) for venture capital
funds in the USA (in number of transactions)

700
600
500
400
300
200
100
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Sprzedaż 21 27 91 97 110 127 145 226 273 282 372 426 366 336
IPOs 71 158 198 221 169 206 280 139 79 271 262 41 24 29

[x: sprzedaż = trade sale]

Source: ibidem
In value terms, IPO and trade sale disinvestments reached the level of USD 1.7
billion in 1990, then increased to USD 16.4 billion, closing with an all-time high of
USD 104.3 billion in 2000. The value of IPOs was USD 2 billion and the value of
trade sales amounted to USD 14.6 billion at the end of 2003 (see Chart 2.14).
Chart 2.14
Disinvestments: IPO and Trade Sale in USD billion

120.0
100.0
80.0
60.0
40.0
20.0
0.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Trade sale 0.3 0.8 3.3 2.2 3.7 8.2 14.5 18.4 30.1 46.0 78.9 25.0 14.8 14.6
IPOs 1.4 4.9 7.5 6.7 4.7 8.2 12.2 4.9 3.9 20.9 25.4 3.5 2.5 2.0

Source: ibidem
1.8. PRIVATE EQUITY STIMULATION BY THE US GOVERNMENT71

As mentioned in Chapter I, the foundation of the American Research and

Development (ARD) in 1946 was an important step in the evolution of the venture
capital sector in the USA. ARD was a listed closed-end fund investing in small, high-
risk companies, which provided technological solutions developed for the arms sector
during WWII to the civil market. While the limited partnership structure did not
emerge in the USA until 1958, investing in high-risk assets had been forbidden at
first. In the 1960s venture capital funds acquired capital mainly through closed-end
funds such as the ARD and with the help of the government scheme called Small
Business Investment Company (SBIC), which enabled equity financing of new, high-
growth companies.
In the 1970s venture capital operations staggered due to the weak stock
market, high capital gains tax and global economic recession. In order to stimulate
venture capital development, the US government introduced new regulations and tax
changes. CGT rates were reduced. Amendments to the Employee Retirement
Income Security Act (ERISA) with regard to the Prudent Man Rule enabled funds to
allocate a small part of their assets in high-risk investments. Those changes triggered
an inflow of new funds to venture capital investments. Between 1980-2000, any US
states – though to different effect – began offering various tax incentives to attract
domestic venture capital resources. Despite the intermittent rallies and declines on
the US venture capital market, many of those federal and state schemes have
survived to this day.

1.8.1. Investment regulations

The policy of the US government plays an important role in stimulating private equity
investments on the part of institutional investors and accelerating the development of
the venture capital market. Over 7% of the assets of US institutional investors (such
as pension or insurance funds) are allocated in all forms of private equity (including
management buyouts); as compared with less than 1% in other OECD countries with
a similar financial market profile (UK, Canada)72.
Until 1978 institutional investors had been unable to invest in venture capital
funds. This changed in 1978, after the ERISA amendments concerning the Prudent
Man Rule, which enabled the funds to allocate as small part of their assets in high-
risk investments.
The ERISA regulates the functioning of employee pension funds with regard to
the administration and allocation of funds, risk management and profit distribution.
Previously, pension funds in the USA and many OECD countries had been unable to
allocate cash to risky investments.

71
This Subchapter was prepared on the basis of Baygan Günseli, Venture Capital Policy Review: United States,
STI Working Paper 2003/12, OECD
72
Baygan Günseli, Venture Capital Policy Review: United States, STI Working Paper 2003/12, p. 13, OECD
 In 1978, the legislation in this area was liberal with regard to the application of
the amended version of the prudent rule to pension plans. As result of those
changes, pension funds could invest in new companies and venture capital funds.
According to the new rules, investments had to be managed with care, skill,
prudence and diligence73. In 1980 new amendments to the ERISA were introduced,
concerning the so-called „safe harbor”, defining pension funds in legal terms as
limited partnerships, thus limiting the liability of venture capital funds that managed
the capital provided to them by pension funds.
The investment regulations were mitigated in 1999 with regard to other
financial institutions (Financial Modernization Act). That act enabled banks, insurance
companies to affiliate and sell investment products to each other.

1.8.2. Tax incentives

Venture capital investments in the USA were stimulated by low CGT and targeted tax
reliefs. Reduction of the CGT rate from 49% in 1978 to 20% in 1981-1986 had an
important impact on the development of venture capital. However, the influence of
later increased and decreased of that tax on the venture capital sector is not clear.
For instance, the CGT increase in 1986 (Tax Reform Act) did not adversely affect
new capital acquisition into venture capital funds. The specific tax incentives for
venture capital investments have a clearer impact on state rather than on federal
level.

1.8.3. Capital schemes

The US Small Business Investment Companies (SBICs) scheme launched in
1958 as an initiative of the Federal Reserve is the best example of a government
initiative supporting the small company sector by creating an incentive scheme to
increase the inflow of private equity as well as long-term loan capital and support the
development of companies with restricted access to financing. The principle of
maximizing the share of private equity in the SBIC was adopted. The main aim of the
scheme was to support active venture capital funds with public capital. SBICs are
organized and managed by private owners, and licensed and partly financed (shares
and/or loans) by the Small Business Administration (SBA). SBICs act as
intermediaries between large investors and small companies. The scheme is based
on leveraging public capital of active, private venture capital funds which have
complied with the statutory conditions (SBIC Act of 1958) and acquired the status of
a Small Business Investment Company. The leveraging is obtained by granting the
fund a low-interest, long-term loan (no more than 15 years) or purchasing privileged
shares in the fund. The capital leverage is 1:3, i.e. three dollars of capital funding
from government funds per each private dollar engaged in the fund. If special
conditions are met, the leverage may be 1:4, but it may not exceed USD 90 million.
As result of the capital leverage rule introduced under the SBIC Act, the value of
capital engaged in the venture market increased. “In early 1960s there were ca. 585
SBICs with a capital of USD 205 million. And even though the number quickly

73
“with care, skill, prudence and diligence under the circumstances then prevailing, that a prudent man acting in
a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and
with like claims”
declined to 318 in 1998 after a period of rapid increase (to 700), the value of capital
allocated to private companies rose several dozen times"74.
According to US government data, the SBIC has helped to finance over 90
thousand small companies and created over 670 thousand new jobs since its
foundation, i.e. since April 1959. The total cumulative value of capital engaged on the
venture capital market was ca. USD 37.7 billion. 75
Table 2.8 presents the following trends apparent between 1995-2001:
a. the share of small projects at early stage and of young companies (up to 3
years) was decreasing;
b. the share of equity in the financing of new companies was rising.

Table 2.8.
SBIC financing between 1995-2001
Year Number of Number of Financing value
new SBIC transactions
licenses
Total Early stage In USD % share % share of
projects (%) billion of equity companies
up to 3
years
1995 208 2 221 60 1.25 51 56
1996 209 2 107 54 1.62 55 54
1997 208 2 731 50 2.37 58 50
1998 233 3 456 50 3.24 67 55
1999 244 3 096 45 4.22 72 53
2000 304 4 639 49 5.47 74 63
2001 331 4 277 35 4.45 72 58
Source: SBA (2002)

According to Piotr Tamowicz, the SBIC scheme revealed two important

conditions of public capital engagement.
On the one hand, it is a correct structure of capital leverage, adjusted to the
specifics of the venture capital market. SBIC was obligated to regulate interest
payments for loan or dividend leverages in the case of equity engagement. Income
from SBIC investments appeared only after several years, mostly in the form of
endowment. As a result, SBICs had to struggle to maintain liquidity, i.e. regulate their
obligations, seeking rescue in investments that quickly generated free cash. That
restriction was eliminated in early 1990s.
The second condition was the efficient monitoring of the scheme,
management and quick reaction to any irregularities. The SBA was unable to
effectively monitor the vast number funds that had emerged as result of the attractive
capital leverage structure and the high popularity of venture capital. The SBIC
scheme did not attract quality investment managers. As a result, the number of ill-

74
Tamowicz Piotr, Wspieranie rozwoju rynku venture capital przez władze publiczne, IbnGR, Gdańsk
November 1999, p. 7
75
Small Business Investment Company Program, Fiscal Year 2002, 15.06.2002, p. 7 – report prepared by the
SBA (www.sba.gov)
managed funds facing liquidation was growing. In June 1996 the SBA Secretary
informed the Congress that the SBA had lost USD 18 million due to poor
management of the investment portfolio by SBIC managers76. As a result, in late
1960s 232 out of 700 existing SBICs were facing bankruptcy. In 1977 there were 276
SBICs. There were also cases where SBICs were founded to finance the founder’s
own company77.
Other America government schemes aimed at stimulating high-tech
development, including the growth of new technological companies, included: Small
Business Investment Research (SBIR), Small Business Technology Transfer (SBTT)
and Advanced Technology Program (ATP).
The SBIR was launched in 1982 under the Small Business Innovation
Development Act to facilitate the participation of small companies in federal R&D
programs. All federal agencies with an R&D budget above USD 100 million were
forced to participate in SBIR. 10 such agencies spend 2.5% of its R&D budget on
small company grants. Over small companies receive over USD 1 billion for
technology innovation research every year.
The SBTT was launched under the Small Business Technology Transfer
Act to enhance the public-private partnership in the area of research. 5 federal
agencies transfer a part of their R&D funds to small companies (up to USD 100
thousand on technological feasibility studies and up to USD 500 thousand on
relevant research).
The ATP, launched in 1988 by the National Institute of Standards and
Technology (NIST), finances high-risk research. Between 1990-2002 over USD 1.96
billion was allocated to this purpose, of which almost a half was transferred to small
companies.
Apart from federal schemes, many states created venture capital funds to
support local economies, including: Massachusetts Technology Development
Corporation (MTDC), California Emerging Ventures (CEV), New York State Venture
Capital Investment (NYSCVCI).
The MTDC was launched in 1978 to create new jobs in high-tech sectors in
Massachusetts. It is the oldest program offering a combination of equity and debt
financial instruments. It offers seed capital and mezzanine capital, usually in the
range of USD 250 thousand to USD 500 thousand. Its primary goal is
commercialization of high technologies. It is expected that the capital will exit the
portfolio companies within 7-10 years through IPOs or M&As. Between 1980-mid
2001 total investments amounted to over USD 57 million and were addressed to 109
companies. MTDC enters the company’s capital together with private funds, which
allocate in average 4.5 times more capital than MTCD.
The CEV scheme was created in 1998 by CalPERS (California Public
Employees’ Retirement System), the largest American public pension fund. CEV
operates as fund of funds, by 2002 it had invested seed capital of over USD 2 billion.

76
Fenn G.W, Liang N, Prowse S., The Economics of the Private Equity Market, Federal Reserve System –
working paper, December 1995
77
Bygrave W.D., Timmons J.A., Venture Capital at the Cross Road. Harvard Business School Press, 1992
 The NYSVCI, initiated in 1999, is part of the second largest pension fund in
the USA – the New York State’s Common Retirement Fund (CRF). CDR invests in
private equity funds operating in the form of limited partnerships.

1.8.4 Business angel networks

Due to its informal nature, the business angel market is difficult to measure.
Nevertheless, according to SBA there are ca. 250 thousand business angels in the
USA, spending ca. USD 20 billion every year on investments in over 30 thousand
private companies. In 1995 SBA launched an online platform called Angel Capital
Network (ACE-Net), whose task it is to facilitate networking between individual
investors, SBICs and venture capital funds with small companies. Regional ACE-Net
operators offer advice to entrepreneurs and investors. In 2011, when the government
target had been achieved, ACE-Net was privatized. Recently SBA has been
developing a new platform, the Technology Network (TECH-Net), which will provide
all possible information (including financial figures) to small technological companies.

1.8.5 Over-the-counter markets – NASDAQ

An efficient capital exit market – especially in the form of IPOs on NASDAQ – has
been the key development factor for US venture capital. The first electronic market
called the National Association of Securities Dealers Automated Quotation
(NASDAQ) was opened in New York in 1971 and has since outperformed all other
markets in terms of IPOs. In 1992 NASDAQ SmallCap Market was opened – a stock
market segment addressed to very small companies. With introduction of new
products and services it was possible to cut listing costs, enhancing NASDAQ
competitiveness in the USA and globally. At the end of July 2004 ca. 3300
companies were listed on NASDAQ. The annex at the end of the book presents in
Schedule 5 a comparative analysis of NASDAQ against other OTC markets in
Europe and Asia. This table contains information on the number of IPOs, number of
listed companies and share of the stock market’s capitalization in the GDP of the
given country between 1999-2002.

2. PRIVATE EQUITY FUNDS IN EUROPE

2.1. ACQUIRED AND INVESTED CAPITAL OF PRIVATE EQUITY FUNDS

The development of private equity investments in Europe between 1990-2003 can
also be divided into two phases, just as in the USA. The first phase is a period of
growth until 2000, the second phase is a period of decline and stabilization since
2001.
The statistical category of private equity in Europe at Venture Economics
includes:
a. seed, start-up, expansion capital, which may be summarized as venture
capital;
 b. replacement capital;
c. buyouts.
The private equity market in Europe experienced a strong growth, especially
between 1997-2000, measured in terms of acquired and invested capital (see Chart
2.15). The value of acquired private equity increased from EUR 4.6 billion in 1990 to
USD 20 billion in 1997 and then to EUR 48 billion in 2000. The value of the PE
investments reached EUR 4.1 billion and in 2000 – the record year – closed with
EUR 35 billion. In 2001 the upward trend for acquired and invested private equity
reversed. However, PE investments started to grow already in 2002 (EUR 27.6 billion
in 2002, EUR 29.1 billion in 2003).
Chart 2.15

Private equity in Europe received and invested by funds between 1990-2003

60.0

50.0

40.0

30.0

20.0

EUR billion 10.0

0.0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
PE pozyskany 4.6 4.2 4.2 3.4 6.7 4.4 8.0 20.0 20.3 25.4 48.0 40.0 27.5 27.0
PE zainwestowany 4.1 4.6 4.7 4.1 5.4 5.5 6.8 9.7 14.5 25.1 35.0 24.3 27.6 29.1

[x: acquired PE, invested PE]

Source: EVCA yearbooks

Chart 2.16 below presents a list of venture capital investments compared with other
investments (buyouts, replacement capital). In 2000 alone the value of venture
capital investments exceeded the two other segments of PE investments, reaching
EUR 19.7 billion. Since that time the value of buyouts has grown steadily, and the
value of venture capital investments has been declining.
Chart 2.16
Venture capital, buyout capital and replacement capital in Europe

25.0

20.0

15.0

10.0

5.0

0.0
EUR billion 199 199 199 199 199 199 199 199 199 199 200 200 200 200
0 1 2 3 4 5 6 7 8 9 0 1 2 3
Buyouts zainwestowany 1.5 1.6 1.9 1.7 2.4 2.6 3.2 4.8 7.4 13.3 14.4 10.9 16.9 18.4
Replacement zainwestowany 0.2 4.6 4.7 4.1 5.4 5.5 6.8 0.7 1.1 1.2 0.9 1.2 0.9 2.3
Venture capital zainwestowany 1.7 2.8 2.4 2.1 2.6 2.6 3.2 4.1 6.0 10.7 19.7 12.2 9.8 8.4

[x: Invested buyouts; invested replacement; invested venture capital]

Source: EVCA yearbooks

The UK is one of the leaders of private equity investments. The value of

invested private equity represented 47% of all such types of investments in Europe in
2003. The second place in 2003 was held by France (15%), followed by Italy (10%),
Germany (9%) – see Table 2.9.
Table 2.9.
Private equity invested by European countries between 2000-2003
Country Invested PE in EUR million
2000 % 2001 % 2002 % 2003 %
UK 13 180 38% 6 926 28% 10 385 38% 13 539 47%
France 5 304 15% 3 287 14% 5 851 21% 4 246 15%
Germany 4 767 14% 4 435 18% 2 506 9% 2 481 9%
Netherlands 1 916 5% 1 887 8% 1 722 6% 1 092 4%
Sweden 2 300 7% 2 043 8% 1 468 5% 1 015 3%
Italy 2 969 8% 2 185 9% 2 626 9% 3 034 10%
Spain 1 127 3% 1 199 5% 968 4% 1 337 5%
Norway 296 1% 279 1% 201 1% 276 1%
Belgium 565 2% 410 2% 360 1% 304 1%
Finland 384 1% 257 1% 456 2% 441 2%
Switzerland 626 2% 243 1% 312 1% 223 1%
Ireland 223 1% 145 1% 105 0% 255 1%
Austria 163 0% 147 1% 146 1% 113 0%
Greece 195 1% 104 0% 45 0% 26 0%
Portugal 183 1% 108 0% 69 0% 116 0%
Denmark 274 1% 331 1% 242 1% 414 1%
Poland 202 1% 150 1% 118 0% 133 0%
Czech 122 0% 26 0% 35 0% 13 0%
Republic
Hungary 51 0% 143 1% 17 0% 34 0%
Iceland 138 0% 18 0% 13 0% n/a n/a
Slovakia 1 0% 9 0% 3 0% 3 0%
Total Europe 34 986 100% 24 332 100% 27 648 100% 29 095 100%
Source: EVCA yearbooks

2.2. MEASUREMENT OF FUND PORTFOLIO VALUE

The average portfolio value of venture capital funds in Europe increased from USD 2
billion in 1980 to USD 20 million in 1988. Next, between 1989-1998 oscillated
between USD 23-28 million, exceeding USD 30 million in 1999 and reaching an all-
times high of USD 40 million in 2000. Between 2001-2003 the average portfolio value
was ca. SUD 35 million (see Chart 2.17). For the sake of comparison, the average
portfolio value for American VC funds amounted to USD 54 million in 2003.
Chart 2.17
Average value of venture capital fund portfolio in Europe (in
USD million)

45 40
40 38
35 34 35
35
28 27 28 28
30 26 26 28 27
23 24
25 20
20 17
14
15 12 13
9
10 7
4
5 2
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Source: Jesse Reyes, Vice-president of Thomson Venture Economics, presentation entitled Private
Equity Performance 2004, The Coming Shakeout on the basis of database VentureXpert Thomson
Venture Economics and The Money Tree Survey conducted by PricewaterhouseCoopers/Thomson
Venture Economics/ NVCA.

The average portfolio value of buyout funds in Europe has grown steadily, reaching
USD 141 million in 2003 and it is half the value of US portfolios (see Chart 2.19).

Chart 2.18
Average value of buyout fund portfolio in Europe (in USD
million)

160 141
140 132136

120 108
100
80 73
53 55
60 45
39
40 27 26
12
20 3 3 3 3 7
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

Source: ibidem

2.3. FINANCIAL BENEFITS FOR INVESTORS

In the 20-year horizon European private equity funds produced a rate of return of
9.9%, of which the venture capital funds alone generated 7.2%, the buyouts – 12.2%
and mezzanine funds only 9.1% (see Table 2.10).

In the 10-year and 5-year horizon the buyouts produced higher rates of return
than venture capital funds and mezzanine funds. In the 3-year horizon venture capital
funds and mezzanine funds generated negative rates of return and the buyouts
generated IRR of 1.0%. In an annual perspective venture capital funds had an IRR of
-7.5% buyouts: +1.6% and mezzanine funds: +2.4%.

Buyout funds produced the highest rates of return as compared with other
private equity segments in each of those time horizons.

Table 2.10.
Net Internal Rate of Return on private equity fund investments in Europe for
31/12/2003. All funds created between 1980-2003.
No. Stage of company development 1 year 3 5 10 20
years years years years
78
1 Early Stage -13.1 -11.1 -1.8 1.3 1.9
79
2 Development -7.2 -4.8 4.6 10.7 9.1
80
3 Balanced -5.4 -10.2 4.2 12.3 9.0
I All venture capital stages -7.5 -9.0 2.3 8.3 7.2
81
II. Total buyouts 1.6 1.0 9.6 12.7 12.2
82
III. Generalist 2.4 -10.7 7.8 14.6 9.1
IV Total private equity -0.6 -3.8 7.3 11.9 9.9
Source: Thomson Venture Economics VentureXpert

Comparing the IRR realized by PE sectors with other securities indices in Europe we
see that IRR for PE (9.9%) is higher than other comparative indices, i.e. Morgan
Stanley Euro Index, HSBC Small Company Index, JP Morgan EuroBonds (see Table
2.11).

78
Early stage – VC funds concentrating on investments in companies at early stages of development
79
Development – VC funds concentrating on investments in companies at the stage of expansion or need of
capita lat later stages of development
80
Balanced – VC funds concentrating on investments in companies at two stages: early stage, development
without special emphasis on either of them.
81
Buyouts – funds whose strategy does not focus on purchasing the assets of stte-owned and private enterprises;
this includes mezzanine funds, providing external capital to finance share/stock buyouts of companies.
82
Generalist – diversified funds, investing in all private equity assets without special emphasis on either of them.
Table 2.11.
Comparison of Internal Rate of Return (IRR) of European private equity funds
(since establishment) with indices of the European stock market (bonds and
equities). CLN Index method (put forward by Coller, published by Long and
Nickels).
Stage of company development European Morgan HSBC JP Morgan
Private Stanley Small EuroBonds
Equity Euro Company
Index Index
Early Stage 1.9 1.8 5.7 9.8
Development 9.1 7.9 7.5 9.3
Balanced 9.0 2.7 6.2 9.1
All venture capital stages 7.2 4.3 6.4 9.4
Buyouts 12.2 -2.9 3.8 9.9
Generalist 9.1 5.9 4.3 9.4
Total all private equity 9.9 0.5 4.8 9.7
Source: Thomson Venture Economics VentureXpert
The ITT for capital market indices was calculated by investing relevant cash flows allocated in private
equity assets in MSEI, HSBC SCI, JP Morgan EB. Then the IRR for each index was calculated.

Cumulative IRR for PE funds is higher in USA than in Europe (see Chart 2.19).

Chart 2.19
Comparison of cumulative rate of return of PE funds in the USA and
Europe since starting date (31/12/1979)

USA Europa
25

20

15

10

0
1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-5
Source: Jesse Reyes, Vice-president of Thomson Venture Economics, presentation entitled Private
Equity Performance 2004, The Coming Shakeout on the basis of database VentureXpert Thomson
Venture Economics and The Money Tree Survey conducted by PricewaterhouseCoopers/Thomson
Venture Economics/ NVCA.
PricewaterhouseCoopers/Thomson Venture Economics/ NVCA
2.4. PRIVATE EQUITY INVESTMENTS – STAGES AND VOLUMES

Table 2.12 presents segments of invested private equity in Europe. Among venture
capital investments, the value of seed capital, start-up capital and expansion capital
has declined steadily since 2000. PE investors are exiting highly risky VC
investments for the benefit of buyouts and replacements.

Table 2.12.
Private equity investments in Europe by segments
1990 1995 1996 1997 1998 1999 2000 2001 2002 2003
EUR billion
1. Buyout 1.5 2.6 3.2 4.8 7.4 13.3 14.4 10.9 16.9 18.4

2.
Replacement 0.2 5.5 6.8 0.7 1.1 1.2 0.9 1.2 0.9 2.3

3. Venture
capital 1.7 2.6 3.2 4.1 6.0 10.7 19.7 12.2 9.8 8.4
Of which:
3.1.Expansion 1.3 2.3 2.7 3.4 4.3 7.4 13.0 8.0 6.9 6.2
3.2. Start-up 0.4 0.3 0.4 0.6 1.5 2.8 5.8 3.7 2.6 2.0
3.3. Seed 0.0 0.0 0.1 0.1 0.2 0.5 0.8 0.5 0.3 0.2

Total PE
(1+2+3) 3.4 10.7 13.1 9.7 14.5 25.1 35.0 24.3 27.6 29.1
Source: Own work on the basis of EVCA yearbooks

2.5. PRIVATE EQUITY INVESTMENT RECIPIENTS

The three top PE recipient sectors in 1995 included: consumer goods (with a share in
PE investments of 22.6%), industrial goods and services (11.5%) and other industrial
products (9.4%). The top three sectors in 2000 included: consumer goods (18.5%),
telecommunications (13.8%) and computers (13.3%). In 2003 consumer goods
represented 19.4%, telecommunications – 16.9% and other services – 9.8% of the
value of PE investments, see Table 2.13.

Table 2.13.
PE investment recipients in Europe by sectors
Sector 1995 1996 1997 1998 1999 2000 2001 2002 2003
Telecommunications 4.7 4.4 5.7 8.6 11.6 13.8 13.9 9.1 16.9
Computers 7.1 5.1 6.6 9.3 10.8 13.3 12.3 5.5 6.0
Other electronics 4.5 4.1 4.6 2.9 2.1 3.9 2.4 2.4 1.9
Biotechnology 2.1 2.7 2.6 2.4 2.6 2.9 3.5 4.0 2.3
Healthcare 5.5 3.6 4.3 4.7 4 7.9 6.7 7.0 6.0
Energy 2 1.1 0.8 1.5 0.8 0.7 2.8 1.0 1.2
Consumer goods 22.6 18.1 22.2 14.9 18.8 18.5 15.5 21.7 19.4
Industrial goods and 11.5 15.1 13.1 10.8 11.6 10
services 8.3 17.0 6.8
Chemicals and 3.4 3.2 2.7 2.5 5.3 2.9
materials 6.7 3.1 2.3
Industrial automatics 0.7 1.9 0.9 1.2 0.9 2.1 1.1 0.8 1.6
Transport 6.4 2.9 7.2 3.1 3.4 1.2 2.3 2.6 5.3
Financial services 2.7 6.4 4.1 2 1.8 1.8 2.6 3.9 2.3
Other services 7.6 11.9 2.4 9.8 8.2 5.6 5.8 8.4 9.8
Other industrial goods 9.4 9.8 13.1 11.9 9.1 9.3 6.1 6.6 7.7
Agriculture 2.3 1.6 0.6 2.2 0.4 0.2 0.4 0.9 0.3
Construction 4.8 3.8 3.8 2.4 2.5 1.8 6.1 1.9 3.4
Other 2.7 4.3 5.3 9.8 6.1 4.1 3.5 4.1 6.8
Total in % 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Total PE in EUR billion 5.5 6.8 9.7 14.5 25.1 35.0 24.3 27.6 29.1
Of which venture
capital in EUR billion 2.6 3.2 4.1 6.0 10.7 19.7 12.2 9.8 8.4
Source: EVCA yearbooks

2.6. DISINVESTMENTS
Table 2.14 presents the value and types of disinvestments at European PE funds
between 2000-2003. The PE funds usually sold their portfolio companies to a sector
investor. Sale to another PE fund was a major exit strategy in 2003 (with a share of
20.2% in the value of all disinvestments).

Table 2.14.
Investment exit strategies in Europe between 2000-2003
EUROPE 2000 2001 2002 2003
In
EUR In EUR In EUR In EUR
million % million % million % million %
Write-off 689.1 7.6% 2 847.9 22.8% 3 201.2 30.0% 1 577.2 11.6%
Trade sale 3 33.0% 4 228.0 33.9% 3 301.1 30.9% 2 762.0 20.4%
004.8
IPO 573.3 6.3% 250.3 2.0% 702.7 6.6% 756.0 5.6%
Sale of shares on 705.4 7.7% 1 135.2 9.1% 560.8 5.3% 843.7 6.2%
secondary market
Repayment of 1 19.6% 1 807.3 14.5% 896.4 8.4% 2 150.4 15.9%
preferential 782.9
loans/shares to
investor
Sale to another 1 11.6% 478.7 3.8% 418.3 3.9% 2 740.2 20.2%
PE fund 051.4
Buy back n/a n/a n/a 742.3 5.5%

Sale to financial 356.7 3.9% 539.3 4.3% 420.4 3.9% 819.0 6.0%
institution
Other 938.9 10.3% 1 187.6 9.5% 1 173.7 11.0% 1 162.8 8.6%
Total 9 100.0% 12 100.0% 10 100.0% 13 553.6 100.0%
102.5 474.3 674.6
Source: EVCA yearbooks

2.7. STIMULATION OF PRIVATE EQUITY DEVELOPMENT BY THE

EUROPEAN COMMISSION 83

In 1980s many small- and medium-sized enterprises in Europe (especially in the UK

and Germany) listed their shares on the American NASDAQ, due to lack of similar
markets in Europe.
Therefore, in early 1990s the European Commission put forward an initiative to
create stock markets for small- and medium-sized growth enterprises for the EU
member states.
As a result of many earlier studies conducted among European companies and
venture capital funds new stock markets for small- and medium-sized high-growth
enterprises emerged, including:
a. Le Nouveau Marché (France – Paris, launch: 14 February 1986;
b. Easdaq (Belgium – Brussels; launch: November 1996) – since autumn 2000
Nasdaq Europe;
c. Euro-Nm Belgium (Belgium – Brussels, launch: April 1997);
d. Euro-Nm Amsterdam (Netherlands – Amsterdam, launch: 20 February 1997);
e. Neuer Markt (Germany – Frankfurt, launch: 10 March 1997) – does not exist
anymore;
f. Nuovo Mercato (Italy – Milan. launch: January 1999).84
As A. Kornasiewicz85 points out, initiatives of the European Commissions aimed at
stimulating the development of venture capital investments were located as part of
activities for full deregulation of the financial services market. The program of a
harmonized European market was opened in January 1993. In November 1997 the
European Employment Committee decided that the pan-European Risk Capital
Market – the non-public market – may play an important role in creating new jobs.
The Committee asked the European Commission to prepare a report on the barriers
to development of that market in EU countries. In April 1998 the European
Commission published a document entitled: Risk Capital Markets: A Key to Job
Creation in Europe. In order to elevate the barriers, the European Commission

83
This part was prepared on the basis of “Venture Capital Incentives in Europe. European Private Equity special
paper” (ed. S.J.Berwin), EVCA 1997; Baygan G., Venture Capital Policy Review: United Kingdom, STI
Working Paper 2003/1; A.Kornasiewicz “Venture capital w krajach rozwiniętych I w Polsce”, CeDeWu,
Warsaw 2004
84
Nowe rynki kapitałowe zostały opisane przez autora w „Naszym Rynku Kapitałowym” February, March,
May, July 2000
85
A.Kornasiewicz “Venture capital w krajach rozwiniętych I w Polsce”, CeDeWu, Warsaw 2004, p. 179
drafted a Risk Capital Action Plan (RCAP), adopted in June 1998. RCAP served
three aims:
a. creation of a pan-European risk capital market;
b. development of entrepreneurial culture;
c. construction of a harmonized market for financial services (under the so-
called Financial Service Action Plan or FSAP, for the public market);

The RCAP provided for six action directions:

a. limiting market fragmentation;
b. eliminating institutional and regulatory barriers;
c. eliminating tax barriers;
d. increasing high-tech sector dynamics;
e. improving human capital quality;
f. reducing cultural barriers.86

In March 2000 the European Council adopted the so-called Lisbon Strategy,
which assumed that by 2010 the EU will have the most competitive and dynamic
knowledge-based economy in the world. The RCAP (as part of the FSAP) should
have been implemented by the end of 2003. The Commission emphasized that high
risk capital is a very important source of financing for small- and medium-sized
enterprises (including the high-tech sector), and has considerable importance for
early stage companies.

2.8. STIMULATION OF PRIVATE EQUITY DEVELOPMENT BY THE UK

GOVERNMENT

The UK private equity market was fragmented and undeveloped until late 1990s. The
UK government introduced many initiatives, schemes, to broaden the access to
capital for small early stage companies. Already in 1929 the McMillan Committee
identified an access barrier to capital for small companies as a significant inhibitor to
their growth. With the support of the Bank of England, clearing banks and Scottish
banks the Industrial and Commercial Finance Corporation (ICFC) was created in
1945. The ICFC was later replaced by 3i, now the top venture capital fund in the UK.

2.8.1. Investment regulations

According to G. Baygan, scarce engagement of UK institutional investors in venture
capital results partly from government regulations. Even in 2000, the record year for
private equity investments, less than 1% of the asset value of institutional
investments, i.e. pension funds and insurance companies, was allocated in private
equity (in the USA: 7%).Such institutions are reluctant to invest in private equity,
especially in venture capital, due to high risk and low market liquidity.

86
P.Tamowicz, Rynek kapitału ryzyka w Polsce, Polskie Forum Strategii Lizbońskiej, Niebieskie księgi 2003 no. 4, p. 14
 The accounting regulations and standards in the UK thwarted the activity of
institutional investors. The Financial Services Act of 1986 excluded most British
pension funds from direct investments in private equity funds.
The Insurance Companies Regulation Act of 1994 reduced the investment
barriers for insurance companies, increasing the investment engagement of these
investors in private equity assets. While British pension funds increased their private
equity investments to 42.2% in 2001 from 24% in 1999, most capital flowed to those
companies at later development stages.
The amendments to the 1986 Financial Services Act implemented in 2003
mitigated the investment restrictions for pension funds with regard to private equity
assets.

2.8.2. Tax incentives

The UK government introduced many tax reliefs addressed to various investors, in
order to boost private equity supply.
The tax incentives in the UK include:
a. The Enterprise Investment Scheme;
b. Venture Capital Trusts;
c. The Corporate Venturing Scheme.

The Enterprise Investment Scheme (EIS) – initiated in 1994

The EIS provides tax reliefs to individual investors or business angels that acquire
shares or stocks of unlisted companies. Initiated in 1994, the EIS replaced the
previous Business Expansion Scheme. The EIS aims to reduce the access barriers
to equity for small companies (both new and existing). The EIS offers a number of
investor tax reliefs:
a. income tax relief – for investments in unlisted companies not exceeding GBP
150 thousand, individual investors have a tax relief equal to the lowest income
tax rate, which was 20% in the tax year 1999-2000. If an investor is eligible for
the relief, he/she may also benefit from one or several of the following reliefs:
b. exemption from the capital gains tax;
c. possibility to set aside the investor’s loss on investment against the company’s
capital gains or income;
d. exemption from the capital gains tax – if the funds from disposal of the assets
are re-invested in the EIS (a non-listed company).

Venture Capital Trusts (VCT) – initiated in 1995

The VCTs are investment vehicles addressed to individual investors who may benefit
from various income tax and capital gains tax reliefs. Some VCTs are exempt from
the corporate income tax on their profits from investments in a portfolio company.
VCT shares are traded on the London Stock Exchange.
There are two significant tax reliefs. First, natural persons purchasing shares for up
to GBP 100 thousand in one tax year are entitled to an income tax relief of 20% of
the investment value, provided that they hold the securities purchased for at least 3
years. Second, the investor is exempt from the income tax on dividends on ordinary
shares in the VCT.

The Corporate Venturing Scheme (CVS) – initiated in 2000

This scheme aims to encourage enterprises to invest in venture capital funds. The
tax reliefs for investments in shares of eligible companies between 01/04/2000 –
31/03/2010 were as follows:
a. an investment relief on the personal income tax by purchase of 20% of new
ordinary shares in small, non-listed companies charged with high risk, provided
that those shares are held for at least 3 years;
b. exemption from corporate income tax – on the capital gains in the CVS;
c. possibility to set aside the investor’s loss on investment against the company’s
operating costs.
The investor and capital recipient has to meet several criteria to be eligible for the
above tax reliefs: The investor may not hold more than 30% of ordinary shares in the
portfolio company and the asset value of the portfolio company may not exceed GBP
15 million.

2.8.3. Capital schemes

In the second half on the 1990s the UK government shifted its focus from tax and
regulatory policy to initiatives aimed at facilitating the access to venture capital for
small companies.
In 1998 the Enterprise Fund (EF) was established to reduce the capital
access barrier for small companies and drive regional growth. Apart from loan
guarantees offered by the EF, its activities were gradually expanded to include other
instruments, such as the UK High Tech Technology Fund and Regional Venture
Capital Funds.
The UK High Tech Technology Fund initiated in 2000 is a fund of funds
supporting high-tech companies at early stages. The Department of Trade and
Industry planned to spend GBP 20 million on investment capital of that fund and
acquire an additional GBP 100 million from British capital investors.
The Regional Venture Capital Funds (RVCF) aim to reduce geographical
disproportions in private equity allocations. The first RVCF was launched in
2001/2002 and charged with the task of creating a network of venture capital funds in
nine regions of the country. Each fund has to be commercial, managed by
experienced investment managers and look for attractive investment projects on the
private market. Every fund should acquire and manage capital of at least GBP 10
million, and up to GBP 250 thousand should be spend on the first investment round,
and the subsequent investments (in the next 6 months) my increase by another GBP
250 thousand. The European Investment Fund has promised to inject the scheme
with capital amounting to 20% of the value of the entire scheme.
 The University Challenge Fund is yet another government initiative to
enhance the public-private partnership by facilitating the transfer of knowledge and
technologies from universities to the private market. The fund provides capital for
ventures at the early stage, enabling universities to develop business projects and
create new companies.
The Early Growth Fund initiated in 2002 by the Small Business Service is an
initiative to encourage the financing of highly risky new companies. By creating the
above fund, the UK government wants to act by leveraging private investments.
Local promotion of venture capital investments is expected to reduce the number of
investment failures in companies at early development stages. The authors of capital
schemes do not mean to compete with existing private equity funds.

2.8.4. Business angels network

The UK was the first European country to establish a business angels network. In
2001 the number of business angels networks was estimated at 50, one of the top
results among OECD countries. It is estimated that there are from 20 thousand to 40
thousand business angels in the UK, which invest ca. GBP 500 million to GBP 1
billion a year in 3000 – 6000 companies.
The British business angels invest mainly in new technology companies (30%)
and their investment horizon is generally longer (5 years and more) than that of
private equity funds.
In 1999 the UK government helped to create the National Business Angels Network
Limited (NBAN), supported by UK Small Business Service and sponsored by major
banks and financial institutions.

2.8.5. Over-the counter markets

The London Stock Exchange opened a new OTC market, the Alternative Investment
Market (AIM) in 1995. The AIM is addressed to a broad range of companies, from
young companies to management buyouts and management buyins or employment
buyouts and family enterprises not meeting the LSE criteria. Potential AIM issuers
may operate in the high-tech and service sector. All types and classes of securities
can be listed on the AIM (ordinary shares, preferential shares, bonds). Unlike on
LSE, potential AIM issuers do not have to meet requirements of specific capital
volume, issue volume or years in operation. Deregulation of the eligibility criteria
drew the attention of many issuers, thus making AIM an attractive package for
acquiring capital on an IPO-basis.
At the end of 2004 there were 890 companies listed on the AIM market with a
total capitalization of GBP 24.4 billion.

2.9 CHALLENGES FOR FUTURE DEVELOPMENT OF PRIVATE EQUITY

INVESTMENTS IN THE EU
 According to Josh Lerner87, there are many premises for further development
of private equity investments in Europe.
First, internationalization of capital sources. Banks, insurance companies
and government agencies in individual countries are the most important source of
private equity in Europe. Capital engagement of foreign investors was low. That
changed for two reasons: growing interest in European private equity funds,
especially among American institutional investors, and intensified activity of foreign
private equity funds in Europe.
The second growth factor covers new talents in the private equity sector.
Traditionally, many investment managers in the private equity sector have
experience in the financial or consulting services sector, and not many of them were
experienced in operational management of companies. Therefore, the relationships
between fund managers and the management of portfolio companies focused on
“dry” monitoring of agreed financial indicators and not on active cooperation between
the parties. According to Lerner88, there is a group of European investment managers
who are trying to imitate the management methods of American private equity funds
and are willing to manage them in US conditions.
The third growth factor is related to geographical investment distribution.
European private equity investors tended to invest in the country in which the fund
was established. The lack of supranational investments was motivated by their
unwillingness to struggle with legal and regulatory barriers as well as various cultural
barriers, specific to individual European countries. The shaping of a pan-European
private equity market will support higher supranational activity of private equity funds.
The forth growth factor in the private equity sector concerns changing market
characteristics. In early 1990s private equity financing from outside of the USA was
used for management buyouts/buyins and capital injection of existing companies. In
the last decade the role of venture capital investments in early stage companies has
grown.

Summary
The second chapter shows, on the basis of studied literature, that the use of
private equity in the United States and in Europe has grown dynamically, contributing
to the development of new sectors.
The MBOs have enjoyed increasing popularity both in the USA and in Europe,
especially after 2000, which was a year of severe losses for private equity funds. At
that time the investments were directed mostly at new ICT and Internet companies.
As the “Internet bubble” burst, the share prices adjusted sharply and the value of
investment portfolios at private equity funds plummeted.
The value of PE investments in the USA closed with EUR 49.1 billion89
(including EUR 16.3 billion or 37.2% of the so-called venture capital investments at
the early stage of company development) in 2003. The value of private equity

87
Lerner J., profesor bankowości inwestycyjnej Harvard Business School i National Bureau of Economic
Research
88
Caseli S., Gatti S (red.), Venture Capital. A Euro-System Approach, Springer-Verlag Berlin-Heidelberg, 2004,
p. V
89
Average weighted exchange of the National Bank of Poland in 2003: EUR 1.00 = USD 0.884873.
investments in Europe amounted to EUR 27 billion (including EUR 8.4 billion or
31.1% of the so-called venture capital investments at the early stage of company
development) in 2003. In Europe, seed capital had a very low share in venture capital
of just 0.2% in 2003. In the USA the share of seed capital in venture capital was
much higher (6.4%), though it had been declining steadily since 1995 (when it was
23.6%).
Private equity funds generated higher rates of return in the USA than in
Europe. In a 20-year horizon:
a. US venture capital funds generated a rate of return of 15.5% (7.2% in Europe):
b. buyout funds in the USA had a rate of return of 12.5% (12.2% in Europe);
c. private equity risks covering all types of investments generated a return on
equity of 13.6% in the USA (9.9% in Europe).
The three key sectors, which together represent ca. 50% of invested venture
capital in the USA in 2003, were: software, biotechnology and telecommunications.
The major private equity recipients in Europe in 2003 included: consumer goods
(19.4% of PE investment value), telecommunications (16.9%) and other services
(9.8%).
Sale of portfolio company shares through IPOs and trade sales were the most
popular exit strategies in the USA, although the number of IPOs has declined sharply
since 2000. In Europe, in terms of disinvestment value, sale to sector investors
represented 20.4% and sale to another PE funds 20.2% in 2003.

Summary
On the example of the USA and the UK this chapter also aimed to prove, that
private equity development was supported by the national governments through:
a. beneficial investment regulations, which enabled pension funds, insurance
companies to invest in private equity funds;
b. tax incentives (low capital gains tax);
c. capital schemes (such as the SBIC in the USA) which engaged public and
private funds allocated in unlisted small- and medium-sized;
d. creation of business angels networks (AC-Net) to enable networking of private
investors and companies in need of capital; What is interesting, when the AC-
Net platform had achieved its aims, it was sold to private investors.
e. opening of OTC markets (NASDAQ in the USA, Alternative Investment Market
in the UK, which offered less strict eligibility criteria for high-growth small- and
medium-sized companies.
In March 2000 the European Council adopted the so-called Lisbon Strategy,
which assumed that by 2010 the EU will have the most competitive and dynamic
knowledge-based economy in the world. The Risk Capital Action Plan (as part of the
Financial Services Action Plan) should have been implemented by the end of 2003.
The Commission emphasized that high risk capital is a very important source of
financing for small- and medium-sized enterprises (including the high-tech sector),
and has considerable importance for early stage companies.
III. SELECTED LEGAL AND ECONOMIC ASPECTS OF THE
ACTIVITY OF PRIVATE EQUITY FUNDS
1. CYCLICAL NATURE OF PRIVATE EQUITY INVESTMENTS
The investment process of private equity funds is cyclical. Private equity funds
are usually established for the period of between 7 and 10 years, and the results that
they generate for investors determine to a large extent whether new funds are
created or not.
It is possible to define four distinct stages of this process, i.e.:
a. attracting capital from investors for the purpose of launching the fund and
simultaneous search for and acquisition of attractive investments;
b. launching of the fund (selection of business plans, due diligence, i.e. detailed
analysis of selected projects, negotiations and planning of investment stages,
calls upon investors for additional funding, investing the capital);
c. value creation and monitoring in portfolio companies;
d. exit from the investment and realisation of financial benefits90.
The above-mentioned investment stages are presented in figure 3.1.

90
In their work “Inwestycje Private Equity/Venture Capital”, KeyText, Warsaw, 2004, on p. 33 K. Sobańska and
P. Sieradzan present four stages of functioning of private equity funds: acquisition of capital; search for, analysis
and selection of prospective investment projects and initiation of investments; duration of investments (increase
in the value of portfolio companies); realisation of portfolio profits (disinvestment, i.e. exit from the companies).
Figure 3.1
Private Equity Investment Process

Development
of the fund’s concept

Raising capital Search for attractive

from investors investments

Year 0
Launch of the fund
First call for capital

Selection of Detailed Negotiations Calls for Investing of

2-3 business analysis of and planning additional the capital
years plans selected of investment capital
projects stages

Value creation and monitoring in portfolio

4-5 companies
years  Participation in the supervisory board
 Continuous evaluation of the outcomes of the
fund’s investments
 Recruitment of managerial staff
 Establishing commercial contacts
 Assistance in acquiring additional funding

2-3 Exit of the investment Benefits from the investment

years or  Initial public offering  Cash
longer (IPO)  Share issue
 Acquisitions  Others
 Management buy-
out
 Liquidation
 Sale

7-10 years
and longer
Source: Prepared by the authors on the basis of: Smith J.K., Smith R.L., Entrepreneurial Finance,
John Wiley & Sons, 2000, p. 505

Private equity funds are a kind of financial intermediaries between capital investors
(both institutional and individual) and portfolio companies, i.e. capital recipients (cf.
Diagram 3.1).

Diagram 3.1
Simplified Model of the Private Equity Market
Portfolio Capital Private Capital Capital investors
companies equity - individual (so-called business
(SME) funds angels)
- institutional, i.e. pension
Capital funds, insurance companies,
repayment Capital banks),
repayment - corporate (businesses)
Source: prepared by the author.

On the one hand private equity funds ensure that professional principles of
selecting promising investment projects are applied, on the other one they
accumulate capital and attract a lot of investors with the aim of investing the collected
funds in portfolio companies. They also enable investors to shape the manner in
which the capital they entrusted to the fund is managed and to monitor the
investment, and provide them with relevant reports. Hence, private equity funds
reduce costs and risk on the part of the investor, especially seeing as fund managers
are compensated by investors in the form of annual management fees and a share in
future capital gains.

2. PRIVATE EQUITY FUNDS OPERATING AS INVESTMENT COMPANIES IN

THE FORM OF LIMITED PARTNERSHIPS

The most frequent organisational and legal form among private equity funds is
the limited partnership91 (sharing some features with limited partnership under Polish
law, i.e. spółka komandytowa), in which there is at least one general partner
(corresponding to komplementariusz under Polish law) and at least one limited
partner (equivalent of komandytariusz under Polish law).92 Hence, this section

91
In the USA nearly 80-90% of private equity funds operate as limited partnerships.
92
In the USA there are also limited liability partnerships (LLP). This legal form was introduced to the legislation
of individual states in the 1980s. The structure of this legal form was based on the German legislature and the
limited liability company (Gesellschaft mit beschränkter Haftung, GmbH), which also served as a model for the
Polish limited liability company (spółka z ograniczoną odpowiedzialnością, sp. z o.o.) LLP has its own legal
personality separate from its partners, and the partners are not personally liable for the entity’s debts and
obligations. In Europe this legal form has many variations. For instance, in Great Britain, the Netherlands,
Denmark, Finland and partially in Sweden private equity organisations may operate as limited partnerships. In
Germany there are limited liability companies, i.e. GmbH and GmbH & Co. KG. Other forms worth mentioning
are investment trusts, quite popular also in Great Britain, whose form resembles the Polish limited joint-stock
partnership (spółka komandytowo-akcyjna), and Venture Capital Trusts, whose certificates are traded on the
London Stock Exchange. Other organisational and legal forms of private equity funds in Europe are discussed in
detail by A. Kornasiewicz in the work Venture capital w krajach rozwiniętych i w Polsce (pp. 114-117 – Great
Britain, pp. 134-138 – France, pp. 156-159 – Germany).
presents the specific nature of functioning of private equity funds operating as limited
partnerships, as this is the form preferred by investment partners.
Individual and institutional investors investing in limited partnerships may entrust
investment decisions and the monitoring process to professionals serving as general
partners.
A general partner holds unlimited personal liability for the partnership’s debts
and obligations. In contrast, the liability of a limited partner is limited to the value of
that partner’s contribution to the partnership. This is why limited partnerships are
attractive especially to large individual investors.
The main advantages of a limited partnership are as follows:
 it is transparent for the purposes of the capital gains tax; the fund’s income on
investment are taxed directly as income of the fund’s participants. E.g. An
investor of X ventures from Poland that is a limited partner in a limited
partnership will pay tax at source (in Poland), i.e. in 2004 CIT = 19% on the
difference between the value of the capital upon exit and the value of the capital
invested in the limited partnership;
 The management fee is VAT-exempt as due to a partner in a partnership (e.g. in
Great Britain).
In practice (for tax reasons and due to the extent of liability for the partnership)
general partners are normally other limited partnerships, which serve then as fund
managers. General partners usually make only a small contribution (typically as little
as 1% of the investment capital), whereas limited partners provide the remaining
part, i.e. 99% of the partnership’s capital. Among limited partners there prevail
pension funds, insurance companies, higher education institutions, enterprises and
individual investors.93 (cf. Figure 3.2, Table 3.1).
Private equity funds offer investors an alternative to investments in securities
(shares, bonds). They provide investors with diversified investment portfolios, which
they may freely modify by increasing or decreasing the level of risk associated with a
given project in which the fund plans to get involved.

Table 3.1
Description of Individual Types of Investors in Private Equity Funds
Investor Description
Designation
Pension funds  They manage large amounts of capital.
 They have a very long investment time horizon.
 They enlist very sophisticated risk management methods.
 Although private equity usually constitutes only a fraction of
pension funds’ portfolios, from the perspective of private
equity funds their contributions are quite substantial.
Banks  They are some of the largest private equity investors.
 By extending their investment activity banks strive to
acquire new clients and make additional capital gains.
 Aside from capital contributed to funds, banks may also
lend money for financing e.g. management buy-outs.
Funds of Funds  They entrust capital to private equity funds for

93
In Germany and Japan the main capital providers to private equity funds are banks and enterprises.
(FoF) management. Funds of funds that invest in newly
established private equity funds are so-called primary FoFs,
whereas those focusing on investments in already existing
private equity funds are secondary FoFs.94
Insurance  Just like pension funds, insurance companies manage large
companies amounts of capital and search for attractive investments in
which to allocate them.
Large enterprises  Their engagement in private equity funds serves two
purposes:
(1) long-term allocation of surplus money aimed at maximising
profits and minimising risks;
(2) development of certain technologies and solutions they
intend to use in their own operating activity (venture
management). In their case maximisation of profits is not the
primary aim.
Public institutions,  Their participation as private equity investors may
government effectively stimulate business development, help activate
agencies selected geographical regions and serve as a method of
creating new jobs.
Higher education  By investing in private equity funds they aim to diversify
institutions their existing financial asset portfolio.
Private persons  They allocate money directly in private equity projects
(business angels) or entrust it to private equity funds.
Source: prepared by the author on the basis of: Sobańska K., Sieradzan P., Inwestycje Private
Equity/Venture Capital, KeyText, Warsaw, 2004, p. 32-35

Flexibility of legal entities in the form of limited partnerships allows their

internal and external participants to sign contracts under which compensation of
general partners is contingent upon an increase in the investment capital and to
reduce agency costs. For instance, in spite of restrictions concerning the right to
manage the entity, limited partners usually may vote on amendments to the
partnership agreement or its termination, prolongation of the partnership, termination
of the agreement with the general partner and portfolio valuation.95
Each limited partnership is established for a specified period of time. Its
average duration is between 7 and 10 years; subject to the consent of limited
partners it may be prolonged for additional 4 years. In the first 3-5 years after
incorporation the partnership invests the collected capital. Upon initial selection of
investment projects, the investment structure is agreed with the former owners of
the enterprise (private equity recipient). Subsequently, the general partner manages
the investment portfolio and successively closes individual investments.
As a result limited partners receive cash or securities (e.g. shares or convertible
bonds). Once a limited partnership is terminated, general partners (partnership
managers, investment directors) usually launch another one. In practice every 3-5
years partnership mangers establish new funds, which implies that at a single point in
time they may manage a couple of funds at different stages in their life cycle. Each

94
Definition derived from http://www.ppea.org.pl/new/slowniczek.php
95
Sahlman W., The structure and governance of venture capital organizations, “Journal of Financial
Economics”, Vol. 27, pp. 473-521, 1990
such fund operating as a limited partnership is legally autonomous and managed
independently, i.e. although a manager manages a few partnerships at the same
time, each of them is treated individually and a separate investment strategy is
created for each and every one of them.
Limited partnerships that finance ventures such as management buy-outs differ from
venture capital companies in the value of the collected investment capital and
number of limited partners. Some venture capital companies investing in firms at
early stages of development may have a regional focus (e.g. on the Silicon Valley in
the USA). In the USA the minimum aggregate value of capital that funds may invest
is USD 10 million, whereas limited partnerships specialising in management buy-outs
may manage as much as USD 1 billion.
In the first 3-5 years of existence, a limited partnership invests usually in 5-50
enterprises (from 2 to 15 annually). The number of limited partners is not constant.
Many limited partnerships that finance large-scale enterprises have from 10 to 30
limited partners, but some of them have over 5096. The minimum unit equity
participation of a limited partnership is usually USD 1 million, although some venture
capital funds may attract new entrepreneurs willing to acquire less than USD 1
million97. Large limited partnerships invest at least USD 10-20 million.
Most managing companies (general partners) have from 6 to 12 managers, even
though many new limited partnerships start with only 2 or 3.

96
Most limited partnerships with only one limited partner are established by a limited partner rather than a
general partner. In many cases the function of a limited partner is fulfilled by a non-financial enterprise, e.g. a
firm that wants to develop a competitive technology. The aims of limited partners are more of a strategic than
investment nature.
97
Private equity funds operating in Poland have similar capital requirements as regards the minimum investment
value in a single venture, i.e. USD 1 million, e.g. Baring Communications Equity (Emerging Europe) Ltd,
although there are also funds in which the threshold is lower, e.g. MCI Management S.A. (USD 0.5 million), or
higher, e.g. Advent Private Equity Fund, Advent Central & Eastern Europe (USD 5 million); Raiffeisen CEE
Private Equity Fund LP (EUR 3 million); Enterprise Investors funds (USD 3 million).
Figure 3.2
Organisational Structure of a Private Equity Fund (Limited Partnership)

General Partner: Fund Organiser

 Acquiring capital from limited partners (LPs)
 Searching for attractive investments for LPs
 Negotiating the fund’s capital entry
 Investment monitoring and consultancy
 Disinvestment (IPO, LBO, liquidation,
acquisition)

1% of Annual 20-30% share

capital and management in profits
fund fee: expressed as
manageme 2-3% of the increase in
nt investment capital value
capital

Investment
Private Equity Funds capital and Portfolio
participation in Companies
(Limited Partnership) the
management  Value
process creation

Capital needs

99% of 70-80% share in

investment profits from
capital appreciation in the
value of the capital
 Limited Partners: Investors
 Pension funds
 Insurance companies (life
insurance)
 Universities/higher education
institutions
 Businesses
 Individual investors
Source: Prepared by the authors on the basis of: Entrepreneurial Finance, J.K. Smith, R.L. Smith,
John Wiley & Sons, 2000, p. 500

Compensation Packages for Private Equity Managers

In practice there are two forms of compensating investment partners (cf. Figure 3.2).
Partners participate in the distribution of profits from appreciation in the value of the
capital. Limited partners usually receive 70-80%, and general partners 20-30% of the
profits from the appreciation in the value of the capital98. For example, in the USA
and Great Britain there is no so-called double taxation of the profits of a partnership
and the income of its partners. This means that partners of a limited partnership pay
tax only on the appreciation in the value of the capital that they contributed for the
purpose of launching the partnership (i.e. capital gains tax).
Additionally, general partners receive an annual fee for managing the partnership in
the amount of 2-3% of the investment capital99. According to M. Klausner and K.
Litvak the management fee is on a nearly uniform level in the entire private equity
sector100. P.A. Gompers and J. Lerner101 observe that the older and more mature the
fund, the lower the fixed management fee. Younger funds more frequently apply
incentives related to market share, as their aim is to create an image that is going to
help them strengthen their market position in the future.

3. RELATIONSHIP BETWEEN PRIVATE EQUITY FUNDS AND PORTFOLIO

COMPANIES
Literature on the subject frequently emphasises that the information
asymmetry and potential conflicts of interests between the capital recipient and its
provider may have a negative impact on financial and investment decisions. The first
author to apply this theory specifically to venture capital funds was W.A. Sahlman 102.
In his pioneering study, he presented private equity funds from the angle of their dual
relationship with the capital recipient (i.e. portfolio company) and the end investor

98
According to T. Baums and R.J. Gilson (Comparative venture capital contracting, Working Paper, Stanford
University, 2000) for general partners this ratio amounts to 20%.
99
According to T. Baums and R. J. Gilson this ratio amounts to 2.5%.
100
Klausner M., Litvak K., What economists have taught us about venture capital contracting [in:] Whincop
M.J. (ed.), Bridging the Entrepreneurial Gap: Linking Governance with Regulatory Policy, Aldershot: Ashgate,
pp. 54-74, 2001
101
Gompers P.A., Lerner J., The Venture Capital Cycle, Cambridge, MIT Press, 1999
102
Sahlman W.A., The structure and governance of venture capital organizations, “Journal of Financial
Economics”, Vol. 27, 1990
(e.g. pension fund): in the first relationship a private equity fund acts as a principal
and in the other one as an agent (cf. Diagram 3.2).

Diagram 3.2
Relations between Private Equity Funds and Institutional Investors and
Portfolio Companies

Portfolio companies Information Private equity fund Agent Capital

investors
Principal Capital

Source: prepared by the author.

In the first relationship a private equity fund serves as a principal, and as such
is faced with the problem of estimating the investment potential of companies that are
capital recipients (in this case agents) in an uncertain environment.
In the second relationship a private equity fund serves as an agent and thus
bears a risk that if it fails to generate a satisfactory rate of return it will find it difficult
to acquire additional funding from end investors.
As regards the first relationship, what a private equity fund expects from a
small company is first and foremost information ensuring that current investments are
adequately monitored and serving as a valid basis for the decision whether to
engage in that company additional capital or not103. The problem is that the
company’s owner wants to remain independent and thus is unwilling to share the
information that it has at its disposal on a systematic basis104. This implies that in the
course of an investment’s duration the private equity fund must perform negative
selection, as it is hard to assess the entrepreneur’s achievements. This may induce
the fund to tighten financing conditions in order to avoid the risk of having to sustain
excessive costs associated with badly managed investments.105 As pointed out by M.
Wright and K. Robbie106, this may explain why companies with huge growth potential
sometimes find it initially difficult to acquire private equity and why only small
amounts are invested in companies at early stages of development, where
information asymmetry is greatest.
Many other studies touch upon the issue of the expectations of private equity
funds (systematic information) and the entrepreneur’s willingness to maintain
independence and self-reliance in the sphere of operating control. Both the agency
theory developed by M.C. Jensen and W.H. Meckling107 and the transaction cost
theory proposed by O.E. Williamson108 stress the importance of cooperation
between private equity funds and entrepreneurs, which facilitates minimisation of the
costs associated with investment monitoring. A very innovative approach is the

103
Bruno A.V., Tyebjee T.T., The entrepreneur’s search for capital, “Journal of Business Venturing”, Vol. 1,
1995
104
Sapienza H.J., Korsgaard M., Performance feedback, decision making process and venture capitalists’
support for new venture [in:] Bygrave W.D. (ed.), Frontiers of Entrepreneurship Research, 1995
105
Model developed by Amit: Amit R., Glosten L, Muller E., (1990), Entrepreneurial ability, venture
investments and risk sharing, “Management Science”, Vol. 36
106
Wright M., Robbie K., Venture capital and private equity: a review and synthesis, “Journal of Business
Finance and Accounting”, Vol. 25, 1998
107
Jensen M.C., Meckling W.H., Theory of the firm: managerial behaviour, agency costs and ownership
structure, “Journal of Financial Economics”, Vol. 3, 1976
108
Williamson O.E., Markets and hierarchies: analysis and anti-trust implications, Free Press, New York, 1975
model of the relationship between a private equity fund and a small company drawing
on the so-called prisoner’s dilemma. It shows that private equity funds and SME may
gain a considerable financial reward should their relationship deteriorate and that
both sides may maximise mutual return on the invested capital through cooperation.
Chances for cooperation improve with an increase in quality and frequency of
communication, closeness of business relations, expected compensations, term of
the investment and imposition of penalties in situations when cooperation is lacking.
A large part of the literature on the relationship between private equity funds and
entrepreneurs discusses mechanisms whose implementation renders it possible for
the fund to reduce the problem of moral dilemma and negative selection arising from
the risk associated with acting as an agent. They may be divided into the following
categories:
 imposition of high rate of return thresholds (so-called hurdle rates);
 investment evaluation;
 detailed contract specification;
 creating equal opportunities by means of adequate compensation;
 utilisation of preference and/or convertible securities;
 meticulous monitoring of the investment.
Applying high discount rates or rates of return by private equity funds in
calculation of investments profitability is well documented in the global literature on
the subject. A number of studies have shown that the rate of return on the invested
capital that private equity funds expect to achieve is usually higher in the case of
companies commencing their business activity. C.M. Mason and R.T. Harrison109, for
instance, estimate that operating companies must generate annualised internal rate
of return at the level of at least 30%; this value increases to 60% and above for
investments in entities at early stages of development (i.e. seed and start-up
investment s). 110 This finds it confirmation in earlier calculations by J.L. Plummer111.
G.C. Murray and R. Marriott112 demonstrated that private equity funds tend to
assume a higher expected rate of return in the case of projects related to advanced
technologies at every stage of the investment than in the case of comparable
ventures from non-technology sectors. G.W. Fenn, N. Liang and S. Prowse113
represent the stance that more than a half of all private equity investments generate
a below-average rate of return (i.e. at the level of 25-30%), and that only a small
fraction of them produce a rate of return significantly above the average.
In some cases high expected rates of return may toughen the negative selection
by forcing high-growth enterprises to search for alternative sources of financing and
leaving slightly weaker companies with no funding options. This risk may be
mitigated by efficient due diligence and by tightening the relations between the

109
Masson C.M., Harrison R.T., Public policy and the development of the informal venture capital market, [in:]
Cowling K. (ed.), Industrial Policy in Europe, 1999
110
G.W. Fenn, N. Liang and S. Prowse maintain that venture capital funds demand rate of return at the level of
50% in the case of companies (capital recipients) at the initial stages of development and at the level of 25% in
the case of enterprises at later stages. Cf. The Economics of the Private Equity Market, Board of Governors of
the Federal Reserve System, December 1995
111
Plummer J.L., QED report on venture capital financial analysis, QED Research Inc, Palo Alto, CA, 1987
112
Murray G.C., Marriott R., Modelling the economic viability of an early – stage, technology focused venture
capital fund [in:] Oakey R.P., During W. (ed.), New technology-based firms in the 1990s, No. 5, Paul Chapman,
London, 1995
113
The Economics of the Private Equity Market, Board of Governors of the Federal Reserve System, December
1995
private equity fund and the entrepreneur. In this case due diligence114 is carried out
in order to confirm results of an internal audit and verify information provided in the
information memorandum. The process consists in examining source documents,
establishing the final version of the business plan, determining the final list of
suspension clauses and specifying the final transaction structure.
The key questions posed at this stage are:
 Is the company’s management reliable and does it have the necessary
experience?
 Is the strategy of the entrepreneur consistent with the strategy of the fund?
 Is the sector in which the company operates attractive in the long term and are
the company’s product competitive or may they be competitive?
 Is the business plan credible? Will the capital provided by the fund be utilised in
an efficient manner?
 Will the fund be able to achieve the required annualised rate of return and will it
be possible for it to exit the investment?
 Does the transaction structure give the company’s management enough
motivation to strive for success?
There are various types of due diligence, i.e. business, financial, tax, legal,
environmental, technological and insurance due diligence (cf. Table 3.2).

Table 3.2.
Types of Due Diligence
Type of Due Aims
Diligence
Business  Determining whether the sector in which the enterprise operates is
promising from the point of view of the investor.
 Assessing the long-term attractiveness of the industry/sector.
 Evaluating the industry’s development potential, competition and
the company’s position as compared to other market players.
Financial  Verifying whether the financial data presented in the business
plan/investment memorandum reflect the enterprise’s actual
financial standing.
 Confirming whether financial results achieved by the enterprise
correspond to the figures presented to the investor.
 Establishing actual margins generated by the enterprise.
Tax  Identifying tax risks which may result in future tax liabilities that are
related to the transaction’s tax structure.
 Results of tax due diligence serve as a basis for establishing the
final tax structure of the transaction.
Legal  Identifying legal risks to which the given company is exposed.
 Preparing the legal structure of the transaction.
Environmental  Determining whether the company’s operation involves material
violations of environmental protection regulations.
 Conducting any and all necessary surveys and examinations of the
soil, sewage and air for the purpose of establishing the state of the
natural environment.

114
The due diligence process was described in detail by Sobańska K., Sieradzan P., Inwestycje private equity /
venture capital, Key Text, Warszawa, 2004, pp. 57-87, and by Camp J.J., Venture capital. Due diligence, John
Willey & Sons, Inc., New York, 2002
Technological  Determining the state of the equipment and technologies applies by
the company.
 Estimating whether the company’s equipment and technological
resources will allow it to increase output without having to incur
considerable investment outlays.
Insurance  Verifying whether all assets material for the company’s operation
are insured.
 Evaluating the terms of the concluded insurance contracts.
 Identifying any areas that require additional insurance.
st
Source: prepared by the author on the basis of: Ryszkiewicz P., Proces due diligence, paper for the 1
National Venture Capital Forum, Warsaw 2003

Selection Criteria
Authors of a number of other studies analysed the criteria that private equity funds
take into consideration when assessing prospective investments (e.g. A.V. Bruno and
T.T. Tyebjee115). Early works suggest that the key criterion applied by private equity
funds is the entrepreneur’s managerial experience and personality rather than
attractiveness of the product and demand for it on the market. However, the
importance of these criteria varies significantly, and many recent studies have
demonstrated that the industry and market factors take precedence over the
entrepreneur and the management team.
In both cases samples were small, which leaves room for larger-scale studies
in this area. Conducted studies have focused exclusively on early-stage investments.
More in-depth studies encompassing all stages of private equity investments (V.H.
Fried and R.D. Hisrich116) demonstrate that when evaluating investments funds take
into account three groups of criteria:
a. project’s ability to function;
b. integrity, company’s history, managerial skills;
c. prospects for achieving high rates of return by way of a quick disinvestment.
Another important study (D. Muzyka117) points to the fact that private equity
funds tend to form a very positive opinion on enterprises with an experienced team of
managers, realistic premises for further development of the market for the product
and a proper calculation of capital demands, even if they do not fit the fund’s general
expectations in these regards.
S.N. Kaplan and P. Strömberg118 studied 42 enterprises financed by ten
American private equity funds. In their assessment of the portfolio companies the
funds were guided by four groups of investment criteria:
a. enterprise’s attractiveness perceived from the point of view of its share in the
market and the market’s development potential, merchantability of the
product, strategy, company’s competitive position;
b. experience of the managerial staff and the results that it had achieved so far;
c. transaction terms;
d. financial terms and disinvestment path.

115
Bruno A.V., Tyebjee T.T., The entrepreneur’s search for capital, “Journal of Business Venturing”, Vol. 1,
1985
116
Fried V.H., Hisrich R.D., Towards a model of venture capital investment decision making, “Financial
Management”, Vol. 23, 1994
117
Muzyka D., Birley S., Leleux B., Trade-offs in the investment decisions of European venture capitalists,
“Journal of Business Venturing”, Vol. 11, 1996
118
Kaplan S.N., Strömberg P., How do venture capitalists choose investments, Working paper, University of St.
Gallen, 2000
 On the basis of these analyses private equity fund employees may prepare
financial projections for the enterprise taking into consideration the risk associated
with the project and odds on success.
Some private equity funds specialise in investments in enterprises at specific
stages of development or from a given industry (e.g. information and communication
technology). Varying experience and skills, apart from financial analyses, frequently
induce analysts/investment partners to focus a selected industry (e.g. biotechnology),
where the critical factor for success is optimisation of investment outlays for research
and development.
The entire literature of the field corroborates that many projects are rejected due
to the necessity to carry out an in-depth assessment and low probability of achieving
a satisfactory rate of return. According to a study conducted in 1991 by Bannock
Consultants, each year private equity funds in Great Britain had rejected ca. 95% of
all applications for financing.
Many papers also elaborate upon an optimal construction of contracts for the
purpose of reducing or eliminating problems related to the agency between private
equity funds and entrepreneurs. These contracts are drafted in such a way as to
specify the rights of both parties and the basis on which their execution is monitored
and compensated (e.g. E. Fama and M.C Jensen119). A.N. Berger and G.F. Udell120
classify these possibilities into the following categories:
a. division of the venture capital investment into phases and ensuring an
efficient project development (cf. D. Bergemann and U. Hege 121);
b. control and selection of specific debt and capital instruments;
c. appropriate schemes for compensating entrepreneurs;
d. restrictive contracts;
e. representation in the supervisory board;
f. distribution of voting rights at the general shareholders’ meeting.

For instance, using compensation schemes for the purpose of reducing agency
conflicts between the private equity fund and the entrepreneur involves introduction
of structures related to the outcomes of the management process and management
share option schemes. Bonding schemes provide for certain sanctions for a failure to
comply with imposed guidelines, e.g. exceeding a given debt ratio. One of the
existing models (D. Bergemann and U. Hege122) is based on the concept of an
optimal contract between the venture capital fund and the entrepreneur, which
secures against periodic risk sharing. The entrepreneur’s interest is similar to an
option contract, and as such in contingent upon the term of the contract. This model
takes into account a situation in which the venture capital fund is not always able to
monitor whether the entrepreneur misappropriates the capital invested by the fund. In
the case of some attractive projects the probability of a misuse of the capital that the
entrepreneur was entrusted with by the fund is high enough to discourage funds from
investing in such companies in the first place. Funds may reduce agency problems
by offering companies-capital recipients quasi-equity instead of 100% equity.

119
Fama E., Jensen M.C., Separation of ownership and control, “Journal of Law and Economics”, Vol. 26, 1983
120
Berger A.N., Udell G.F., The economics of small business finance: the role of private equity and debt markets
in the financial growth cycle, “Journal of Banking and Finance”, Vol. 22, 1998
121
Bergemann D., Hege U., The economics of small business finance: the roles of private equity and debt
markets in the financial growth cycle, “Journal of Banking and Finance”, Vol. 22, 1998
122
Op.cit.
Convertible Securities
Utilisation of convertible and/or preference securities (e.g. bonds convertible into
ordinary shares, preference shares convertible into ordinary shares) is very popular
among private equity funds upon concluding contracts with capital recipients (E.
Norton and B. Tenenbaum123; S.N. Kaplan and P. Stromberg124), as such
instruments make it considerably easier for funds to allocate separately: cash, voting
rights, ownership rights and rights on account of liquidation of the company-capital
recipient. Introduction of convertible preference securities is very common in the case
of companies operating in high-tech industries, such as software and biotechnology
sector.

S.N. Kaplan and P. Stromberg125 conducted some other interesting studies

concerning private equity investment contracts. They used detailed information on
200 private equity investments based on studies carried out in 118 American firms by
14 private equity funds in the years 1987-1999. Over 36% of these enterprises
operated in the software/IT industry and further 39% in other high-tech industries, i.e.
in the biotechnology, telecommunication and healthcare sector. These studies
demonstrated that convertible preference securities had been until then the most
popular financial instrument appearing in 189 out of 200 rounds of enterprise funding.
In general, these instruments ensure that dividend rights 126, voting rights at general
meetings of shareholders, right to control invested funds and entrepreneurs are
possible on the basis of observable financial and non-financial measures allowing to
assess the quality of the company’s management. If a company is poorly managed,
the fund takes over full control over it; if a company improves its profitability, its
owner acquires more control rights and is entitled to more money. Subsequently, if a
company is highly profitable (which is defined as generating rate of return above the
median = at the annualised level of 30% in the period of 4 years as from the IPO),
then the venture capital fund renounces most of its rights to control the company and
to its share in its assets upon the company’s liquidation, but retains the right to
dividend. These terms are applied predominantly in the case of companies at early
stages of development than those at its later stages. This outcome supports the
theory that potential conflicts of interests between the entrepreneur and the venture
capital fund depend on the degree of uncertainty as regards the project’s financial
viability, which is highest in the case of high-tech sectors and enterprises at early
stages of development.

Changes in Management Board

This section pertains to instances in which entrepreneurs acquiesce in giving up
power in their companies. In their research carried out among 173 companies from
the Silicon Valley in California, T. Hellman and M. Puri127 proved that companies
receiving venture capital are more open to special share option schemes and to

123
Norton E., Tenenbaum B., Factors affecting the structure of venture capital deals, “Journal of Small Business
Management”, Vol. 30, 1992
124
Kaplan S.N., Stromberg P., Financial contracting theory meets the real world: an empirical analysis of
venture capital contracts, 2000, National Bureau of Economic Research Working Paper,
www.nber.org/papers/w7660
125
Op.cit.
126
Dividend right is the right to participate in a company’s profits allocated for distribution by way of a
resolution of a general meeting of shareholders.
127
Hellman T., Puri M., Venture capital and professionalization of start-up firms: empirical evidence, Working
paper, Stanford University Business School, 1999
employing sales vice-presidents than enterprises which do not take advantage of this
form of funding. These companies turned out to be twice as willing to hire a president
of the management board from outside the company than entities without venture
capital. It is worth mentioning that M. Baker and P.A. Gompers128 discovered in their
research that the probability of the president of the management board being
replaced is not a precondition for a company to receive funding from a private equity
fund. T. Hellman129 proposes a theoretical explanation why entrepreneurs decide to
stand down for the benefit of a professional president of the management board. On
the one hand partners of private equity funds believe that managerial staff adds value
to a portfolio company, whereas entrepreneurs are unwilling to take actions which to
their best knowledge are contrary to the company’s best interests. On the other hand,
entrepreneurs are usually reluctant to step aside if they could benefit from exercising
control over the company. Moreover, replacement of the president may negatively
affect the enterprise’s reputation. However, if the entrepreneur reserves in the
contract the right to maintain control over the company, the role of private equity
funds will be limited to providing capital. As a result, the entrepreneur will be faced
with a choice: give up a majority stake in the enterprise or relinquish more control
rights.

4. RELATIONSHIP BETWEEN PRIVATE EQUITY FUNDS AND CAPITAL

PROVIDERS

When investing free funds indirectly through limited partnerships, limited partners
(usually institutional clients) delegate to general partners the responsibility for
selection of investment enterprises, investment structure, management, monitoring
and possibly also the manner of closing the investment. In this relationship the
private equity fund fulfils the function of an agent (intermediary), and the investor acts
as the principal. Just like in the relationship between the entrepreneur and the fund,
in the fund-investor relationship there is an information asymmetry, which leads to
agency conflicts. There is a number of mechanisms aimed at reducing these
problems, among them:
a. incentives focused on mutual gains;
b. prohibition to carry out actions leading to conflicts of interests by the private
equity fund;
c. limited duration of the contract;
d. monitoring of the private equity fund by investors;
e. regular provision of information for investors (cf. W.A. Sahlman130).
The purpose of these actions is to create a tighter connection between the interests
of the private interest fund that those of the investors. As limited partnerships have a
limited duration, investment managers (general partners) must regularly acquire new
funds in order to remain in the business. Establishing new partnerships is a very
time- and cost-consuming process, encompassing a number of presentations
addressed to institutional investors and their advisers. In order to attract investors’

128
Baker M., Gompers P.A., The determinants of board structure and function in entrepreneurial firms,
Working paper, Harvard University, 2000
129
Hellman T, The allocation of control right in venture capital contracts, “Rand Journal of Economics”, Vol.
29, pp. 57-76, 1998
130
Sahlman W.A., The structure and governance of venture capital organizations, “Journal of Financial
Economics”, Vol. 27, 1990
capital, private equity funds must have a track record of prior successful investments
as well as experience in accurate assessment of enterprises’ development potential,
legal and financial analysis of companies and contract formulation before they start
investing in any risky enterprises (cf. M.S. van Osnabrugge 131). Agency problems
may be reduced by an active approach of intermediaries between private equity
funds and institutional investors. Intermediaries advise funds on the selection of
business plans and manage funds of funds, which invest in a number of private
equity funds. In limited partnerships agency problems are mitigated by way of linking
the interests of limited partners (i.e. usually institutional investors) with the interests
of general partners. W.A. Sahlman132, M. Hay and S. Abbott133 and other authors
mention facilitations in the form of various contract constructions, predominantly by
linking managers’ compensation with the company’s results by setting a constant
share (usually 2-3% annually) of the aggregate engaged capital plus an interest
(currently 20-30%) in generated capital gains on capital growth (carried interest), and
thus making compensation of the general partner contingent upon success of the
entire enterprise.
P.A. Gompers and J. Lerner134 discovered that limited partners impose a
number of restrictions before entering into a limited partnership agreement. In their
empirical studies they formulated two hypotheses:
(a) cost contract hypothesis;
(b) demand and supply hypothesis.
In the case of the first hypothesis the authors predicted that there was a correlation
between introducing restrictions and the tendency of investment partners to
conservative relations. When an investment partner acquires funds for the purpose of
investing them in early-stage enterprises, the limited partner is bound to suggest to
the general partner more restrictions as regards the terms of the investment contract
with the portfolio company. Having analysed 140 partnership agreements, P.A.
Gompers and J. Lerner135 found fourteen cases pertaining to the problems regarding
fund management, conflicts of interests and restrictions related to the specific nature
of the fund’s investments. Many agreements involved uncertainty, information
asymmetry and agency costs on the part of the portfolio company. Other factors that
may lead to implementation of restrictions are: size of the fund, compensation
scheme for professionals and their reputation.
The second hypothesis states that demand and supply on the venture capital market
affect agreements and restrictions provided for in long-term contracts. It implies that
when demand for services of well-managed funds changes rapidly due to a constant
supply of venture capital in the short term, contracts with portfolio companies should
contain less restrictions.
Therefore, limited partners use restrictive contracts to curb value erosion
caused by uncertainty and agency costs; as a result they are unable to select and
monitor enterprises in a pro-active manner. On the other hand, contractual
restrictions may lead to a decline in the fund’s value in situation when they limit

131
Van Osnabrugge M.S., A comparison of business angel and venture capitalist investment procedures: an
agency theory-based analysis, “Venture Capital”, Vol. 2, 2000
132
Sahlman W.A., The structure and governance of venture capital organizations, “Journal of Financial
Economics”, Vol. 27, 1990
133
Hay M., Abbott S., Investing for the future: promoting seed, start-up and early-stage venture capital funding
of new technology based firms in the UK, London Business School, London, 1993
134
Gompers P.A., Lerner J., The use of covenants: an analysis of venture partnership agreements, “Journal of
Law and Economics”, Vol. 39, pp. 463-498, 1996
135
Gompers P.A., Lerner J., The Venture Capital Cycle, Cambridge, MIT Press, 1999
investment partners’ flexibility as regards risk diversification and shaping of the
transaction as such combined with agency problems, which arise in every enterprise.
This creates additional pressure on the average rate of return generated by private
equity funds136.
Sometimes it happens that due to the additional risk that they bear private equity
funds are reluctant to invest in high-tech companies at early stages of operation.
Linking the annual compensation of investment partners to the amount of the
capital engaged by investors motivates private equity funds to expand and increase
their investments. On the basis of conducted studies G.C. Murray and R. Marriott 137
constructed a private equity fund model which demonstrates that the internal rate of
return for limited partners is positive in the case of funds with capital base of over
GBP 10 million and achieves an acceptable level (IRR=30%) when the fund’s capital
exceeds GBP 20 million. Pressure on the increase of investments’ scale may also
induce funds to shift their investment policy to later stages of enterprises’
development (cf. P.A. Gompers138).
As a general rule funds with a low capital base invest in classic venture capital
investment stages, i.e. seed stage, start-up stage and early enterprise development
stages, but such investments may be unprofitable due to high operating costs (G.C.
Murray139). What we deal with here is the economy of scale in the high-risk
investment sector. Funds that invest in companies at early stages of their
development have at their disposal less capital than their counterparts financing
enterprises at later development stages or management buy-outs (MBO), and this is
why their operation is characterised by higher unit costs. The larger the capital base
at the fund’s discretion, the less attractive is it for the fund to invest small amounts in
start-up companies, in particular in enterprises from the high-tech industry that
require the fund to incur additional information costs related to their products.

5. RISK AND RATES OF RETURN

The aversion of end institutional investors to finance venture capital funds that
invest in small and middle enterprises from the high-tech sector depends on the
relationship between risk and rate of return, especially on whether the achieved rate
of return is commensurate with the risk borne. Rate of return on private equity
investments depends among others on such factors as:
a. investment period;
b. manner of exiting the investment (disinvestment);
c. enterprise valuation as at exiting the investment.
This is why in order to estimate rate of return it is necessary to take into
consideration the process of exiting the investment, as the easiness and attainability
of disinvestment is the most important factor determining whether an enterprise will
be able to acquire private equity. Statistical data on the venture capital industry in the
USA demonstrate that there is a correlation between a possibility of disinvestment by

136
Gompers P.A., Lerner J., Money chasing deals? The impact of fund inflows on private equity valuations,
“Journal of Financial Economics”, Vol. 55, pp. 281-325, 2000
137
Murray G.C., Marriott R., Modelling the economic viability of an early-stage, technology focused venture
capital fund [in:] Oakey R.P., During W. (ed.), New technology-based firms in the 1990s, No. 5, Paul Chapman,
London, 1995
138
Gompers P.A., Venture capital growing pains: should the market diet?, “Journal of Banking and Finance”,
Vol. 22, 1998
139
Murray G.C., Early-stage venture capital funds, scale economies and public support, “Venture capital”, Vol.
1, Vol. 4, 1999
way of an initial public offering and the readiness of institutional investors to allocate
funds in companies-private equity recipients (measured with newly engaged funds)
with about a year’s delay.
The option to exit an investment through an IPO may also help overcome the
supply barrier as regards capital for small high-tech enterprises resulting from the
reluctance of company owners to surrender a part of corporate governance. The IPO
process is frequently tantamount to a partial disengagement of the investor in the
enterprise and allows the owner to regain control over the company. There is no such
possibility in the case of company sale, where the control over the enterprise is
transferred to the buyer, even if the entrepreneur still manages the company.
According to this theory, the possibility to exit an investment through an IPO is an
important condition for the development of an active private equity market, as it
allows private equity funds and entrepreneurs to conclude transparent contracts
regulating the issue of future control over the company. However, this model does
not set enough store by the fact that an IPO frequently involves a transfer of control
over the enterprise both from the private equity fund and the entrepreneur to a third
party, i.e. a strategic and/or industry investor. It is consistent, though, with the idea
that the success of the process of financing small high-tech companies with private
equity is closely related to the possibility of exiting the investment through an IPO.
The fact that there are highly-developed capital markets, among them also markets
for small high-tech companies (e.g. Nasdaq in the USA, AIM in Great Britain,
Nouveau Marchè in France), encourage funds to take interest in classic stages of
private equity funding.
The influence of risk on rate of return (and vice versa) in various types of
activity pursued by private equity funds is not a particularly popular research area in
the literature on the subject. Unlike many other markets, the private equity market is
not characterised by a fast flow of information, large number of clients and sellers or
relatively uniform expectations of its participants. Most investments in new
companies at early stages of development are financed with owners’ funds or
companies’ internal capital. As transactions are concluded quite rarely, it is difficult to
formulate comparable criteria. Furthermore, for most venture capital investments
information on transaction prices are not available in logical time intervals. This
means that rates of return may not be calculated at a monthly or quarterly basis, as
in the case of other securities markets. Due to a lack of systematic information on
market prices, it is practically impossible to establish the risk price (e.g. Beta) for the
private equity market. This in turn explains why literature concentrates on long-term
rates of return.
The planned internal rate of return should be compared with current rates of
return generated by private equity investments. B. Huntsman and J.P. Heban (1980)
were one of the first researchers to study rates of return on private equity
investments in the USA. They calculated that the average annual rate of return for
the sample of 110 private equity investments in three funds in the years 1960-75 was
18.9%. The calculations were made only for those companies that survived on the
market, so they are incomplete. In their work the researchers present also two other
results concerning the relationship between risk and rate of return:
a. a high (1 in 6) probability of a total investment failure;
b. the fact that the average rate of return is generated mainly by a few very
profitable investments.
Other American studies reveal that internal rates of return (IRR) are sensitive to the
fund’s starting date, but a review of results for the USA (Bygrave 1994) demonstrates
that funds generate returns mostly at the mature stage of their operation: they usually
amount to 20%-30%, and are rarely higher.

6. DISINVESTMENT STRATEGIES OF PRIVATE EQUITY FUNDS

The fund’s exit from a portfolio company is the last stage of a private equity
investment. It consists in the sale of the shares held in the portfolio company to an
investor (investors) on the primary or public market.
Private equity companies may choose from a variety of disinvestment
methods. K. Sobańska and P. Sieradzan distinguish 11 ways of exiting an
investment; they are listed in Table 3.3.

Table 3.3. Disinvestment Methods

No. Disinvestment Method Abbreviation

1 Initial public offering, public sale, going IPO

public
2 Trade sale
3 Secondary buy-out, secondary FIBO
purchase, financial investor buy-out
4 Management buy-out MBO
5 Management-employee buy-out MEBO
6 Management buy-in MBI
7 MBO + MBI BIMBO
8 Leverage buy-out LBO
9 Reverse takeover
10 Buy-back
11 Write-off
Source: Sobańska K., Sieradzan P., Inwestycje Private Equity/Venture Capital, KeyText, Warszawa,
2004

Summary

Chapter 3 presents selected legal and economic aspects of the functioning of private
equity funds: cyclical nature of their investments, specificity of their operation in the
form of limited partnerships, description of various investor groups, fund’s
organisational structure, relationships between funds and portfolio companies as well
as between funds and capital providers, risk and rates of return and disinvestment
strategies.
Private equity investments are cyclical (with duration from 7 to 10 years), but
launching another fund depends on whether the previous one turned out to be
successful or not as well as honesty and transparency of investment partners.
The most frequent organisational and legal form among private equity funds is
limited partnership (sharing some features with limited partnership under Polish law,
i.e. spółka komandytowa), in which there is at least one general partner
(corresponding to komplementariusz under Polish law) and at least one limited
partner (corresponding to komandytariusz under Polish law). Among investors in
private equity funds (i.e. limited partners) there prevail: pension funds, insurance
companies (in the USA and Great Britain), banks (in Germany and Japan), higher
education institutions (in the USA) and private persons. General partners are
responsible for collecting capital from investors, both institutions and individuals,
required to launch the fund, for identifying and acquiring attractive investments, for
creating portfolio company value and for exiting the investment. They are usually
highly experienced in investment banking and enterprise management and familiar
with selected industries in which they search for portfolio companies. Limited
partners usually contribute 99% of the capital invested in a company, whereas the
remaining 1% is provided by general partners. Correspondingly, limited partners are
entitled to 70-80% and general partners to 20-30% of the profits from the
appreciation in the value of the limited partnership’s capital. Funds’ managers
(general partners) have an additional incentive in the form of an annual management
fee, which amounts to 2-3% of the investment capital.
Each private equity fund stands in a dual relationship: it acts as a principal in
relations with the company-capital recipient (portfolio company) and as an agent in
relations with the end investor (e.g. pension fund). In the first relationship a private
equity fund acts as a principal, and as such is faced with the problem of estimating
the investment potential of companies, that is recipients of the capital (and in this
case agents), in an uncertain environment.
In the second relationship the private equity fund serves as an agent and thus risks
that if it fails to generate a satisfactory rate of return it will find it difficult to acquire
additional funding from end investors.
IV. MANAGEMENT CAPITAL AS A SOURCE OF INCREASE
IN THE VALUE OF PORTFOLIO COMPANIES
1. CONCEPT OF MANAGEMENT CAPITAL OFFERED BY PRIVATE EQUITY
FUNDS

Researchers have taken interest in the phenomenon of creating additional benefits

by private equity funds already since 1980s. They have tried to estimate them in
various ways, among others with the use of:
 interviews and questionnaires addressed to private equity funds;
 interviews with presidents of portfolio companies;
 case studies measuring contribution of private equity funds in the development of
portfolio companies;
 calculation of the rate of return upon a portfolio company’s IPO;
 influence on human resources management (incentive schemes, i.e. share
options or own share buy-back programmes).
In the present work additional benefits mean the management capital that
private equity funds contribute to portfolio companies apart from equity as
their shareholders.
Equity providers are not keen on getting interest on the capital entrusted to the
company and charging it towards costs. As equity providers, private equity funds are
shareholders with a limited possibility of securing the capital that they contributed,
and are fully dependent on the success of the company in which they invested.
Because of this different nature of the seller-buyer relationship financial institutions
had to come up with new methods of protecting their capital investments in portfolio
companies. In the traditional approach debt provided by lenders is usually secured
with tangible assets. Private equity funds, however, have to acquire profound
knowledge of the business of portfolio companies and engage actively in their
management.
Investments of private equity funds are not liquid and thus they do not receive
regular income in the form of interest on the equity contributed to the company. In the
course of the investment’s duration, which is usually from 7 to 10 years, partners of
private equity funds pursue certain strategic objectives, such as:
a. limiting the risk of unfavourable developments up to the amount of the
invested capital;
b. maximising the company’s value in the form of future capital gains: the
“Capital Plus” concept140.
Investors that follow the “Capital Plus” rule offer portfolio companies not only
capital, but also additional benefits (the “Plus” factor). An efficient implementation of
the “Capital Plus” concept by private equity funds in a given portfolio company
depends on how well its employees can apply the acquired experience.

140
The term “capital plus” was introduced by professor Nathusius Klaus in the work Adding Value to
Investments, Entrepreneurship Education Course, Module 7, EVCA, Yaventem, Belgium, 2002.
2. TYPES OF PRIVATE EQUITY FUNDS FROM THE POINT OF VIEW OF
THEIR INVOLVEMENT IN PORTFOLIO COMPANIES
The community of private equity investors distinguishes between two types of
involvement in the portfolio company management: the pro-active (hands-on)
approach and the passive (hands-off) approach. T. Lorenz141 adds a third category:
the reactive approach. Table 4.1 below presents those three types of funds and the
nature of their relationship with their portfolio companies.

Table 4.1
Types of Private Equity Funds
Approach Level of Fund’s Nature of Relationship with Portfolio
Involvement Companies
Hands-on Pro-active  Co-creation of business;
 Active partnership;
 Many additional benefits;
 Investment monitoring.
Reactive Pro-active  “Watching from behind the company’s
back”;
 Additional benefits offered depending on
the needs of the portfolio company;
 Monitoring.
Hands-off Passive  Monitoring arising from the investment
contract;
 Limited financial monitoring.
Source: Klaus Nathusius, Adding Value to Investments, Entrepreneurship Education Course, Module
7, EVCA

The hands-on approach is applied by investors in the case of portfolio companies at

early stages of development, whereas the remaining two approaches are used when
companies are more mature.

FUNDS USING THE HANDS-ON APPROACH

Investment partners of funds falling within this category must devote a lot of time to
the analysis and due diligence of the portfolio company and assess the quality of its
management team. In most cases the investment is executed only provided that the
fund is deeply convinced that the management staff of the portfolio company will
make every endeavour to ensure that the goals set forth in the business plan are
accomplished. Partners/investment analysts from private equity funds have more
experience in the field of building and managing company value.

REACTIVE FUNDS
In this approach investment partners of the private equity fund are less involved in
the operational management of the portfolio company. However, they still contribute
to the company’s development and recommend their representative to sit on the
portfolio company’s supervisory board. This is usually an internal consultant with
experience in the field of finance or audit.
The reactive approach involves: supervision of the management board’s
performance, monitoring of the company’s development process, signalling and
responding to negative deviations from the business plan.

141
Lorenz T., Venture Capital Today, A practical guide to the venture capital market, New York-London, 1989
Should any unfavourable developments be observed, funds take a more active
stance. Although reactive funds do not exercise such a strong influence on the
management board as regards the development and financial strategy of the portfolio
company, their actions encompass:
a. owner’s supervision over monthly and quarterly financial reports;
b. recruitment of key managers;
c. fund management (acquiring additional capital).

FUNDS FOLLOWING THE HANDS-OFF APPROACH

Private equity funds apply predominantly the hands-on and reactive approach; the
passive approach, in contrast, is used quite rarely. This type of involvement is
characterised by infrequent contacts of the fund with the portfolio company. Meetings
take place on the initiative of the portfolio company. The fund does not normally have
its representative on the company’s supervisory board, although it may be entitled to
nominate a supervisory board member under the investment agreement. The fund
receives financial reports on an annual or semi-annual basis. The overriding
objective of private equity funds which follow the hands-off approach is the focus on
protection of the interests of investors that provided the fund with capital. Funds from
this category are particularly active as regards monitoring of special shareholder
rights and other rights set forth in the investment agreement. Due to limited staff they
monitor finances of portfolio companies only in a limited scope or not at all.

3. TYPES OF MANAGEMENT CAPITAL

Investment partners from private equity funds have capital and industry
experience. Their managerial skills and familiarity with the industry constitute a
competitive advantage over other financial agents offering funds to young innovative
companies.
As a general rule a representative of the private equity fund sits on the
management board of the company acquiring capital and sometimes on the
supervisory board (depending on the company’s needs).
A private equity investor usually contributes more than just capital: it
implements new management methods (e.g. advanced production processes, well-
tried product introduction and distribution methods) in order to increase value for
owners, provides access to established commercial contacts, serves as a strategic
consultant, enhances the company’s credibility in the eyes of other capital providers
or contracting parties and assists in recruiting managers.
In the studies conducted in 1983 M. Gorman and W.A. Sahlman142 analysed 49
venture capital funds) and on that basis created the following list of additional
benefits offered to companies-capital recipients:
a. assistance in acquiring additional funds;
b. strategic planning;
c. help in recruiting managers;
d. operational planning;
e. support in gaining access to prospective customers and suppliers;
f. settling compensation issues.

142
Gorman M., Sahlman W.A., What Do Venture Capitalists Do?, “Journal of Business Venturing”, Vol. 4, pp.
231-248, 1989
 In 1988 I.C. MacMillan143 analysed 62 venture capital funds and on that basis
prepared a list of the most important activities performed by professionals in
portfolio companies:
a. an active vote at the company’s supervisory board and management board;
b. assistance in acquiring alternative sources of equity financing;
c. agency in contacts with groups of investors interested in purchasing the
company’s shares;
d. monitoring of the company’s financial results;
e. control over operational management;
f. assistance in acquiring external financing.
In 1989 and 1993 J. Rosentstein and others144 studied input of investment
partners from venture capital funds in the supervisory board of portfolio
companies. The researchers analysed 162 high-tech companies and asked them—
just like MacMillan—about additional benefits that they gained apart from private
equity. The study demonstrated that consultancy provided by supervisory board
members from venture capital funds from the TOP-20 ranking was more valuable
than that provided by supervisory board members or members of venture capital
funds not listed on the TOP-20 ranking145. Interviewed management board members,
i.e. executive directors, maintained that supervisory board members (both investment
partners from venture capital funds and others) were very active as regards
performance of the owner’s supervision in portfolio companies, contacts with
investors, monitoring the companies’ operating activity, recruiting management board
members and dealing with ad hoc issues. However, their input was more perceptible
in companies at early stages of development.
H.J. Sapienza146 analysed differences in additional benefits between venture
capital funds from Great Britain, the Netherlands, France and those from the USA.
The results of the study demonstrated that—similarly as in the case of the USA—in
the opinion of representatives of venture capital funds in Great Britain, France and
the Netherlands the most important additional benefits included: strategic, human
resources and operational consultancy. In all of the three surveyed countries
these benefits were named in the same order. In his later studies conducted in 1996,
which were a continuation of those carried out in 1994, H.J. Sapienza 147 established
that the role of a strategic consultant (financial and business consultancy; an active
supervisory board) was the predominant additional benefit. In the second place there
was mentioned the role of a human resources consultant (mentor, a confident of the
president of the management board). As the third most important additional benefit
investment partners from venture capital funds indicated the role of an intermediary
in contacts e.g. with other firms and private equity funds. According to H.J. Sapienza
the ratings were similar in all four countries. However, in the USA and Great Britain

143
MacMillan I.C., Kulow D.M., Corporate Ventures into Industrial Markets: Dynamics of Aggressive Entry,
“Journal of Business Venturing”, Vol. 4, pp. 27-47, 1988
144
Rosentstein J., Bruno A.V., Bygrave W.D., Taylor N.T., Do Venture Capitalist on Boards of Portfolio
Companies Add Value Besides Money? Frontiers of Entrepreneurship Research, Babson College: Wellesley,
MA, 1989, and Rosentstein J., Bruno A.V., Bygrave W.D., Taylor N.T., The CEO, Venture Capitalists, and the
Board, “Journal of Business Venturing”, Vol. 8, pp. 99-113, 1993
145
Rosentstein J., Bruno A.V., Bygrave W.D., Taylor N.T., 1993
146
Sapienza H.J., Amason A.C., Manigart S., The Level and Nature of Venture Capitalist Involvement in Their
Portfolio Companies: A Study of Three European Countries, “Managerial Finance”, Vol. 20, Issue 1, pp. 3-17,
1994
147
Sapienza H.J., Manigart S., Vermeir W., Venture Capitalist Governance and Value-added in Four Countries,
“Journal of Business Venturing”, Vol. 11, pp. 439-469, 1996
the involvement of venture capital funds was greatest; consequently, it was in these
two countries that additional benefits provided by professionals from such funds were
most perceived.
The same scholar in cooperation with another academician, J. Timmons148,
interviewed 120 entrepreneurs and investment partners from venture capital funds.
For each portfolio company the survey explored the point of view of the president
of the company’s management board/entrepreneur and the leading venture
capitalist. According to the authors answers provided by respondents revealed that
the observations of both sides were very similar. Results of the survey are presented
in Table 4.2.

Table 4.2
Additional Functions of Private Equity Investors
Role of the Representative of the Private Importance Efficiency
Equity Fund (from 1 to 5) (from 1 to 10)
Strategic
- active member of the supervisory board 4.38 8.07
- tax consultant 4.27 7.71
- financial consultant 3.73 7.78
Social/supportive
- mentor 3.76 7.00
- friend/confidant 2.93 6.73
Intermediary in contacts
- recruitment of managers 2.93 4.74
- contacts with investment partners from other 2.88 6.17
funds
- contacts with other market participants from 2.47 4.07
the company’s industry
Source: Klaus Nathusius, Adding Value to Investments, Entrepreneurship Education Course, Module
7, EVCA, Zaventem, Belgium, 2002, quoted from: Timmons J.A., Sapienza H.J., Venture Capital:
More than Money?, [in:] Pratt’s Guide to Venture Capital Sources, 1997 edition, New York, 1997

Strategic Function
A common problem of quickly developing companies is an excessive involvement of
their managerial staff in the on-going activity and dealing with short-term issues. In
contrast, private equity funds and their investment partners focus on strategic
aspects, e.g. current market changes that may affect the company’s long-term
objectives. The position of an investor, that is a person from outside the enterprise,
allows fund representatives to take an objective look at the company and
demonstrate its managerial staff all pros and cons of available solutions.
An active supervisory board, represented also by a private equity investor,
may take a critical stance to the company’s current situation and planned decisions.
Thanks to this the company may avoid costly mistakes and delays. The supervisory
board may also serve as an adviser to the company’s management board members
and their managerial staff. Board members may suggest new ideas, solutions and
directions of the company’s development.
Another important function of private equity fund representatives is that of a
financial consultant of the portfolio company. Such a person prepares financial

148
Timmons J.A., Sapienza H.J., Venture Capital: More than Money?, [in:] Pratt’s Guide to Venture Capital
Sources, 1997 edition, New York, 1997, pp. 57-63
analyses and establishes the company’s financial needs depending on its further
development. Representatives of private equity funds use their contacts to acquire
other capitalists and provide advice in the process of collecting funds. When
searching for appropriate investors, an investment partner takes into account
nonfinancial (marketing, intangible) factors which affect further growth of the
company’s value.

Social/Supportive Function
Fund representatives, which have a rich experience from previous investments, may
serve as mentors. Their role may consist in:
a. consultancy in the field of building and maintaining the “atmosphere of
entrepreneurship” at the company;
b. focusing on crucial tasks in the process of product development and market
launch;
c. recruiting key staff members;
d. motivating employees.
Managers in new companies, which is faced with this kind of challenges for the first
time, may avail itself of the experience of private equity fund representatives.
Good personal relations between fund representatives and company’s management
board are essential for their mutual success.

Intermediary in Contacts
Every experienced private equity fund has a network of contacts, both among other
types of investors as well as among national and foreign entrepreneurs. Access to
these contacts constitutes an invaluable additional benefit to a portfolio company.
Fund employees may provide assistance in the recruitment process and help the
company establish contacts with partners from other private equity funds and
participants of the industry in which it operates.
In order to identify various additional benefits that venture capital funds offer to
companies, L. Steier and R. Greenwood149 conducted in-depth case studies of
companies that used this kind of financing. Investment partners from funds
provided such companies with numerous spin-offs, such as knowledge, expert
opinions, experiences and—last but not least—funds. V.H. Fried and R.D. Hisrich 150
also applied the case study method to explore relations between entrepreneurs and
their venture capitalists. On the basis of interviews conducted in 14 young firms that
were recipients of venture capital, the authors identified seven areas in which venture
capital funds had the most significant influence: capital, operational consultancy,
network of contacts, image, moral support, general knowledge in the field of
management, discipline.
In later studies assessing the quality of investments in portfolio companies, T.
Seppä and M. Maula151 used data on 2327 venture capital investments in IT
companies from the years 1982-2000. They established that—although key venture

149
Steier L., Greenwood R., Venture Capitalist Relationships in the Deal Structuring and Post-Investment
Stages of New Firm Creation, “Journal of Management Studies”, Vol. 32, Issue 3, pp. 337-357, 1995
150
Fried V.H., Hisrich R.D., The Venture Capitalist: A Relationship Investor. California Management Review,
Vol. 37, Issue 2, pp. 101-113, 1995
151
Seppä T., Maula M.V.J., Investor Certification of Venture Capital Investments: Does Top-End Backing Lead
to Improved Value Creation?, paper presented at the 21st Annual International Conference of Strategic
Management Society, 2001
capital funds found it hard to achieve high rates of return—their main achievement
was a strong future creation of the value of portfolio companies.
In 1992 H.J. Sapienza152 conducted questionnaire interviews among 51
directors managing venture capital funds in the USA. His studies revealed that the
higher the innovation level of the enterprise financed by the fund, the more
frequent the contacts between the fund and the company, the better the
communication and the greater the fund’s involvement. Studies conducted by the
same researcher in Europe led to similar conclusions.153 European venture capital
funds devoted more time to their portfolio companies and contacted their
management boards more frequently in the case of highly innovative investments
and firms at early stages of development.
On the other hand, studies conducted among 149 venture capital funds by B.
Elango154 demonstrated that there was no strong correlation between the assistance
provided by investment partners from private equity funds and the target stage of the
portfolio company’s development. Funds following the hands-on approach are more
involved than those using the hands-off approach.
On the basis of studies conducted among Swedish companies-venture capital
recipients H. Landström155 concluded that an active involvement of investment funds
translated into their better financial results.
Other studies concentrated on supervisory boards in companies that
acquired venture capital. For instance, having analysed 68 venture capital funds V.H.
Fried156 discovered that representatives of venture capital funds had a positive
influence on the quality of work of the supervisory boards of the portfolio companies,
thanks to which the supervisory boards suggested advantageous strategic moves to
their management boards. Ø. Fredriksen and M. Klofsten157 conducted a
questionnaire study among management board members in 41 companies-venture
capital recipients. Their conclusion was that companies in which the “decision-
making power” was distributed evenly between the president of the management
board and the supervisory board achieved better financial results. Studies also
showed that openness and trust in relations between the president of the portfolio
company’s management board and its supervisory board had a positive impact on
the company’s results.
J. Lerner158 conducted studies among management board members of 271
companies-venture capital recipients from the biotechnology industry in the USA, in
which he demonstrated that the number of representatives of venture capital funds
sitting on supervisory boards increased in periods when management board
presidents in portfolio companies changed, whereas the number of representatives of

152
Sapienza H.J., When Do Venture Capitalists Add Value?, “Journal of Business Venturing”, Vol. 7, Issue 6,
pp. 9-27, 1992
153
Sapienza H.J., Amason A.C., Manigart S., The Level and Nature of Venture Capitalist Involvement in Their
Portfolio Companies: A Study of Three European Countries, “Managerial Finance”, Vol. 20, Issue 1, pp. 3-17,
1994
154
Elango B., Fried V.H., Hisrich R.D., Poloncheck A., How Venture Capital Firms Differ, “Journal of Business
Venturing”, Vol. 10, pp. 157-179, 1995
155
Landström H., Co-operation Between Venture Capital Companies and Small Firms, “Entrepreneurship &
Regional Development”, Vol. 2, pp. 345-362, 1990
156
Fried V.H., Bruton G.D., Hisrich R.D., Strategy and the Board of Directors in Venture Capital-Backed
Firms, “Journal of Business Venturing”, Vol. 13, pp. 493-508, 1998
157
Fredriksen Ø., Klofsten M., CEO vs. Board Typologies in Venture Capital-Entrepreneur Relationships,
Frontiers of Entrepreneurship Research, Babson College, Wesseley, MA, 1999
158
Lerner J., Venture Capitalists and the Decision to Go Public, “Journal of Financial Economics”, Vol. 35, pp.
293-316, 1995
other investors on supervisory boards remained constant. The researcher came also
to the conclusion that the distance to the seat of a portfolio company determined to a
large extent whether investment partners from venture capital funds participated in
supervisory board sessions or not.
On the basis of studies conducted in 80 venture capital funds operating in the USA
H. Higashide and S. Birley159 demonstrated that the quality of information exchanged
between representatives of venture capital funds and entrepreneurs was positively
correlated with the results of portfolio companies.
Schedule 2 contains a list of additional benefits offered by venture capital
funds covering 19 European companies. The value-added of venture capital
investments encompasses the following benefits:
 assistance in recruiting persons occupying key functions in the company, i.e.
president of the management board, management and supervisory board
members, representatives of the scientific community;
 aid in expansion into new, frequently foreign, markets;
 strategic consultancy (creation of the company’s restructuring and strategic
plan);
 access to commercial contacts, distribution channels and other market
information;
 financial consultancy (specifying demand for current and/or investment capital at
various stages of the company’s development).

4. COMPARISON OF COMPANIES WITH AND WITHOUT VENTURE CAPITAL

Companies having a venture capital fund as their investor may usually invest,
regardless of the economic situation, in research and development, new products,
marketing and other strategic activities that prepare them to go public.
For this reason companies-venture capital recipients are generally younger at the
moment of their IPO than entities not using this type of financing (cf. Table 4.3).

Table 4.3
Comparison of the Median of Age Upon IPO for Selected Companies Using and
Not Using Venture Capital in the USA

Industry Companies with Companies

Venture Capital Without Venture
Capital
Age Upon IPO in Months
Metallurgical industry 115.5 145
Engineering industry 56 67
Electronics industry 65 97
Aviation industry 48 50
Telecommunications 54 53
Finance 49 77
Software 54 93.5
Consulting services 69 72
Repair services 49.5 77
159
Higashide H., Birley S., Value Created through the Socially Complex Relationship Between the Venture
Capitalist and the Entrepreneurial Team, Frontiers of Entrepreneurship Research, Babson College, Wellesley,
MA, 2000
 Health care 41.5 29
Social services 28 44
Source: on the basis of: Gompers P.A., Lerner J., Venture Capital and the Creation of Public
Companies: Do Venture Capitalists Really Bring More Than Money?, “Journal of Private Equity”, Vol.
1, (Fall 1997), pp. 15-42

This implies that venture capital funds place emphasis on a fast development of
enterprises by allowing their managements to execute efficient strategies without
having to worry about availability of capital.

Chart 4.1 presents yearly average rates of return (in %) for all companies that went
public in the previous five years. Thus, the figures reflect the quality of management
of those new stock exchange listed companies that had acquired private equity and
those that had not used this kind of financing at all.

Chart 4.1

Relative Performance of Venture Capital-Backed

and Non-Venture Capital-Backed Initial Public Offerings
Cummulative Return on IPOs (%)

18.0%
16.0%
14.0%
12.0%
Venture Capital Returns Nonventure Capital Returns
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%

Year

Source: P.A. Gompers, J. Lerner, The Money of Invention, Harvard Business School, 2001, p. 65

Had an investor put USD 1 in 1976 in non-venture capital-backed companies that

went public, as at the end of 1999 he would have gained USD 11.02. Had he
invested the same amount in venture capital-backed companies that went public, as
at the end of 1999 he would have earned USD 164.4.
Venture capital funds play an important part in value creation of stock exchange
listed companies and in creating their development strategies. Their function in this
area is elaborated upon in the next chapter.

5. ATTRIBUTES OF PRIVATE EQUITY FUNDS

According to professor K. Nathusius160 private equity fund representatives may fulfil

the following functions in portfolio companies:
 chairman of the supervisory board,
160
Nathusius K., Adding Value to Investments, Entrepreneurship Education Course, Module 7, EVCA,
Zaventem, Belgium, 2002, p. 22
 member of the supervisory board,
 president of the management board (in exceptional situations);
 founder of the enterprise (until the management is clearly separated from the
supervisory board),
 “fireman” at the company,
 project coordinator,
 intermediary in alliances and cooperation with other firms,
 head-hunter recruiting key managers,
 financial consultant as regards acquiring capital,
 seller for key customers,
 mentor.
Managers of corporate venture capital organisations161 have usually an extended
scope of responsibility. As intermediaries between the portfolio company and the
investor, they may be involved in the process of initiating and monitoring joint
ventures as:
 leaseholders of commercial premises, office space, laboratories etc.,
 leaseholders of production equipment, logistics systems etc.,
 licensors of patents and other intellectual property items,
 provides of analyses and market research,
 creators of a positive image of the portfolio company.

6. PROBLEMS RELATED TO ADDING VALUE TO COMPANIES BY PRIVATE

EQUITY FUNDS

Professor K. Nathusius162 points to the fact that an active involvement of a

private equity fund in the management of a portfolio company may result in conflicts
on both sides.
From the point of view of private equity fund representatives they may be
related to:
 the need of management board members and other managerial staff to prepare
very detailed presentations to win the investor’s approval for the planned
solutions;
 insufficient preparation of managerial staff/management board members for
meetings with the supervisory board;
 directors/members of the management board attaching a greater significance to
the company’s current affairs than to preparing for meetings with the supervisory
board or investors.
Such problems create an atmosphere of mistrust between the investor and the
portfolio company, which may lead to a deterioration in communication in the future
and discourage private equity fund employees from a deeper involvement and adding
value to the investment.

161
Corporate venture capital is a VC-type organisation established by an enterprise. For instance, Intel, IBM,
Alcatel established their own VC funds. The main criterion for selecting investment enterprises is their
consistency with the product strategy of the parent company.
162
Nathusius K., Adding Value to Investments, Entrepreneurship Education Course, Module 7, EVCA,
Zaventem, Belgium, 2002
On the other hand, from the point of view of the managerial staff/management
board members, an active involvement of a private equity fund may cause the
following problems:
 delegating investment analysts to supervisory board meetings as replacement;
 failure to read through reports prepared by the management board;
 coming unprepared to supervisory board meetings;
 unavailability when strategic decisions must be met;
 focusing on immaterial errors in the prepared materials.
The issues mentioned above and others may confirm the managerial staff and
management board in the belief that their company is not a priority for investors.
Representatives of private equity funds want to understand that their personal
dedication to the portfolio company has an impact on the joint creation of its value.
Any opposite signals undermines good relations with the managers and destroy the
atmosphere of unity.
B.H. Byers163 presented a list of common problems resulting from an active
involvement of private equity funds in the management of portfolio companies:
 Involvement requires time, which can mean harder work by investors or a
necessity to hire more staff.
 Some managers are slow to accept significant investor involvement, viewing it as
an intrusion on their authority (in this case the fund made a mistake in its initial
evaluation of the managerial staff);
 Once trust is established with management, some entrepreneurs begin to expect
unlimited support from private equity representatives (in this case the managerial
staff must learn which problems it must solve on its own and which ones together
with the fund’s investment partners);
 An investor, because of significant capital involvement, is often obliged to
participate in later equity financings, because such participation will determine the
success of the offering. A problem arises when the fund is unwilling to increase its
capital contribution.
 An involved investor that has established a good relation with a portfolio company
may lose sight of the planned direction of the company’s development.

7. ADDITIONAL BENEFITS OFFERED BY PRIVATE EQUITY FUNDS IN

POLAND: ANALYSIS OF QUESTIONNAIRE STUDY RESULTS
This subchapter presents results of questionnaire studies conducted in March
and April 2004 among companies managing private equity funds 164 operating in
Poland or among funds themselves.

7.1. Study Results

When asked to: “Indicate 5 preconditions that a prospective portfolio company
must meet for your fund to become its capitalist” 12 respondents named:

163
Byers B. H., Relationship Between Venture Capitalist and Entrepreneur [in:] Pratt’s Guide to Venture
Capital Sources, New York, 1997, pp. 98-100
164
These are management companies operating under the Polish commercial law. A single management
company may run a few VC/PE funds. For example, Enterprise Investors Sp z o.o. manages already five private
equity funds. In the study participated 13 respondents, which accounts for 60.7% (criterion: total value of
investments in USD as from the beginning of the company’s operation in Poland) and 51.0% (criterion: current
number of portfolio companies in Poland in April 2004) of the market.
a. experienced and professional management with a vision how to use the
acquired capital in an efficient manner, and
b. an attractive industry with growth potential or an evident market niche.
The remaining answers are listed in Table 4.4 below.

Table 4.4
Preconditions that Must be Met by a Prospective Portfolio Company

No Preconditions Times
. named
(number
of
responde
nts n=13)
1 Experienced and professional management with a vision how to use 12
the acquired capital in an efficient manner.
2 An attractive industry with growth potential or an evident market niche. 12
Strong market position.
3 Predictable easy disinvestment path agreed upon with all company 8
owners.
4 Forecasted dynamic increase in the company’s value. 7
5 A history of satisfactory financial results. 6
6 An attractive rate of return on the invested capital 3
(expected annualised rate of return exceeding 25%).
7 The company’s demand for capita, e.g. at least USD 10 million or 3
between USD 0.5 and 2.2 million.
8 A remarkable business model. e.g. material innovations in the product, 3
service or marketing.
9 Corporate rights granted to the private equity fund, e.g. at least a 2
significant minority interest in the company ensuring that the fund as
investor has a considerable influence on the company’s strategic
decisions.
10 A strong and well-established brand of the company. 2
11 An attractive company valuation upon the fund’s entry as an investor. 2
12 Credibility of the company’s owner and a “clean” origin of the 2
company’s assets and its shareholders.
13 A high level of the company’s technological development. 1
14 An undertaking of all shareholders to sell a majority interest in the 1
company.
15 A positive influence of the products or services offered by the 1
company on the environment.
16 A possibility to merge the company’s activity with that of another 1
portfolio company.
17 A private company with an apparent competitive advantage and 1
potential to expand abroad.
18 Capital structure: 1 or 2 shareholders. 1
19 Companies at later stages of development. 1
20 Companies at the stage of restructuring. 1
21 The industry must not involve the necessity to pay excise tax. 1
22 A possibility to arrange cooperation with other owners. 1
Source: prepared by the author on the basis of questionnaire studies.

When asked to: “Name 5 main privileges that your fund as an investor expects
to be granted by a portfolio company” nine respondents mentioned the right of a
representative of the fund to sit on the company’s supervisory board as its member
or chairman. Seven respondents indicated:
a. the right to accept budge, share issues and all strategic decisions, even if the fund
should hold only a minority interest, and
b. being granted a set of privileges making it possible for the fund to exit the
company, in particular the right to dispose of the fund’s shares together with shares
of the management board. Other privileges named by the respondents are listed in
Table 4.5 below.

Table 4.5
Main Expectations of Private Equity Funds towards Portfolio Companies

No. Funds’ Expectations Times

named
(number of
respondents
n=13)
1 A seat on the company’s supervisory board for a representative of 9
the fund as a member or chairman.
2 The right to accept budge, share issues and all strategic 7
decisions, even if the fund should hold only a minority interest
(e.g. changes in equity, taking out/settling debt; mergers and
acquisitions, introduction of owner’s supervision standards).
3 Being granted a set of privileges making it possible for the fund to 7
exit the company, in particular the right to dispose of the fund’s
shares together with shares of the management board.
4 A say as regards dismissing/appointing members of the portfolio 6
company’s management board
(right to introduce changes in the management board, should
actual financial results diverge significantly from the plan; right to
veto changes in the composition of the management board; the
right to appoint a board member).
5 A majority interest in the company/control over the company 5
(right to hold 51% of votes at the shareholders’ meeting; control
block of shares; majority on the supervisory board).
6 Right of pre-emption regarding shares held by remaining owners. 4
7 Right to veto key decisions 4
(in strategic matters; in the case of a minority interest the right to
obstruct key decisions of the shareholders’ meeting, in particular
concerning an increase in the share capital, assuming liabilities in
excess of the budget and disposal of shares by the management
board).
8 Right to appoint a management board member competent for 2
 finances.
9 Subscription right with regard to shares of new issues. 2
10 Right to receive full information on the company. 2
11 Control over the disinvestment process. 2
12 Right of first refusal in the case of the company’s liquidation. 2
13 Right to introduce monitoring principles. 1
Source: prepared by the author on the basis of questionnaire studies.

In response to the question: “Does the firm or fund that you represent follow
the hands-on or hands-off approach?” ten respondents answered that “hands-on” (cf.
Table 4.6). This implies that from the moment a private equity fund invests in a
company its investment partners want to exercise a significant influence on the
creation of growth in the company’s value and monitor its progress along this path by
way of: business co-creation, an active partnership with the portfolio company’s
management board and its managerial staff as well as providing the company with a
number of additional benefits. Three out of 13 respondents stated that the funds they
represented followed the hands-off approach, which did not mean, however, that
representatives of a given capitalist were not interested in the process of creating the
value of portfolio companies. In this case monitoring of the financial situation of the
portfolio company was probably limited to activities provided for in the investment
contract.

Table 4.6
Type of Involvement of the Studied Private Equity Funds
No. Approach Times named
(number of
respondents n=13))
1. Hands-on 10
2. Hands-off 3
Source: prepared by the author on the basis of questionnaire studies.

In response to the question: “What are in your opinion the five most important
additional benefits offered by your managing company or fund to portfolio
companies?” ten respondents mentioned consultancy/strategic planning. Strategic
consultancy consists among others in assistance in preparing business plans and
long-term financial strategies. Nine respondents named three other benefits, i.e.:
a. help in finding a strategic investor (financial or industry investor),
b. owner’s supervision over the company’s on-going activity, and
c. implementation of financial control and budgeting systems.
The elements of the owner’s supervision applied by the funds represented by
the respondents were systematised in the response to the next question.
The remaining additional benefits are listed in Table 4.7 below.
Table 4.7
Additional Benefits Offered by Private Equity Funds to Portfolio Companies
Additional Benefits Provided by Private Equity Funds to Times
No. Portfolio Companies named
(numbe
r of
respon
dents
n=13))
1 Strategic consultancy/planning (assistance in preparing 10
business plans and long-term financial strategies).
2 Assistance in searching for strategic investors and negotiations. 9
3 Owner’s supervision over the company’s on-going activity/staff 9
monitoring.
4 Development of financial control and budgeting systems. 9
5 Assistance in selection, choice, evaluation and acquisition of 6
additional sources of financing.
6 Access to databases of national and foreign commercial 6
contacts.
7 Assistance in the process of searching for managers at various 4
stages in the company’s development.
8 Promotion/lobbing for the portfolio company. 2
9 Strengthening and consolidating the company’s market 2
position.
10 Support in the process of transforming the company’s 2
organisational and corporate structure in the process of
company value creation.
11 Assistance (investment support) in mergers and acquisitions. 2
12 Legal and accounting assistance. 2
13 Assistance in using expert advice. 1
14 Assistance in the process of implementing and streamlining 1
procedures.
Source: prepared by the author on the basis of questionnaire studies.
In response to the question: “What are in your opinion the five most important
elements of the owner’s supervision that your managing company or fund uses in ‘its’
portfolio companies?” ten respondents named: implementation of a budgeting system
and developing a management evaluation model combined with an incentive
scheme.
Budgeting and controlling encompasses preparation of a budget (the company’s
annual operational plan), specification of budget execution indicators, manner of
financial reporting to the fund and monitoring of budget execution. Just as often the
respondents indicated a mechanism for evaluating performance of the company’s
management board (indicators, parameters) linked to an incentive scheme (annual
bonuses, participation in the company’s share capital). The remaining elements are
listed in Table 4.8 below.
Table 4.8
Key Elements of the Owner’s Supervision
Elements of the Owner’s Supervision Times
No named
. (numbe
r of
respon
dents
n=13)
1 Budgeting and controlling: 10
- specification and monitoring of budget execution indicators,
- approving and monitoring annual plans of the company,
- systematic financial reporting complying with the applicable
requirements.
2 Evaluation of the management’s performance linked to an incentive 10
scheme:
- incentive campaigns for key managers,
- incentive scheme for the management board (annual bonuses,
company shares).
3 An active role of the supervisory board. 3
4 On-going cooperation with the management board. 3
5 In the case of a poor performance of the management board, the 2
possibility to replace it.
6 Quick response to situations that might hinder growth in the 2
company’s value.
7 Motivating the management board to participate in the 1
"success fee” upon sale of the company.
8 Selection of the company’s auditor. 1
9 Selection of the company’s financial director. 1
10 Decisions concerning promotions and career paths. 1
11 Close and regular contacts between the project coordinator and the 1
company’s management board.
12 Regular internal audits covering financial and procurement 1
procedures; cooperation with certified auditors.
13 Care for the natural environment and people. 1
14 Mentoring. 1
15 Business and financial audits. 1
Source: prepared by the author on the basis of questionnaire studies.
In response to the question: “What functions do partners of your managing
company/fund normally fulfil? Please indicate functions typical for your
company/fund” eleven respondents named the function of a supervisory board
member in the portfolio company. The remaining functions are listed in Table 4.9
below.
Table 4.9
Functions Fulfilled by Investment Partners in Portfolio Companies

No. Function Times named

(number of
respondents
n=13)
1 Supervisory board member 11
2 Business consultant 9
3 Financial consultant 9
4 Chairman of the supervisory board (regardless of interest in 8
the share capital)
5 Head -hunter 8
6 Mentor 6
7 Chairman of the supervisory board (only when interest in the 5
share capital exceeds 50%)
8 President of the Management Board (only in exceptional 4
situations)
9 Co-founder of new portfolio companies 2
Source: prepared by the author on the basis of questionnaire studies.

Answers to the last open-ended question: “What are the five factors that in your
opinion would have a stimulating effect on the investment activity of private equity
funds in Poland?” are presented in Chapter 6 (section 6.7), which is devoted to the
diagnosis and prospects for the development of private equity investments in Poland.

7.2. Conclusions from the Study

The aim of the study was to obtain answers to the following questions:
a. Do private equity funds in Poland operate in the same manner as in other
economically developed countries?
b. What—apart from equity—do private equity funds offer to portfolio
companies?

The answer to the first question is “yes”.

Firstly, the majority of investment capital of private equity funds stems from
foreign sources and many investment partners have gained experience abroad.
Secondly, most funds included in the study are registered outside Poland. They
have representative offices in Poland or are run by managing companies established
in Poland. This is a common practice also among many other funds that were not
taken into account in the study.
Thirdly, this also finds its confirmation in the stages of development indicated
by the respondents at which their private equity funds invest capital. From among 13
respondents only two represented funds that invest in companies at early stages of
development (venture capital). A similar situation is observable in Europe and—to an
ever greater extent—in the United States. In order to avoid excessive risk, funds offer
companies capital necessary to finance management buy-outs, expansion and
development.
Fourthly, most of the funds questioned in the study diversify their investment
portfolios, which encompass almost all industries save for mining, extraction,
metallurgy and heavy industry. Only two funds from among 13 participating in the
study have a clear focus on selected sectors, e.g. environmental protection or IT.
European and American private equity funds use a similar strategy and tend to
distribute the investment risk among companies from various industries.
Fifthly, the criteria for selecting prospective portfolio companies applied by the
questioned funds are similar to those used by American and European funds. The
crucial factor is not rate of return on investment, but experienced and professional
management with a vision how to use the acquired capital in an efficient manner or
an attractive industry with growth potential (or an apparent market niche).

As regards the second question, apart from equity private equity funds provide
portfolio companies also with a number of additional non-financial benefits
(management capital), which contribute to an increase in their value.
The most important components of the management capital that a portfolio company
may take advantage of are:
a. strategic consultancy/planning consisting among others in assistance in
preparing business plans and long-term financial strategies,
b. assistance in finding a strategic investor (financial or industry investor),
c. owner’s supervision over the company’s on-going activity, and
d. implementation of financial control and budgeting systems.
Ten respondents believe that development of the owner’s supervision in portfolio
companies consists in implementing a budgeting and controlling system as well as
developing a management evaluation model linked to an incentive scheme.
According to the respondents, ten out of thirteen funds participating in the
study “deemed” to follow the hands-on approach, which implies that from the moment
a private equity fund invests in a company its investment partners want to exercise a
significant influence on the creation of the increase in the company’s value and
monitor its progress along this path by way of: business co-creation and an active
partnership with the portfolio company’s management board and its managerial staff.
Eleven respondents maintained that representatives of their funds serve as
supervisory board members in portfolio companies (according to eight respondents
they always occupy the position of chairman). Nine respondents stated that fund
representatives serve also as business or financial consultants in portfolio
companies. Moreover, eight respondents mentioned that investment partners of
private equity funds may also assist in recruiting key managers. Sometimes they act
as mentors to members of the companies that were provided with capital. The closer
and more open the relations between employees of a private equity funds and a
portfolio company, the greater the gains for the company and—consequently—the
higher the probability that both parties will achieve their common objective, i.e.
increase in the company’s value.

Summary
In Chapter 4 the author tried to demonstrate the degree of private equity funds’
involvement in the management of portfolio companies, different kinds of
management capital and the functions fulfilled by fund representatives in companies.
Its integral part are results of a questionnaire study carried out in March and April
2004 among representatives of private equity funds operating in Poland.
From the point of view of their involvement in the management of portfolio
companies, private equity funds may be divided into three categories: those that
follow the hands-on, the reactive or the hands-off approach. The hands-on approach,
which involves a pro-active involvement, consists in co-creation of the company’s
development strategy, offering it a wide variety of additional benefits and monitoring
the progress of the investment. The more innovate a company (i.e. the higher its
technology level) and the earlier its development stage, the more active the
investment partners of private equity funds.
The reactive approach consists in watching the work of managers “from
behind their backs” and interfering as need arises.
The hands-off approach is limited to monitoring the company as set forth in the
investment contract concluded with its owners.
As shareholders private equity funds contribute to their portfolio companies also
management capital. These additional benefits include:
 assistance in acquiring additional funds;
 strategic and operational consulting;
 assistance in recruiting managers;
 assistance in gaining access to prospective customers and suppliers;
 assistance in settling compensation issues.

The questionnaire study conducted among investment managers of private equity

funds in Poland demonstrated that:
a. The majority of private equity funds (10 out of 13) represented by the respondents
declared to apply the hands-on approach;
b. Almost all funds (12 out of 13) are ready to invest in a company only if it is run by
experienced and professional management with a vision how to use the acquired
capital in an efficient manner and when it there is an evident market niche
consistent with the scope of its operation;
c. Private equity funds expect to be granted by portfolio companies a number of
privileges, which include: participation of a fund representative in the company’s
supervisory board in the capacity of its member or chairman (9 out of 13
respondents) as well as the right to accept budge, share issues and all strategic
decisions, even if the fund should hold only a minority interest, and privileges
rendering it possible for the fund to exit the company, in particular the option to
right to dispose of the fund’s shares together with shares of the management
board (7 out of 13 respondents);
d. Apart from equity, private equity funds offer portfolio companies the following
additional benefits: consultancy/strategic planning (10 out of 13 respondents),
assistance in finding a strategic investor (financial or industry investor), owner’s
supervision over the company’s on-going activity and implementation of financial
control and budgeting systems (9 out of 13 respondents);
e. Representatives of eleven funds always sit on supervisory boards of portfolio
companies, whereas representatives of eight funds always serve as supervisory
board chairmen.
The results of the study confirm the hypothesis that, apart from equity, private
equity funds offer portfolio companies also a number of non-financial additional
benefits (management capital), which contribute to an increase in their value.
V. STRATEGIES FOR INCREASING PORTFOLIO
COMPANIES’ VALUE BY PRIVATE EQUITY FUNDS
1. CONCLUSIONS FROM VALUE-BASED MANAGEMENT THEORY

The investment strategy of private equity funds is strictly subordinated to the principle
of value maximisation for its owners (capital providers), irrespective of whether the
given fund operates as an investment company of the limited partnership type or a
commercial law company (limited liability company or joint stock company).
Maximising the fund’s value consists in creating the value of its portfolio companies.
For example, the operating philosophy of the MCI Management S.A. venture
capital fund is phrased as follows: “The essence of the fund’s operation is to identify
IT and Internet projects at the early stage of their development and then achieve their
dynamic growth and maximum value increase. Portfolio value growth is achieved
through providing funds and support regarding business and industry know-how
which are necessary for project development.”165 However, MCI Management is not
a typical fund for its shares are traded publicly. The majority of private equity funds
around the world are not listed companies.
Another example of strategy employed by Innova Capital, a company
managing three private equity funds: “We believe that we can achieve above-
average profits if our involvement increases the competitiveness of the enterprise we
invest in. For that purpose, we focus on four transaction types (growth capital,
acquisition/development, platform-based growth, international expansion) in which
we believe we can maximise the value.”166
Renaissance Partners, another company managing three private equity
funds, has adopted the following mission in its operation: “Our mission is to assist
entrepreneurs in increasing the value of their companies. Instead of supervising
and controlling, we are a partner who assists and supports.”167
Investment partners in private equity funds usually have extensive experience
in corporate management or experience in specific industries. After concluding the
investment agreement with current beneficiary company owners, such partners may
provide assistance (depending on the company management quality) in formulating
the strategy for the enterprise’s further growth. Not all funds are an active investor
who wishes to impact the decisions of the management board. However, if a fund
has a majority stake in a portfolio company, it is only natural for it to have some
influence on the composition of the management board and the creation of the
company’s value growth strategy.
Value-based management pertains to a contemporary management method
which encompasses tools and procedures for making strategic and operating
decisions aimed at long-term corporate value increase and multiplying the wealth of
its owners. 168 There already exists relatively extensive Polish literature related to this
area169.
165
MCI Management S.A. operating philosophy is presented on: www.mci.com.pl
166
www.innovacap.com
167
Ze strony www.rp.com.pl
168
Szablewski A. (red.), Strategie wzrostu wartości firmy. Studium przypadków [Corporate value growth
stategies. Case Study], Poltext, Warsaw, 2000, p. 15
169
E.g. Szablewski A., Herman A. (ed [. ) Zarządzanie wartością firmy [Value-based management], Poltext,
Warsaw 1999; Cwynar W., Cwynar A., Zarządzanie wartością spółki kapitałowej [Value-based management],
 The beginnings of VBM reach back to mid 1980s and pertain to US
°
companies. In 1986, Professor A. Rappaport wrote170 that in the coming years VBM
would become a global standard for measuring and assessing corporate
performance. According to A. Cwynar and W. Cwynar 171, Europe undertook the first
attempts to implement VBM a whole decade later than US enterprises.
In the process of selecting companies, private equity investors focus on
enterprises which can guarantee an above-average rate of return.
In order to increase the company’s value, a private equity investor undertakes the
following tasks:
 Defining the generators of company value growth;
 Defining or re-defining the company’s strategy elements in consultation
with the current company authorities;
 Selecting key personnel, depending on the stage of development;
 Implementing or strengthening financial controlling: a measurement
system;
 Creating a modern incentive system for the managerial staff, focused on
increasing the company’s value.

Defining the generators of company value growth

After signing the investment agreement between a private equity fund and the
company which is the capital beneficiary, the fund becomes its shareholder or
partner (depending on the form of the company). A fund representative joins the
company’s supervisory board and has impact on formulating the program for
increasing the company’s value which is consistent with the interests of the fund and
hitherto owners of the beneficiary company. The fund’s investment partners can help
define the company’s value basic value builders.172. A. Black, P. Wright and
J.E.Bachman173 enumerate three groups of factors influencing the value of
enterprises, i.e.:
a. Strategic (risk, profitability),
b. Financial (sales, operating margin in cash terms, outlays for current assets,
outlays for fixed assets, income tax rate in cash terms, cost of equity);
c. Operating (among others, unit sales level, settlement policy, labour costs,
prices, product range, capital budgeting, productivity, etc.).
A. Szablewski also identified three groups of value generators; however, apart
from the financial factors he also differentiates between marketing and non-tangible
factors. Among marketing generators, he enumerates: building customer loyalty and
means for attracting new customers, new sales markets, new distribution channels,
growth internationalisation, advantageous alliances and takeovers. In the group of

FRR, Warsaw, 2002; Bieliński J.(ed.), Zarządzanie wartością przedsiębiorstwa a alokacja kapitału [Value-based
management and capital allocation], Cedewu, Warsaw 2004; Pawłowicz L., Kasiewicz S. (ed.), Zarządzanie
wartością firmy w dobie kryzysu [Value-based management in a crisis], Cedewu, Warsaw, 2003; Panfil M. (ed.)
Value-based management – VBM (manual), Weka Sp z o.o., Warsaw, 2003
170
Rappaport A., Creating Shareholder Value. A Guide for Managers and Investors, [translation into Polish:]
WIG-Press, Warsaw, 1999
171
Cwynar W., Cwynar A., Zarządzanie wartością spółki kapitałowej [Value-based management], FRR, W-wa,
2002, p. 33
172
In „Zarządzanie wartością firmy” [Value-based management], Poltext, Warsaw 1999, A.Herman and
A.Szablewski use the term value builders, value drivers.
173
A.Black, P.Wright, J.E.Bachman, In Search for Shareholder Value: Managing the Drivers of Performance,
[translation into Polish:] Dom Wydawniczy ABC, Warsaw 2000, p. 101
intangible generators he includes intellectual capital, innovation potential of the
enterprise, brand strength, efficient logistics, international communication,
organisational culture, information systems and social reputation.

Defining or re-defining company’s strategy elements in consultation with the

current company authorities174
Having defined the basic factors of company’s value growth, the investor (private
equity fund) together with the company’s authorities create a strategy for increasing
the said value. The fund’s investment period lasts for 5-7-10 years; consequently, the
strategic plan is subordinated to the fund’s expectations. The investment agreement
usually specifies the negotiated terms, i.e. estimated date and mode of the fund’s
disinvestment. It is a common practice among US funds to sell the shares held by
way of IPO or shortly after the company floats on the stock exchange. In Poland,
such practice is applied by Enterprise Investors funds (e.g. Polfa Kutno S.A., Stomil
Sanok S.A., Eldorado S.A., Grupa Kęty S.A.). Therefore, the company’s growth
strategy from the fund’s point of view is formulated until the fund disinvests.

Selecting key personnel, depending on the stage of development

If the management staff of the beneficiary company receiving private equity lacks key
persons, fund representatives can provide assistance in finding such persons. Key
corporate management personnel includes the chief financial officer who takes an
active part in constructing and monitoring company value with the use of modern
financial engineering tools. If the company lacks a person experienced in this area,
the fund may temporarily delegate its own employee to train the accounting and
financial personnel of the beneficiary company in the field of value reporting,
calculating the profitability of investment projects, calculating the cost of equity, etc.
However, the liability for managing the company is vested with management board
members and usually the private equity fund plays only an advisory role.

Implementing or strengthening financial controlling: a measurement system

An important element in the value growth program in the portfolio company by the
private equity fund is to create an effective controlling system, e.g. introduce activity-
based costing (ABC) or identifying cost (profit) centres which makes it possible to
calculate the profitability of respective business units175.

Modern incentive system for the management staff focused on increasing the
company’s value
Devising an incentive system addressed at the management staff is an important tool
in creating corporate value. According to A.Szablewski 176, managers play a decisive
role in the process of creating the value of the company for its shareholders. Their
know-how and ability to learn, their creativeness and determination in pursuing

174
In other words, as in A.Szablewski, A.Herman [in:] Zarządzanie wartością firmy [Value-based management],
p. 51 : reorientign business priorities and corporate strategy, i.e. subordinating enterprise reconstruction to long-
term interests of its owners
175
A discussion of this problem can be found in the following books: Vollmuth H.J., Controlling – planowanie,
kontrola, kierowanie. [in Polish] Placet Agencja Wydawnicza, Warsaw 2000; Sierpińska M., Niedbała B.,
Controlling operacyjny w przedsiębiorstwie. Centra odpowiedzialności w teorii i praktyce. [Operating
controlling in enterprises. Responsibility centres in theory and practice], PWN Warsaw 2003
176
Szablewski A. (ed.), Strategie wzrostu wartości firmy. Studium przypadków [Corporate value growth
stategies. Case Study] , Poltext, Warsaw, 2000, p. 25
success determine the mode and efficiency of using available capital and resources
as well as all intangible assets.
Management stock options are a very popular instrument, offered to a selected group
of key managers, as are bonuses for reaching and/or exceeding the company’s
annual operating budget177.

2. CREATING PORTFOLIO COMPANIES’ VALUE BY PRIVATE EQUITY

FUNDS

2.1. CASE STUDY METHODOLOGY

In this chapter, the case study method was applied regarding 4 selected companies
included in the portfolios of Enterprise Investors funds’ operating in Poland since
1990. In the period 1990-2003, over 400 disinvestments took place in Central and
Eastern Europe, 59 of which pertained to Enterprise Investors funds 178. An analysis
of these four cases presents the philosophy of value-based management by a private
equity fund in the example of funds managed by Enterprise Investors. It is a
representative sample and, it seems, a sufficient one for drawing conclusions, since
the selected companies operate in different industries.

MODE OF SELECTING COMPANIES

a. 4 companies listed on the Warsaw Stock Exchange: representatives of 4 different
industries (acc. to NACE: Polish Classification of Business PKD), i.e.
Polfa Kutno S.A. 24.42, manufacture of pharmaceutical preparations
Stomil Sanok S.A. 25.10, manufacture of rubber products
Eldorado S.A. 51.39, wholesale of foodstuffs, beverages and tobacco products
Grupa Kęty S.A. 27.42 processing aluminium and its alloys

Only listed companies were selected for the purpose of the analysis on account of
free access to their financial information and stock exchange notices.
b. investments in the said companies are already completed;
c. In case of all the 4 analysed companies, the investor was the group of largest
private equity funds in Poland (in Central and Eastern Europe) with total investment
capital around USD 1.1 billion (in January 2004);

RESEARCH LIMITATIONS
a. data regarding the quality of portfolio investments, such as internal rate of return
(IRR) are subject to strict confidentiality on the part of the investment partners. They
are often obligated to refrain from publishing any information under agreements
concluded with company owners. It should be noted that in late October 2004 EVCA
published a report on 25 case studies of CEE companies which acquired private
equity. 3 among those 25 companies are analysed in this chapter: Stomil Sanok,

177
This issue is presented by Cwynar A., Cwynar W. [in:] Zarządzanie wartością spółki kapitałowej [Value-
based management], FRR, Warsaw, 2002, pp. 297-331
178
Quoted from Enterprise Investors, www.ei.com.pl of 08.04.2004 in the note entitled „Strategic Investor for
Bauma”.
Polfa Kutno, and Eldorado. Other Polish companies presented in the said report are:
@entertainment, Lukas, Town&City, HTL, and ComputerLand.179
b. so far, no disinvestment database has been created in Poland. Polish Private
Equity and Venture Capital Association (PSIK) which has been operating since 2002
does not as yet gather such information.

CASE STUDY METHODOLOGY DESCRIPTION:

Each of the four companies was analysed from the perspective of five aspects:

a. Company profile: this part encompasses key information on the company, its
products, services and market position;

b. Key events from the company’s operations and stages of investment by

Enterprise Investors funds: this item covers the list of significant stages in the
company’s history and stages of EI funds’ investment (share purchase, sale);

c. Strategy for company value increase by EI funds:

this item encompasses a fundamental analysis of the company and its
interpretation during the period of EI funds’ investment; it also covers a graphic
presentation of:
- Net sale revenues,
- Level of EBIT and net profit,
- Value of assets and equity,
- EPS value: net profit/ number of shares
- market prices of company’s share (minimum, maximum, at the end of the period);
- MC/S value (market capitalization to sales): company’s market capitalisation / net
sale revenues;
- P/BV value (price to book value): company’s market value (capitalisation) / book
value.180
Furthermore, within the scope of the company’s fundamental analysis three
profitability ratios (operating profit margin, net profit margin, return on equity) were
compared with the mean value (median, 5th decile) in the given company’s industry.
An extract from the PONT INFO GOSPODARKA database was used for analysing
the decile distribution of the ratio values for analysed industries.
The values of the abovementioned three profitability ratios were considered to
constitute a measurable economic consequence of EI fund representatives’
presence in the Supervisory Boards of the four portfolio companies.

d. Funds’ financial benefits

This part encompasses above all two key factors measuring the profitability of
investing in portfolio companies:
- Net internal rate of return (net IRR): after deducting the costs of share sales and
salaries for EI funds’ managers. The calculated IRR is an annualised rate of return on
the invested capital.
- Multiplier which is the quotient of net receipts (without the costs of share sale, legal
fees and salaries for EI funds managers) and share purchase costs in respective

179
Report entitled Central and Eastern Success Stories, EVCA, October 2004, posted on: www.evca.com.
Company specification is presented in schedule 6.
180
Book value and market value pertain to the company’s equity.
periods. The multiplier shows how many times total net revenues exceed the incurred
costs of purchasing share stake(s).

e. Further creation of corporate value after the EI funds disinvestment

Here we look among others for an answer to the key question: whether after the
Enterprise Investors’ disinvestment as the capital investor in the portfolio company
the latter’s market value grows or decreases.

2.2. CHARACTERISTICS OF PRIVATE EQUITY FUNDS MANAGED BY

ENTERPRISE INVESTORS SP Z O.O.
The investment activity of Enterprise Investors started in May 1990 together
with the creation of the Polish-American Enterprise Fund (PAEF) with the capital of
USD 240mn. PAEF is an American non-profit corporation founded in accordance with
the law of Delaware, USA, under the Support for East European Democracy (SEED)
Act of 1989 for the purpose of promoting the private sector in Poland and pursuing
activity streamlining its development, including capital investments, loans, donations,
and technical assistance. PAEF’s headquarters are in Jersey, USA.
In 1992, PAEF’s success resulted in the creation (on PAEF’s initiative) of the
Polish Private Equity Fund I181 and Polish Private Equity Fund II182 with USD 50
million invested by PAEF itself and USD 101 million contributed by private
institutional investors. In 1995, yet another (fourth) fund was established under the
name Polish Enterprise Fund.
In 2000, Enterprise Investors announced the foundation of the new fund under
the name Polish Enterprise Fund IV (PEF IV) with the capital of USD 217mn. PEF IV
capital was contributed by leading international insurance companies, pension funds
and other financial institutions. The fund’s capital is invested also outside Poland in
other Central European countries.
In January 2004 EI created a new private equity fund (Polish Enterprise Fund
V LP) with the total capital of EUR 300mn. It is so far the largest private equity fund
to be created in Central Europe. PEF V’s investors are leading pension funds,
insurance companies and financial institutions from the USA and Western Europe.
Since 1990, EI has been managing a group of investment funds in Poland:
Polish Enterprise Fund IV, Polish Enterprise Fund, Polish Private Equity Fund I and
II, Polish-American Enterprise Fund and Polish Enterprise Fund V with the total
capital of USD 1.1 billion .
So far, EI funds invested almost USD 750 million in 93 companies, becoming
one of the largest foreign investors and the largest group of private equity funds in
Poland and the whole CEE region. The funds completed 61 investments, multiplying

181
PPEF I is a limited partnership, created under British law, in which PAEF has a stake of 15.5 % as the limited
partner. PAEF holds indirectly a 50% stake in Polish Fund Partners LP which is the general partner in PPEF I
with a 1% stake. PPEF I conducts business activity in the field of equity investments. The fund’s headquarters is
in Jersey, USA.
182
PPEF II is a limited partnership created under the law of the state of Delaware, USA, in which PAEF has a
49.8% stake as the limited partner. PAEF with a 1% stake is the general partner in PPEF II.
 183
the invested capital ca. 2.5 times. The Enterprise Investors investment team
comprises 20 persons.
EI funds are the investor184 in the following companies:
a. Production / Services (Bauma S.A., LPP S.A., Messenger Service Stolica
S.A., Nomi S.A., Opoczno S.A., Polish Energy Partners S.A., Polska Grupa
Gospodarki Odpadami S.A.);
b. Consumer goods (Agros-Fortuna / Sonda S.A., Harper Hygienics Sp. z o.o.,
Kinoplex S.A., Sfinks S.A., W. Kruk S.A.);
c. Pharmaceuticals / Healthcare (Medycyna Rodzinna SA)
d. IT / Telecommunications / Media (AB S.A., Comp Rzeszów S.A., Netia SA,
Orange Romania S.A., Orange Slovensko a.s., Teta S.A., Bulgarian
Telecommunications)
e. Financial services (Kruk Systemy Inkaso Sp. z o.o., Magellan Sp. z o.o)

EI funds specialise in the following types of investments:

a. Co-financing fast-developing enterprises (e.g. Lukas Bank S.A. which
ensured EI funds revenues around USD 85mn, which means that between May
1997 and June 2001 the value of the company for all its shareholders increased
5.4 times with a 50% rate of return185).
b. Recapitalisation combined with floatation (e.g. Eldorado S.A., in case of
which EI funds sold half their stake in it at the WSE. This investment brought the
funds USD 7 million and the invested capital was multiplied 2.7 times in the
period between February 1999 and June 2003186);
c. start-up (e.g. Polish Energy Partners S.A. in which EI funds have been present
since 1997);
d. Restructuring (e.g. CarnaudMetalbox-Gopak, previously known as Fabryka
Opakowań Blaszanych);
e. Capital and management privatisation (e.g. Grupa Kapitałowa Kęty S.A. In
2002 the funds sold on the WSE all their shares in Kęty; their sale through
secondary trading to financial investors proved to be a big success.) Kęty’s
management group became the company’s co-owner.
f. joint-venture (e.g. Donnelley Polish-American Printing Company).

183
Source: Enterprise Investors www.ei.com.pl (note entitled „EI inwestorem w Bułgarskiej Telekomunikacji”
[EI invests in Bulgarian Telecom] of 14.06.2004).
184
Source: Enterprise Investors website www.ei.com.pl (version of 19.07.2004).
185
Data of EI
186
Data of EI
2.3. POLFA KUTNO S.A. VALUE GROWTH STRATEGY BY EI FUNDS

2.3.1. POLFA KUTNO S.A. profile187

The origins of Polfa Kutno S.A. date back to 1935 when the Warsaw chemical plant
Motor-Alkaloida purchased a one-hectare lot in Kutno with the former premises of
Alfred Wiśniewski’s machinery and agricultural appliances plant. The Kutno branch
was organised by F. Więckowski, A. Cholewicki and S. Ryl who supervised the
production of a morphine sub-product called “jam” manufactured on a license based
on the patent of Janos Kabay, a Hungarian pharmacist.188
Today, Polfa Kutno S.A. is a modern and dynamically growing Polish pharmaceutical
company focusing on the most promising pharmaceutical preparations in the Rx
(prescription drugs) and OTC (over-the-counter drugs) categories. Polfa Kutno’s key
market segments include: diabetes, gastroenterology, cardiovascular drugs,
painkillers, anti-osteoporosis drugs, medicines used in central nervous system
diseases as well as OTC, the best-known among which is the multi-vitamin
preparation called Vibovit.

2.3.2. Key events and EI funds’ investment stages

21/02/1992 The Minister for Ownership Transformation executed the

transformation of the state-owned company called Kutnowskie
Zakłady Farmaceutyczne “POLFA” into a one-person joint stock
company of the State Treasury.

04/01/1995 Polish-American Enterprise Fund and Polish Private Equity Fund I

and II, managed by Enterprise Investors, purchased from the State
Treasury the total of 450,763 shares in Polfa Kutno S.A. by way of a
public offering (separate tranche for the strategic investor) at PLN 24
per share which constituted 25% (cf. Table 5.1) of the company’s
share capital, of which PAEF purchased 139,300 shares, PPEF I
acquired 156,754 shares and PPEF II purchased 154,709 shares.
The funds were obligated to trade Polfa Kutno shares on the
Warsaw Stock Exchange.

Table 5.1
Polfa Kutno S.A. share sale mode on 4 January 1995
Specification Public Separate tranche Total
offering
Buyers of the Domestic Company’s State Strategic investor
share tranche sold investors employees Treasury (EI funds)
Number of shares 1 003 914 258 221 90 152 450 763 1 803 050

187
The case study of Polfa Kutno S.A. was first described by the authord in his article entiled „Budowanie
wartości spółki przez fundusze venture capital i private equity” [Company value increase through venture capital
and private equity funds] [in:] Wycena i zarządzanie wartością firmy [Valuation and value-based management],
ed.A.Szablewski, R.Tuzimek, Poltext, Warsaw, 2004r., pp. 305-344. The case study is laid down in more
precision in this publication.
188
Gawłowski S., Skuza M., Strategia wzrostu wartości spółki giełdowej na przykładzie Polfy Kutno S.A.
[Value growth strategy of a joint stock company in the example of Polfa Kutno S.A.] thesis prepared for the
completion of the WSE post-graduate studies in Value-Based Management (9th issue), Warsaw, June 2004, p. 5
(pcs)
Percentage of 55,68 % 14,32 % 5% 25 % 100 %
share capital
Source: Own work based on Polfa Kutno S.A. issue prospectus, 1995

10/01/1995 Polish-American Enterprise Fund and Polish Private Equity Fund I and
II managed by Enterprise Investors purchased from the State Treasury
further 432,732 shares (cf. Table 5.2) at PLN 20 per share, increasing
their joint stake in the company’s share capital to 49%, of which: PAEF
purchased 133,728 shares, PPEF I acquired 150,484 shares and PPEF
II purchased 148,520 shares.

03/04/1995 first successful listing of company’s shares at the Warsaw Stock

Exchange at PLN 23.8. Polfa expands its operation to the Ukrainian
market.

12/02/1996 Increase of the company’s share capital to 982,143 shares by way of a

new share issue. Enterprise Investors funds acquired jointly 481,250
shares in a closed tranche (cf. Table 5.2) at the issue price PLN 29.5,
of which: PAEF purchased 148,721 shares, PPEF I acquired 167,356
shares and PPEF II purchased 165,173 shares. The total number of
shares in Polfa Kutno S.A. amounted to 2,785,193, of which the EI
funds held jointly 49%. Revenues from Polfa Kutno’s sales in the
Ukraine exceeded USD 1mn.

01/09 – 09/10/1998 : EI funds purchased 64,529 shares (cf. Table 5.2) on the
secondary market at the average price of PLN 31.40, of which: PPEF I
acquired 32,476 shares and PPEF II purchased 32,053 shares. As a
result of this transaction the stake of EI funds in the company’s share
capital increased to 51.3%. In the same year, the restructuring process
was started in the company.

Table 5.2
Specification of total share stake in Polfa Kutno SA purchased by EI funds
from 01.09.1998
Specification 04.01.1995 10.01.1995 12.02.1996 to 09.10.1998 Total
Number of shares
purchased by EI 450 763 432 732 481 250 64 529 1 429 274
Stake value in PLN
189
(nominal prices) 10 818 312 8 654 640 13 715 625 2 025 932 35 214 509
Source: Own work based on Polfa Kutno S.A. issue prospectus, 1995 and Polfa’s stock exchange
communications

1999 Buyback of 453,330 shares (i.e. 16.28% of the share capital) by the company
at the average price of PLN 75190 on the secondary market for the purpose of their
redemption. In the same year, license for manufacturing Prinivil was purchased from
Sharp Dohme.

189
Data: Enterprise Investors
190
In 1999 the company bought back own shares to redeem them for PLN 34,343,000.
2000 after the redemption, the number of Polfa Kutno S.A. shares dropped to
2,332,000 and EI funds’ stake in the share capital increased to 58.5%. Buyback of
further 415,380,000 own shares (i.e. 17.81% of the share capital) at the average
price of PLN 65 per share191 for the purpose of their redemption.
The buyback of own shares was financed with a bank loan In the same year, a new
management board of the company was appointed and the company’s new office in
Warsaw was opened.

2001 After the redemption, the number of Polfa Kutno S.A. shares dropped to
1,916,483 and EI funds’ stake in the share capital increased to 70.0%. The same
year witnessed the creation of HR department and the introduction of target-based
management. Furthermore, new licenses were purchased from Novartis for trading in
Anafranil.

09.2001 EI funds started an unsuccessful process of selling their shares in Polfa

Kutno. An industry investor from the US market was looked for. The 09/11 tragedy
(terrorist attack on the WTC in New York) caused a change in the investment
strategy of many American companies or even a suspension of foreign investments.

28/06/2002 issue of 60,000 shares within the scope of management share option
offer (at the issue price of PLN 129 per 1 share). The number of shares in Polfa
Kutno increased to 1,976,483.

2002 Buyback of 99,447 (i.e. 5.2% of share capital) shares by the company at the
average price of PLN 130.2192 on the secondary market for redemption purposes.
"Srebrny Byk" [Silver Bull] award given by the President of the Warsaw Stock
Exchange to Polfa Kutno for the highest return on investment rate (=138.5%) in 2001.
Finalised sales of the Infusion Liquid Plant to Fresenius Kabi. GMP (Good
Manufacturing Practice) Certificate for the Dry Moulds department at the Kutno plant.
Purchasing rights to the Doxar urologist preparation from Biovena Pharma.

24/09/2003 Funds managed by Enterprise Investors sold to Polish and foreign

financial investors 1,318,839 shares in Polfa Kutno S.A. (68.81% shares in the
company) at PLN 235 per share. The share sale was conducted through 70 off-
session stake transactions at the Warsaw Stock Exchange (WSE). Buyers
included Polish pension funds and investment funds as well as EU financial
institutions. The total transaction value amounted to ca. PLN 310mn.

Chart 5.1 below presents the specification of share value appraised by brokering
house analysts in September and October 2003 prior to the final stake sale
transaction by EI funds.

191
In 2000 the company bought back own shares to redeem them for PLN 27,203,000.
192
In 2002 the company bought back own shares to redeem them for PLN 12,950,000.
Chart 5.1
Appraisal of Polfa Kutno SA share value by brokering house
analysts in 2003

350 zł 320 zł 314 zł 309 zł

285 zł 275 zł
300 zł
235 zł
250 zł
200 zł
150 zł
100 zł
50 zł
0 zł
DI BRE Banku ING Securities DM BZ WBK CDM PEKAO Maksium roczne Transakcja EI
(3.09) (20.10) (10.09) (4.09) (24.09)

[maksimum roczne] annual maximum

[transakcja EI] EI transaction
Source: annual report of Polfa Kutno for 2003

31/12/2003 Open-End Pension Funds invested the total of PLN 170.45 million in
shares in Polfa Kutno, i.e. 42.3% of the share capital.193

2.3.3. Strategy for increasing the value of POLFA KUTNO S.A. by EI funds

EI Funds to a large extent contributed to operational and financial restructuring of

the company, focused on product specialisation and profitability improvement. The
restructuring process consisted in:
a. in 1997-2003 focusing on the strategic, most profitable operating segments
(i.e. OTC and prescription drugs) which meant giving up on the remaining sectors
(e.g. producing additives to animal fodder, supplements and infusion liquids).
Departments manufacturing these products were sold in 1996-1999.
According to Stanisław Knaflewski, partner in EI and EI’s representative in Polfa’s
Supervisory Board during the period of EI’s investment194, in 1995 Polfa was a
technologically backward manufacturer of various products with drugs making up
only 25% of its sales.
EI encouraged Polfa to shift is operation from pure manufacturing to sales-oriented
and customer-oriented.

b. changing the previous product strategy characterised by:

- Focusing on improving product quality, searching for and launching new products;
- Forming commercial relations with Western producers and launching licensed drugs
on the Polish market (e.g. license agreements with Merck Sharpe Dohme, Servier
and Mundipharma). The company improved and patented some of its current
products.

193
„Najczęściej w największe spółki” [Most often in the largest companies], Rzeczpospolita, 16.01.2004,
194
Until 17.12.2003 there were two members of Polfa Kutno S.A. Supervisory Board representing EI funds:
Ryszard Wojtkowski (chairman of the Supervisory Board) and Stanisław Knaflewski (Vice Chairman of the
Supervisory Board).
c. employment restructuring, including among others developing sales and
marketing departments. Almost 40% of the company’s staff (226 people) is involved
in selling and marketing its products. In 1995, these tasks were carried out by few
(only 6) from among 1400 employees. According to Stanisław Knaflewski, Polfa
Kutno was called the “production branch of the Polish Ministry of Health”. In 1999,
employment in sales and marketing departments increased to 112 people and
reached the level of 226 people in 2003. (cf. Chart 5.2).
EI influenced the motivation of previous and new lower-level managers using
financial incentive mechanisms and ambitious challenges.

Chart 5.2
Polfa Kutno employment level 1997-2003

1400 1215
1200 1070
1000
792
800
600 431
351 340 329
400 226
145 160 191
200 77 112
42
0
1997 1998 1999 2000 2001 2002 2003

Produkcja Marekting i sprzedaż

[produkcja] Production
[Marketing I sprzedaż] Sales and marketing

Source: Based on presentation of Polfa Kutno Management Board of 24.06.2003.

d. reinforcement of the company’s management which is a common practice on

the global venture capital/ private equity market. EI was the first private equity fund in
Poland to introduce the management share options program at the WSE in order
to attract attractive managers and retain them at Polfa Kutno S.A. The new president
of the management board (Janusz R. Guy), suggested by EI in November 2000,
brought with him extensive experience acquired during his work for leading
international FMCG companies on the US, Italian and Russian markets.

New investment program

During recent years, Polfa Kutno incurred significant investment outlays for
modernising its production line so that it conforms to international standards. Thanks
to the investments in the total amount of PLN 180 million (from 1994) allocated
chiefly to the construction of the new production plant, Polfa Kutno obtained the
Good Manufacturing Practice (GMP) certificate confirming its compliance with the
recommendations of the World Trade Organisation which is respected in the majority
of European countries.

“Our mission in Polfa Kutno is complete. After a period of fundamental changes

which we undertook together with Polfa’s Management Board, the Company has
recently proved that it is ready for independent growth. Selling the total of over 70%
in the Company’s capital was undoubtedly the largest stake sold to portfolio financial
 investors during the whole history of stock exchange in Poland. Today’s transaction
confirms that portfolio investors present at WSE are able to take over control of a
public company and are not afraid to do so.” Ryszard Wojtkowski, partner in
Enterprise Investors, Chairman of Polfa Kutno Supervisory Board in 2000-2003

FUNDAMENTAL ANALYSIS OF THE COMPANY

As a result of quick and effective decisions of the company’s Management

Board stimulated by the Supervisory Board, including two EI investment partners, the
company experienced an improvement in its financial standing:
- Increase in sale revenues from PLN 179,672,000 in 1998 to 245,145,000 in 2003
(cf. Chart 3). In the period 1998-2003 revenue CAGR was around 107% per year.
- Increase in operating profit margin from 11.3% in 1998 to 19.4% in 2003. Operating
profit margin CAGR over that period amounted to 126%.
- Increase in net profit margin from 7.9% in 1998 to 12.4% in 2003. In the analysed
period, net profit margin CAGR amounted to 166%.
- ROE increase from 9.6% in 1998 to 18.0% in 2003. ROE CAGR in those years was
104%.

Polfa Kutno generated a high level of operating cash flows (cf. Table 5.3),
thanks to which it could pursue a large-scale investment program in order to
modernise its production plants, purchase licenses for the production of new drugs
as well as buy back shares to redeem them which had a considerable impact on
the increase of the company’s market value.

Table 5.3
Stomil Sanok cash flow statement in 1998-200
1998 1999 2000 2001 2002 2003 2003
Q1-3
Cash at the beginning of the year 1 444 382 2 163 2 806 6 081 5 227 2 388
(PLN thousand)
Operating cash (PLN thousand) 17 157 28 639 44 757 33 259 35 081 32 328 51 268
Investment cash (PLN thousand) -22 652 -33 733 2 192 -10 559 -10 360 -43 221 -40 808
Financial cash (PLN thousand) 6 875 4 433 * -46 306** -19 425 -25 575*** 8 054 1 837
Cash at the end of the year (PLN 382 2 163 2 806 6 081 5 227 2 388 17 524
thousand)
Source: www.polfakutno.pl
* redemption of own shares in 1999 in the amount of PLN 34,343,000 (financial expenditure)
** redemption of own shares in 2000 in the amount of PLN 27,203,000 (financial expenditure)
*** redemption of own shares in 2002 in the amount of PLN 12,950,000 (financial expenditure)

Net sale revenues increased from PLN 179,672,000 in 1995 to PLN 245,145,000 in
2003 (annualised growth by 107%). In 2000, a drop in revenues could be observed
which is reflected in the company’s other financial results (cf. Chart 5.3).
Chart 5.3
Polfa Kutno net sale revenues in 1998-2003

CAGR = 107%
300,000
245,145
250,000 212,779 211,209
179,672 187,297 191,427
200,000
PLN thousand

150,000
100,000
50,000
0
1998 1999 2000 2001 2002 2003

Year

Source: Own work based on financial statements of Polfa Kutno S.A.

The company’s 1995 EBIT (PLN 20,312,000) was more than doubled in 2003 (PLN
47,605,000); similarly, net profit increased from PLN 14,227,000 in 1995 to PLN
30,280,000 in 2003 (cf. Chart 5.4).
Chart 5.4
Polfa Kutno S.A. EBIT and net profit 1998-2003

50,000
45,000
40,000
35,000
PLN thousand

30,000
25,000
20,000
15,000
10,000
5,000
0
1998 1999 2000 2001 2002 2003
Zysk operacyjny w tys. zł 20,312 27,012 17,240 32,874 39,149 47,605
Zysk netto w tys. zł 14,227 16,039 4,031 17,343 23,072 30,280

[zysk operacyjny] EBIT in PLN thousand

[zysk netto] Net profit in PLN thousand
Source: Own work based on financial statements of Polfa Kutno S.A.

The growth rate of Polfa Kutno’s assets amounted to 109% in the analysed period
while the equity growth rate to 104%. The balance sheet sum (assets) grew from
PLN 221,841,000 in 1995 to PLN 310,273,000 and equity from PLN 147,871,000 in
1995 to PLN 167,820,000 (cf. Chart 5.5).
Chart 5.5
Polfa Kutno S.A. assets and equity in 1998-2003

350,000
300,000
250,000
PLN thousand

200,000
150,000
100,000
50,000
0
199 199 200 200 200 200
8 9 0 1 2 3
Aktywa w tys. zł 221,841 235,965 196,239 212,617 217,906 310,273
Kapitał własny w tys. zł 147,871 129,567 105,353 123,312 131,030 167,820

[aktywa] Assets in PLN thousand

[Kapitał] Equity in PLN thousand
Source: Own work based on Polfa Kutno S.A. annual reports

In the period 1998/2003 EPS ratio was growing systematically (with the exception of
2000). In 1998, it was PLN 5.11 per 1 share compared to as much as PLN 16.13 per
share in 2003 (cf. Chart 5.6).

Chart 5.6
Polfa Kutno S.A. Earnings per Share (EPS) ratio in 1998-2003

18.00 16.13
16.00
14.00 12.04
12.00
9.05
10.00
8.00 5.76
5.11
6.00
4.00 1.73
2.00
0.00
1998 1999 2000 2001 2002 2003

Source: Own work based on financial statements of Polfa Kutno S.A.

The following index (Chart 5.7) presents the price per 1 share in the company. The
price per 1 share on the day of floating on the stock exchange was PLN 23.80.
2003 was the best year in the history of Polfa’s listings on the WSE and consequently
the best for EI to withdraw from the investment (share sale through off-session
transactions at PLN 235 per 1 share).
Chart 5.7
Polfa Kutno price per share (minimum, maximum, at year end) in 1998-2003

300 zł
250 zł
200 zł 222.0 zł
150 zł 159.0 zł
130.0 zł
100 zł
50 zł 52.5 zł 72.5 zł 54.5 zł
0 zł
1998 1999 2000 2001 2002 2003
Cena max 1 akcji 101.0 zł 76.0 zł 91.0 zł 130.0 zł 160.0 zł 278.0 zł
Cena min 1 akcji 28.6 zł 48.0 zł 46.0 zł 52.3 zł 111.0 zł 139.0 zł
Cena 1 akcji na zamknięciu 52.5 zł 72.5 zł 54.5 zł 130.0 zł 159.0 zł 222.0 zł

[max] Maximum price per share

[min] Minimum price per share
[Zamknięcie] Closing price per share
Source: Own work based on text files from http://www.parkiet.com/dane/dane.jsp

MC/S ratio was growing in the analysed period (with the exception of 2000). Since
2001 the company’s market value has been exceeding the level of its net sale
revenues (cf. Chart 5.8).

Chart 5.8
Polfa Kutno SA market capitalisation to sales (MC/S)
ratio in 1998-2003

1.80 1.70
1.60 1.44
1.40 1.30
1.20
0.95
1.00 0.81
0.80 0.68
0.60
0.40
0.20
0.00
1998 1999 2000 2001 2002 2003

Source: Own work based on financial statements of Polfa Kutno S.A. and information on Polfa’s share
prices posted on http://www.polfakutno.pl/notowania_wykresy.php

Apart from 1998, the company’s market value throughout the analysed period
exceeded its book value and this phenomenon was subject to an uptrend from 2000
which means that the company was creating value for its shareholders (cf. Chart
5.9).
Chart 5.9
Polfa Kutno S/A price to book value (P/BV) ratio
in 1998-2003

3.00
2.48
2.50 2.32
2.02
2.00
1.56
1.50 1.21
0.99
1.00

0.50

0.00
1998 1999 2000 2001 2002 2003

Source: Own work based on financial statements of Polfa Kutno S.A. and information on Polfa’s share
prices posted on http://www.polfakutno.pl/notowania_wykresy.php

ANALYSIS OF THE COMPANY COMPARED TO THE INDUSTRY (NACE=24.42

MANUFACTURE OF DRUGS AND PHARMACEUTICALS)

Polfa Kutno’s operating margin was higher in 1999 and in 2001-2003 than the mean
value (median, 5th decile) for the industry. As from 2001 the value of this ratio
(median) was visibly decreasing for the industry, but not for Polfa Kutno. In 2003, the
company’s operating margin was 19.4% compared to the mean of 7.5% for the
industry (cf. Chart 5.10).

Chart 5.10
Polfa Kutno operating profit margin (OPM) in 1998-2003

25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
1998 1999 2000 2001 2002 2003
Polfa OPM 11.3% 12.7% 9.2% 17.2% 18.5% 19.4%
Decyl 5 OPM 11.41% 12.3% 10.0% 12.5% 10.4% 7.5%

th
[decyl 5] 5 decile
Source: Own work based on financial statements of Polfa Kutno S.A.
and data from the PONT INFO GOSPODARKA database
On the other hand, net profit margin for Polfa Kutno was lower than the industry
median only in 2000. Also in this case the mean value has been systematically
decreasing in the industry since 2001 in contrast to Polfa Kutno (cf. Chart 5.11).

Chart 5.11
Polfa Kutno S.A. net profit margin (NPM) in 1998-2003

14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
1998 1999 2000 2001 2002 2003
Polfa NPM 7.9% 7.5% 2.2% 9.1% 10.9% 12.4%
Decyl 5 NPM 4.27% 6.4% 6.0% 7.5% 7.2% 7.0%

th
[decyl 5] 5 decile

Source: Own work based on financial statements of Polfa Kutno S.A. and data from the PONT INFO
GOSPODARKA database

Return on equity (ROE) was lower in 1998-2000 than 5th decile in the industry; an
opposite situation took place in 2001-2003. In 2003, Polfa Kutno’s ROE was 18%
compared to the 11.6% median for the industry (cf. Chart 5.12).
Chart 5.12
Polfa Kutno S.A. ROE in 1998-2003

20.0%
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
1998 1999 2000 2001 2002 2003
Polfa ROE 9.6% 12.4% 3.8% 14.1% 17.6% 18.0%
Decyl 5 ROE 15.55% 12.5% 12.4% 13.4% 14.8% 11.6%

th
[decyl 5] 5 decile

Source: Own work based on financial statements of Polfa Kutno S.A. and data from the PONT INFO
GOSPODARKA database
2.3.4. Financial benefits for Enterprise Investors funds

In 1999-2001, after completing the investments in the production segment, the

company took out a loan in the amount of ca. USD 20 million and bought back its
shares at the WSE. This transaction, a novelty on the Warsaw Stock Exchange,
gained Polfa Kutno recognition for the transparency of its actions and equal
treatment of minority shareholders.
According to Stanisław Knaflewski, Polfa’s purchase could not be credited
since no bank wanted to grant a loan for that purpose.
In the purchase agreement concluded with the State Treasury, EI Funds
undertook to float Polfa Kutno S.A. on the WSE. After completing the restructuring
process, in 2001 EI funds started to sell their shares in the company. According to S.
Knaflewski, low demand for Polfa’s shares resulted from unfavourable global climate
for mergers and acquisitions and a different strategy pursued by international
corporations which wanted to introduce their global brands to the Polish market and
treated Polfa as a platform for their sale.
As a result, EI funds decided to sell their shares in Polfa Kutno on the
secondary market by way of off-session transactions. The company’s shares,
appraised at ca. PLN 310 million (i.e. USD 79mn) were purchased by Polish pension
funds and investment funds as well as EU financial institutions which allocated their
funds in securities in Central Europe. The transaction was finalised on 24 September
2003.
The EI partner quoted above stressed the fact that the investors’ favourable
disposition towards EI’s offer resulted from similar sale transactions regarding shares
held by EI. For example, in November 2002 EI funds sold a large stake in Grupa Kęty
S.A. on the Warsaw stock exchange, after which the company started to generate
record-breaking profits and its capitalisation increased considerably. In the first half of
2003 EI funds sold another share stake, this time in Eldorado. Selling shares in Polfa
Kutno was one of the largest transactions concluded by private equity funds at the
Warsaw Stock Exchange so far.
Tables 5.4 and 5.5 below present a simplified cash flow statement taking into
consideration cash receipts and expenditures connected with the EI funds’
investment in Polfa Kutno. Table 5.4 shows the calculation in PLN, table 5.5 in USD.

Table 5.4
Consolidated cash flow statement: EI’s investment in Polfa Kutno (calculation in PLN)
Specification 1995-2003
I. Receipts (1+2) PLN 309,964,221.70
1. Share sale to Polfa Kutno managers in 1999-2001 PLN 36,835.70
2. Sale of 1,318,839 shares on 24.09.2003 PLN 309,927,386.00
II. Expenditures (1+2) PLN 48,743,518.64
1. Costs of share sale, legal fees, managers’ salaries PLN 13,529,009.45
2. Cost of share purchase in respective periods PLN 35,214,509.19
III. Net cash flows (I – II) PLN 261,220,703.06
Source: Enterprise Investors

Total receipts of EI exceeded the amount of Polfa Kutno share purchase 8.4 times
(in PLN).
According to the formula:
 (Receipts – share sale costs, legal fees) / Share purchase costs

Table 5.5
Consolidated cash flow statement: EI’s investment in Polfa Kutno (calculation in USD)
Specification 1995-2003
I. Receipts (1+2) $79 116 193,18
1. Share sale to Polfa Kutno managers in 1999–2001 $8 687,45
4. Sale of 1,318,839 shares on 24.09.2003 $79 107 505,73
II. Expenditures (1+2) $17 467 422,41
1. Costs of share sale, legal fees, managers’ salaries $3 453 311,71
2. Cost of share purchase in respective periods $14 014 110,70
III. Net cash flows (I – II) $61 648 770,77

Total receipts of EI exceeded the amount of Polfa Kutno share purchase 5.4 times (in
USD).
Net internal rate of return on the 8-year investment (in USD) amounted to
22.75%.

EVCA recommends the IRR calculation by month or by quarter. For the purpose of
presenting the investment profitability calculation methodology, the calculation is
presented by year. Its IRR amounts to 25.04% which means that it is different from
22.75% IRR=25.04% should be treated only as an example.

Table 5.6
Calculation of net IRR on EI’s investment in Polfa Kutno SA
1995 1996 1997 1998 1999 2000 2001 2002 2003

I. Receipts in USD 0 0 0 0 1 369 3 855 3 464 0 79 107 506

1. Selling shares in the company 1 369 3 855 3 464 79 107 506

II. Expenditures in USD 8 061 206 5 403 469 0 549 436 0 0 0 3 453 312
1. Purchasing shares in the company 8 061 206 5 403 469 549 436
2. Fees for managing a portfolio company 2 124 917
3. Sales costs (including legal services,
brokering commission) 1 328 395

III. Net cash flow (I-II) in USD -8 061 206 -5 403 469 0 -549 436 1 369 3 855 3 464 0 75 654 194

IV. IRR 25,04%

EI’s profit on investment in Polfa Kutno amounted to: PLN 261,220,703

(USD 61,648,770).
Internal rate of return (IRR) on the 8-year investment (in USD) amounted to
22.75%.
2.3.5. Further creation of corporate value after the EI funds disinvestment

“After the disinvestment of Enterprise Investors the liquidity of Polfa Kutno’s shares
will increase which should attract important players to it. It has become almost a
tradition that when Enterprise Investors group funds withdraw from the given
company, its price starts to grow dynamically (Grupa Kęty or Stomil Sanok can serve
as a case in point here). Analysts have few doubts that this scenario will repeat itself
also in case of the Polfa Kutno drug manufacturer, though perhaps to a lesser degree
(…). Why are companies inherited from EI so popular? Analysts agree also on that.
After taking over a company, the funds conduct an in-depth restructuring process and
if shares are further resold, the company is already in a very good condition.” – Puls
Biznesu “Polfa Kutno będzie rosnąć” [Polfa Kutno on a path to growth], 29.09.2003

Plans for consolidating the pharmaceuticals market in Poland

After the successful restructuring process, Polfa Kutno was transformed from an
ordinary drug producer into an organisation focused on effective sales. It also
decided to seek added value through consolidating the Polish pharmaceuticals
market.

On 20 February 2004 Polfa Kutno made a conditional bid on purchase 29.84%

shares in Jeleniogórskie Zakłady Farmaceutyczne Jelfa S.A. ("Jelfa") from the State
Treasury at PLN 49.00 per share. The purpose of this acquisition was to increase the
competitiveness of the merged organisation against international pharmaceutical
companies on the Polish market as well as to increase the corporate value for stock
exchange investors.

On 1 April 2004 the company made another bid to purchase 29.84% in Jelfa from the
State Treasury. The offer remained valid until revoked.
Polfa has a well-developed distribution network focused on profitable medications.
On the other hand, Jelfa’s drug portfolio complements that of Polfa; Jelfa’s production
and lab park is more modern and it has a strong position in the field of exports to the
East. However, Jelfa was only beginning the restructuring process.
The Jelfa takeover would ensure the newly merged company synergy effects,
opportunities for taking over new companies from the pharmaceuticals industry and
more effective exports.
On 19 June the Polish Ministry of State Treasury unexpectedly announced that
1,763,287 shares in Jelfa (25.9% in its share capital) will be used to recapitalise
Stocznia Szczecińska Nowa (SSN) shipyards through the Industry Development
Agency.
Polfa Kutno counted on negotiations with the Agency regarding the purchase of
almost 26% shares in Jelfa. Ultimately it wants to hold 100% shares in Jelfa, merge
with it and with Ivax Pharma Poland owned by Ivax Corporation, Polfa’s shareholder.

Battle for Polfa Kutno between Ivax and Recordati

On the other hand, Polfa Kutno itself became an attractive target for foreign
investors. On the Polish market Polfa is the only restructured company ready for a
takeover, in a good condition and with good prospects. In 2004, a battle for Polfa
started between two pharmaceutical groups: the US IVAX Corporation and Italian
Recordati Industria Chimica a Farmaceutica S.p.A.
IVAX was a global pharmaceuticals company operating in 36 countries, with the
turnover exceeding USD 1.4 billion (2003), listed on the American Stock Exchange in
New York and on the stock exchanges in London, Frankfurt/Main and Munich. IVAX’s
net profit for 2003 was USD 121mn. The company’s total capitalisation as at 8 April,
2003 amounted to ca. USD 4.8 billion Around one half of IVAX’s 2003 revenues was
generated outside the US. IVAX was already involved in operations in Central
Europe.
Recordati was a European pharmaceuticals group listed on the Italian Stock
Exchange in Milan and operating also in France, Ireland, Spain, Switzerland and the
USA.
Recordati employs 2,100 people, of which 150 works in research and
development. The company’s products are sold in around 100 countries around the
world. In 2003, its consolidated revenues amounted to EUR 488mn, of which ca.
57% was generated on the international market. In the same period EBIT amounted
to EUR 81mn.
The competition between those two groups for Polfa Kutno influenced a
significant increase in the latter’s value over a short period of time. As at the end of
2003 the price per 1 Polfa share was PLN 222 and on 30 June 2004 it was already
PLN 325 (cf. Chart 5.13).

Chart 5.13
Index of Polfa Kutno’s share price in the period 1 January 2004-30 June 2004

Source: http://www.polfakutno.pl/notowania_wykresy.php

The following table 5.7 sums up the spring competition between Ivax and Recordati
and its impact on Polfa Kutno’s share price.
Table 5.7
Competition between Ivax and Recordati for Polfa Kutno SA
Date Event influencing change in Polfa Kutno’s share price Share price at
the end of the
day
30.03.2004 Recordati announces a call for shares with the price at PLN 287 PLN 273.0
13.04.2004 Ivax announces a call for shares with the price at PLN 310-325 PLN 278,5
15.04.2004 Recordati declares a call for shares with the price at PLN 287 PLN 303,5
22.04.2004 Recordati increases the price under the call for shares to PLN 310 PLN 304,5
23.04.2004 Ivax announces increasing the price under the call for shares to PLN 340 PLN 310,0
26.04.2004 Polfa Kutno’s Management Board, directors and trade unions decisively support PLN 312,0
the company’s takeover by Ivax
28.04.2004 Through the call for shares Recordati manages to purchase only 16.4% in Polfa PLN 314,0
Kutno, i.e. 307,839 ordinary shares
13.05.2004 Polfa Kutno prolongs until 39 June 2004 its letter of intent signed with IVAX PLN 324,00
regarding the parties’ intention to conclude a cooperation agreement between
Polfa Kutno and IVAX pertaining to research and development growth, access to
product portfolio under exclusive rights and the sales network in Poland and in
other CEE and EU markets specified by the parties.
14.05.2004 Recordati increases its stake in Polfa’s share capital to 24.99% through acquiring PLN 324,00
shares on the secondary market.
21.05.2004 IVAX obtains the consent of the Polish Office for Competition and Consumer PLN 332,00
Protection to the purchase of an over 50% stake in Polfa Kutno S.A.
01.06.2004 Ivax indirectly purchases from Recordati 469,149 shares in Polfa Kutno (at PLN PLN 319,00
340 per 1 share) representing 24.99% of Polfa Kutno’s share capital and 24.99%
of total number of votes at the company’s general shareholders meeting.
IVAX also informed the company that over the following 12 months it intended to
increase its stake in Polfa Kutno’s share capital through acquiring all shares in it
and obtaining the position of Polfa Kutno’s long-term strategic investor. It was
IVAX’s intention to purchase Polfa Kutno’s shares through public subscription for
the exchange of Polfa Kutno’s shares against IVAX Corporation shares.
Source: Stock exchange notifications, www.polfakutno.pl, www.biznes.onet.pl

In the middle of 2004, the Management Board of Polfa Kutno presented its forecast
for the company’s growth in the period of 2004-2006, providing for maintaining the
current dynamics of annual increase in sale revenues by ten-plus per cent and
doubling the net profit by 2006 (cf. Table 5.8).
Table 5.8
Forecasts of sale revenues and net profit for Polfa Kutno S.A.
Specification 2004 2005 2006
Sale revenues in PLN mn 285,0 313,7 350,3
Net profit in PLN mn 37,8 48,0 62,5
Source: Forecasts of the Polfa Kutno Management Board for 2003

Sale revenues growth drivers assumed by the company’s Management Board195

included:
a. launching own new products which were supposed to bring ca. PLN 60
million in sale revenues in 2006;
b. product acquisitions in 2004-2006 which were supposed to generate several
dozen million zlotys in revenues. An alternative for product acquisition was to
take over smaller Polish drug manufacturers and using the synergy effects
between the current product portfolio of Polfa Kutno and the acquired
companies;
c. purchasing new licenses, whose share in the company portfolio would
decrease gradually in time according to the forecast;

195
Cf. Polfa Kutno annual report for 2003.
d. developing the current base product portfolio: prescription meds (Rx) and
OTC drugs.

2.4. STOMIL SANOK S.A. VALUE GROWTH STRATEGY BY EI FUNDS

2.4.1. STOMIL SANOK S.A. profile

Stomil Sanok S.A. is Poland’s largest manufacturer of technical rubber products and
fan belts.
The recipients of Stomil Sanok’s products are:
a. international automotive companies, e.g. Ford, Volvo, Fiat, Volkswagen, General
Motors (body insulation, rubber and metal/rubber mould products for automotive anti-
vibration systems (AVS)
b. construction companies, such as Veka, Brugmann, Roto Frank (insulation systems
for aluminium profiles, PVC profiles and sunroofs;
c. household appliances manufacturers, i.e. Miele, Bosch-Siemens, Amica Wronki,
Zelmer (rubber elements for washing machines, dishwashers and vacuum cleaners);
and
d. agriculture and other industry branches (fan belts for combine harvesters and
industrial machinery).

2.4.2. Key events and EI investment stages

02.01.1991 Transformation of the state-owned Sanockie Zakłady Przemysłu

Gumowego "STOMIL SANOK" into a joint stock company wholly owned by the State
Treasury. On the transformation date, the share capital amounted to PLN 3,100,000
(post denomination) and was divided into 310,000 shares at the value of PLN 10
each (post denomination).

14/10/1993 The State Treasury represented by the Minister of Ownership

° °
Transformation sold 248,000 shares (i.e. 80%) on Stomil Sanok S. A. at 35,4826 zł
per share196 to EI funds (i.e. PLN 8,799,684.8), of which: PAEF took up 77,000
shares, PPEF I took up 87,000 shares and PPEF II took up 84,000 shares.
The remaining stake (62,000) was purchased by the company's employees at a price
decreased by half compared to the price paid by the funds (under the Act on the
privatisation of State-owned enterprises and the company's Articles of Association).
The company's share capital amounted to PLN 3,100,000.

28/07/1995 Stomil share capital increase by 160,000 shares with the nominal value
of PLN 10 each (pre-emptive right), as a result of which the share capital was
increased to PLN 4.7mn.
10/04/1996 Another Stomil share capital increase by 470,000 shares with the
nominal value of PLN 10 each, as a result of which the share capital was increased
to PLN 9,400,000. All of the above shares were covered from the supplementary
capital (transfer of supplementary capital to equity).

196
After the denomination, the nominal value of the shares was PLN 10.
24/05/1996 Another increase of Stomil’s share capital by PLN 1,000,000 i.e. to the
amount of PLN 10,400,000 through the issue of 500,000 ordinary shares (with the
nominal value of PLN 2 each) at the issue price of PLN 25.
The General Shareholders Meeting changed the nominal value of shares from PLN
10 to PLN 2 (share split 1:5), as a result of which the total number of shares
amounted to 4,700,000, of which:
a. PAEF held 1,138,700 shares;
b. PPEF I held 1,281,380 shares;
c. PPEF II held 1,269,660 shares.

In total, the funds held: 3,689,740 shares, i.e. 78.5% in the company’s share capital.

16/01/1997 First listing of Stomil Sanok S.A. shares on the Warsaw Stock
Exchange. The opening price was PLN 55 per share.

05/09/1999 Buyback of 391,384 own shares at the average price of PLN 25.56
per share for redemption purposes

17/04/2000 Buyback of 282,224 own shares by the Company at the average price
of PLN 40.00 per share for redemption purposes

04/10/2000 Dividend payment for the company’s shareholders for 1999 (PLN 2.95
per share). The EI funds acquired the total of PLN 8,551,236.

06/11/2001 Dividend payment for the company’s shareholders for 2000 (PLN 1.7
per share). The EI funds acquired the total of PLN 4,909,605.

20/02/2003 Agreement concluded between the EI funds and the Stomil Sanok S.A.
Management Group.

Basic arrangements contained in the agreement included:

a. if by 30 June 2003 the company announces a buyback of own shares in order to
redeem them at a price not lower than PLN 40, EI funds would respond to such a call
and the members of the management group would not respond to the announced call
for shares.
b. if by 31 March 2005 the company announces another buyback of own shares in
order to redeem them at a price constituting the equivalent in PLN of EUR 15, EI
funds in reply to such a call for shares will place subscriptions for all currently held
shares in the company.
c. introducing a management share option program through the issue of senior
bonds. The bondholders will be entitled to take up shares if:
- The company announces by 31 March 2005 a call for all its shares apart from the
shares held by the management group at EUR 15 per share, or
- Funds managed by Enterprise Investors sell all their shares in the company at the
average price of at least EUR 12 per share by 31 March 2005 and at the same time
the company achieves the following EBITDA levels: PLN 46.5 million in 2003, PLN
55 million in 2004, PLN 65 million in 2005
d. in order to secure the performance of the agreement the parties agreed on the
possibility of establishing a pledge on the shares held by the members of the
management group in favour of EI funds and of granting a power of attorney to vote
under the shares held by the members of the management group.

27/06/2003 Buyback of 1,361,617 own shares from EI funds by way of a call for
shares at the average price of PLN 40 per share, i.e. for PLN 45,256,916 (USD
11,878,166) in order to redeem them. The EI funds’ stake in the company’s share
capital dropped to 43.05%.
It was the first management buy-out (MBO) conducted by a company listed on the
Warsaw Stock Exchange and one of the first LBO transactions at this scale in Central
and Eastern Europe

30/06/2003 Redemption of 1,361,617 shares to the level of 3,394,855 (nominal

value PLN 2 per share), as a result of which the company’s share capital was
decreased by PLN 2,263,234 to PLN 6,789,710. As a result of the redemption, the EI
funds’ stake in Stomil’s share capital increased to 57.40%.

08/08/2003 EI funds sold to Polish financial institutions 647,400 shares at PLN 83

per share by way of off-session transactions. The total sale value amounted to PLN
53,734,200 (USD 13,993,281.24). EI funds’ stake in the company’s share capital
decreased to 38.33%.

02/09/2003 EI funds sold 452,647 shares at PLN 103 per share by way of off-
session transactions. The total transaction value amounted to PLN 46,622,641 (USD
11,583,264.84). EI funds’ stake in the company’s share capital decreased to 25%.

4/11/2003 Enterprise Investors funds sold all their shares in Stomil Sanok SA
(848,713 shares, i.e. 25% in the company’s share capital) in response to the call for
shares announced by the company. An average unit price per 1 share amounted to
PLN 83. The company bought back the shares in order to redeem them. Transaction
value amounted to PLN 70,443,179 (USD 17,716,894).
The above share sale constituted the last stage of performing the agreement
concluded between the EI funds and the company’s management group on 20
February 2003. In accordance with the agreement, the funds sold in several stages
their controlling stake in the company (68% in the share capital) and disinvested in
Stomil Sanok.

19/11/2003 The Polish Securities and Exchange Commission admitted for trading on
the stock exchange 450,000 ordinary bearer shares in STOMIL SANOK S.A. with the
nominal value of PLN 2 offered for acquisition on the holders of senior bonds with the
pre-emptive right to take up new shares.
This right could be exercised not earlier than on 2 January 2004 and not later than on
28 December 2006.
In order to hold an issue of shares offered within the scope of conditional share
capital increase, it was possible for the holders of senior bonds participating in the
Incentive Program to exercise their pre-emptive right with regard to the shares from
the new issue.

20/11/2003 Investment in Stomil Sanok S.A. was considered the European Growth
Capital Deal of the Year. The award was given by a jury composed of
representatives of important European institutional investors supported in factual
matters by analysts from INSEAD, a leading European school of business. Stomil
Sanok was selected from among several dozen transactions reported by the largest
private equity investors based on the following criteria: financial performance, value
added by the investor in the process of company’s growth, innovativeness and
impact on the environment (e.g. natural environment). The competition was
organised by the European Private Equity and Venture Capital Association and the
Real Deals industry magazine.

2.4.3. Strategy for STOMIL SANOK value increase by EI funds

The strategy for company value increase by EI funds consisted in:

a) Assisting in the implementation of the investment program (in the amount of USD
50mn) which contributed to modernising the production plant. The company
obtained funds for the investment from the sale of its plants not connected with
the core operation profile.
b) Assisting in recruiting specialists in the field of sales and technology from EU
countries.
c) Reorienting the company’s product sales to EU markets (exports to EU countries
grew from 1% in 1990 to 30% in 2002).
EI partners helped build:
- Controlling system in Stomil based on the responsibility centres of the company’s
business units. It helped calculate precisely the profitability of respective products;
- Management incentive system (share option program, operating ratios). The
company’s management staff accumulated around 20% shares in Stomil’s share
capital.
The company applies a broad-range development and incentive program. In 2003,
the average number of training hours per 1 employee exceeded 15.
The company reached the “0” level with regard to defects for 97% of its customers.
Stomil Sanok implemented a quality management program and its products meet the
most demanding standards (QS-9000, ISO 9001, VDA-6.1, ISO 14001).
In 2003, Stomil Sanok adopted the code of best practices in public companies
and undertook to observe the principles of corporate governance.

FUNDAMENTAL ANALYSIS OF THE COMPANY

Similarly to Polfa Kutno, Stomil Sanok experienced an improvement in its financial

standing, largely thanks to the actions of the Supervisory Board which comprised
three representatives of the Enterprise Investors funds. Throughout the period of EI
funds’ investment in Stomil Sanok, the function of the Supervisory Board chairman
was held by an EI representative.
Stomil Sanok S.A. generated a high level of operating cash flows (cf. Table 5.9)
thanks to which the company could pursue its large-scale investment program aimed
at modernising its production plants and buy back shares to redeem them which
had a considerable impact on the growth of its market value. On two occasions the
company paid dividend to its shareholders.
Table 5.9
Stomil Sanok cash flow statement in 1998-2003
1996 1997 1998 1999 2000 2001 2002 2003
Cash at the beginning of the year 2,0 19,0 12,4 19,0 15,6 1,0 1,9 24,2
(PLN million)
Operating cash (PLN million) 21,5 18,3 27,3 27,9 12,9 30,4 30,8 42,7
Investment cash (PLN million) - 11,1 - 20,9 -20,7 -21,0 -17,0 - 7, 9 - 6,1 -10,2
Financial cash (PLN million) 6,7 - 6,7 6,6 -10,3 -10,5* - 21,6** - 2,4 -54,8
Cash at the end of the year (PLN 19,0 12,4 19,0 15,6 1,0 1,9 24,2 2,0
million)
Source: www.mojeinwestycje.interia.pl
* redemption of own shares in the amount of PLN 11,289,000 and dividend payment in the amount of
PLN 13,353,000.
* dividend payment in the amount of PLN 7,695,000.

The growth dynamics of net sale revenues in 1993-2003 amounted to the average of
116%. In 1993, the company generated net sale revenues around PLN 62 million and
in 2003 PLN 263 million (cf. Chart 5.14) which constitutes an increase by 322%.

Chart 5.14
Stomil Sanok SA net sale revenues
in 1993-2003

300.0 CAGR = 116% 263

250.0
203
200.0 181 181
161 171 168
PLN million

150.0 139
114
100.0 85
62
50.0
0.0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Year

Source: Own work based on financial statements of Stomil Sanok S.A.

The company’s EBIT CAGR in the period 1993-2003 amounted to 121% and 122%
for net profit. In 1993, the company’s EBIT was PLN 7 million (net profit at PLN
4.7mn) and in 2003 its EBIT was PLN 26.3 million (net profit at PLN 20.3mn), cf.
Chart 5.15.
Chart 5.15
Stomil Sanok SA EBIT and net profit in 1993-2003

30.0
25.0
20.0
15.0
10.0
5.0
0.0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Zysk operacyjny ( mln zł) 7.0 9.0 9.2 13.5 21.3 21.3 16.6 9.8 8.3 15.8 26.3
Zysk netto (mln zł) 4.7 5.6 8.2 15.1 16.1 18.0 13.7 8.0 8.0 12.6 20.3

[zysk operacyjny] EBIT (PLN million)

[zysk netto] Net profit (PLN million)
Source: Own work based on financial statements of Stomil Sanok S.A.

The growth rate of Stomil Sanok’s assets amounted to 112% in the analysed period
while the equity growth rate to 111%. The considerable decrease in equity in 2003
(cf. Chart 5.16) resulted from the redemption of 1,131,617 own shares.

Chart 5.16
Stomil Sanok SA assets and equity in 1993-2003

250

200

150

100

50

0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Kapitał własny (mln zł) 48.7 98.3 116.4 143.7 158.8 176.9 190 155.3 156.3 168.6 72.8
Aktywa (mln zł) 66.9 115.4 135.5 157.2 173.5 191.8 208 192.5 178.5 196.8 177.3
[kapitał] Equity (PLN million)
[aktywa] Assets (PLN million)
Source: Own work based on financial statements of Stomil Sanok S.A.

In 1993, earnings per share amounted to PLN 1.52, compared to PLN 5.98 in 2003
(cf. Chart 5.17).
Chart 5.17
Stomil Sanok S.A. earnings per share (EPS) ratio in 1993-
2003

7.00
5.98
6.00
5.00
4.00 3.46
2.90 3.10
2.63 2.78
3.00
1.52 1.81 1.74 1.77 1.77
2.00
1.00
0.00
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Source: Own work based on financial statements of Stomil Sanok S.A.

Chart 5.18 below presents the market prices of Stomil Sanok shares in the period
1997-2003. Price per 1 share in the company at its debut at the Warsaw Stock
Exchange on 16 January 1997 amounted to PLN 55 and at the end of December of
the same year to PLN 57.5. In the following years (1998-2002) Stomil Sanok shares
were heavily discounted and only 2003 proved to be the best year in the history of
the company’s listing at the WSE. The maximum price per 1 share reached PLN 128
and at the end of 2003 it was PLN 106. In the same year EI funds sold their shares in
the company.

Chart 5.18
Stomil Sanok price per share (minimum, maximum, at year end) in 1997-2003

140.0 zł
120.0 zł
100.0 zł 106.0 zł

80.0 zł
60.0 zł 57.5 zł
40.0 zł 33.5 zł 33.0 zł
25.0 zł 26.5 zł 29.5 zł
20.0 zł
0.0 zł
1997 1998 1999 2000 2001 2002 2003
Cena max 1 akcji 72.0 zł 59.0 zł 33.5 zł 48.0 zł 32.5 zł 29.7 zł 128.0 zł
Cena min 1 akcji 53.0 zł 20.5 zł 23.2 zł 25.5 zł 22.4 zł 24.1 zł 29.4 zł
Cena 1 akcji na zamknięciu 57.5 zł 25.0 zł 33.5 zł 33.0 zł 26.5 zł 29.5 zł 106.0 zł

[max] Maximum price per share

[min] Minimum price per share
[zamknięcie] Closing price per share
Source: Own work based on text files from http://www.parkiet.com/dane/dane.jsp

MC/S ratio was the highest in the first year (1997) of Stomil Sanok’s presence on the
Warsaw Stock Exchange (cf. Chart 5.19). In 1998 and 2000-2002 the company’s
market capitalisation was lower than its sale revenues. The ratio reached the level of
1.37 only in 2003.

Chart 5.19
Stomil Sanok S.A. market capitalisation to sales (MC/S) ratio
in 1997-2003

2.00 1.85
1.80
1.60 1.37
1.40
1.20 1.04
1.00 0.76 0.82
0.80 0.66 0.66
0.60
0.40
0.20
0.00
1997 1998 1999 2000 2001 2002 2003

Source: Own work based on financial statements of Stomil Sanok S.A.

and information on the price of Stomil Sanok shares at www.bossa.pl

In 1997, the company’s market value exceeded its book value by 88%. In 1998-2002
market capitalisation was lower than the company’s book value which may suggest
that Stomil Sanok’s shares were undervalued in that period. Only in 2003 (the year of
the EI funds’ disinvestment) the ratio reached the record-breaking level of 4.94 which
means that the market value exceeded book value by as much as 394% (cf. Chart
5.20).
Chart 5.20
Stomil Sanok S.A. price to book value (P/BV) ratio in 1997-
2003

6.00
4.94
5.00
4.00
3.00
1.88
2.00
0.73 0.92 0.96 0.77 0.79
1.00
0.00
1997 1998 1999 2000 2001 2002 2003

Source: Own work based on financial statements of Stomil Sanok S.A. and information on Stomil
Sanok’s share prices posted on www.bossa.pl

COMPANY ANALYSIS COMPARED TO THE INDUSTRY (NACE = 25.1

MANUFACTURE OF RUBBER PRODUCTS)

Stomil Sanok’s operating profit margin was clearly higher than the industry median (5
decile) throughout the analysed period (cf. Chart 5.21).

Chart 5.21
Stomil Sanok S.A. operating profit margin in 1993-2003

14.0%

12.0%

10.0%

8.0%

6.0%

4.0%

2.0%

0.0%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Sanok OPM 11.2% 10.6% 8.1% 9.7% 13.2% 12.5% 9.9% 5.4% 4.6% 7.8% 10.0%
Decyl 5 OPM 8.0% 7.8% 5.6% 5.2% 6.2% 4.5% 4.3% 3.3% 3.0% 1.0% 0.1%

th
[decyl 5] 5 decile
Source: Own work based on financial statements of Stomil Sanok S.A.
and data from the PONT INFO GOSPODARKA database

Net profit margin value for Stomil Sanok was also higher throughout the period 1993-
2003 than the industry median (cf. Chart 5.22).
Chart 5.22
Sanok S.A. net profit margin in 1993-2003

12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Sanok NPM 7.5% 6.6% 7.2% 10.9% 10.0% 10.5% 8.1% 4.4% 4.4% 6.2% 7.7%
Decyl 5 NPM 2.0% 2.8% 4.0% 2.1% 2.8% 2.0% 1.9% 1.7% 0.6% 0.9% 2.2%

th
[decyl 5] 5 decile

Source: Own work based on financial statements of Stomil Sanok S.A.

and data from the PONT INFO GOSPODARKA database

In 1993-1995, 1997 and 1999 Stomil Sanok’s ROE was slightly lower than the
industry median. On the other hand, in 1996, 1998 and 2000-2003 ROE’s value for
the company visibly exceeded the 5th decile for the industry (cf. Chart 5.23).
Chart 5.23
Stomil Sanok S.A. ROE in 1993-2003

30.0%

25.0%

20.0%

15.0%

10.0%

5.0%

0.0%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Sanok ROE 9.7% 5.7% 7.0% 10.5% 10.1% 10.2% 7.2% 5.2% 5.1% 7.5% 27.9%
Decyl 5 ROE 9.0% 10.0% 7.6% 6.3% 10.9% 8.6% 7.5% 4.8% 3.1% 3.3% 8.7%

th
[decyl 5] 5 decile

Source: Own work based on financial statements of Stomil Sanok S.A.

and data from the PONT INFO GOSPODARKA database
2.4.4. Financial benefits for Enterprise Investors funds

Stomil Sanok’s performance and growth perspectives confirmed the effectiveness of

the strategy pursued by the management group in cooperation with the company’s
leading shareholders–funds managed by Enterprise Investors. Since the company’s
privatisation by the funds in 1993 the Company had invested over USD 50 million in
production modernisation, tripled efficiency per employee, increased the share of
exports in total sales from a couple per cent in early 1990s to 35% in 2002 and won
itself a position on the European Union market.
Its management board proved its ability to help the company grow dynamically
without support from an industry investor. In May 2002 the company announced an
end to the search for such an investor. Due to Stomil Sanok’s dynamic growth and
high capacity for generating significant financial surplus, the management group
directed by President Marek Łęcki presented a new offer of management buy-out.
1st stage of disinvestment:
On 27 June 2003 the company bought back 1,361,617 own shares from EI funds by
way of a call for shares at the average price of PLN 40 per share, i.e. for PLN
45,256,916 (USD 11,878,166) in order to redeem them. EI funds’ stake in the
company’s share capital decreased to 43.05%. It was the first management buy-out
(MBO) conducted by a company listed on the Warsaw Stock Exchange and one of
the first LBO transactions at this scale in Central and Eastern Europe.

2nd stage of disinvestment:

08.08.2003 EI funds sold 647,400 shares at PLN 83 per share to Polish financial
institutions by way of off-session transactions. The total sale value amounted to PLN
53,734,200 (USD 13,993,281.24). EI funds’ stake in the company’s share capital
decreased to 38.33%.
3rd stage of disinvestment:
On 2 September 2003 EI funds sold 452,647 shares at PLN 103 per share by way of
off-session transactions. The total transaction value amounted to PLN 46,622,641
(USD 11,583,264.84). EI funds’ stake in the company’s share capital decreased to
25%.

4th stage of disinvestment:

On 4 November 2003 EI funds sold 848,713 shares in Stomil Sanok S.A. in response
to a call for shares announced by the company. The above share sale constituted the
last stage of performing the agreement concluded between the EI funds and the
company’s management group on 20 February 2003. In accordance with the
agreement, the funds sold in several stages their controlling stake in the company
(68% in the share capital) and disinvested in Stomil Sanok.
Management buy-out transaction at Stomil Sanok SA:
 closed the process started with the company’s privatisation in 1993;
 crowned the activities of Stomil Sanok’s management board aimed at
restructuring and developing the company;
 enabled a Polish management group to take over control in the managed
company;
 constituted an example of good cooperation between the financial investor and
the management group;
 was the first example of a management buy-out transaction on the Warsaw Stock
Exchange;
 created an opportunity for Stomil Sanok’s further expansive development on the
European markets.

Tables 5.10 and 5.11 below present a simplified cash flow statement taking into
consideration cash receipts and expenditures connected with the EI funds’
investment in Stomil Sanok. Table 5.10 shows the calculation in PLN, table 5.11 in
USD.

Table 5.10
Consolidated cash flow statement: EI’s investment in Stomil Sanok (calculation in
PLN)
Specification 1993-2003
I. Receipts (1+2+3+4) PLN 230,417,603.05
1. Share sale in 1997 to several managers of Stomil Sanok PLN 899,826.00
2. Dividend paid to EI for 2000 PLN 8,551,236.15
3. Dividend paid to EI for 2001 PLN 4,909,604.9
4. Sale of 3,080,377 shares in 2003 PLN 216,056,936.00
II. Expenditures (1+2) PLN 19,598,535.00
1. Share sale costs, legal fees PLN 756,696.00
2. Cost of share purchase in respective periods PLN 18,481,839.00
III. Net cash flows (I – II) PLN 211,179,077.00
Source: Enterprise Investors

Total receipts of EI exceeded the amount of Stomil Sanok share purchase 12.4 times
(in PLN).
According to the formula:

(Receipts - share sale costs, legal fees) / Share purchase costs

Table 5.11
Consolidated cash flow statement: EI’s investment in Stomil Sanok (calculation in
USD)
Specification 1993-2003
I. Receipts (1+2+3+4) $59 167 656,46
1. Share sale in 1997 to several managers of Stomil Sanok $198 954,32
2. Dividend paid to EI for 2000 $1 879 599,10
3. Dividend paid to EI for 2001 $1 196 589,05
4. Sale of 3,080,377 shares in 2003 $55 892 513,99
II. Expenditures (1+2) $8 907 588,72
1. Share sale costs, legal fees $196 488,99
2. Cost of share purchase in respective periods $8 711 099,73
III. Net cash flows (I – II) $50 260 067,74
Source: Enterprise Investors

Total receipts of EI exceeded the amount of Stomil Sanok share purchase 6.8 times
(in PLN).
.
Net internal rate of return on the 10-year investment (in USD) amounted to 25%.
EI’s profit on investment in Stomil Sanok amounted to: PLN 211,179,077.00
(USD 50,260,067.74).

Internal net rate of return on the 10-year investment (in USD) amounted to 25%.

2.4.5. Further creation of corporate value after the EI funds disinvestment

Chart 5.24 below presents the systematic increase of Stomil Sanok share price
starting in February 2004 and lasting until today The funds sold their stake in 4
stages in the period between June and November 2003.

Chart 5.24
Stomil Sanok share index in the period 10.07.2002 – 16.07.2004
16.07.2004
PLN 153/share

08.08.2003 04.11.2003
2nd stage of 4th stage of
disinvestment disinvestment

27.06.2003
1st stage of
disinvestment

02.09.2003
3rd stage of
disinvestment

Source: http://gielda.onet.pl

According to Stomil Sanok’s forecasts, in 2004 the company’s revenues would

increase by 12% compared to 2003 and amount to PLN 306.6 million and net profit
would grow by 68% to PLN 37.6mn. Stomil Sanok intended to assign over PLN 33
milion to investments.} The company intended to purchase new production
machinery, undertake modernisation, launch two new production lines and implement
an integrated management system. A part of the investment would be financed with
the use of PLN 4.6 million acquired from the Ministry of Labour for creating 300 jobs.
The main purpose of the investment was to maintain the company’s exports position.
At present, ca. 45% of Stomil’s production is exported, chiefly to EU markets.
Furthermore, the company intended to strengthen its presence on Eastern markets.
Stomil Sanok’s strategy assumed growing sales of components for cars produced in
West European countries, gaining a larger share of the consumer o-ring market,
strengthening its leading position in the field of delivering household appliances
components and maintaining its share of the domestic fan belt market.

2.5. ELDORADO S.A. VALUE GROWTH STRATEGY BY EI FUNDS

2.5.1. ELDORADO S.A. profile

Eldorado did very well on the competitive food distribution and retail market. Thanks
to the financing acquired from EI funds in 1999, Eldorado transformed from a local
foodstuffs wholesaler into one of the largest companies in the trading sector in south-
eastern Poland. The company expanded its territorial reach through developing its
network and launched an IT platform for communicating with the wholesaler’s
customers. Today, Eldorado’s retail sale is conducted through its own “Stokrotka”
supermarket chain located all over Poland as well as the franchise “Groszek” chain,
encompassing over 200 shops.} The company has the leading position in the
application of electronic communication channels in food trading. Eldorado’s
operation is organised in the form of a capital group within which each entity is
responsible for a strictly determined segment. The group encompasses the following
entities:
- Eldorado S.A. (controlling entity). Its core operation is the wholesale distribution of
foodstuffs;
- Stokrotka Sp z o.o. (subsidiary, wholly-owned): Retail operation;
- Groszek Sp. z o.o. (subsidiary, wholly-owned): Retail operation;
- Elpro Sp. z o.o. (subsidiary, wholly-owned): Company in charge of purchasing and
managing the group’s real estate;
- Infinite Sp. z o.o. (subsidiary, wholly-owned): Company delivering modern
communication and IT solutions for the group and its customers.

2.5.2. Key events and EI investment stages

1990 The predecessor of Eldorado S.A. in economic sense was the sole
proprietorship established on 15 June 1990 by Artur Kawa and transformed in
December into Eldorado s.c. (civil law partnership) with Artur Kawa and Jarosław
Wawerski as partners. From the beginning of its existence it operated in the field of
foodstuffs distribution.

1991 A dynamic territorial expansion began with the first Eldorado branch
opened in Ryki.

1994 Eldorado S.A. was registered on 30 November 1994 and pursued

business activity in the same area as the Eldoraro s.c. Additionally, in November
1994 Eden Sp. z o.o. was founded for the purpose of developing retail sales.

1995 In 1994 Eldorado s.c. was dissolved and the funds obtained by its
partners were used by them for taking up a part of B-Series Shares in Eldorado S.A.
The remaining part of the B-series Shares was purchased by the company’s new
shareholders Edward and Grzegorz Wawerski.

02. 1996 Launching the first Stokrotka supermarket in Łęczna.

1997 In November, a merger took place with Mad-Max Sp. z o.o., the second
largest foodstuffs distributor in terms of size in south-eastern Poland.

1998 In March, telephone modem was installed at the first Eldorado S.A.
customer, rendering electronic communication possible.
In December, the second Stokrotka supermarket was launched in Puławy.

1999 In January, an investment agreement was concluded between Eldorado

S.A., its current shareholders and Polish Enterprise Fund L.P. under which the issue
of C-series Shares would be taken up by Polish Enterprise Fund L.P. and the issue
of D-series Shares by the current shareholders. Furthermore, the Eldorado S.A.
capital group structure was reorganised. Polish Enterprise Fund (PEF) managed
by Enterprise Investors invested PLN 14.8 million in Eldoraro, taking up the
new share issue in 1999 at PLN 7.09 per share. PEF’s stake in the company’s
share capital amounted to 43.6%.

2000 In June, eleventh cash&carry type branch of Eldorado S.A. was opened in
Rzeszów.
In September, Groszek Sp. z o.o. was founded, organising a chain of franchise-
based grocery stores.
In December, the B2B eHurtownia Internet platform was launched.
In December, the tenth Stokrotka supermarket was opened in Radom.
In December, the 50th Groszek store was opened.
2001 In January, Elpro Sp. z o.o. was founded, operating in the development
and real estate administration segment.
In April, Eden Sp. z o.o. was finally rebranded to Stokrotka Sp. z o.o.
In May, the 100th Groszek store was opened.
In August, Elpro Sp. z o.o. launched the first mini-mall in Lublin and the seventeenth
Stokrotka supermarket.
In October, the 600th store was connected to the B2B eHurtownia platform.
In October, the Polish Securities and Exchange Commission admitted the shares of
Eldorado S.A. to public trading.
In December, the public offering of E-series, F-series and G-series shares proved to
be a success.
Eldorado obtained PLN 20 million for financing the expansion of its supermarket
chain, creating a logistics centre and further development of its IT system.

2002 In January, Eldorado S.A. moved its headquarters to the newly opened
Logistics Centre in Lublin.
In January, Eldorado S.A. floated on the Warsaw Stock Exchange. The price per 1
share was PLN 15.45.
PEF sold 491,989 shares in the company, decreasing its stake in the share
capital to 24.14%.

2003 In January, the 22nd Stokrotka supermarket was launched.

In February, a cash&carry branch of Eldorado S.A. was opened in Kielce.
In June, a cash&carry branch of Eldorado S.A. was opened in Kraków.
In June, a cash&carry branch of Eldorado S.A. was opened in Łódź.
On 26 June, Polish Enterprise Fund L.P. disinvested in Eldorado S.A.
In June, Credit Suisse Life&Pensions PTE became a large shareholder in Eldorado
S.A.

2.5.3. Strategy for increasing the value of ELDORADO S.A. by EI funds

Thanks to the growth capital and know-how invested by EI, Eldorado changed from a
foodstuffs wholesaler into an important regional retailer.
EI representatives encouraged Eldorado Management Board to invest in means of
swift growth in retail foodstuffs trading. EI obtained an industry consultant from Great
Britain for the company which helped develop the retail strategy. Additionally, EI
encouraged Eldorado Management Board to implement and observe corporate
governance and investor relations principles.197
Ultimately, in 2002 the management board of Eldorado undertook actions regarding
observing the principles of corporate governance in the company and on 30 June
2003 it was announced that the company undertook to observe the Code of Best
Practice for WSE Listed Companies.
The chairman of Eldorado’s Supervisory Board was an investment partner delegated
by the Polish Enterprise Fund LP. EI helped float the company’s shares on the
Warsaw Stock Exchange.

FUNDAMENTAL ANALYSIS OF THE COMPANY

The growth dynamics of net sale revenues in 1999-2003 amounted to the average of
120%. In 1999 the company generated revenues around PLN 377,577,000 and in
2003 PLN 767,618,000 (cf. Chart 5.25) which constitutes an increase by 103%.

Chart 5.25
Eldorado S.A. net sale revenues in 1999-2003

900,000
800,000 CAGR = 120%
700,000
600,000
500,000
400,000
300,000
200,000
100,000
0
1999 2000 2001 2002 2003
Przychody netto w tys zł 377,577 433,916 481,199 576,078 767,618

[przychody] Net sale revenues in PLN thousand

Source: Own work based on financial statements of Eldorado S.A.

The company’s EBIT CAGR in the period 1993-2003 amounted to 126% and 125%
for net profit. In 1999, the company’s EBIT was PLN 6,144,000 (net profit at PLN
4,157,000) and in 2003 its EBIT was PLN 13,254,000 (net profit at PLN 8,695,000),
cf. Chart 5.26.

197
Cf. EVCA report entitled Central and Eastern Europe Success Stories, October 2004, p. 33
Chart 5.26
Eldorado S.A. EBIT and net profit in 1999-2003

16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
1999 2000 2001 2002 2003
Zysk operacyjny w tys. zł 6,144 10,307 9,372 13,903 13,254
Zysk netto w tys. zł 4,157 7,001 5,941 9,002 8,695

[operacyjny] EBIT in PLN thousand

[netto] Net profit in PLN thousand
Source: Own work based on financial statements of Eldorado S.A.

The growth rate of Eldorado S.A.’s assets amounted to 132% in the analysed period
while the equity growth rate to 137% (cf. Chart 5.27).

Chart 5.27
Eldorado S.A. assets and equity in 1999-2003

250,000

200,000

150,000

100,000

50,000

0
1999 2000 2001 2002 2003
Aktywa w tys. zł 65,687 85,483 123,893 150,536 196,160
Kapitał własny w tys. zł 23,657 30,658 57,994 67,044 75,206

[aktywa] Assets in PLN thousand

[kapitał] Equity in PLN thousand
Source: Own work based on financial statements of Eldorado S.A.

In 1999, earnings per share amounted to PLN 0.86, compared to PLN 1,31 in 2003
(cf. Chart 5.28).
Chart 5.28
Eldorado S.A. earnings per share (EPS) ratio in 1999-2003

1.6000
1.3567 1.3105
1.4000
1.2000 1.0551
1.0000 0.8657 0.8954
0.8000
0.6000
0.4000
0.2000
0.0000
1999 2000 2001 2002 2003

Source: Own work based on financial statements of Eldorado S.A.

Chart 5.29 below presents the market prices of Stomil Sanok shares in the period
2002-2003 Price per 1 share in the company at its debut at the Warsaw Stock
Exchange on 3 January 2002 amounted to PLN 15,45 and at the end of December of
the same year to PLN 14.5. In the period between December 2003 and December
2002 the closing share price of Eldorado S.A. increased by 100%, i.e. up to PLN
30.10
Chart 5.29
Price per share (minimum, maximum, at year end) for Eldorado SA in 2002-2003

35.00 zł
30.00 zł 30.10 zł
25.00 zł
20.00 zł
15.00 zł 14.50 zł
10.00 zł
5.00 zł
0.00 zł
2002 2003
Cena max 1 akcji 15.95 zł 33.00 zł
Cena min 1 akcji 12.40 zł 13.55 zł
Cena 1 akcji na zamknięciu 14.50 zł 30.10 zł

[max] Maximum price per share

[min] Minimum price per share
[zamknięcie] Closing price per share
Source: Own work based on text files from http://www.parkiet.com/dane/dane.jsp

As at the end of 2002 MC/S amounted to 0.167 and increased to 0.26 at the end of
2003 (cf. Chart 5.30).
Chart 5.30
Eldorado S.A. market capitalisation to sales (MC/S)
ratio in 2002-2003

0.30
0.260
0.25
0.20 0.167
0.15
0.10
0.05
0.00
2002 2003

Source: Own work based on financial statements of Eldorado S.A.

The market value of the company visibly exceeds its book value (by 44% in 2002 and
by 166% in 2003), cf. Chart 5.31.
Chart 5.31
Eldorado S.A. price to book value (P/BV) ratio in 2002-2003

3.0 2.66
2.5
2.0
1.44
1.5
1.0
0.5
0.0
2002 2003

Source: Own work based on the financial statements of Eldorado S.A. and information on Eldorado
share prices from text files at www.parkiet.com.pl

COMPANY ANALYSIS COMPARED TO THE INDUSTRY (NACE=51.39 NON-

SPECIALIZED WHOLESALE OF FOOD, BEVERAGES AND TOBACCO)

In the analysed period between 1999 and 2003, the operating profit margin for
Eldorado S.A. exceeded the industry median (5th decile) (cf. Chart 5.32).
Chart 5.32
Eldorado S.A. operating profit margin in 1999-2003

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%
1999 2000 2001 2002 2003
Eldorado OPM 1.6% 2.4% 1.9% 2.4% 1.7%
Decyl 5 OPM 1.38% 1.26% 1.50% 0.69% 0.60%

th
[decyl 5] 5 decile
Source: Own work based on financial statements of Eldorado S.A. and data from the PONT INFO
GOSPODARKA database

Similarly, in case of the net profit margin its value was higher for Eldorado than the
industry mean (cf. Chart 5.33).

Chart 5.33
Eldorado S.A. net profit margin in 1999-2003

1.8%
1.6%
1.4%
1.2%
1.0%
0.8%
0.6%
0.4%
0.2%
0.0%
1999 2000 2001 2002 2003
Eldorado NPM 1.1% 1.6% 1.2% 1.6% 1.1%
Decyl 5 NPM 0.56% 0.43% 0.42% 0.76% 0.81%

th
[decyl 5] 5 decile
Source: Own work based on financial statements of Eldorado S.A.
and data from the PONT INFO GOSPODARKA database

With the exception of 2002, ROE for Eldorado S.A. was lower than the industry
median (cf. Chart 5.34). However, equity CAGR exceeded net profit CAGR and
amounted to 137% and 125%, respectively.
Chart 5.34
Eldorado S.A. ROE in 1999-2003

25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
1999 2000 2001 2002 2003
Eldorado ROE 17.6% 22.8% 10.2% 13.4% 11.6%
Decyl 5 ROE 19.58% 12.25% 17.16% 20.30% 13.95%

th
[decyl 5] 5 decile
Source: Own work based on financial statements of Eldorado S.A.
and data from the PONT INFO GOSPODARKA database

2.5.4. Financial benefits for Enterprise Investors funds

In February 1999, Polish Enterprise Fund LP managed by Enterprise Investors

invested ca. USD 4 million (PLN 14.8mn) in Eldorado S.A., becoming the company’s
largest shareholder with a 43.6% stake in its share capital.
In January 2003 PEF sold 491,989 shares in the company on the secondary market,
decreasing its stake in the share capital to 24.14%.
In June 2003 PEF sold its stake of 24.14% shares on the secondary market (Warsaw
Stock Exchange) for USD 11mn.
Total receipts of EI exceeded the amount of Eldorado share purchase 2.7 times. The
internal rate of return (IRR) for receipts and expenditures calculated in USD during
the investment period (02.1999 – 06.2003) amounted to 28% annualised.

2.5.5. Further creation of corporate value after the EI funds disinvestment

Eldorado has a clearly determined and consistently pursued growth strategy which is
a guarantee of the further company value growth. Its aim is to evolve from a regional
to a nationwide company both in terms of distribution and retail trade. Expansion
requires considerable investment outlays but each investment is subject to a detailed
assessment in terms of the period of return on investment and the rate of return on
the capital involved. The company pays a lot of attention to developing modern
distribution methods ensuring it lasting competitive advantage.
Chart 5.35
Price index of Eldorado S.A. in the period 18.07.2002 – 16.07.2004
16.07.2004
PLN 41.50 per
share

Source: www.onet.pl

The Management Board plans to continue the company’s growth through:

 Creating mechanisms of influencing customers and binding them to the
supplier,
 Further investments in fixed assets and software as well as timely execution of
investments planned by the company without exceeding the budget provided,

 Decreasing operating costs through: implementing organisational and IT

solutions and expanding operating scale,
 Introducing structural and organisational changes aimed at creating a holding
organisation with a large market share,
 Purchasing attractive locations for the purpose of pursuing trading activity,
 Expanding and supplementing the trading offer,
 Actions aimed at improving cash flow,
 Perfecting methods of communicating with customers through modem and
Internet,
 Professional trainings for employees, creating work assessment incentive
programs, building creative teams.

2.6. GRUPA KĘTY S.A. VALUE GROWTH STRATEGY BY EI FUNDS

2.6.1. GRUPA KĘTY S.A. profile

The company’s origins date back to post-war years. In autumn 1950 it was decided
to create a modern aluminum processing plant. In 1953, the foundry hall was erected
in which the production of casting alloys was launched. In 1956, Foil Rolling Mill
Department was created, followed by the Pressing and Drawing Mill two years later.
These functions operate until this day within the company’s structure under the
Flexible Packaging Segment and Extruded Product Segment. Grupa Kęty has been a
listed company since early 1996. The company’s shares are listed on the primary
market of the Warsaw Stock Exchange and are counted among blue chips.

As a listed company, Kęty executed a number of investments with the total value
exceeding PLN 600mn. The largest among them include launching a modern flexible
packaging plant and aluminum profile stamping plant in Tychy, one of the most
modern in Europe.
Kęty’s path to growth from the moment of its takeover by the group of private equity
investors in 1995 through the process of its restructuring to its sale to portfolio
investors in 2002 was the first case in Polish history of a model mature private equity
transaction: a private equity investor invests in a company, helps develop it, launches
it on the stock exchange and sells shares in it to other financial investors.

2.6.2. Key events and EI investment stages

1992 Transformation of Zakłady Metali Lekkich „Kęty” [Kęty Light Metals

Plant] into a joint stock company.

11/1995 A consortium of financial investors together with three funds managed

by Enterprise Investors (Polish Private Equity Fund I, Polish Private Equity Fund II,
Polish-American Enterprise Fund) purchased a 40.8% stake in the company’s share
capital from the Polish State Treasury. EI funds acquired the total of 18,6% shares in
Grupa Kęty.

1996 The company floated on the Warsaw Stock Exchange.

The company purchased 47% stake in Metalplast-Bielsko SA, Poland’s largest
producer of aluminum window and door systems, starting the formation of the capital
group.

1999 The modern Alupol flexible packaging production plant is launched in

the Tychy economic zone.

2000 A modern aluminum profile pressing mill is launched in the Tychy

economic zone at Alupol premises. The company changes its name to Grupa KĘTY
SA

2001 Modernisation of the foil rolling plant in Kęty.

13/08/2002 As a result of a call for shares the Company bought back 1,575,117
own shares to redeem them. The buyback price per 1 share was PLN 45.

30/05/2003 The General Shareholders Meeting of Grupa Kęty allocated PLN

17,851,326.00 to the dividend for shareholders for the year 2002 in the amount of
PLN 2 per share.

30/06/2002 Company issues a representation on observing the principles of

corporate governance.
07/11/2002 Enterprise Investors sells through the Warsaw Stock Exchange shares
in Grupa Kęty SA held by the Polish-American Enterprise Fund and Polish Private
Equity Fund I and II managed by Enterprise Investors (in total 14.87% of the share
capital) and the stake held by the Credit Suisse First Boston Central European
Merchant Partners LP (Enterprise Investors was CSFB’s proxy in share sale). As a
result of the transaction, all shares held by PAEF, PPEF I and II and CSFB were sold
(i.e. 2,550,246 shares constituting 24.29% of the company’s share capital).

2.6.3. Strategy for increasing the value of GRUPA KĘTY S.A. by EI funds

The funds managed by Enterprise Investors were the largest investor in Grupa Kęty
S.A. The transaction of share sale to portfolio investors ended the 7-year period over
which the consortium of financial investors organised by Enterprise Investors
encompassing three funds managed by EI, i.e. Polish Private Equity Fund I, Polish
Private Equity Fund II, Polish-American Enterprise Fund, as well as Bank Austria AG,
Bank Handlowy S.A., and Credit Suisse First Boston were involved in the Kęty
investment.
Their exposure started with the company’s privatisation in which the consortium
purchased the stake of 40.8% shares and ensured that the privatisation took place
despite the lack of success of the public share offering conducted by the Polish State
Treasury.
The company devoted the following years to in-depth restructuring (first 4-5 years
from the investment) and implementing the growth program. That process
encompassed:
a. company reorganisation consisting in simplifying its structure and clear
allocation of responsibility for respective tasks to employees and management
combined with the limitation of overall costs;

b. implementing staff recruitment and training program, in particular for middle

management staff which was considered to be of key importance for the success of
any large organisation;

c. implementing the program of continuous improvement of production

processes efficiency combined with ongoing benchmarking against the
performance of Grupa Kęty’s competitors;

d. selecting strategic operating directions and deciding on selling all segments

not fitting them; at the same time, controlling stakes were purchased in Metalplast
Bielsko-Biała and Interbel Lublin as a strategic integration further down in the added
value chain which helped Grupa Kęty get closer to the final customer and closed the
most attractive path for expansion into the Polish market for large international
competitors;

e. initiating a program of investing in production capacity with the total value

exceeding EUR 100 million in 1995-2002. Investment outlays resulted in the
company becoming an unquestioned leader in Poland and gaining an important
position in Central and Eastern Europe. At present, Grupa Kęty is one of the most
modern enterprises in the aluminum processing industry in Europe. The company
possesses advanced technologies in the field of producing aluminum profiles and
flexible packaging;

f. investing in the creation of strong sales and marketing divisions, initially

(1995-1999) for the Polish market, later on also for Eastern markets and the EU.

“Implementing the restructuring and growth program is a great success of Jan Kryjak,
President of Grupa Kęty, and his collaborators. At the same time this process shows
the advantages of introducing far-reaching changes when a company has a strong
owner ensuring its management board a stable support,” said Michał Rusiecki, EI
representative on the Grupa Kęty S.A. Supervisory Board. “I think that the great
contribution of Enterprise Investors in the success achieved by Grupa Kęty was that
the Management Board could always count on a matter-of-fact discussion on the
Company’s standing and its plans and on a consistent support for the execution of
those plans once they were adopted,” he added.

Introducing corporate governance as an element supporting value creation for

shareholders was another success of the cooperation of the Grupa Kęty
Management Board with Enterprise Investors.

FUNDAMENTAL ANALYSIS OF THE COMPANY

Upon analysing chart 5.36 which shows net sale revenues generated by Grupa Kęty
S.A. it is possible to differentiate between three distinctive periods:
a. 1996-1999: Systematic growth in revenues with the average growth dynamics at
11.7%;
b. 2000-2001: Drop in the company’s sale revenues.
The 11% drop in sale revenues in 2000 (compared to 1999) was blamed by the
Management Board on the transformation of the foundry into Alumetal Sp. z o.o.
Additionally, among other reasons for further decline in revenues in 2001 the
Management Board of the company enumerated:
- Lack of sale of goods and services worth PLN 19 million in 2000 during the
transformation of the foundry into Alumetal Sp. z o.o.,
- Annualised drop in USD and EUR prices determining sales prices (in 2000
PLN/EUR was 4.01, in 2001 PLN/EUR was 3.65; y/y drop of 9.0%).
- Annualised drop in aluminum prices determining sales prices (in 2000 USD
1,550/t, in 2001 USD 1,457/t; y/y drop of 6.0%).
c. 2002-2003: Growth period
In 2002 sale revenues increased by 7% compared to the previous year which
according to the company’s Management Board was due chiefly to exports
intensification aimed at compensating continued unfavourable phenomena on the
domestic market.
In 2003, sale revenues grew by 19% compared to the previous year also due to
exports increase and a growth of domestic sales by over 10%.
Chart 5.36
Grupa Kęty SA net sale revenues in 1996-2003

600,000
500,000
400,000
300,000
200,000
100,000
0
1996 1997 1998 1999 2000 2001 2002 2003
Przychody netto w tys zł 393,088 487,913 528,606 543,601 483,642 404,025 432,919 513,668

[przychody] Net sale revenues in PLN thousand

Source: Own work based on financial statements of Grupa Kęty S.A.

In 1999, Grupa Kęty’s EBIT and net profit reached record-breaking levels (EBIT
54.3mn, net profit PLN 46.7mn), followed by their decline in 2000-2001 and further
improvement in 2002-2003 (cf. Chart 5.37).
Chart 5.37
Grupa Kęty SA EBIT and net profit in 1996-2003

60,000

50,000

40,000

30,000

20,000

10,000

0 1996 1997 1998 1999 2000 2001 2002 2003

Zysk operacyjny w tys. zł 40,326 45,626 43,459 54,268 26,897 20,673 35,240 34,278
Zysk netto w tys. zł 29,188 31,382 38,210 46,702 11,460 12,526 19,727 37,665

[operacyjny] EBIT in PLN thousand

[netto] Net profit in PLN thousand
Source: Own work based on financial statements of Grupa Kęty S.A.

The value of the company’s assets was on the rise until 2000 up to PLN 550.3mn,
similarly to equity (PLN 326.6 million in 2000). As at the end of 2003, the company’s
assets amounted to PLN 479 million and its equity to PLN 296.9 million (cf. Chart
5.38).
Chart 5.38
Grupa Kęty SA assets and equity in 1996-2003

600,000

500,000

400,000

300,000

200,000

100,000

0
1996 1997 1998 1999 2000 2001 2002 2003
Aktywa w tys. zł 276,823 291,637 329,039 481,947 550,291 530,586 486,867 479,096
Kapitał własny w tys. zł 188,437 219,819 258,029 319,591 326,606 324,273 264,382 296,955

[aktywa] Assets in PLN thousand

[kapitał] Equity in PLN thousand
Source: Own work based on financial statements of Grupa Kęty S.A.

EPS ratio grew systematically in 1996-1999, after which it crashed to 1.09 in 2000
due to a strong drop in the company’s net profit. As of 2001, it has been growing
gradually every year. In 2003 it already amounted to 3.59 (cf. Chart 5.39).
Chart 5.39
Grupa Kęty SA earnings per share (EPS) ratio in 1996-2003

5.00 4.45
4.50 3.82
4.00 3.59
3.50 2.92 3.14
3.00
2.50 1.88
2.00
1.50 1.09 1.19
1.00
0.50
0.00
1996 1997 1998 1999 2000 2001 2002 2003

Source: Own work based on financial statements of Grupa Kęty S.A.

The price per share on 30 October 1996 when Grupa Kęty floated on the Warsaw
Stock Exchange was PLN 27.75. As at the end of 1996, price per share was PLN
52.5. In 1998 the company reached the historical low at PLN 18 per share but in
2003 it rebounded to a historical peak of PLN 142 per share (cf. Chart 5.40). After the
EI funds’ disinvestment, the company’s shares started to rally.
Chart 5.40
Price per share (minimum, maximum, at year end) for Grupa
Kęty SA in 1996-2003
160.0
140.0 135.0
120.0
100.0
80.0
60.0 52.5 54.0 56.0 50.8
40.0 44.0 46.2
34.8
20.0
0.0
1996 1997 1998 1999 2000 2001 2002 2003
Cena max 1 akcji 55.0 76.8 67.5 56.0 75.0 48.6 53.0 142.0
Cena min 1 akcji 28.75 40.00 18.00 29.80 33.30 35.50 39.20 50.30
Cena 1 akcji na zamknięciu 52.5 54.0 34.8 56.0 44.0 46.2 50.8 135.0

[max] Maximum price per share

[min] Minimum price per share
[zamknięcie] Closing price per share
Source: Own work based on text files from http://www.parkiet.com/dane/dane.jsp

The market capitalisation of Grupa Kęty S.A. was lower than its net sale revenues
only in 1998 and 2000. Between 2000 and 2003 MC/S was growing systematically
and in 2003 it reached the record-breaking level of 2.76 which means that the
company’s market value was higher by 176% than its net sales (cf. Chart 5.41).

Chart 5.41
Grupa Kęty S.A. market capitalisation to sales (MC/S) ratio in 1996-2003

3.00 2.76

2.50
2.00
1.50 1.34 1.20 1.23
1.11 1.08 0.96
1.00 0.66
0.50
0.00
1996 1997 1998 1999 2000 2001 2002 2003

Source: Own work based on financial statements of Grupa Kęty S.A.

and information on the price of Grupa Kęty S.A. shares at www.bossa.pl

During the analysed period between 1996 and 2003 the company’s market value was
higher than its book value. P/BV was the lowest in late 1998 and the highest in late
2003 (cf. Chart 5.42).
Chart 5.42
Grupa Kęty S.A. price to book value (P/BV) ratio in 1996-2003

6.00

5.00 4.77

4.00
2.79
3.00 2.46
1.84 2.02
2.00 1.41 1.50
1.35
1.00

0.00
1996 1997 1998 1999 2000 2001 2002 2003

Source: Own work based on financial statements of Grupa Kęty S.A.

and information on the price of Grupa Kęty S.A. shares at www.bossa.pl

COMPANY ANALYSIS COMPARED TO THE INDUSTRY

Throughout the analysed period, the operating profit margin for Grupa Kęty S.A.
exceeded the industry median, even in the difficult 2000-2001 period. In 2000 and
2001 the company had to make do with lower sales margins but nevertheless their
level was still advantageous compared to the 5th decile in the industry (cf. Chart
5.43).

Chart 5.43
Grupa Kęty S.A. operating profit margin in 1996-2003

12.0%

10.0%

8.0%

6.0%

4.0%

2.0%

0.0%
1996 1997 1998 1999 2000 2001 2002 2003
Kęty OPM 10.3% 9.4% 8.2% 10.0% 5.6% 5.1% 8.1% 6.7%
Decyl 5 OPM 10.2% 5.9% 7.9% 7.6% 4.1% 2.4% 6.2% 2.9%

th
[decyl 5] 5 decile
Source: Own work based on financial statements of Grupa Kęty S.A. and data from the PONT INFO
GOSPODARKA database
The value of net profit margin exceeded the industry median in 1996-2003 (cf. Chart
5.44).

Chart 5.44
Grupa Kęty S.A. net profit margin in 1996-2003

10.0%
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
1996 1997 1998 1999 2000 2001 2002 2003
Kęty NPM 7.4% 6.4% 7.2% 8.6% 2.4% 3.1% 4.6% 7.3%
Decyl 5 NPM 3.4% 2.0% 3.9% 4.8% 0.9% 0.6% 4.2% 4.7%

th
[decyl 5] 5 decile
Source: Own work based on financial statements of Grupa Kęty S.A. and data from the PONT INFO
GOSPODARKA database

With the exception of 1996-1997, return on equity in Grupa Kęty S.A. was lower than
the industry median (cf. Chart 5.45). In 1996-1999 the company’s ROE remained on
a relatively high level of ca. 15%, after which as a result of the drop in net profit
Grupa Kęty experienced a decline in ROE to 3.5% in 2000; it has been on the rise
since 2001. In 2003, ROE was already 12.7% (14.4% being 5th decile for the
industry).

Chart 5.45
Grupa Kęty S.A. ROE in 1996-2003

30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
1996 1997 1998 1999 2000 2001 2002 2003
Kęty ROE 15.5% 14.3% 14.8% 14.6% 3.5% 3.9% 7.5% 12.7%
Decyl 5 ROE 6.6% 5.8% 19.0% 25.0% 5.2% 5.2% 14.0% 14.4%

[decyl 5] 5th decile

Source: Own work based on financial statements of Grupa Kęty S.A. and data from the PONT INFO
GOSPODARKA database

2.6.4. Financial benefits for Enterprise Investors funds

On 7 November 2002, Enterprise Investors sold through the Warsaw Stock

Exchange shares in Grupa Kęty SA held by the Polish-American Enterprise Fund
and Polish Private Equity Fund I and II managed by Enterprise Investors (in total
14.87% of the share capital) and the stake held by the Credit Suisse First Boston
Central European Merchant Partners LP (Enterprise Investors was CSFB’s proxy in
share sale). As a result of the transaction, all shares held by PAEF, PPEF I and II
and CSFB were sold (i.e. 2,550,246 shares constituting 24.29% of the company’s
share capital).

The sale price amounted to PLN 44 per share. The value of the transaction exceeded
PLN 112.2 million (USD 28mn). Buyers included Polish and foreign institutional
investors. The transaction contributed to fragmentation in the Group’s ownership
structure; no entity or group of affiliated entities acquired more than 3% shares in the
company. “According to the estimates of the Management Board, around 50%
shares were purchased by foreign investors and the remaining 50% share are in the
hands of Polish investors, chiefly open-end pension funds and insurance
companies,” said Jan Kryjak, President of the Grupa Kęty S.A. Management Board.
As a result of the transaction, Grupa Kęty became a company with total free float,
one of the few at the Warsaw Stock Exchange and the only one among companies
included in the WIG20 index.
The sale transaction of Grupa Kęty shares was the largest secondary offer
conducted so far at the Warsaw Stock Exchange. “It turned out that a good company
may count on finding buyers for its shares even in a difficult period for the equity
market. The fact that 25% shares changed hands in one day when the group of
buyers included a large number of financial investors is a proof of good liquidity
potential of our stock exchange,” said Michał Rusiecki, partner in Enterprise Investors
in charge of the Grupa Kęty investment.
Total receipts of EI exceeded the amount of Grupa Kęty S.A. share purchase 1.6
times. The internal rate of return (IRR) for receipts and expenditures calculated in
USD during the investment period (11.1995 – 11.2002) amounted to 8% annualised.

2.6.5. Further creation of corporate value after the EI funds disinvestment

“Grupa Kęty Management Board intends to continue creating corporate value and
counts on cooperation with its new shareholders who believe in our potential and
ability to generate profits in the future,” said Jan Kryjak.
Today, Kęty is a type of company common on global stock exchanges but scarce in
Poland: a well-organised, transparent industrial corporation without a dominating
shareholder but with a Management Board which has the trust of the investors. In
other words, Grupa Kęty has become a blue chip in the full meaning of the term.
Chart 5.46
Grupa Kęty SA share price index
16.07.2004
PLN 146.5 per
share

7.11.2002
EI funds sell 14.8% in Grupa
Kęty S.A. share capital

Source: www.onet.pl

2.7. COLLECTIVE SPECIFICATION OF CASE STUDIES

EI funds multiplied invested capital and achieved a positive net rate of return for their
investors (cf. Table 5.12).

Table 5.12
Financial benefits for funds managed by Enterprise Investors
NACE Investor Investment Number of times IRR in
period capital was USD
multiplied in USD
Polfa Kutno S.A. 24.42, manufacture of EI 01.1995 – 09.2003 5,4 23 %
pharmaceutical
preparations
Stomil Sanok S.A. 25.10, manufacture of EI 10.1993 – 11.2003 6,9 25 %
rubber products
Eldorado S.A. 51.39, wholesale of EI 02.1999 – 06.2003 2,7 28 %
foodstuffs, beverages
and tobacco products
Grupa Kęty S.A. 27.42 processing EI 09.1995 - 11.2002 1,6 8%
aluminum and its
alloys
Source: own work based on EI information

Table 5.13 below presents a comparison of share market prices for the four analysed
companies in various periods, i.e. at floating date, at the date on which the private
equity investor sold the last share stake and as at 16 July 2004.
Table 5.13
Comparison of price per 1 share on the date of companies’ floating on the WSE, on the
date of EI funds selling the last share stake in the companies and on 16 July 2004
Floating Price per share Closing price per 1 share on the Closing price
date on floating date date of EI funds selling their last per 1 share on
share stake on secondary 16.07.2004
market
Polfa Kutno S.A. 03.04.1995 PLN 23.80 PLN 243.0 on 24.09.2003 PLN 330.00
Stomil Sanok S.A. 16.01.1997 PLN 55.00 PLN 105.0 on 4.11.2003 PLN 153.00
Eldorado S.A. 03.01.2002 PLN 15.45 PLN 22.90 on 26.06.2003 PLN 41.50
Grupa Kęty S.A. 30.01.1996 PLN 27.75 PLN 45.0 on 7.11.2002 PLN 146.50
Source: Own work based on EI information and data on share prices from text files on
www.parkiet.com.pl

The market prices per share for the four companies have rallied considerably from
the date of their floating on the WSE and particularly after the EI funds disinvestment
in them (i.e. after the sale of their shares in respective companies) (cf. prices of 16
July 2004).

Table 5.14 below presents a specification of selected profitability ratios for the four
analysed companies compared to the industry median.

Table 5.14
Comparison of OPM, NPM and ROE198 for the selected companies against the industry
median (+ means higher than industry median, - means lower than industry median,
n/a means not applicable) in the period of EI investment
Year Polfa Kutno S.A. Stomil Sanok S.A. Eldorado S.A. Grupa Kęty S.A.
OPM NPM ROE OPM NPM ROE OPM NPM ROE OPM NPM ROE
1993 n/a n/a n/a + + + n/a n/a n/a n/a n/a n/a
1994 n/a n/a n/a + + - n/a n/a n/a n/a n/a n/a
1995 n/a n/a n/a + + - n/a n/a n/a n/a n/a n/a
1996 n/a n/a n/a + + + n/a n/a n/a + + +
1997 n/a n/a n/a + + - n/a n/a n/a + + +
1998 - + - + + + n/a n/a n/a + + -
1999 + + - + + - + + - + + -
2000 - - - + + + + + + + + -
2001 + + + + + + + + - + + -
2002 + + + + + + + + - + + -
2003 + + + + + + + + - + + -
Source: Own work

Upon analysing Table 5.14, the following conclusions can be drawn:

- OPM, NPM: Throughout the investment period of EI funds in Stomil Sanok,
Eldorado and Grupa Kęty the value of operating profit margin and net profit margin
exceeded the industry median. In case of Polfa Kutno, the above is true for: 1999,
2001-2003.

198
OPM – operating profit margin, NPM – net profit margin, ROE – return on equity
- ROE: The value of ROE exceeded the industry’s 5th decile for Polfa Kutno in 2001-
2003 and for Stomil Sanok in 2000-2003 while for Eldorado and Grupa Kęty it was
lower than the industry median.

A detailed analysis of the decile distribution for the three analysed ratios is presented
in the Table 5.15 below.

Table 5.15
Specification of financial ratios for the analysed companies compared to the decile
distribution for the industry (e.g. D6 means the previous decile below the value of the
given ratio for the analysed company)
Year Polfa Kutno S.A. Stomil Sanok S.A. Eldorado S.A. Grupa Kęty S.A.
OPM NPM ROE OPM NPM ROE OPM NPM ROE OPM NPM ROE
1993 N/a N/a N/a D5 D7 D5 N/a N/a N/a N/a N/a N/a
1994 N/a N/a N/a D6 D7 D4 N/a N/a N/a N/a N/a N/a
1995 N/a N/a N/a D5 D8 D4 N/a N/a N/a N/a N/a N/a
1996 N/a N/a N/a D7 D9 D6 N/a N/a N/a D6 D5 D8
1997 N/a N/a N/a D8 D9 D4 N/a N/a N/a D6 D6 D6
1998 D3 D6 D4 D8 D9 D5 N/a N/a N/a D5 D6 D4
1999 D5 D6 D4 D7 D8 D4 D5 D6 D4 D5 D7 D3
2000 D4 D2 D2 D6 D7 D5 D7 D7 D5 D6 D6 D4
2001 D6 D6 D5 D5 D7 D5 D6 D6 D4 D6 D7 D4
2002 D6 D6 D5 D7 D8 D6 D8 D7 D4 D6 D6 D3
2003 D8 D7 D6 D8 D8 D7 D7 D6 D4 D6 D6 D4
Source: Own work

Conclusions for each company are as follows:

1. Polfa Kutno S.A.:

The value of operating profit margin (OPM) oscillated between 3 rd decile (in
1998) and 8th decile (in 2003). In 2001-2003 the brackets were narrower, i.e.
between 6th and 8th decile. This means that Polfa Kutno S.A. is a “gazelle” in its
industry. This is also confirmed by an analysis of the decile distribution for net profit
margin (NPM): it was contained between the 2nd decile (in 2000) and 7th decile (in
2003). ROE oscillated between 2nd decile (in 2000) and 6th decile (in 2003). In 2001-
2003 the value of ROE for Polfa Kutno exceeded the 5 th decile for the industry and
the company systematically pursued this trend.

2. Stomil Sanok S.A.

In the period 1993-2003 high OPM values (between 5th decile and 8th decile) and
NPM values (between 8th decile and 9th decile) as well as high ROE (between 4th
decile and 7th decile) proved that Stomil Sanok was also a star in its industry.
3. Eldorado S.A.
Compared to the three previously state-owned and now private enterprises Eldorado
is a relatively young company. However, also in this case the value of OPM, NPM
and ROE compared to the industry prove that Eldorado is among the leading
companies in its industry and satisfies its shareholders.
In the analysed period between 1999 and 2003 the value of OPM oscillated between
5th decile and 8th decile and of NPM between 6th and 7th decile for the industry. On
the other hand, ROE values were between 4th and 5th decile.
4. Grupa Kęty S.A.
Thanks to its financial performance this company also stands out compared to
the industry and belongs to its leaders. In the analysed period between 1996 and
2003 the value of OPM oscillated between 5th decile and 6th decile and of NPM
between 5th and 7th decile for the industry. ROE varied between 3rd decile and 8th
decile.

Conclusion

Based on literature research and a case study, chapter five focused on managing the
value of portfolio companies by private equity funds. The supreme goal of each PE
fund is to maximise the value growth of the capital entrusted to it by investors through
value creation in portfolio companies. This is why private equity investors are looking
for companies which can guarantee them achieving an above-average return on
investment over 7-10 years. In order to increase the company’s value, a private
equity investor undertakes the following tasks:
 Defining the generators of company value growth;
 Defining or re-defining company’s strategy elements in consultation the current
company authorities;
 Selecting key personnel, depending on the stage of development;
 Implementing or strengthening financial controlling: a measurement system;
 Creating a modern incentive system for the managerial staff, focused on
increasing the company’s value.

These activities have been verified through case studies in which private equity funds
managed by Enterprise Investors Sp. z o.o. (the largest group of six funds in Central
and Eastern Europe with the total investment capital of around USD 1.1 billion in
January 2004) invested in four different companies. The analysed companies are:
Polfa Kutno SA, Stomil Sanok S.A., Grupa Kęty S.A., and Eldorado S.A.
The value growth strategy in selected companies consisted in:
a. Operating and financial restructuring of the companies (reorienting them to
strategic and highly profitable operating sectors, changing the current product
strategy, employment restructuring: Polfa, Stomil, Kęty;
b. assisting in recruitment of key managers and specialists: , Stomil, Eldorado;
c. Designing incentive programs (management share options): Polfa, Stomil;
d. Assisting in the implementation of investment program: Polfa, Stomil, Kęty;
e. Creating a modern controlling system: Stomil.
EI funds helped the analysed companies float on the Warsaw Stock Exchange as
well as encouraged their management boards to implement and observe the
principles of corporate governance and investor relations.

The fundamental analysis of the companies against the background of their

industries during the period of EI funds’ investment showed that the companies
generated higher NPM and OPM values that the median (medium value, 5th decile)
in the industries they represent (according to the Polish Classification of Business
Activity) It is to a large extent the result of consulting provided by EI funds investment
partners who cooperated with respective management boards with regard to forming
the value growth strategy and often suggested the best directions for change.

The market prices per share for the four companies have rallied considerably from
the date of their floating on the WSE and particularly after the EI funds disinvestment
in them (i.e. after the sale of their shares in respective companies).
VI. PRIVATE EQUITY FUNDS IN POLAND – THEIR
CURRENT STATUS AND FUTURE DEVELOPMENT
1. EVOLUTION OF PRIVATE EQUITY FUNDS IN POLAND SINCE 1990

The market for private equity investments in Poland is over 14 years old and actually
emerged just accidentally. In the analysis of the private equity fund business in
Poland, P.Tamowicz’s199 research was used. Tamowicz divided the industry into
three groups:
a. small funds, created mostly through economic assistance money or
(foreign) government funds
b. private funds (Polish and foreign): funds founded by banks, during the
General Privatization Program, funds continuing their activity from mainly 1994.;
c. supra-regional funds active in CEE (including Poland).

The private equity business started mushrooming in 1990 (see Table 1) with
the Polish-American Enterprise Fund (PAEF) as its first major player. PAEF was
funded by US administration to support the private sector and market economy in
Poland through direct capital investments, participation in privatizations, loans to
SMEs. The fund acquired its initial capital of USD 240 million, and its nature was
purely for-profit, despite its assistance goals.
The same year witnessed the beginning of operations of Danish Investment
Fund for Central and Eastern Europe - IØ. It was again fully funded by a foreign
government (approx. DKK 900m). It had a clearly defined goal: to support Polish-
Danish co-operation, mainly by funding joint ventures.
In 1991 a small venture capital fund called Towarzystwo Inicjatyw
Społeczno – Ekonomicznych S.A. (TISE) was created. Its initial capital was a few
million zlotys, partially funded by the French government.
In 1992 yet another assistance-based fund was created, Caresbac – Polska
SA. Its shareholders were Caresbac (Care Small Business Assistance Corporation),
Fundusz na Rzecz Rozwoju Polskiego Rolnictwa (Polish Agriculture Development
Fund), Fundusz Współpracy (Co-operation Fund), European Bank for Reconstruction
and Development (EBRD) and USAID.
These were the foundations of PE funds in Poland, soon followed by the
British assistance money, as within the British Know-How Fund the Lubelski and
Białostocki Fundusz Kapitałowy was founded.
Within the EU Phare – Struder program supporting regional development in
Poland, two Regional Investment Funds were created, based in Łódź and Katowice.
The last example of assistance-based activity was the Northern Fund, created by
Small Enterprise Assistance Funds (SEAF), Co-operation Fund and Fundacja na
Rzecz Rozwoju Rolnictwa Polskiego (Foundation for the Development of Polish
Agriculture), so that in co-operation with CARESBAC - Polska S.A they would
support northern Poland. The fund was aided by the Ford Foundation.
In mid-1990s, as credibility of Poland increased together with Poland’s
economic growth, also private capital started coming to Poland to form commercial
PE funds and creating another segment of the private equity market.

199
Tamowicz P., “Rynek venture capital w Polsce” p. 16-17 [in:] “Analiza rynku venture capital w Polsce”,
IBnGR, Gdańsk, October-November 2001
 In 1992 the Polish-American Enterprise Fund created the Polish Private
Equity Fund funded by PAEF (USD 50m), EBRD (USD 50m), Creditanstalt (USD
7m) and private American financial institutions, including corporate pension funds
(USD 44m).
In 1994 Poland Partners Fund was created with the initial capital of USD
65m. Then Pioneer group launched Pioneer Poland Fund with USD 40m capital.
Polish companies were also, for the first time, involved in its creation (Elektrim,
Stalexport, BRE).
New funds appeared soon after: Poland Investment Fund (with EBCD and
International Financial Corporation) with USD 26m capital, White Eagle Industries
(managed by Schooner Fund), Renaissance Capital and Poland Growth Fund (
approx. USD 36m).
In 1994 banks operating in Poland started to show capital investment activity. The
following funds appeared:
 Powszechny Bank Gospodarczy – Fundusz Inwestycyjny,
 Wschodnie Towarzystwo Inwestycyjne (Bank Depozytowo-Kredytowy),
 Pomorski Fundusz Kapitałowy (Pomorski Bank Kredytowy).
The funds did not however have a fully commercial nature, as they were created
partially thanks to assistance money from British Know-How Fund, and they were
based on a portfolio created through a revamping of credit portfolios and conversion
of bad debts into shares. The process took place on the basis of the Act of 1993 (The
Act on restructuring companies and banks).200 In 1996 the three funds were merged
into PEKAO - Fundusz Kapitałowy as a result of banking sector consolidation and
the creation of PEKAO Group. The banking part of the private equity segment was
later supplemented by Pierwszy Polski Fundusz Rozwoju (BRE), PBK-Inwestycje,
Handlowy Inwestycje, and Hals (BGŻ). Also Central Poland Fund (with
participation of PEKAO SA) created in 1998, can be counted here.
In late 1990s commercial funds continued to grow. Experience gained by
Enterprise Investors (PAEF’s manager) let it create Polish Enterprise Fund I (in
1997), and Polish Enterprise Fund IV (in 2000). Poland Partners successes led to
creation of Innova / 98 (in 1998) and Innova/3 (w 2000r.). Likewise, Renaissance
Capital II emerged from Renaissance Partners.201
In 1994 supra-regional funds started to appear, like AIG New Fund, the first
regional fund of American International Group (320m USD), Advent Private
Equity Fund Central Europe (USD 57m), Dresdner Kleinwort Capital, DBG.
Representative offices of supra-regional funds focusing on particular sectors (Internet
and telecom, media, IT) were opened in Poland, namely 3TS Venture Partners (with
3i’s participation) managing Technologieholding Central and Eastern Europe,
BMP / CEEV, Argus Capital Partners, DBG OstEuropa, Riverside Central
Europe, Baring Communications Equity, Environmental Investment Partners
(preferred industry – environment protection). New players – funds from the general
privatization program – entered the equity in late 1990s. They were known as
National Investment Funds, NIF (NFI in Polish). Originally only a few of those funds
ventured into private equity waters, but in time more and more plied those seas: NFI
Magna Polonia (this fund created Nova Polonia Private Equity Fund in 2000), a
number of NFIs purchased by BRE and NFI Jupiter (NFI III and NFI XI). In 1999 MCI
Management S.A. a venture capital fund, was created, and it managed to acquire
almost PLN 25.2m at the Warsaw Stock Exchange in December 2000. In 2000-2001
200
Analysis of the venture capital market, IBnGR, October-November 2002
201
Polskie Stowarzyszenie Inwestorów Kapitałowych, yearbook 2002, p. 16
Lloyd’s Internet Investment Fund, Softbank Emerging Markets, and Raiffeisen
CEE Private Equity Fund, Baring Central European Fund (EUR 86m) appeared in
Poland.
In January 2004 Enterprise Investors set up Polish Enterprise Fund V with
EUR 300m capital, being the largest private equity fund to be set up in CEE. Its
investors are leading pension funds, insurance companies and financial institutions
from USA and Europe.
A.Kornasiewicz notes202 that some Polish companies started operating in a
way similar to private equity funds:
a. Kuchnia Polska – investor in foodstuff companies like Stovit, Leżajsk, Hanka,
Wodzisław;
b. Kulczyk Holding;
c. ITI’s investments (eg. purchase of Optimus)
d. Prokom Software SA’s investments
There are more and more business angels appearing in Poland (founders of
Europejski Fundusz Leasingowy or Lukas). P. Tamowicz estimates that approx. 5000
people may fit the business angel profile in terms of risk aversion in Europe (average
value of investment: EUR 200k).203 So far no empirical studies were made in Poland
in that area. The Polish Network of Business Angels was created in 2003 as an
organization promoting that movement in Poland.

Table 6.1: Phases of development and types of private equity funds in Poland
Rok Assistance funds Commercial funds Supra-regional funds
1990 Polish-American
Enterprise Fund
1991 Towarzystwo Inicjatyw
Społeczno -
Ekonomicznych
1992 Caresbac Polska Polski Prywatny Fundusz
Kapitałowy I&II
UNP-Holdings
1994 Poland Partners European Renaissance
Pioneer Poland Fund* Capital I
Poland Investment Fund Advent Private Equity Fund
PBG Fundusz Inwestycyjny Sp z o.o.
Pomorski Fundusz Kapitałowy Sp. z o.o.
White Eagle Industries
Poland Growth Fund
1995 Lubelski Fundusz Polski Fundusz Przedsiębiorczości Oresa Ventures
.Kapitałowy Sp z o.o. Dolnośląska Spółka Inwestycyjna Sp z Alliance Scan East Fund
Białostocki Fundusz o.o. NEEIF
Kapitałowy Sp z o.o. CET
1996 Regionalny Fundusz PEKAO Fundusz Kapitałowy Sp z o.o East European Food Fund
Inwestycyjny Sp z o.o Dolmel Investment Sp z o.o.
Katowice
RFI Sp z o.o. Łódź
Górnośląski Fundusz
Restrukturyzacyjny SA
1997 I NFI S.A., III NFI SA
NFI Magna Polonia S.A., XI NFI S.A.
1998 PBK Inwestycje S.A. Innova / 98

202
Kornasiewicz A., Venture Capital w krajach rozwiniętych i w Polsce, CeDeWu, Warszawa, 2004, p. 193
203
Tamowicz P.,Rynek kapitału ryzyka w Polsce, Polskie Forum Strategii Lizbońskiej, Niebieskie księgi 2003,
p. 21
 Central Poland Fund BMP Polska Sp z o.o.
Advent C&EE I&II
1999 Fundusz Północny MCI Management SA Technologieholding
(Northern Fund) Internet Investment Fund Strateg BV
Argus Capital Partners Environmental Investment
Partners
DBG OstEuropa
Riverside Central Europe
Fund
Dresdner Kleinwort Benson
Emerging Europe Fund
2000 Nova Polonia Private Equity Fund European Renaissance
Polski Fundusz Przedsiębiorczości IV Capital II
Hals Fundusz Kapitałowy Sp z o.o. Lloyd`s IT IF
2001 Baring Central European
Fund
Raiffeisen Central and
Eastern Europe Private
Equity Fund
2002 Innova / 3
2004 Polski Fundusz Przedsiębiorczości V
Source: IBnGR + own additional work
* since April operating under Prospect Poland Funds brand

2. PRIVATE EQUITY FUNDS IN POLAND

Over 14 years private equity unds acquired over EUR 5 billion, the majority of which
stemmed from foreign institutional investors. They invested EUR 2.2 billion in over
600 companies in Poland (3% of the FDI value in Poland until 2003204), and EUR
USD 2.1 in companies from other CEE countries like the Czech Republic, Slovakia,
Hungary, Romania.
In Poland there are approximately 35 companies managing over 60 private
equity funds, of which the Polish Private Equity and Venture Capital Association
(PSIK) has at present205 29 members (PE funds or managers). The 29 PSIK
members were characterized in Table 6.2 (value of investments in Poland, current
number of portfolio companies) and 6.3 (total capital managed, investment limits,
stages of investments, industry preferences).
As at 31/10/2004 private equity funds in Poland invested PLN 5.7 billion in 234
companies (see Table 6.2). Enterprise Investors’ managed funds have the top place
here (slightly over PLN 2 billion in 38 companies), followed by Ballinger Capital (PLN
0.75m in 12 companies), and Adwent International (PLN 0.5m in 6 companies).
The amount invested by private equity funds in 2000 was EUR 201 million,
with EUR 332m acquired equity, namely the capital that may be allocated in portfolio
companies206. The year 2000 was best in private equity markets in USA, Europe and
Poland. Then the value of the acquired equity steadily decreases to EUR 26 million in
2003. Also the amount of private equity investment decreased in 2001-2002, while
2003 proved to be better (see Chart 6.1).

204
Until 2003 FDI equaled USD 72bn, according to the Polish Agency for Foreign Investment
205
November 2004
206
Polish VC market was under a pilot study by Venture Economics, and 2002 has been considered
representative in an annual report of EVCA. In 2002 also Polskie Stowarzyszenie Inwestorów Kapitałowych was
formed, which collects information on VC market.
Chart 6.1
Capital acquired and invested by private equity funds operating in
Poland in 2000-2003

350.0 332
PE pozyskany
300.0
PE zainwestowany
250.0
201
EUR million

200.0 176
151
150.0 118 133
119
100.0

50.0 26

0.0
2000 2001 2002 2003

[x: acquired PE; invested PE]

Source: own work basing on EVCA 2002, 2003.

Next, Chart 6.2 shows the structure of the private equity market. Venture capital
consists of three sub-sectors:
a. seed capital;
b. start-up capital,
c. expansion capital
Four years shown on Chart 2 demonstrate the following trends:
a. venture capital share decreasing in total private equity;
b. value of share of buyouts increases;
c. replacement capital starts to play a major role in private equity207.

207
Replacement capital consist of: second purchase of shares, capital conversion, bank loan refinancing
Chart 6.2
Segments of private equity invested in Poland in 2000-2003

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2000 2001 2002 2003
Venture capital zainwestowany 199.5 98.9 63.5 57.6
Replacement capital zainwestowany 2.0 47.8 34.7 42.7
Buyouts zainwestowany 0.0 3.8 19.5 32.9

[x: invested VC; invested replacement capital; invested buyouts]

Source: own work basing on EVCA 2002, 2003.
Table 6.2: Managers / private equity funds in Poland (members of the Polish Private Equity and Venture Capital Association) as of 31/10/2004
No Manager Managed funds Amount of Value of Amount of
investments investment in portfolio
in Poland PLN million companies in
Poland
1 Enterprise Investors Polish Private Equity Fund I&II, Polish American Enterprise Fund, Polish USD 618m 2 098.73 38
Enterprise Fund, Polish Enterprise Fund IV, V
2 Ballinger Capital 1. Pierwszy NFI, 2. V NFI „Victoria”, 3. NFI Fortuna EUR 172.0m 745.04 12
3 Advent International 1. Advent Private Equity Fund, 2. Advent Central & Eastern Europe USD 138.5m 470.35 6
4 Trinity Management Sp z o.o. 1. Pekao Fundusz Kapitałowy Sp z o.o., 2. Jupiter NFI S.A. EUR 100.0m 433.16 30
5 AIB WBK Fund Management 1. NFI Magna Polonia SA, 2. Nova Polonia Private Equity Fund LLC, 3. Prospect EUR 89.0m 385.51 25
Poland Funds
6 Innova Capital 1. Innova / 3 LP 2. Innova/ 98 LP 3. Poland Partners EUR 45.0m 194.92 15
7 Baring Communications Equity (Emerging Europe) The Baring Communications Equity (Emerging Europe) Ltd USD 51.0m 173.20 0
Ltd
8 Argus Capital International Ltd. Argus Capital Partners USD 50m 169.80 5
9 Copernicus Capital Partners 1. Central Poland Fund LP, 2. Poland Investment Fund LP, 3. Croatian Capital USD 34.2m 116.14 14
Partners LP
10 Baring Corilius Private Equity Baring Central European Fund EUR 25.0m 108.29 2
11 Renaissance Partners 1. European Renaissance Capital I, 2. European Renaissance Capital II USD 29.9m 101.54 10
12 DBG Eastern Europe 1. DBG OstEuropa-Holding GmbH, 2. DBG OstEuropa-Holding GmbH II EUR 22.0m 95.30 2
13 PBK Inwestycje S.A. PLN 90.0m 90.00 12
14 Krakowskie Centrum Inwestycyjne S.A. PLN 87.49m 87.49 7
15 Allianz Specialised Investments Central Europe Sp. z USD 20.325m 69.02 3
o.o. – earlier called Dresdner Kleinwort Capital
16 Caresbac Polska S.A. USD 17.2m 58.41 12
17 Riverside Europe Partners 1. Riverside Central Europe Fund, 2. Riverside Europe Fund II USD 14.5m 49.24 4
18 MCI Management S.A. PLN 46.21m 46.21 9
19 Raiffeisen Private Equity Management AG Raiffeisen CEE Private Equity Fund LP EUR10.0m 43.32 2
20 Royalton Partners Emerging Europe Capital Investors USD 9.3m 31.58 1
21 Hals Fundusz Kapitałowy Sp z o.o. PLN 31.5m 31.50 7
22 Environmental Investment Partners Environmental Investment Partners EUR 6.5m 28.16 2
23 Bmp Polska Sp z o.o. 1. bmp AG, 2. Central and Eastern Europe Venture Gmbh, 3. Deutsche EUR 5.0m 21.65 2
Investitions und Entwicklungsgesellschaft mbH
24 Górnośląski Fundusz Restrukturyzacyjny S.A. PLN 12m 12 .00 7
25 3TS Venture Partners 1. Technologieholding Central and Eastern Fund 2.Technologieholding Central EUR 2.206m 9.56 1
and Eastern Fund European Parallel Fund
26 Apax Partners 0 0 0
27 Regionalne Fundusze Inwestycji (Łódź) Sp z o.o. EUR 1.2m 5.20 3
28 Mezzanine Management (Poland) Sp z o.o. EUR 7.0m 30.32 1
29 Intel Capital N/A 2
Total 5 693.64 234
Source: Polskie Stowarzyszenie Inwestorów Kapitałowych. USD, EUR investments converted to PLN according to NBP’s exchange rate of 31/10/2004; USD 1.00=PLN 3.396;
EUR 1.00=4.3316
Table 6.3: Characteristics of fund managers / private equity funds in Poland
No Fund manager Total managed capital Investment limits Investment stages Industry preferences
1 Enterprise Investors USD 1.1 billion Max: 25m USD Early stages, Expansion and Goods and services for industry, consumer goods,
Min: 3m USD development, Restructuring, buyout, IT, telecom, healthcare, environment protection
Privatization
2 Ballinger Capital Eur 187m Min: 5m EUR Expansion and development, buyout, No preference
Restructuring,
3 Advent International Global Funds USD 250 Max. 20m USD Expansion and development, buyout, Telecom, goods and services for industry, media, IT,
billion Min. 5m USD changing structure, Privatization, other services, consumer goods, chemistry and
going private materials
4 Trinity Management Sp z o.o. USD 63m Max: 20m EUR Early stages, Expansion and Chemistry and materials, IT, ecology, hi-tech
Min : 2m EUR development industry
5 AIB WBK Fund Management EUR 127m Min.: 1.2m EUR All No preference
Max: 10m EUR
6 Innova Capital USD 300m Max: 15m EUR Expansion and development, buyout, Services, telecom, media, IT
Min: 5m EUR bridge financing, going private,
replacement capital
7 Baring Communications Equity (Emerging USD 74.25m Min: 1m USD Expansion and development, bridge Internet, telecom, media
Europe) Ltd financing, buyout
8 Argus Capital International Ltd. USD 172m Max : 25m USD Early stages, Expansion and All sectors save for real estate
Min: 5m USD development, Restructuring, going
private, buyout
9 Copernicus Capital Partners USD 35m Max: 2.5m USD Early stages, start-up, Expansion and ITservices , communications, telecom,
Min: 1m USD development, replacement capital manufacturing, Internet, consumer goods
10 Baring Corilius Private Equity Eur 86m Max: 2m EUR Expansion and development, buyout No preference
Min: 15m EUR
11 Renaissance Partners USD 60m Max: 2.2m USD Early stages – start-up, other, No preference, apart from heavy and light industry
Min: 0.5m USD Expansion and development, buyout
12 DBG Eastern Europe Eur 113m Max: 12m EUR Buyout, replacement capital, going Services, manufacturing, telecom, media, IT,
Min: 3m EUR private, Expansion and development, consumer goods
Restructuring
13 PBK Inwestycje S.A. PLN 90m Max: 12m PLN Early stages – start-up, Expansion Internet, telecom, goods and services for industry,
Min: 0.5m PLN and development, Restructuring environment protection, media
14 Krakowskie Centrum Inwestycyjne S.A. PLN 311.5m Max: 50m PLN Restructuring, Privatization Manufacturing, goods and services for industry,
Min: 30m PLN services, electronics, industrial automatics, real
estate
15 Allianz Specialised Investments Central EUR 225.6m Min: 3m USD Development capital, MBO/MBI, Telecom, media, IT, medical services , consumer
Europe Sp. z o.o. – wcześniej Dresdner Max: 25m USD privatizations and (in exceptional goods, distribution and logistics,retail, business
Kleinwort Capital cases) restructurings services , industrial production
16 Caresbac Polska S.A. USD 15m Max: 3m USD Early stages (start-up, other), No preference
Min: 0.4m USD mezzanine
17 Riverside Europe Partners USD 24.5m Max: 20m USD Development, buyout, replacement No preference – apart from weapons industry,
Min: 3m USD capital alcohol industry, foodstuffs, distribution, real estate.
18 MCI Management SA PLN 52.6m Max: 0.5m USD Start-up, Expansion and development, Mobile telephones, IT, Internet
Min: 0.1m USD bridge financing, Restructuring,
buyout, mezzanine
19 Raiffeisen Private Equity Management AG Eur 83m Max: 14m EUR Expansion and development Computers: software, computers: IT services ,
Min: 3m EUR Media, industrial goods and services, Consumer
goods: trade, consumer goods: manufacturing.
Other services.
20 Royalton Partners USD 94.4m Max: 22m USD Expansion and development, buyout, Non-trading goods, Services
Min: 10m USD Restructuring
21 Hals Fundusz Kapitałowy Sp z o.o. PLN 36m Max: 4m zł Development No preference
Min: 1m zł
22 Environmental Investment Partners EUR 22m Max: 4m EUR All Environment protection
Min: 0.5m EUR
23 Bmp Polska Sp z o.o. Around EUR 20m Max: 5m USD Early stages, start-up, Expansion and Biotechnology, IT, Computers: IT services , Media,
development Industrial goods and services,Consumer goods:
trade, Consumer goods :manufacturing , Telecom:
operators, Telecom: equipment, Transport
24 Górnośląski Fundusz Restrukturyzacyjny S.A. PLN 25m Max: 5m zł Early stages, Expansion and Health protection, environment protection, services,
Min: 0.5m zł development, bridge financing, buyout IT, electronics, biotechnology
25 3TS Venture Partners USD 66m Max: 6.5m EUR Expansion and development, Early Electronics, IT, Internet, telecom, services
Min: 0.5m EUR stages – seeds, start-up, other
26 Apax Partners Min: 5m EUR Early stage, Growth&expansion stage, IT, Media, Medicine: pharmaceuticals, Medicine:
Max: 440m EUR MBO, LBO health protection, Consumer goods: trade,
Consumer goods: manufacturing , Telecom:
operators, Telecom: equipment, Financial services
27 Regionalne Fundusze Inwestycji (Łódź) Sp z Eur 2.5m Max: 0.5m EUR Early stages, expansion and No preference
o.o. Min: 50k. EUR development
28 Mezzanine Management (Poland) Sp z o.o. Min: 5m EUR Buyouts MBO, MBI, replacement Industrial automatics, Biotechnology, Construction,
Max: 35m EUR capital, financing expansion and Chemistry and materials, Electronics, Power sector,
growth Other, IT, Computers: software, Computers:
equipment, Computers: IT services, Computers:
hardware, Media, Medicine: pharmaceuticals,
Medicine: health protection, Medicine: medical
equipment, Environment protection, Industrial goods
and services, Consumer goods: trade, Consumer
goods: manufacturing, Processing industry,
Telecom: operators, Telecom: equipment,
Transportation, Services - other, Financial services ,
29 Intel Capital Max: 10 m USD Early stages (seed, start-up), Telecom, Internet, IT, biotechnology
Min: 0.5m USD Expansion and development
Source: Polskie Stowarzyszenie Inwestorów Indywidualnych
3. SOURCES OF MONEY FOR THE FUNDS

The majority of capital acquired by private equity funds operating in Poland comes
from abroad (see Table 6.4).

Table 6.4
Geographical origin of private equity in Poland
Wyszczególnienie 2000 % 2001 % 2002 % 2003 %
EUR EUR EUR EUR
million million million million

Poland 24.4 7.4 10.0 5.7 0.0 0.0 5.2 20.4

Europe 169.7 51.1 138.9 79.0 118.7 100.0 19.2 74.8
Outside Europe 138.2 41.6 26.9 15.3 0 0 1.3 4.9
Total 332.3 100.0 175.8 100.0 118.7 100.0 25.7 100.0
Source: own work basing on EVCA 2002, 2003.
* PLN to EUR conversion using NBP’s average FX rate, in 2000 4.011 PLN, and in 2001 3.6685 PLN
Since 2000 the value of the capital acquired has been steadily going down, in 2000 it was EUR 332.2
million while in 2003 only EUR 25.7 million.

Banks, including EBRD, were the largest investors to place their money in VC funds
(EUR 90m), followed by pension funds (mainly American – EUR 71m), and insurance
companies (EUR 63m). VC funds, after a consent from investors, acquired in 2000 a
possibility to plough back their profits in the amount of EUR 56m (see Table 6.5). In
2001 companies invested EUR 57m, followed by banks (47m EUR). In 2002
companies invested EUR 44m, while banks EUR 33m. In 2003 most money in VC
funds stemmed from government agencies (EUR 9m), followed by banks (EUR 8m).

Table 6.5
Capital acquired by VC funds operating in Poland in 2000-2003 according to type of
investors
Type of investor 2000* 2001* 2002 2003
EUR % EUR % EUR % EUR %
million million million million
Companies 2.18 0.79 56.76 35.92 44.07 38.92 1.46 5.89
Individuals 2.07 0.75 20.85 13.19 14.50 12.81 2.50 10.07
Government agencies 23.67 8.57 4.96 3.14 3.35 2.96 9.26 37.33
Banks 90.06 32.60 47.23 29.89 33.46 29.55 8.04 32.41
Pension funds 70.93 25.67 0.00 0.00 6.69 5.91 0.00 0.00
Insurance companies 63.80 23.09 9.93 6.28 0.00 0.00 0.00 0.00
Funds’ funds 21.41 7.75 8.31 5.26 5.58 4.93 3.05 12.28
Academic institutions 0.00 0.00 0.79 0.50 1.12 0.98 0.00 0.00
Capital markets 0.00 0.00 6.55 4.14 4.46 3.94 0.00 0.00
Not disclosed 2.17 0.79 2.63 1.67 0.00 0.00 0.50 2.02
Total : new funds 276.30 100.0 158.01 100.0 113.21 100.0 24.81 100.0
Reinvested capital gains
56.07 - 17.83 - 5.50 - 0.93 -
Total - 175.84 - 118.71 - 25.74 -
Source: own work basing on EVCA 2002, 2003.
* PLN to EUR conversion using NBP’s average FX rate, in 2000 4.011 PLN, and in 2001 3.6685 PLN
4. FUNDS’ INVESTMENTS

There is a large difference between sectors of portfolio companies, yet the funds look
for companies from niche and perspective sectors.
According to EVCA’s research in 2000-2001 among the most popular sectors there
were telecom, industrial goods, and consumer goods. In 2003, companies from
telecom, consumer goods and financial services prevailed. (see Table 6.6).

Table 6.6
Investments according to sectors – Poland
Sector 2000 2001 2002 2003
EUR m % EUR m % EUR m % EUR m %
Telecommunications 114.36 56.8% 69.81 46.4% 16.37 13.9% 39.51 29.7%
Computers 20.37 10.1% 1.20 0.8% 4.52 3.8% 0.12 0.1%
Other electronics 0.00 0.0% 0.00 0.0% 0.69 0.6% 1.56 1.2%
Biotechnology 0.00 0.0% 0.00 0.0% 0.57 0.5% 0.00 0.0%
Health/healthcare 4.46 2.2% 7.39 4.9% 4.20 3.6% 6.16 4.6%
Energy 0.87 0.4% 1.14 0.8% 8.06 6.8% 6.92 5.2%
Consumer goods 24.83 12.3% 13.36 8.9% 41.36 35.1% 33.88 25.4%
Industrial goods and 4.14 0.65 2.00 0.00
services 2.1% 0.4% 1.7% 0.0%
Chemistry and materials 0.20 0.1% 9.51 6.3% 0.00 0.0% 1.78 1.3%
Industrial automatics 0.00 0.0% 0.00 0.0% 2.15 1.8% 0.00 0.0%
Other industrial products 6.68 3.3% 21.94 14.6% 18.70 15.9% 3.92 2.9%
Transportation 0.00 0.0% 0.00 0.0% 7.07 6.0% 1.23 0.9%
Financial services 5.81 2.9% 0.68 0.5% 1.39 1.2% 31.53 23.7%
Other services 13.04 6.5% 24.78 16.5% 3.81 3.2% 1.45 1.1%
Agriculture 0.00 0.0% 0.00 0.0% 0.00 0.0% 0.00 0.0%
Construction 0.00 0.0% 0.00 0.0% 6.81 5.8% 2.00 1.5%
Other 6.68 3.3% 0.08 0.1% 0.00 0.0% 3.09 2.3%
Total 201.45 100.0% 150.55 100.0% 117.70 100.0% 133.16 100.0%
Source: own work basing on EVCA 2002, 2003

In 2000-2003 funds invested in 291 companies, while the most common stage of
development was the expansion stage (expansion capital) - 155 companies. 66
companies acquired start-up capital, 41 companies replacement capital, 14
companies financed buyouts, and only 15 companies acquired seed capital (10 in
2000) – see Table 6.7.

Table 6.7
Number of companies receiving private equity in Poland in 2000-2003
Total
2000 -
No Type of capital 2000 2001 2002 2003 2003
1. Buyouts 0 2 6 6 14
2. Replacement capital 4 7 18 12 41
3. Total venture capital 87 56 62 31 236
3.1 Expansion capital 52 30 49 24 155
3.2 Start-up capital 25 23 13 5 66
3.3 Seed capital 10 3 0 2 15
Total private equity 91 65 86 49 291
Source: own work basing on EVCA 2002, 2003.

5. WAYS OF FUNDS’ DISINVESTMENTS

Total value of divestments of VC funds was EUR 279 million in 2000-2003 of which
the most popular way of disinvestment was a trade sale (36.7%). The value of
divestments has been on the increase since 2002, equalling EUR 79.5m by the end
of 2002 and EUR 115.2m in 2003, of which EUR 14.1m was from liquidated
companies (see Table 6.8).

Table 6.8
Types and value of private equity funds disinvestments in 2000-2003
Divestment method 2000 2001 2002 2003 2000-2003
EUR million %
Write-off 0.74 2.95 4.48 14.13 22.30 8.0%
Trade sale 23.56 26.19 41.87 10.79 102.41 36.7%

IPO 0.00 0.00 19.40 0.00 19.40 7.0%

Secondary market sale 0.53 3.06 6.02 24.86 34.47 12.4%
Buy back 0.00 0.00 0.36 34.41 34.77 12.5%
Sale to another PE fund 1.11 1.94 5.70 3.97 12.72 4.6%
Sale to a financial institution 1.89 0.00 0.00 0.00 1.89 0.7%
Other 14.86 7.52 1.70 27.02 51.10 18.3%
Total 42.69 41.66 79.53 115.17 279.06 100.0%
Source: own work basing on EVCA 2002, 2003.

In 2000-2003 the funds sold 135 portfolio companies and liquidated 24 (see Table
6.9).

Table 6.9
Number of companies, in which the funds finished their investments in 2000-
2003
2000 2001 2002 2003 2000-2003
EUR million
Write-off 1 10 4 9 24 15.1%
Trade sale 7 10 14 22 53 33.3%

IPO 0 0 5 1 6 3.8%
Secondary market sale 1 5 3 3 12 7.5%
Buy back 0 0 1 8 9 5.7%
Sale to another PE fund 3 1 1 1 6 3.8%
Sale to a financial institution 3 0 0 0 3 1.9%
Other 11 12 2 21 46 28.9%
Total 26 38 30 65 159 100.0%
Source: own work basing on EVCA 2002, 2003.
6. POSSIBILITIES OF CREATING PRIVATE EQUITY FUNDS IN VIEW OF THE
POLISH LAW

6.1. THE ACT ON INVESTMENT FUNDS

The fundamental legal act for investment funds based in Poland is the Act on
investment funds of 27 May 2004.208 According to the Act, an investment fund is a
legal person, the sole object of which is to place money (acquired through public or
non-public offer to purchase participation units or investment certificates) in securities
described in the act, in money market instruments and other property rights.
The fund’s body is an investment fund association, which means that the fund itself is
only an amount of property administered by that association.
The Act stipulated that an investment fund may be formed solely by an association,
after consent from the Securities and Exchanges Commission, and gathering
payments for the investment fund of at least PLN 4 million. For close-end investment
funds, where certificates are not publically traded, the total minimal value of
payments and the way of collecting them is provided for in the fund’s bylaws.
The Act provides for the following types of funds:
a. Open-end investment fund,
b. Specialized open-end investment fund,
c. Closed-end investment fund.

From the point of view of the existing legal framework a closed-end investment
fund seems to be the best form of VC funds in Poland.

Closed-end investment fund (CIF)

A closed-end investment funds issues its units (called in Poland investment
certificates) which may be publically traded. CIF investment certificates may either be
registered securities or bearer’s securities (ordinary investment certificates). If they
are to be publically traded, they must be ordinary.
A unit issue not to be publically traded may be placed with no more than 300 people.
CIF values its assets, sets its net asset value and net asset value per unit at least
once a quarter.

A closed-end investment fund may invest its assets in:

a. securities,
b. receivables, excluding receivables from natural persons,
c. interest in limited liability companies,
d. FX,
e. Derivatives, including non-standardized ones,
f. Property rights,
g. Money market instruments (provided they are negotiable).
Investment policy of such a fund is subject to certain limitation, e.g. securities issued
by one entity, receivables towards that entity and interest in that entity may not
exceed 20% of the fund’s assets.

208
Journal of Laws Dz.U. 2004, no 146, item 1546. The Act replaced the previous Act on investments funds of
28 August 1997.
The Act introduced sub-classes of investment funds (especially closed-end
investment fund): money market fund, portfolio fund, securitizing fund, non-public
assets fund. For VC purposes the non-public assets fund plays the most important
role, as it can invest at least 80% of its funds in assets other than publically traded
securities and money market instruments. 209
Bylaws of a non-public investment fund may provide for payments for fund
participants from selling the fund’s deposits (decreased by the operating costs
directly connected to selling of the deposits and by a part of the operating costs pro
rata in relation to value of such deposits in the fund’s portfolio). In such a case the
fund is obliged to adjust its assets to values resulting from the Act and its bylaws 12
months from such payments at the latest. This condition does not apply if 36 months
are left until the fund’s liquidation. As P.Sieradzan states210 this regulation is pretty
favorable to VC funds, as their deposit-selling incomes are rarely reinvested, and
moneys gained from individual portfolio items are usually paid to its participant
regardless of the fund’s further activity.
In P.Miller’s opinion211 the new 2004 Act removes most barriers, namely:
a. facilitates capital drawing;
b. removes capital concentration limits during investment portfolio construction;
c. introduces cash distribution system, similar to the one present in the PE market
(cash from investment is not reinvested, but returned to capital donor together
with any accrued profit).
A significant obstacle for new solution is according to P.Miller’s the fact, that the
legislator introduced into the 2004 Act the obligation for a regulated PE market,
supervised by KPWiG. Any entity wishing to use the closed-end investment fund will
have to create an investment fund association, which will limit the flexibility of its
activity and increase its costs. The Act eliminated double taxation, which is a good
thing.
Globally, PE funds are rarely listed on a public market, and their majority
operates on a private market and is not supervised. The VC market is a self-
regulatory market, with contractual liability of fund managers towards their investors
and the risk of losing reputation.

Taxation of investment funds

Generally we may assume that a taxation structure of investment funds facilitates
their VC uses. There are no special preferences or tax incentives to invest in this
asset category, but the lack of double taxation is a good thing. Investment funds as
legal persons are exempted from CIT. Fund participants are taxed in the following
way. Any income of legal persons from participation in a fund (dividends, redemption
profits for fund units) are taxed on general principles. Revenues stemming from
selling of fund units at the stock exchange are taxed similarly. These rules do not
apply, however, to open pension funds or investment funds, a target group for private
equity funds.
The case gets more complicated with natural persons. A general rule is as follows:
presently any income derived from shares in investment funds (redemption of fund

209
Already the first closed-end non-public assets fund appeared in Poland (Copernicus Private Equity
Fundusz Inwestycyjny Zamknięty), starting its subscription on 29.10.2004. If the subscription proves to be
a success the fund investing in other PE funds will be the first fund listed on the Warsaw Stock Exchange which
invests in non-public assets, i.e. securities other than shares or bonds.
210
Sieradzan P., Sobańska K., Inwestycje private equity / venture capital, Key Text, Warsaw, 2004, p. 286
211
Miller P., Reputacja ważniejsza niż regulacje, Gazeta Bankowa, 26.04.2004.
units, profits payable by the fund) are subject to a flat-rate 20% tax withheld at the
source, namely by the fund, which pays the tax to the Revenue Office.

When natural persons sell their investment certificates at the stock exchange
(according to the Act such investment certificates are securities), provisions of Article
52 of the PIT Act shall apply, where capital gains from publicly traded securities are
exempt from the tax.

CIF as private equity funds

Interest in forming PE funds according to Polish law is closely connected with the
pension system reform and the appearance of open pension funds. Before that just a
few investors were interested in PE investments. Most capital came from foreign
investors, favoring familiar legal solutions and registered their funds in countries with
appropriate regulations and tax regime. Together with an increase in open pension
funds’ assets there appeared a need for alternative investments, apart from debt
securities and publically traded companies. PE funds can be such an alternative
investment.
A closed-end investment fund, and in particular a non-public one, seems to be
the most favorable vehicle for PE funds on the Polish market. Open-end funds are
not an optimum choice, due to private equity funds having:
a. Investment policy of investing in non-public companies,
b. Long-term investment,
c. Low liquidity of investment.
There are numerous nuisances, however, with PE funds created as CIF. The first is
the need to be subject to KPWiG’s supervision, greatly limiting flexibility of the fund,
and brings about other formal and administrative complications (like a need to closely
follow IT reporting procedures or concentration ratios). This concerns particularly
CIFs as, being publically traded, they are subject to same provisions of the act on
public trading of securities as any other public company.
The second nuisance is a need to create an investment fund association
(unless one is already available). A list of formal requirements to obtain KPWiG’s
permit is very long, which in addition to a high capital requirement limits the liberty of
creating funds.
The third weakness is a statutory obligation of semi-annual valuation of fund’s
assets (twice a year, end of March and end of September; this amendment has been
effective since 1 April 2004, before valuations had to be do at least quarterly).
All this leads to the fact that a vast majority of PE funds operating in Poland
are registered abroad, usually in tax havens.

6.2. ACT ON NATIONAL INVESTMENT FUNDS (NFI)

In 1993 the Act on National Investment Funds and their privatization was adopted 212.
The act provided for creation of 15 National Investment Funds. They were founded
as joint-stock companies, but in many respects resemble PE funds. Statutory aim of
these funds is the multiplication of their assets, in particular through increasing the
value of shares of companies they invest in. Investment goals of PE funds are
defined similarly. The difference is that PE funds have full liberty in creating their

212
Journal of Laws Dz.U. of 1993, no 44, item 202, and of 1994, no 84, item 385
investment portfolio (they invest their money in selected companies), while in NFI
companies’ share were an in-kind contribution, with little possibility of shaping the
investment portfolio. NFIs have their statutory organs (Managing Board, Supervisory
Board) but external companies were employed to manage their assets in order to
maximize profits for shareholder. This is pretty similar to a typical PE fund.

Taxation of National Investment Funds

Despite the fact that National Investment Funds operate as joint-stock companies
and as such are taxed under the CIT act, there are some exemptions for them. For
example, NFI are exempted from tax payment on dividends and other income on
interest in profit of legal persons domiciled in Poland, as well as on selling share of
companies with a registered office in Poland. This preference is without time limit,
therefore those exemptions could be used also if NFIs continued to function as PE
funds.

National Investment Funds as private equity funds

The Act on NFI stipulates that after the expiry of the time allocated for their
functioning (that is after 31.12.2004), they will be able to transform themselves into
open- or closed-end investment funds. Taking into account their profile, PE funds
seem an obvious choice. Some NFIs seem to be heading that way, like Jupiter NFI,
which evolved into a PE fund and allocated moneys from companies it acquired as
the in-kind contribution to buy shares of companies from outside the NFI program.
Another example of evolution towards venture capital is NFI Magna Polonia’s asset
manager - AIB WBK Fund Management Sp. z o.o. Apart from managing the NFI fund
they also gathered moneys for Nova Polonia fund and started managing Pioneer’s
VC fund (currently operating as Prospect Poland Funds). BRE Private Equity (now
Ballinger Capital) also evolved into a private equity fund.

Taking into account the experience gathered by fund managers during the NFI
program, their transformation into private equity funds seems very much justified. If,
however, such transformation was to take place within the existing legal framework
(reinvesting profits from selling of portfolio companies) and not, as was the case with
AIB WBK Fund Management, by gathering money for a new fund, an exit strategy for
shareholder who do not approve of the fund’s transformation must be in place. They
have the right to expect that after 8 years of the program they will get their money
back. This would also help to increase fund managers’ credibility, and facilitate
clearing their results in the future. With the end of the program in sight (31/12/2004)
more and more funds declare their transformation into private equity funds.

6.3. CODE OF COMMERCIAL COMPANIES AND PARTNERSHIPS

Analyzing creation of private equity funds on the basis of the Code of Commercial
Companies and Partnerships we need to distinguish between companies (limited
liability company and joint stock company) and partnerships (limited partnership and
limited joint-stock partnership).

Limited liability company (spółka z o.o.)

According to the Code of Commercial Companies and Partnerships (CCCP), a
limited liability company may be founded by one or more persons to pursue each and
every legally permissible goal. We may therefore assume that also VC-type activity
may be pursued within a limited liability company. It is however only a theoretical
assumption. In Poland this type of company is hardly ever used to create private
equity funds, which is due to several factors. First, the management structure of a
limited liability company is not well-suited to this type of activity. CCCP clearly states
that such a company must have a Management Board and (usually) a Supervisory
Board, which makes management a bit complex. Second reason is that open
pension funds, the largest investors on the market, have a statutory prohibition of
investing in a limited liability company shares. Third and perhaps the most important
reason is tax inefficiency. Limited liability companies are subject to corporate income
tax, which makes any profits made by fund member taxed twice – once at the
corporate level, and for the second time when they are distributed to members.

Joint-stock company (spółka akcyjna)

Joint-stock companies suffer from problems similar to limited liability companies, with
some advantages, however. Shares of a joint-stock company may be publically
traded, and open pension funds may invest here. The problem of double taxation still
remains unsolved.
MCI Management S.A. is an example of how a joint-stock company form may be
used to operate on the Polish private equity market. This company is listed on the
Warsaw Stock Exchange, and during its IPO in 2001 its shares were acquired mainly
by institutional investors.

A limited partnership (spółka komandytowa) and a limited joint-stock

partnership (spółka komandytowo-akcyjna)
A limited partnership is a partnership operating under its own business name, where
at least one of the partners (general partner) has an unlimited liability and at least
one of the partners (limited partner) has a limited liability.

Taxation of limited partnerships and limited joint-stock partnerships

These two partnerships are not tax payers in the understanding of the CIT Act and
the PIT Act. In accordance with Art.1 sec.2 of the CIT Act the regulations of the CIT
Act apply to organizational units without a legal personality, excluding a limited
partnership and a limited joint-stock partnership. Art.5 sec.1 states that income from
an interest in a partnership which is not a legal person, including a limited partnership
and a limited joint-stock partnership are combined with incomes of each partner
proportionally to the interest they hold. Unless proven otherwise, the interests are
assumed to be equal. This principle also applies to deductible costs, to costs which
cannot be deduced, tax reliefs and exemptions and decreases of the taxable basis
and the taxable income. Similar principles apply also to tax payers subject to PIT.
Therefore there is no double taxation for limited partnerships and limited joint-stock
partnerships.

A limited partnership and a limited joint-stock partnership as a PE fund

In these partnerships one can find some analogies with typical PE fund structures.
The general partner of a limited partnership or limited joint-stock partnership may be
seen as an equivalent of a general partner managing a PE fund, while the limited
partner of a limited partnership or limited joint-stock partnership – an equivalent of
the limited partner being an investor of the fund. Managerial contracts with an
external entity is not in line with the character of these partnerships213.
It is unlikely, however, that a limited partnership or a limited joint-stock
partnership would gain broader usage as PE fund frameworks. One of the reasons is
that they are partnerships, so institutional investors, in particular open pension funds,
would find it difficult to invest in them. OFE have a statutory prohibition of investing in
non-public companies, not to mention partnerships.
So far there have been no PE funds in Poland operating as a limited
partnership or a limited joint-stock partnership.

6.4 CONCLUSIONS FROM THE ANALYSIS OF LEGAL FORMS FROM THE

POINT OF VIEW OF PE FUNDS
From among presented legal structures the one most suited to PE funds seems to be
the one contained in the act on investment funds, namely a closed-end non-public
investment fund. Despite numerous inconveniences, like the need to set up a fund
association and to be supervised by KPWiG, this legal form has some advantages,
like the lack of double taxation and a possibility of acquiring capital from institutional
investors, like OFE.
Other legal forms lack these advantages. In case of National Investment
Funds: they are already present on the market, and we may at most consider their
transformation. Presently forming a new NFI and conducting PE activity is not
possible. As for the funds created under the CCCP, their serious drawback is double
taxation (limited liability company and joint-stock company) or the form of
partnerships, therefore OFE’s inability to invest in them (limited partnership and
limited joint-stock partnership).

7. CAPITAL MARKET DEVELOPMENT STRATEGY IN POLAND - AGENDA

WARSAW CITY 2010

On 27/04/2004 the Council of Ministers adopted the Capital Market Development

Strategy - Agenda Warsaw City 2010214, containing a project to create a leading CEE
capital market in Poland by 2010. The Agenda’s timeline correlates with Lisbon
Strategy. The document was prepared by the Ministry of Finance in close co-
operation with KPWiG, GPW, CeTO, KDPW, KNUiFE and NBP as well as the
financial markets.

Pursuant to the Agenda, by 2010 in Poland there should be a large, liquid and safe
capital market, contributing both to removing capital gap especially for SMEs and to
co-financing EU-funded investment.

The project also focuses on private equity investment development (the document
mentions venture capital sector), needed to support innovativeness of the Polish
economy and OPF and investment funds looking for broader spectrum of
investments, to invest their assets more efficiently on the domestic market. Creating

213
After A.Kornasiewicz, Venture capital w krajach rozwiniętych i w Polsce, CeDeWu, Warszawa, 2004, page
207
214
Agenda Warsaw 2010 and its timeline can be found at: www.mf.gov.pl
a possibility for them to invest in private equity and in infrastructure will allow the fund
assets to support Polish economy.

The agenda also allows a possibility of tax solution favoring long-term investments.

8. BARRIERS TO PE DEVELOPMENT IN POLAND

The area of limited development of the PE market has always been a matter of
interest for the Polish Capital Investors Association, created also to promote and
represent PE funds in Poland. A.Kornasiewicz215 also analyzed the barriers here by a
survey, conducted in 2003 among PE fund representatives in Poland. The barriers
that appeared most often in the survey are:
a. low quality of managers in Polish companies,
b. weak development of the capital market,
c. small supply of attractive technological solution with market potential,
d. double taxation (income of a PE fund and of a dividend),
e. lack of climate to popularize PE funds.

J.Rogoziński216 similarly conducted a survey among PE funds representatives in

„nasz Rynek Kapitałowy” monthly and published an essay on that 217. The limitations
in PE investments are, according to PE funds representatives, of the following
nature:
a. supply-related (low share of domestic PE sources);
b. institutional (no state support for SMEs on PE market);
c. regulational (lack of sensible legal regulation and lengthy administrative
proceedings).
The results of the survey218 conducted by the author (March-April 2004) among 13PE
funds representatives in Poland support a majority of the abovementioned limitations
(see Table 6.10). The questions concerned more development factors for PE funds in
Poland, instead of limitations thereto, however basing on answers given we may
deduce that the barriers include:
a. no possibility of capital allocation in PE by large institutional investors like the
open pension funds or insurance companies ;
b. no legal and organizational framework for PE funds ;
c. capital accessibility barrier for SMEs ;
d. low efficiency of the regulated market;
e. no support mechanism for small seed funds;
f. little supply of attractive investments from a PE fund point of view.

Table 6.10.
The most important factors of developing private equity funds in Poland
No Factor of developing private equity funds in Poland Number of hits

215
Kornasiewicz A., Venture capital w krajach rozwiniętych i w Polsce, CeDeWu, Warszawa, 2004, p. 224. The
author acquired 22 completed surveys, that is around 70% of funds operating in Poland.
216
Rogoziński J., Sonda nRK: Bariery rozwoju rynku private equity / venture capital w Polsce, no 7(151), July
2003
217
Rogoziński J., Ograniczenia rozwoju rynku private equity / venture capital w Polsce, „nasz Rynek
Kapitałowy” no 7(151), July 2003.
218
In a survey the author had 13 surveys returned out of 27 sent.
 n =13
1 Allowing domestic institutional investors (like open pension funds, 9
insurance companies) investing in PE funds
2 Stronger promotion of peculiarities of PE investments and ways the funds 7
function among entrepreneurs
3 Defining the investment vehicle for PE funds in legal and tax-related areas. 6
Updating of limited joint-stock partnership following limited partnership
model
4 Further improvement of the economic situation helping to increase the 5
number of portfolio companies
5 Money supporting growth of Polish companies within EU assistance 4
programs, decreasing barriers of accessing capital (including subsidies for
investment memoranda, for employing a financial advisor, for due
diligence)
6 Increasing efficiency of the stock exchange 4
7 Creation of a support mechanism for small seed funds, investing in small 3
companies at their early stage
8 Increase of supply of attractive investments 3
Source: Own work basing on surveys

9. SUGGESTED INSTITUTIONAL, LEGAL AND ORGANIZATIONAL

CHANGES IN POLAND

The activity of private equity funds in Poland calls for institutional, legal and tax
changes following the example of countries with mature market economies. For the
last 14 years in Poland this sector has been undergoing bottom-up development, and
the capital contributed to private equity funds has been provided predominantly by
foreign institutional investors, such as pension funds, insurance companies, banks
and government agencies. Most private equity funds operating in Poland are
registered abroad (e.g. in the US state of Delaware, in Great Britain on the Channel
Islands). In order to set up mechanisms of this market on the foundation of Polish
realities, it would be necessary to consider the following changes:
1. Changes to investment regulations.
2. Changes to the tax law.
3. Development of governmental capital schemes.
4. Stimulation of the development of the network of business angels.

9.1. CHANGES TO INVESTMENT REGULATIONS

Changes to investment regulations in Poland should:

a. render it possible for national institutional investors (such as open pension funds
and insurance companies) to invest in private equity funds;
b. define the investment vehicle for private equity funds from the legal and tax
point of view; amend the construction of the Polish limited joint-stock partnership
as the investment vehicle (modelled on the limited partnership);
c. raise open pension funds’ investment limit in investment certificates;
d. promote private equity investments among investment advisors to institutional
investors;
e. stimulate the emergence of alternative private equity providers in the form of
funds of funds, which serve as financial intermediaries between institutional
investors and private equity funds.

All around the world open pension funds are an important element in the
development of the capital market, and in some countries (USA, UK) they are the
largest provider of capital to private equity funds in terms of value.
In the 1970s and early 1980s in the USA pension funds were allowed under the
Employment Retirement Income Security Act by virtue of the “prudent man rule” to
allocate capital in risky investments, including private equity funds. Other countries
followed in the USA’s footsteps.
In Denmark, Ireland and the Netherlands pension funds may invest in private equity
funds without limitations.219 Just like the USA and Great Britain, those countries apply
the “prudent man rule”.
In other member states of the “old” European Union (with the exception of France,
which until November 2002 had no pension fund system) the legislator allows
pension funds to allocate assets in private equity funds within set investment limits,
e.g. up to 5% in Austria and 10% in Spain.220
Since the reform of the Polish pension system, pension funds have become the
largest institutional investor on the Polish capital market. As at the end of December
2003 assets managed by open pension funds amounted to PLN 45.4 billion 221, which
marked an increase by 43% as compared to 2002. The amount of PLN 44.2 billion
constituted the investment portfolio of the funds, which comprised allocation classes
listed in Table 6.11.
Table 6.11
Investment Portfolio of Open Pension Funds as at the End of 2003
Share in
Allocation Class Value in PLN billion
%
Bonds 26,280,865 59.4%
Shares in companies listed on the regulated stock
14,292,023 32.3%
exchange market
Bank deposits and bank securities 1,698,871 3.8%
Treasury bills 1,719,962 3.9%
Shares in the National Investment Fund (NFI) 45,331 0.1%
Other allocations 195,779 0.4%
Total 44,232,831 100.0%
Source: Insurance and Pension Funds Supervisory Commission (KNUiFE), www.knuife.gov.pl <0

Chart 6.3 presents forecasted value of the portfolio of open pension funds (net
assets) for the years 2004-2010.

Chart 6.3

219
On the basis of: Benchmarking European Tax & Legal Environments. Indicators of Tax & Legal
Environments Favouring the Development of Private Equity and Venture Capital in European Union Member
States, EVCA, March 2003. The study encompassed 15 EU member states.
220
Op.cit.
221
Yearbook of Insurance and Pension Funds 2003, www.knuife.gov.pl
 Net Assets in 2003 and Forecast for the Years 2004-2010
in PLN Billion (Basic Variant)

180.0 167.9
160.0 148.1
140.0 129.7
120.0 112.5
96.6
100.0
79.5
80.0 62.7
60.0 44.2
40.0
20.0
0.0
2003 2004 2005 2006 2007 2008 2009 2010

Source: Insurance and Pension Funds Supervisory Commission (KNUiFE)

The Act on Organisation and Operation of Pension Funds and the Ordinance of the
Council of Ministers222 allow Polish open pension funds to invest up to 10% of their
assets in investment certificates223 (both introduced and not introduced224 to public
trading), which may be issued by closed-end investment funds (in the light of the Act
on Investment Funds of May 2004). A certain novelty is that open pension funds are
allowed to invest in investment certificates not introduced to public trading (up to 10%
of the portfolio value). However, they may not invest in shares of Polish private
companies and be partners in LPs225.
According to P. Sieradzan226 the main reasons why open pension funds do not invest
in private equity funds are:
a. lack of private equity funds whose legal form would allow open pension funds
to allocate assets in such funds.
As already mentioned, on the market there has appeared the first closed-end private
investment fund (in the light of the new Act on Investment Funds). At the end of
October 2004 it offered for sale investment certificates addressed also to open
pension funds.
b. manner of measuring investment results of open pension funds, which have
to calculate their rates of return for the last 36 months and report them to the
Insurance and Pension Funds Supervisory Commission (KNUiFE) twice a year
(at the end of March and September).
This is a new regulation, in force since 1st April 2004, but pension funds are still
under pressure to achieve good short-term results. Earlier open pension funds had to

222
Act of 28th August 1997 on the Organisation and Functioning of Pension Funds (Polish Journal of Laws Dz.U.
1997, No. 139, item 934) and Ordinance of the Council of Ministers of 27 th July 2004 amending the ordinance
on the establishment of the maximum share of assets of an open pension fund that may be invested in individual
allocation classes and additional limitations applying to the allocation activity of pension funds.
223
Polish Journal of Laws Dz.U. 1997, No. 139, item 934, Article 141 item 7
224
This may be a closed-end private investment fund.
225
Many private equity funds in Poland operate in the form of LPs.
226
Sieradzan P., Dlaczego OFE nie inwestują w private equity? [in:] Tamowicz P., Rynek kapitału ryzyka w
Polsce, Polish Lisbon Strategy Forum (PFSL), Blue Books 2003, pp. 47-51
calculate and report to KNUiFE their rates of return for the last 24 months once a
quarter.
c. insufficient information policy pursued by many funds as regards their earlier
achievements and the realised rates of return.

It is only fair to agree with the suggestion of P. Sieradzan 227 that further deregulation
of the investment activity of open pension funds and elimination or lengthening of the
period for which the minimum rate of return is calculated would encourage open
pension funds to engage more actively in the private equity market.

Insurance Companies
Just like pension funds, insurance companies are very important providers of capital
to private equity funds. In Poland this sector does not yet invest free cash in
private equity funds.
Insurers are obliged under the law228 to keep assets that cover their technical
provisions, which may be invested exclusively within the scope provided for in the
said law. Only 10% of the value of those provisions may be allocated in stock not
admitted to public trading on the regulated market and in shares in other securities
with a variable yield rate. An insurance company may engage maximally 5% of the
value of its technical provisions in securities and loans due to a single payee.
As at the end of 2003 there were 74 entities and 4 main branch offices licensed to
pursue insurance activity. In 2003 their technical reserves amounted to PLN 50.7
billion (increase by 13.2% in relation to 2002).229 This amount comprised the following
items:
a. technical reserves in the amount of PLN 32.1 billion on account of life insurance
contracts (increase by 17.7% as compared to 2002);
b. technical reserves in the amount of PLN 18.6 billion on account of property
insurance contracts (increase by 6.1% as compared to 2002).
In 2003 allocations of insurance companies totalled PLN 58.5 billion (increase by
16.5% as compared to 2002), PLN 50.7 billion of which constituted the
aforementioned provisions and PLN 7.8 billion were additional funds from equity
allocated in the insurance companies’ fixed assets (cf. Table 16.12).

Table 6.12
Structure of Basic Types of Allocations of Insurance Companies in Poland in
2003
in PLN
Specification %
billion
Debt securities and other fixed-income securities 43.05 73.59
Term deposits 2.34 3.99
Participation units and investment certificates in trust
1.18 2.02
funds
Shares in related entities 2.35 4.03
Other shares 2.91 4.97
Loans 0.13 0.22

227
Op.cit, p. 52
228
Act of 22nd May 2003 on Insurance Activity (Polish Journal of Laws Dz.U. 2003, No. 124, item 151)
229
Insurance and Pension Funds Market in 2003, KNUiFE
Buildings and structures 0.49 0.84
Remaining allocations 0.23 0.39
Allocations of funds on account of life insurance
contracts in the case of which the allocation risk is 5.82 9.96
borne by the insurance holder
Total 58.50 100.00
Source: Insurance and Pension Funds Supervisory Commission (KNUiFE), www.knuife.gov.pl<0

Banks
According to the law230 banks may allocate their free assets in companies whose
shares are admitted and not admitted to public trading as well as in investment
certificates issued by investment funds. They may also serve as partners in limited
partnerships and limited joint-stock partnerships. Legal regulations do not specify any
investment limits231.
Private equity funds satisfy the requirements of Article 4 item 7 of the said law, so
they are considered financial institutions and amounts invested in them are not taken
into account for the purpose of calculating the value by which an entity exceeded the
capital concentration threshold232.
Few private equity funds operate in Poland taking advantage of the available legal
and organisational forms. There are some exceptions like the National Investment
Funds (NFI) (joint-stock companies), MCI Management S.A., Górnośląski Funduszu
Restrukturyzacyjny S.A., Krakowskie Centrum Inwestycji S.A. and bank subsidiaries,
e.g. Hals Sp z o.o. and PBK Inwestycje Sp z o.o. All remaining funds are registered
abroad and operate as investment limited partnerships, e.g. Poland Investment Fund
LP.
Creation of an appropriate (tax transparent) investment vehicle would certainly
attract Polish institutional investors. Currently only National Investment Funds are
exempted from income tax on capital gains.
On 1st July 2004 the new Act on Investment Funds came into effect233. It
defines a new fund type, that is the private investment fund, which renders it possible
to realise the goals of private equity funds.
The limited partnership is the prevailing organisational and legal form among private
equity funds in the USA and United Kingdom. Also in Sweden, the Netherlands,
Ireland, Finland and Germany private equity funds may operate as limited
partnerships.234
This is why amending the construction of the Polish limited joint-stock
company as an organisational and legal structure dedicated to private equity funds
would be a favourable solution making it possible to register funds in Poland.235
The execution schedule of the Strategy for Development of the Capital Market in
Poland (Agenda Warsaw City 2010) provides, among other legislative changes, for

230
Act of 29th August 2002 – Banking Law (Polish Journal of Laws Dz.U. 2002, No. 72, item 665, as amended)
231
Sobańska K., Sieradzan P., Inwestycje private equity/venture capital, KeyText, Warszawa, 2004, p. 311
232
Op.cit.
233
Act of 27th May 2004 on Investment Funds (Polish Journal of Laws Dz.U. of 2004, No. 146, item 1546).
234
On the basis of: Benchmarking European Tax & Legal Environments. Indicators of Tax & Legal
Environments Favouring the Development of Private Equity and Venture Capital in European Union Member
States, EVCA, March 2003.
235
Alicja Kornasiewicz proposes a similar solution in: Kornasiewicz A., Venture capital w krajach rozwiniętych
i w Polsce, CeDeWu, Warszawa, 2004, p. 262
granting the limited joint-stock company the right to render investment consultancy
and investment portfolio management services.236
In developed economies the activity of private equity funds is not subject to any
supervision or state control. Granting the limited joint-stock company the status of an
investment company would require adapting accounting principles and tax
regulations. It would be also necessary to separate the function of the management
company and the fund as well as specify the principles of taxing this kind of activity
with VAT. 237

A specific feature of the Polish private equity fund market is a low supply of national
capital. If it was possible to establish special agents (alternative private equity
providers) in the form of funds of funds, this tendency could change. At this point it is
worth to mention the draft law on the National Capital Fund238 (KFK), which is
supposed to act as such an investor and provide capital funds investing in innovative
Polish entrepreneurs or companies pursuing research and development activity with
financial means.

KFK will be established by Bank Gospodarstwa Krajowego S.A. Apart from operating
income, the revenues of KFK will include: earmarked subsidies from the State
Treasury stipulated in the budget act, funds from the European Union budget, other
non-refundable funds from foreign sources and other income. Pursuant to the draft
law, the National Capital Fund may provide financial support to capital funds by way
of:
a. taking over and purchasing their shares;
b. purchasing their investment certificates or participation units;
c. purchasing their bonds;
d. non-refundable aid for financing a part of the costs incurred by capital funds for investment
preparation and monitoring of their investment portfolios.

This initiative is unquestionably a very positive development; however, it will be

crucial for the Supervisory Board of the National Capital Fund to select experienced
investment managers for the Investment Committee (5-7 persons) who will
render―against payment―consultancy services for projects to be granted financial
support.
Copernicus Private Equity Fundusz Inwestycyjny Zamknięty is also willing to
fulfil the function of a fund of funds. In autumn 2004 this fund strived
(unsuccessfully) to acquire capital by selling investment certificates that were
intended to be traded publicly at the Warsaw Stock Exchange.

9.2. TAX CHANGES

Suggested tax changes could consist in:
a. cutting the capital gains tax (in particular on dividend) charged to individual
investors;
b. abolishing double taxation for private equity funds operating as limited liability
companies or joint-stock companies;
c. releasing funds from VAT on account of management fees and capital gains.

236
Agenda Warsaw City 2010 and its execution schedule are available at www.mf.gov.pl.
237
Op.cit.
238
Draft Act on the National Capital Fund was adopted by the Council of Ministers on 11 th August 2004,
www.mg.gov.pl.
9.3. DEVELOPMENT OF GOVERNMENTAL CAPITAL SCHEMES
Capital schemes should cover the following areas:
a. utilisation of public funds as a leverage for private financing (modelled on SBIC
in the USA);
b. development of public capital schemes for the purpose of reducing the capital
gap at early stages of enterprise development (lack of seed capital);
c. employing private managers to manage public and public-private capital funds;
d. continuous assessment of the efficiency of investments made by public and
public-private funds.

The Sectoral Operational Programme “Improvement of the Competitiveness of

Enterprises” is planned to be launched within the framework of the European
Regional Development Fund (ERDF). According to Priority 1 (Measure 1.2) the
amount of EUR 174 million is supposed to be allocated for the improvement of
accessibility to external financing of enterprises’ investments. This amount is to
distributed among the following three forms of support: contribution of capital to local
and regional loan funds, guarantee funds and seed capital funds.
It is forecasted that seed capital funds will be established by interested financial
institutions and management companies classified as entities from the public finance
sector. Shareholders of the funds will be banks, quasi-banks, entrepreneurs, regional
institutions, etc. Initially the investors will be territorial and local self-governments
acting in cooperation with supporting organisations, foundations and educational
institutions. The scheme provides for establishment of at least 5 seed capital funds,
and the capital will be provided in the form of subsidies through the Polish Agency for
Enterprise Development (PARP).
Funds will make capital investments in enterprises at early stage of
development, i.e. in the phase of research and product development or upon its
completion, but before commercial sale of the product has been initiated239.
Similarly as in the case of the National Capital Fund, also for seed capital
funds it will be crucial to hire experienced investment managers who will allocate
equity in portfolio companies at early stages of development.

9.4. STIMULATION OF THE DEVELOPMENT OF THE NETWORK OF

BUSINESS ANGELS
Activity in this area may encompass:
a. creating local and regional networks of business angels, whose goal would be to
match up private equity funds with entrepreneurs looking for capital;
b. establishing cooperation between business angels and technological incubators,
higher education institutions and research and development units;
The Polish Business Angles Network (PolBAN), which is a branch of the European
Business Angels Network (EBAN), has been operating only since 2003. Some of its
objectives are:
a. to search for and support business angels in Poland;
b. to promote private capital investments in promising business enterprises at early
stages of development;
c. to create conditions for closing the capital gap that enterprises tend to
experience in the initial phase of development;
239
Por. (draft) Ordinance of the Minister of Economy and Labour on detailed terms of taking over shares with
aid funds granted by the Polish Agency for Enterprise Development (PARP), draft of 20 th August 2004
d. matching investment projects, particularly those in which intellectual capital is of
essence, with capital from individual investors240.
PolBAN could certainly use some aid from public funds, especially as regards
promotion among entrepreneurs. It operates as an on-line platform (just like AC-Net
in the USA); entrepreneurs and individual investors (business angels) send
applications via the Internet. However, it is also worth to consider establishing local
or regional networks.

As pointed out by interviewed investment managers, promotion is a very

important aspect of the functioning of private equity funds. Although private equity
funds have been operating in Poland already for 14 years, entrepreneurs are not very
familiar with their activity. Many entrepreneurs still believe that banks and bank loans
are the only source of capital for business development.
As pointed out by K. Sobańska and P. Sieradzan241, the fact that Polish
entrepreneurs still do not grasp how private equity funds really work finds its
confirmation in experiences of P. Miller, President of the Management Board of NFI
Piast, who until recently was asked by entrepreneurs after his presentation: “OK, but
what is the interest rate on this loan?”242.
In 2002 there was established the Polish Private Equity and Venture Capital
Association (PSIK). Its main objective is to promote knowledge on private equity
funds. PSIK, which already associates 29 ordinary members being the leading
players on the Polish private equity market, publishes annual industry yearbooks (so
far there have appeared yearbooks for 2002, 2003).
For two years PSIK has organised in cooperation with IBnGR, under the patronage of
“Puls Biznesu”, the National Forum Venture Capital in Warsaw, which enjoys a large
interest among entrepreneurs.
“Puls Biznesu” daily newspaper publishes four times a year a supplement
“Road to Capital” devoted among others to private equity funds, and “Nasz Rynek
Kapitałowy” monthly newspaper launched in 2004 a special section on the private
equity market.
However, the author agrees with K. Sobańska and P. Sieradzan 243 that these
initiatives will not replace a public relations policy, which must be developed and
implemented by funds themselves.
A good example of an initiator of such undertakings is MCI Management S.A.,
which since 2001 has been organising together with Biznes Net S.A. conferences
“TMT Executive Seminar”. The aim of these meetings is to educate and integrate
managerial staff from TMT (Technology, Media & Telecommunications) firms and
companies from outside this sector which are interested in acquiring knowledge on
applying modern technological solutions in enterprises and forming business
alliances244. On the other hand, representatives of MCI have the possibility to
promote venture capital investments and search for attractive investment
opportunities. Another interesting initiative of MCI are the Post-Graduate Studies in
Business Restructuring and Venture Capital-Backed Business Development
organised in cooperation with the Wroclaw School of Banking.

240
Objectives listed at www.polban.pl.
241
Op.cit, p. 363
242
Rogoziński J., Sondan R.K., Bariery rozwoju rynku private equity/venture capital w Polsce, „Nasz Rynek
Kapitałowy”, nr 7(151), lipiec 2003
243
Op.cit, p. 364
244
www.mci.com.pl/konferencje.html
Summary

Private equity market has been functioning in Poland for 14 years. During that time it
has undergone bottom-up development. In this period private equity funds have
acquired ca. EUR 5 billion. A large part of the investment capital was provided by
foreign institutional investors. Funds have invested EUR 2.2 billion in over 600
companies in Poland (which accounts for 3% of the value of foreign direct
investments in Poland until 2003245), and EUR 2.1 billion in companies in other
Central and Eastern European countries, such as the Czech Republic, Slovakia,
Hungary and Rumania.
The market may be divided into the following segments:
a. small funds based on aid funds and government (foreign) funds;
b. funds based on capital provided by (national and foreign) private institutions:
funds established by banks, based on the Mass Privatisation Programme (PPP),
funds continuing investment activity initiated mainly in 1994.
c. supra-regional funds operating in the whole Central and Eastern Europe
(also in Poland).
The Polish Private Equity and Venture Capital Association (PSIK) established in
2002 associates 29 ordinary members (funds and fund management companies),
thus representing a majority of investors from this industry.
As at 31st October 2004 private equity funds in Poland had invested PLN 5.7 billion in
234 companies. Most capital was invested by funds managed by Enterprise Investors
(slightly over PLN 2 billion allocated in 38 enterprises), followed by Ballinger Capital
(PLN 0.75 million allocated in 12 enterprises) and Adwent International (PLN 0.5
million allocated in 6 enterprises).
The market of business angels, i.e. individual investors, has also been
emerging in Poland. In 2003 there was established the Polish Business Angels
Network (PolBAN), whose aim is to promote and organise investments of business
angels.
However, an analysis of the data for the years 2000-2003 demonstrated that in
the said period:
a. the value and share of venture capital in the aggregate private equity
diminished;
b. the value and share of capital for financing management buy-outs increased;
c. replacement capital246 constituted a considerable part of private equity.
In Poland there is a large diversity among portfolio companies, i.e. recipients of
private equity investments, in terms of industry. However, funds search for
enterprises from niche, yet promising sectors.
As demonstrated by the EVCA studies, in the years 2000-2001 the industries
that enjoyed the greatest popularity were: telecommunications, industrial goods and
consumer goods. In 2003 funds’ investment portfolios were dominated by companies
representing the telecommunications, consumer goods and financial services
sectors.
In the years 2000-2003 funds sold 135 and liquidated 24 portfolio companies.

245
According to the Polish Information and Foreign Investment Agency (PAIiIZ) until 2003 FDI amounted to
ca. USD 72 billion.
246
Replacement capital includes: second share purchase, capital replacement and bank loan refinancing.
 It seems that the most appropriate structure for the purposes of establishing
private equity funds are the organisational forms set forth in the Polish Act on
Investment Funds, more specifically the closed-end investment fund, including the
private investment fund. Two major flaws of funds incorporated on the basis of the
Polish Code of Commercial Companies and Partnerships are: double taxation (in the
case of limited liability company and joint-stock company) and the form of a
partnership (in the case of limited partnership and limited joint-stock partnership),
which precludes open pension funds from investing in such entities.
According to investment managers from private equity funds operating in
Poland, the major barriers to expansion of the private equity market in our country
are as follows:
a. no possibility for large institutional investors, such as open pension funds and
insurance companies, to allocate capital in private equity funds;
b. lack of an appropriate organisational and legal structure for private equity funds;
c. an existing barrier preventing small and middle enterprises to gain access to
capital;
d. low efficiency of the stock exchange market;
e. lack of a mechanism supporting small seed capital funds that invest in young
enterprises at early stages of development;
f. low supply of attractive investment undertakings from the point of view of private
equity funds.

The activity of venture capital funds in Poland calls for institutional, legal and tax
changes following the example of countries with mature market economies.
In order to set up mechanisms of this market on the foundation of Polish realities, it
would be necessary to consider the following changes:
1. Changes to investment regulations:
 rendering it possible for national institutional investors (such as open pension
funds and insurance companies) to invest in private equity funds;
 defining an investment vehicle for private equity funds from the legal and tax
point of view; amending the construction of the Polish limited joint-stock
partnership as the investment vehicle (modelled on the LP);
 raising open pension funds’ investment limit in investment certificates;
 promoting venture capital investments among investment advisors to
institutional investors;
 stimulating the development of alternative venture capital providers in the form
of funds of funds, which serve as financial intermediaries between institutional
investors and venture capital funds.
2. Changes to the tax law:
 reducing the capital gains tax (in particular on dividend) charged to individual
investors;
 abolishing double taxation for private equity funds operating as limited liability
companies or joint-stock companies.
 releasing funds from VAT on account of management fees and capital gains.
3. Development of governmental capital schemes:
 utilising public funds as a leverage for private financing (modelled on SBIC in
the USA);
 developing public capital schemes for the purpose of reducing the capital gap at
early stages of enterprise development (lack of seed capital);
 employing private managers to manage public and public-private capital funds;
 continuous assessment of the efficiency of investments made by public and
public-private funds.
4. Stimulation of the development of the network of business angels:
 creating local and regional networks of business angels whose goal would be to
match private equity funds with entrepreneurs searching for capital;
 establishing cooperation between business angels and technological incubators,
higher education institutions and research and development units.

CONCLUSION
The private equity market is one of the youngest segments of the capital market, but
its significance for the economy is increasingly appreciated by creators of the
industrial policy all around the world on the supra-national (e.g. European
Commission), national (e.g. USA, Israel, Germany) and regional (e.g. Silicon Valley
in California) level. The importance of private equity funds for the economy finds its
reflection in the following aspects:
a. creating new technologies (e.g. biotechnology, information and communication
technology),
b. stimulating expansion of stock exchanges by introducing shares of companies
focused on value increase to public trading;
c. generating new jobs and wealth among fund managers, entrepreneurs and
employees;
d. offering equity and managerial capital to portfolio companies.

An analysis of the most developed private equity markets, i.e. in the USA and the
UK, demonstrated that its expansion would have been impossible without
government support. Involvement of governments in the creation and development of
the private equity market consisted in:
 introducing favourable investment regulations rendering it possible for pension
funds and insurance companies to invest in private equity funds;
 introducing tax incentives for individual investors (e.g. a low capital gains tax);
 launching capital schemes (e.g. SBIC in the USA) engaging public and private
funds which were subsequently allocated in small and middle enterprises not
listed on the stock exchange;
 creating networks of business angels (e.g. AC-Net on-line platform in the USA),
whose goal was to match up individual investors with entrepreneurs searching
for capital;
 launching OTC markets (NASDAQ in the USA, Alternative Investment Market in
Great Britain), which were characterised by more liberal admittance conditions
for high-growth small and middle enterprises.

An analysis of demand and supply factors on the venture capital market in the USA
proved that market changes were to the largest degree contingent upon the following
three aspects:
a. the level of IRR offered on the market for investments in portfolio companies;
b. government decisions (e.g. adoption of the Act on SBIC allowing pension funds
to invest in venture capital funds, no tax on capital gains realised by pension
funds on account of investments in venture capital funds);
c. new technological solutions (microchips, Internet, biotechnology,
nanotechnology).

A comparative analysis of private equity markets revealed that both in the USA and
in Europe (also in Poland) financing of management buy-outs enjoys an ever growing
popularity, in particular after 2000, when private equity funds sustained severe
losses. In this period most investments were made in new companies from the ICT
and Internet industry. Bursting of the “Internet bubble” resulted in a strong correction
of share prices, which in consequence led to a drop in the value of investment
portfolios of private equity funds. Private equity funds generated higher rates of
return on the USA market than in Europe. In the course of 20 years:
a. venture capital funds in the USA achieved rate of return at the level of 15.5%
(as compared to 7.2% in Europe);
b. funds financing management buy-outs achieved in the USA rate of return of
12.4% (as compared to 12.2% in Europe);
c. private equity funds in the USA achieved for all types of investments rate of
return of 13.6% (as compared to 9.9% in Europe).
The most popular disinvestment methods among private equity funds in the USA are
sale of shares in portfolio companies through an IPO and trade sale, although since
2000 the number of IPOs has considerably dropped. In 2003 the most popular
disinvestment method in Europe in terms of value was trade sale (20.4%), followed
by sale to another private equity fund (20.2%).
Private equity market has been functioning in Poland for 14 years. During that
time it has undergone bottom-up development. In this period private equity funds
have acquired ca. EUR 5 billion. A large part of the investment capital was provided
by foreign institutional investors. As at 31st October 2004 private equity funds in
Poland had invested PLN 5.7 billion in 234 companies.
The present work demonstrated (on the basis of questionnaire studies, case
studies and literature studies) that apart from equity private equity funds operating in
Poland contribute to their portfolio companies also the so-called management capital,
i.e. a variety of additional benefits thanks to which they can create value of portfolio
companies. Management capital provided by investment partners of private equity
funds comprises:
a. strategic planning/consultancy,
b. assistance in finding a strategic investor (financial or industry investor),
c. owner’s supervision over the enterprise’s on-going activity and implementation
of financial control and budgeting systems,
d. development of financial control and budgeting systems,
e. assistance in selection, choice, evaluation and acquiring additional sources of
financing,
f. access to databases of national and foreign commercial contacts,
g. assistance in the process of searching for managers at various stages in the
company’s development,
h. promotion/lobbing for the portfolio company,
i. strengthening and consolidating the company’s market position,
j. support in the process of transforming the company’s organisational and
corporate structure in the process of company value creation.
According to investment managers from private equity funds operating in Poland, the
major barriers to expansion of the private equity market in our country are as follows:
a. no possibility for large institutional investors, such as open pension funds and
insurance companies, to allocate capital in private equity funds;
b. lack of an organisational and legal structure for private equity funds;
c. an existing barrier preventing small and middle enterprises to gain access to
capital;
d. low efficiency of the stock exchange market;
e. lack of a mechanism supporting small seed capital funds that invest in young
enterprises at early stages of development;
f. low supply of attractive investment undertakings from the point of view of private
equity funds.

Private equity funds may play an important part in the economy by stimulating high-
tech industries. However, their activity requires institutional, legal and tax changes
modelled on countries with mature market economies. In order to set up mechanisms
of this market on the foundation of Polish realities, it would be necessary to consider
the following changes:
1. Changes to investment regulations:
 rendering it possible for national institutional investors (such as open pension
funds and insurance companies) to invest in private equity funds;
 defining the investment vehicle for private equity funds from the legal and tax
point of view; amending the construction of the Polish limited joint-stock
partnership as the investment vehicle (modelled on the LP);
 raising open pension funds’ investment limit in investment certificates;
 promoting venture capital investments among investment advisors to
institutional investors;
 stimulating the development of alternative venture capital providers in the form
of funds of funds, which serve as financial intermediaries between institutional
investors and venture capital funds.
2. Changes to the tax law:
 reducing the capital gains tax (in particular on dividend) charged to individual
investors;
 abolishing double taxation for private equity funds operating as limited liability
companies or joint-stock companies;
 releasing funds from VAT on account of management fees and capital gains.
3. Development of governmental capital schemes:
 utilisation of public funds as a leverage for private financing (modelled on SBIC
in the USA);
 developing public capital schemes for the purpose of reducing the capital gap at
early stages of enterprise development (lack of seed capital);
 employing private managers to manage public and public-private capital funds;
 continuous assessment of the efficiency of investments made by public and
public-private funds.
4. Stimulation of the development of the network of business angels:
 creating local and regional networks of business angels whose goal would be to
match private equity funds with entrepreneurs searching for capital;
 establishing cooperation between business angels and technological incubators,
higher education institutions and research and development units.
LIST OF TABLES, DIAGRAMS, FIGURES AND CHARTS
Tables
Table 1.1 Characteristics of business development stages
Table 1.2 Share of PE investments, market capitalization, R&D
expenditure in GDP in 20 countries.
Table 1.3 Ranking: share of PE investments, market capitalization,
R&D expenditure in GDP in 20 countries.
Table 1.4 Impact of venture capital investments on sales and employment
in the USA between 1970-2000
Table 1.5 Venture capital investment index in relation to R&D expenditure
at US manufacturing companies
Table 2.1 Comparison of venture capital funds in 1997 and 2003 in the
USA
Table 2.2 Comparison of buyout funds in 1997 and 2003 in the USA
Table 2.3 Pooled IRR247 for US private equity funds for the period until
31 December 2003 All funds created between 1969-2003
(PEPI)
Table 2.4 Venture capital investments by stages (in %)
Table 2.5 Number of venture capital investments by stages (in %)
Table 2.6 Venture capital investment recipients in the USA (in %)
Table 2.7 Number of venture capital investments by sectors
Table 2.8 SBIC financing between 1995-2001
Table 2.9 Private equity invested by European countries between
2000-2003
Table 2.10 Net Internal Rate of Return on private equity fund
investments in Europe for 31/12/2003. All funds created
between 1980-2003.
Table 2.11 Comparison of Internal Rate of Return (IRR) of European private
equity funds (since establishment) with indices of the European
stock market (bonds and equities). CLN Index method (put
forward by Coller, published by Long and Nickels).
Table 2.12 Private equity investments in Europe by segments
Table 2.13 PE investment recipients in Europe by sectors
Table 2.14 Investment exit strategies in Europe between 2000-2003
Table 3.1 Description of Individual Types of Investors in Private Equity
Funds
Table 3.2 Types of Due Diligence
Table 3.3 Disinvestment Methods
Table 4.1 Types of Private Equity Funds
Table 4.2 Additional Functions of Private Equity Investors
Table 4.3 Comparison of the Median of Age Upon IPO for Selected
Companies Using and Not Using Venture Capital in the USA

247
Pooled IRR – aggregated Internal Rate of Return calculated jointly for all funds covered by the survey. Cash
flows from each fund are added together, just as the values of their assets, and treated as if pertaining to one fund
(after Sobańska K., Sieradzan P., ibidem)
Table 4.4 Preconditions that Must be Met by a Prospective Portfolio
Company
Table 4.5 Main Expectations of Private Equity Funds towards Portfolio
Companies
Table 4.6 Type of Involvement of the Studied Private Equity Funds
Table 4.7 Additional Benefits Offered by Private Equity Funds to Portfolio
Companies
Table 4.8 Key Elements of the Owner’s Supervision
Table 4.9 Functions Fulfilled by Investment Partners in Portfolio
Companies
Table 5.1 Polfa Kutno S.A. share sale mode on 4 January 1995
Table 5.2 Specification of total share stake in Polfa Kutno SA purchased by
EI funds
Table 5.3 Stomil Sanok cash flow statement in 1998-2003
Table 5.4 Consolidated cash flow statement: EI’s investment in Polfa Kutno
(calculation in PLN)
Table 5.5 Consolidated cash flow statement: EI’s investment in Polfa Kutno
(calculation in USD
Table 5.6 Calculation of net IRR on EI’s investment in Polfa Kutno SA
Table 5.7 Competition between Ivax and Recordati for Polfa Kutno SA
Table 5.8 Forecasts of sales revenues and net profit for Polfa Kutno S.A.
Table 5.9 Stomil Sanok cash flow statement in 1998-2003
Table 5.10 Consolidated cash flow statement: EI’s investment in Stomil
Sanok (calculation in PLN)
Table 5.11 Consolidated cash flow statement: EI’s investment in Stomil
Sanok (calculation in USD)
Table 5.12 Financial benefits for funds managed by Enterprise Investors
Table 5.13 Comparison of price per 1 share on the date of companies’
floating on the WSE, on the date of EI funds selling the last share
stake in the companies and on 16 July 2004
Table 5.14 Comparison of OPM, NPM and ROE for the selected companies
against the industry median
Table 5.15 Specification of financial ratios for the analysed companies
compared to the decil distirbution for the industry
Table 6.1 Phases of development and types of private equity funds in
Poland
Table 6.2 Managers / private equity funds in Poland (members of the
Polish Private Equity and Venture Capital Association) as of
31/10/2004
Table 6.3 Characteristics of fund managers / private equity funds in Poland
Table 6.4 Geographical origin of private equity in Poland
Table 6.5 Capital acquired by VC funds operating in Poland in 2000-2003
according to type of investors
Table 6.6 Investments according to sectors – Poland
Table 6.7 Number of companies receiving private equity in Poland in 2000-
2003
Table 6.8 Types and value of private equity funds disinvestments in 2000-
2003
Table 6.9 Number of companies, in which the funds finished their
investments in 2000-2003
Table 6.10 The most important factors of developing private equity funds in
Poland
Table 6.11 Investment Portfolio of Open Pension Funds as at the End of
2003
Table 6.12 Structure of Basic Types of Allocations of Insurance Companies
in Poland in 2003

Figures
Figure 3.1 Private Equity Investment Process
Figure 3.2 Organizational Structure of a Private Equity Fund (Limited
Partnership)
Diagrams
Diagram 3.1 Simplified Model of the Private Equity Market
Diagram 3.2 Relations between Private Equity Funds and Institutional
Investors and Portfolio Companies
Charts
Chart 1.1. Life cycle of a typical company funded with private equity
Chart 1.2. Global private equity – invested and acquired
Chart 1.3. Private equity (acquired and invested) in North America, Western
Europe and Asia-Pacific
Chart 1.4. Number of new stock exchange companies with venture capital
Chart 2.1 Private equity acquired and invested by the funds between 1990
- 2003
Chart 2.2 Acquired and invested PE between 1990 - 2003 broken down
into buyouts and venture capital
Chart 2.3 Acquired and invested PE between 1990 – 2003, broken down
into buyouts and venture capital
Chart 2.4 Average size of VC funds in the USA in USD million
Chart 2.5 Average size of buyout funds in the USA in USD million
Chart 2.6 Average value of venture capital funds in the USA (in USD
million)
Chart 2.7 Average value of buyout funds in the USA (in USD million)
Chart 2.8 Annual percentage changes in average weighted portfolio
valuation for venture capital and buyout funds created between
1969-2003 in the USA
Chart 2.9 Financial benefits for limited partners in US venture capital and
buyout funds measured in USD million
Chart 2.10 Cumulative IRR for venture capital funds created between 1980-
2002 in the USA (“vintage year”)
Chart 2.11 Annual cumulative IRR for buyout funds created between 1980-
2002 in the USA (“vintage year”)
Chart 2.12 5-year IRR (%) for venture capital buyout funds against private
equity funds and S&P 500 Index
Chart 2.13 Number of disinvestments (IPO, trade sale) for venture capital
funds in the USA (in number of transactions)

Chart 2.14 Disinvestments: IPO and Trade Sale in USD billion

Chart 2.15 Private equity in Europe received and invested by funds between
1990-2003
Chart 2.16 Venture capital, buyout capital and replacement capital in Europe
Chart 2.17 Average value of venture capital fund portfolio in Europe (in
USD million)
Chart 2.18 Average value of buyout fund portfolio in Europe (in USD
million)
Chart 2.19 Comparison of cumulative rate of return of PE funds in the USA
and Europe since starting date (31/12/1979)
Chart 4.1 Relative Performance of Venture Capital-Backed
and Non-Venture Capital-Backed Initial Public Offerings
Chart 5.1 Appraisal of Polfa Kutno SA share value by brokering house
analysts in 2003
Chart 5.2 Polfa Kutno employment level 1997-2003
Chart 5.3 Polfa Kutno net sales revenues in 1998-2003
Chart 5.4 Polfa Kutno S.A. EBIT and net profit 1998-2003
Chart 5.5 Polfa Kutno S.A. assets and equity in 1998-2003
Chart 5.6 Polfa Kutno Earnings per Share (EPS) ratio in 1998-2003
Chart 5.7 Polfa Kutno price per share (minimum, maximum, at year end) in
1998-2003
Chart 5.8 Polfa Kutno market capitalisation to sale (MC/S) ratio in 1998-
2003
Chart 5.9 Polfa Kutno S/A price to book value (P/BV) ratio in 1998-2003
Chart 5.10 Polfa Kutno operating profit margin (OPM) in 1998-2003
Chart 5.11 Polfa Kutno S.A. net profit margin (NPM) in 1998-2003
Chart 5.12 Polfa Kutno S.A. ROE in 1998-2003
Chart 5.13 Index of Polfa Kutno’s share price in the period 1 January 2004-
30 June 2004
Chart 5.14 Stomil Sanok SA net sales revenues
in 1993-2003
Chart 5.15 Stomil Sanok SA EBIT and net profit in 1993-2003
Chart 5.16 Stomil Sanok SA assets and equity in 1993-2003
Chart 5.17 Stomil Sanok S.A. earnings per share (EPS) ratio in 1993-2003
Chart 5.18 Stomil Sanok price per share (minimum, maximum, at year end)
in 1997-2003
Chart 5.19 Stomil Sanok S.A. market capitalisation to sales (MC/S) ratio in
1997-2003
Chart 5.20 Stomil Sanok S.A. price to book value (P/BV) ratio in 1997-2003
Chart 5.21 Stomil Sanok S.A. operating profit margin in 1993-2003
Chart 5.22 Stomil Sanok S.A. net profit margin in 1993-200
Chart 5.23 Stomil Sanok S.A. ROE in 1993-2003
Chart 5.24 Stomil Sanok share index in the period 10.07.2002 – 16.07.2004
Chart 5.25 Eldorado S.A. net sales revenues in 1999-2003
Chart 5.26 Eldorado S.A. EBIT and net profit in 1999-2003
Chart 5.27 Eldorado S.A. assets and equity in 1999-2003
Chart 5.28 Eldorado S.A. earnings per share (EPS) ratio in 1999-2003
Chart 5.29 Price per share (minimum, maximum, at year end) for Eldorado
SA in 2002-2003
Chart 5.30 Eldorado S.A. market capitalisation to sales (MC/S) ratio in 2002-
2003
Chart 5.31 Eldorado S.A. price to book value (P/BV) ratio in 2002-2003
Chart 5.32 Eldorado S.A. operating profit margin in 1999-2003
Chart 5.33 Eldorado S.A. net profit margin in 1999-2003
Chart 5.34 Eldorado S.A. ROE in 1999-2003
Chart 5.35 Price index of Eldorado S.A. in the period 18.07.2002 –
16.07.2004
Chart 5.36 Grupa Kęty SA net sales revenues in 1996-2003
Chart 5.37 Grupa Kęty SA EBIT and net profit in 1996-2003
Chart 5.38 Grupa Kęty SA assets and equity in 1996-2003
Chart 5.39 Grupa Kęty SA earnings per share (EPS) ratio in 1996-2003
Chart 5.40 Price per share (minimum, maximum, at year end) for Grupa
Kęty SA in 1996-2003
Chart 5.41 Grupa Kęty S.A. market capitalisation to sales (MC/S) ratio in
1996-2003
Chart 5.42 Grupa Kęty S.A. price to book value (P/BV) ratio in 1996-2003
Chart 5.43 Grupa Kęty S.A. operating profit margin in 1996-2003
Chart 5.44 Grupa Kęty S.A. net profit margin in 1996-2003
Chart 5.45 Grupa Kęty S.A. ROE in 1996-2003
Chart 5.46 Grupa Kęty SA share price index
Chart 6.1 Capital acquired and invested by private equity funds operating
in Poland in 2000-2003
Chart 6.2 Segments of private equity invested in Poland in 2000-2003
Chart 6.3 Net Assets in 2003 and Forecast for the Years 2004-2010
in PLN Billion (Basic Variant) )
BIBLIOGRAPHY
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UNPUBLISHED MATERIALS AND PAPERS

1. Analiza rynku venture capital w Polsce. Raport końcowy opracowany przez
IBnGR commissioned by Polska Agencja Rozwoju Przedsiębiorczości w
Warszawie, November 2001
2. Freear J., Sohl J.E., Wetzel W.E., The informal venture capital market:
milestones passed and the road ahead, paper for the conerence entitled 4th
Entrepreneurship Research Conference, Kansas City, Missouri, 9-11 Maj 1996
3. Klonowski D., Venture Capital in Poland: A method of financing Polish
enterprises – summary of doctoral accomplishments, SGH, 2000
4. Matthews D., Financing innovation: appraising and investing in small
technology-based firms, material presented during European Commission
workshops on the transfer of innovations and technologies in Europe, Rome,
28/11/1994
5. Venture capital jako źródło finansowania inwestycji dla małych i średnich
przedsiębiorstw, SYGMA Sp. z o.o., material for the 3rd SME Conference in
Warsaw 16-17 June 1999
6. Davila A., G.Foster, M.Gupta, Venture capital Financing and the Growth of
Start-up Firms, Research Paper No. 1667, Stanford University
7. Venture capital incentives in Europe. Europe Private Equity Special Paper.
October 1997
8. Kenney M, Han K, Tanaka S, Scattering Geese: The Venture Capital
Industries of East Asia. A Report to the World Bank, Brie Working Paper 146,
September 17, 2002
9. European Roundtable of Industrialists (ERT), 1998, Job Creation and
Competitiveness through Innovation (Bruksela : ERT).
10. Bygrave B., Building an entrepreneurial economy: lessons from the United
States. Business Strategy Review, no. 9, 1998
11. Lewton T., Missing the target: assessing the role of government in bridging the
European equity gap and enhancing economic growth [in:] Venture capital,
vol. 4, no. 1, 7-23, 2002
12. BVCA, The Economic Impact of Venture Capital in the UK, Bannock
Consulting report, London 1997
13. EVCA, The Economic Impact of Venture capital in Europe. Coopers & Lybrand
Corporate Finance report, 2000

YEARBOOKS AND STATISTICAL MATERIALS

1. The Market for Insurance and Pension Funds in 2003, KNUiFE
2. EVCA Yearbook 2004, Annual Survey of Pan-European Private Equity &
Venture Capital Activity
3. Polish Private Equity and Venture Capital Association, yearbook 2002 and
2003
4. Global Private Equity 2001,2002, 2003, Price Waterhouse Coopers
5. European Private Equity, Investment Benchmarks Report 2001, Thomson
Financial / Venture Economics 2001

LEGAL ACTS AND OTHER DOCUMENTS

1. Act of 29/08/1997, “Banking Law”, Dz.U. 2002, no. 72, Item 665 as amended
2. Act on Investment Funds of 27/05/2004, Dz.U. of 2004 r. no. 146, Item 1546
3. Act of 22/05/2003 on Insurance Activity, Dz.U. of 2003, no. 124, Item 151
4. Act of 28th August 1997 on the Organization and Fuctioning of Pension Funds
5. Regulation of the Council of Ministers of 12/05/1998 (Dz.U. of 26/05/1998, no.
63, Item 407)
6. Thomson Venture Economics, Jesse Reyes, Vice President, Benchmarking
Private Equity in Today’s Environment, 10/09/2003

ON-LINE RESOURCES
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an empirical analysis of venture capital contracts, 2000, National Bureau of
Economic Research Working Paper, www.nber.org/papers/w7660
2. European Economy, Supplement A – Economic Trends, Nr 8/9 Sierpień /
Wrzesień 2000, http://europa.eu.int/comm/economy_finance
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Private Equity (CF), NBER Working Paper,
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(CF PR), NBER Working Paper, www.papers.nber.org/papers/w8773
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NBER Working Paper, www.papers.nber.org/papers/w8954
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Economy (EFG PR), NBER Working Paper,
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Evidence from Venture Capitalist Analyses (CF), NBER Working Paper,
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Knowledge: University Science, Knowledge Capture, and Firm Performance in
Biotechnology (PR), NBER Working Paper,
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Working Paper, www.papers.nber.org/papers/w8066
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Entrepreneurship (PE), NBER Working Paper,
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Bear Fruit?: Evidence from the SBIR Program (IO PR), NBER Working Paper,
www.papers.nber.org/papers/w7877
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Real World: An Empirical Analysis of Venture Capital Contracts (CF),NBER
Working Paper, www.papers.nber.org/papers/w7660
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Working Paper, www.papers.nber.org/papers/w6906
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Securities: Evidence from Venture Capital (CF),NBER Working Paper,
www.papers.nber.org/papers/w6847
17. Kortum Samuel, Lerner J., Does Venture Capital Spur Innovation? (CF PR),
NBER Working Paper, www.papers.nber.org/papers/w6846
18. Gompers Paul A., Lerner J., The Determinants of Corporate Venture Capital
Successes: Organizational Structure, Incentives, and Complementarities (CF),
NBER Working Paper, www.papers.nber.org/papers/w6725
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Working Paper, www.papers.nber.org/papers/w2832
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characteristics of private equity, NBER Working Paper,
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WEBSITES

1. www.nvca.com – North Venture Capital Association

2. www.evca.com – European Venture Capital & Private Equity Association
3. www.ppea.org.pl – Polish Private Equity and Venture Capital Associatoon (PSIK)
ANNEX

SCHEDULE 1: 30 most influential private equity deals in history

Year Company name Industry Private equity type

1957 Fairchild Semiconductor, USA Integrated circuit board manufacturer Venture capital

1957 Digital Equipment Company, USA Later computer networks manufacturer Venture capital

1980 Applied Molecular Genetics, USA Biotechnology Venture capital

1982 Gibson Greeting Cards, USA Greeting card manufacturer LBO

1988 Reedpack, UK Manufacturer of non-paper packaging and office LBO

consumables

1989 Isosceles, UK Retail LBO, mezzanine

1989 Nabisco, USA Food industry LBO

1990 Lexmark, USA Typing machines manufacturer LBO

1992 Snapple, USA Beverages and juices manufacturer MBO

1992 Continental Airlines, USA Airline Turnaround

1994 Netscape, USA Web browser Venture capital

1995 Reed Regional Newspapers, UK Media industry Acquisition

1996 Angel Trans, UK Leasing company: railway Privatisation

1996 Autonomy, UK Corporate software manufacturer Venture capital

1996 Norte, Argentina Retail LBO

1996 Porterbrook, UK Leasing company: railway Privatisation

1996 eToys, USA Online toys sale Venture capital

1997, Seat Pagine Gialle, Italy Telephone directory manufacturer LBO

2003

1998 Regal, USA Cinema chain LBO

1998 Boo.com, USA Online clothing sale Venture capital

1999 Honsel, Germany Automotive light parts manufacturer Takeover

1999 SLEC / Formula One, Switzerland Car racing organiser Acquisition

2000 Seagate, USA Computer disk drive manufacturer Venture capital

2000 Rover, UK Car manufacturer Takeover

2000 XO Communications, USA Telecom operator PIPE

2000 Shinsei, Japan Bank Acquisition

2001 Homebase, UK Retail, construction market Takeover

2002 National Car Parks, UK, Scotland Services, car park management LBO

2002 Yellow Pages Group, Canada Telephone directory manufacturer Takeover

2004 BTC, Bulgaria National telecom operator Privatisation

Source: Private Equity International, 26.06.2004, The 30 most influential private equity deals
 SCHEDULE 2
European companies: private equity receipients. Case study.

No. Company Country Date of Employment Revenues Industry, Name of the investor fund Total investment value. Disinvestment Added value for the private
name operation characteristics equity beneficiary
start Investment history.

1 AbaXX Germany March 1999 150 persons no data Supplier of modern 3i Group Plc, Accenture, Earlybird, EUR 38.5 million in three financing Assistance in recruiting the
Technology AG in 2002 e-CRM and General Atlantic Partners rounds former president of Oracle
website In 1999 abaXX acquired EUR 2.5 million Europe to the post of abaXX
management (1st financing round) from 3i, Earlybird and a Supervisory Board Chairman.
software German government agency through TBG
(Technologie-Beteiligungsgesellschaft). Assistance in expanding to new
markets in Europe and USA.
In 2000, the company acquired further
EUR 18 million from General Atlantic Assistance in devising a
Partners (GAP), Accenture (2nd round). restructuring plan as a result of
In December 2000, due to the cancellation of cancelling the IPO.
abaXX’s IPO, GAP provided the company with
additional capital of EUR 18mn. The reason for
cancelling the IPO was the bad situation on the
global equity markets.

2 Actelion Switzerland 1997 500 persons EUR 43.3 Research and 3i, Atlas Venture, Genevest, EUR 34.6 million (+ a bank loan of EUR 6.3mn) IPO at the Swiss New Assistance in recruiting
Pharmaceuticals in many million in 2001 development, Sofinnova, TVM and Wellington obtained in two rounds of financing. Market Exchange in talented scientists.
Ltd countries in marketing of Partners Zurich on 6.04.2002.
Europe as The forecast pharmaceutical In April 1998, the company acquired EUR 10.9 19x oversubscription Assistance in estimating the
well as in for 2002 is mixtures million for building new laboratories and its R&D in IPO. demand for development
Australia, EUR 64mn connected with program from a group of funds including Atlas capital and in determining the
Canada, USA, vascular Venture, Sofinnova, 3i, TVM, Genevest (1st The company financing structure.
Japan and endothelium round). obtained EUR
Brazil 764.5mn.
In March 1999 the company obtained further
EUR 30mn, of which EUR 23.7 million as equity In September 2002
and EUR 6.3m as a bank loan. Actelion changed
floors to the SWX
main trading floor,
expanding its investor
base.

3 Dartfish Switzerland 1998 50 persons, EUR 2.7 Advanced digital CIMA Corporate Investement and EUR 11.8 million in three rounds of financing. Assistance in trading contacts.
branch office million in 2001 image processing Management Affentranger Holding SA,
in USA, 2 Initiative Capital (BCV), Intel Capital, In 1998, Dartfish founders acquired seed capital Strategic consulting.
franchisees in Nomura (Terra Firma), Renaissance, in the amount of EUR 0.435 million from the
South Korea
 and Australia Venture Partners AG, private investors local development agency. They themselves
invested additionally EUR 0.311mn. In 1999
Dartfish obtained EUR 1.4 million from Venture
Partners AG and other private investors (1st
round). A part of that money was allocated to the
repayment of debt towards the agency.

In October 2000, Intel Capital, Nomura

International and Venture Partners AG invested
EUR 7.6 million in the company (2nd round).

In June 2002 the company obtained EUR 2.8

million (3rd round) for the development of its
distribution network and a marketing campaign.

4 Detection Finland 1992 44 persons EUR 4.5 Producing silicone 3i Group Plc, Start Fund of Kera Oy EUR 5.9 million in two rounds of financing. IPO planned for 2004 Assistance in trading contacts,
Technology Oy million in 2001 radiation sensors or 2005. constructing business plans,
and diodes In the 1st round of financing, the company market research.
obtained EUR 0.9 million of equity and loan
capital. In August 2001, it acquired EUR 5
million (2nd round).

5 Genmab A/S Denmark 1999 111 persons Creating and Apax Partners, BankInvest Group, EUR 54.6 million in four rounds of financing. IPO at the Assistance in company growth,
growing human Dansk Erhvervsinvestering A/S, Index Copenhagen Stock recruiting members of the
antibodies using Ventures, Lombard Odier, Exchange and Neuer Supervisory Board, Scientific
transgenic Lonmodtagernes Dyrtidsfond A/S, Markt in October Advisory Board, Management
technologies Medarex 2000. Board.

Assistance in trading contacts.

6 Giga A/S Denmark 1998 160 persons EUR 26.7 Developing and Dansk Erhvervsinvestering A/S, Dansk USD 2.0 million in various rounds of financing. Share sale to Intel in Assistance in recruiting the
in March million in 1999 manufacturing Kapitalanlaeg A/S, Lonmodtagernes 2000 for EUR 1.3 company’s president. Legal
2000. technologically Dyrtidsfond, NKT Holding A/S billion and accounting consulting.
advanced chips

7 Immuno-Designed France, 1993 117 persons Developing and Alta Partners, Apax Partners, Atlas EUR 66mn: seed fund, venture capital, private Assistance in trading contacts.
Molecules (IDM) Canada, manufacturing Venture, AXA Private Equity Banexi, placement
S.A. USA cellular therapy Bank Vontobel, Biotechnology
drugs Turnaround Fund, BNP, Caisse de
Pensions du Cern, CDC Innovation
Partners, Clal Biotechnology
Industries, Compagnie Lebon, IMH,
Medarex, Musuri, Paribas, Pechel
Industries and Sofinnova
8 LaserBit Hungary 1999 57 persons in Developing and Hungarian Innovative Technologies EUR 7.4 million in two rounds of venture capital Access to market information
Communications 2001. producing free- Fund, Intel Capital, Sandler Capital, financing. and information on competition.
Corp. space optical Technologieholding CEE Funds Assistance in recruiting key
lasers, data and persons to the Management
video transmission and Supervisory Board.
systems;
telecommunication Strategic consulting.
s equipment for
optical networks

9 Morphochem AG Germany 1996 100 persons Integrating modern 3i Deutschland, Alta Berkeley EUR 78 million in four rounds of private equity Assistance in developing the
chemistry with bio- Associates, Alta California Partners, financing. company from a small entity
and Bankhaus Julius Bar, Bionex into an international capital
chemoinformatics; Investment, Domain Associates, IKB group.
chemical genomics Venture Capital, KB Lux, Life Sciences
platform providing Partners, Mayfield Fund, Merlin
new drugs. Biosciences, Nomura (Terra Firma),
Sud VC, TBG Deutsche
Ausgleichsbank, TVM, Viscardi AG,
WestLB, private investors

10 No Wires Needed Holland 1992 60 persons Developing 3Com, Gilde IT Fund, Kennet Capital, EUR 7.6 million in two rounds of venture capital Share sale to Intersil Strategic and financial
wireless networks Parnib Converging Technologies, financing. for ca. EUR 158 consulting.
(WLAN) private investors million in 2000.

11 Novuspharma Italy 1997 Original oncologist 3i Italy, Atlas Venture, Sofinnova EUR 18 million in seed capital. In November 2000, Assistance in recruiting key
S.P.A therapies Partners the company scientists. Strategic consulting.
obtained EUR 155 at
the Nuovo Mercato in
Milan.

12 Tiscali S.P.A Italy 3000 persons Internet provider, Kiwi I Ventura Servicos S.A. with EUR 2 million in seed capital. IPO at the Nuovo
website, e- consulting provided by Pino Venture Mercato in Milan in
commerce Partners October 1999.
services,
communication
services

13 Dr Solomon’s Great 1991 Anti-virus software. 3i Group Plc, Apax Partners EUR 18.1 million at MBO IPO on Nasdaq and
Group PLC Britain Easdaq (Nasdaq
Europe) in November
1996.

14 Flomerics Group Great 1980 Software for heat MTI Partners, private investors EUR 1.1 million in one round of financing. IPO at the Alternative
PLC Britain analyses and Investment Market in
electronic projects London in 1995.
15 Innogenetics NV Belgium 1985 580 persons Discovering and Alta Berkeley Venture Partners, Baring EUR 21 million in two rounds of financing and IPO on Nasdaq and
in Belgium, developing Hambrecht Ventures, Eurocontinental private placement. Easdaq (Nasdaq
France, diagnostics and Ventures, GIMV, JAFCO, Kredietbank Europe) in November
Germany, therapeutical 1996.
Italy, Spain, products
USA and
Central
Europe

16 Maconomy AS Denmark 1988 Developing ERP 3i Denmark, Gilde IT Fund, J&W EUR 4.1 million in several rounds of financing. IPO in December
software for Seligman & Co, Paul Capital Partners, 2000 at the
people-oriented PPU Software, Star Ventures, Vertex Copenhagen Stock
companies Management Exchange

17 SCM Germany 1990 520 people in Solutions ensuring Alpinvest (NIB Capital Private Equity), EUR 1.5 million in 2 rounds of financing and IPO on Nasdaq and
Microsystems Inc. 8 countries swift and secure Genevest Consulting Group, Telenor EUR 7 million obtained in 1993 and 1995 Neuer Markt in
(Europe, Asia, electronic data Venture AS, TVM Techno Venture September and
North control Management GmbH, Vertex October 1997
America) Management

18 Seagull Holding Holland 1990 200 persons Software. Advanced Technology Ventures, Gilde EUR 2 million in one round of financing. IPO on the
BV Amsterdam Stock
Exchange (currently
Euronext) in February
1999.

19 Soitec France 1992 Manufacturing Banexi Ventures, Innovacom EUR 2.44 million in two rounds of financing. IPO at the Nouveau
silicon-insulated Marché in Paris in
chips February 1999

Source: Own study based on: European Technology Success Stories, European Private Equity & Venture Capital Association, September 2002
SCHEDULE 3
Venture capital industry lifecycle in USA and Israel
Stage Israel USA

Conclusion  VC: USA follower;  VC industry devised and created in the

USA, now a global leader to be
 Depending on VC industry in the USA; followed by other global markets;

 Duration of the initial stage and VC industry  Duration of the initial stage and VC
appearance stage: 11 years; industry appearance stage: 26 years;

 Creation of the VC industry stimulated by  Creation of the VC industry stimulated

industrial policy; by the market;

 VC not consolidated yet.  Industry consolidation in early 1980s.

Growth 1970-1989 1930-45

conditions
 External technological development;  Development of aviation and
electronics industry;
 R&D opportunity increase;
 WW2 created demand for high
 Liberation of the capital market and technologies delivered by universities
macroeconomic stabilisation; (R&D);

 Expansion of the first US global  Cooperation between universities and

technological corporations to Israel; the industry;

 First official VC company in Israel creates  Growing awareness for the need to
a new start-up model. support small and medium-sized
enterprises;

 Discussion on the VC industry needs.

Policy
Policy
 Large-scale government R&D
 Specified R&D grants become a expenditures;
government policy;
 Small technological companies as
 BIRD program promoting Israeli and US subcontractors for government
companies in the field of R&D procurements.

Preliminary stage 1989-1992 1945-57

 Further technological revolution;  Creating professionally managed VC

organisations connected with affluent
 Considerable immigration of qualified families;
employees;
 Creating ARD, the first non-family-
 Several VC funds entering the market and owned VC organisation;
creation of new start-ups;
 Increasing approval for
entrepreneurship as a professional
career path;

 US technological companies beginning

to dominate all over the world;

 Attracting the best foreign students to

215
 US universities;

Policy

Policy  GI Act resulting in a wave of well-

educated graduates;
 Government insurance for the state-financed
VC-Inbal program (1992); launching the  Further significant investments in R&D.
technological incubator;

 Changes in the tax regulations and company

law.

VC industry 1993-2000 1958-72

creation stage
 Opportunity to hold an IPO on NASDAQ for  First VC organisation of the limited
non-American and yet unprofitable young partnership type (DGA, launched in
companies; 1958);

 New opportunities in the software,  Creation of new companies;

telecommunication and other industries;
 Development of the semiconductor
 limited partnerships a dominating form of VC and minicomputer industry within the
organisations; USA;

 Israeli Venture Association founded (IVA  Launch of the NASDAQ in 1971 and
1996) Intel shares listing;

 The advantage of the limited

partnership model for VC
organisations over others grows;

 Corruption within the scope of the

SBIC program;

 VC organisations leave the SBIC

Policy program and continue as limited
partnerships.
 Specific policy focused on creating VC
organisations (Yozma 1993); Policy

 Further grants for R&D, developing  SBIC program;

technological incubators.
 Strong growth of investments in R&D;

 Large-scale electronic equipment

purchases by the arms industry

Crisis stage in 2000 - ? 1972-80

the industry
 Strong decline in share prices at the  Creation of NVCA in 1973 and
WSE; lobbying for policy amendment;

 Crisis on the global market and in the  Expanding the „prudent man”
high-tech industry; principle to pension funds leads
ultimately to the lack of possibility
 Considerable drop in the value of to obtain investment capital by
obtained capital; VC funds from these investors;

 End of the exit path from investments  1974-78: low value of capital
for VC funds (Q3 2001); obtained by VC funds.

 Negative impact of the second

Intifada;

 Global slow-down in the high-tech

216
 industry;

 Lack of opportunity for disinvestment

through IPOs, mergers or
acquisitions;

 Salary reductions for engineering

personnel;

 Several VC funds close down with

losses.

Policy

 No taxation for foreign investors;

 Attempts to encourage domestic

pension funds to invest in VC funds;

 Creating a VC seed fund sponsored

by the government;

 Development of biotechnology (Nofar

program and technological
incubators) and nanotechnology;

 Declining grants for R&D.

Consolidation 2003- 1980 –

stage
VC managers from Israel successful in other  private equity assets are for good
countries. included in the investment
portfolio of institutional investors;

 Pension funds and other

institutions become the largest
investors;

 Successful IPOs of Genentech

and Apple

 High-tech industry reorienting

from the arms industry to civilian
industry;

 limited partnership becoming the

dominating form of VC funds’
operation.

Policy

 Regulation loosening in 1978

(ERISA) results in pension funds
again investing in VC funds;

 Reducing the capital gains tax

rates (CGT)

Source: Avnimelech G., Kenney M., Teubal M., Building Venture Capital Industries: Understanding the
US and Israeli Experiences, BRIE Working Paper 160, March 2004.

217
SCHEDULE 4
DEFINITION OF INDUSTRIES BENEFITING FROM VENTURE CAPITAL IN THE USA
This industry focuses on technology promoting the development of
drugs and treatment methods. Biotechnology of humans, animals
and industrial biotechnology: products and services. It also
Biotechnology encompasses bioreceptors and pharmaceutical equipment.

This industry offers products and services for business, i.e.

Business products and advertising, consulting, engineering services. It also encompasses
services distributors, importers and wholesalers.

Manufacturers and distributors of personal computers, servers,

portable computers, printers, monitors, memory cards. This
industry encompasses also suppliers of digital designing services
Computers and peripherals and graphic services as well as the relevant equipment.

Products or services for consumers, i.e. restaurants, cleaning

Consumer goods and services services, car repairs, clothing, toiletries.

Electronic parts used as components for large products and

specialist equipment, i.e. lasers, tools for research purposes. The
industry encompasses also calculators, photocopiers, alarm
Electronics/ Instruments systems.

Financial services providers for business and natural persons, i.e.

banking, insurance services, financial planning, real estate
Financial services agencies.

Hospitals, clinics, nursing services, other healthcare entities,

Healthcare services medical partnerships, childcare.

Manufacturers and distributors of energy, chemicals, raw

materials, industrial automation enterprises, oil and gas
Energy corporations.

Providers of computer and Internet services for business and

individuals, i.e. computer repairs, software consulting, e-
IT services commerce services, security, data processing.

Manufacturers and suppliers of media and entertainment services

for consumers, i.e. films, music, consumer electronics, sports
Media and entertainment equipment, sports events, recreational products and services.

Manufacturers and/or sellers of medical instruments and medical

Medical instruments and diagnostics tools used for medical therapies, patient monitoring,
equipment etc.

Suppliers of data transmission networks, e.g. optical fibres, WAN,

Networks and equipment LAN, hubs, routers and related services.

Providers of goods and services subject to retail sales, e.g. in

hypermarkets, supermarkets, pharmacies, clothing stores,
computer hardware stores, bookstores. This industry
Retail/ distribution encompasses also Internet companies.

Semiconductors Designing, developing and manufacturing chips, microprocessors

and equipment using diodes and transistors. This industry

218
 encompasses also companies testing integrated circuits.

Producers of computer software for business and individuals, i.e.

operating systems, graphic programs, educational applications,
games. This industry encompasses also specialised software for
Software the banking sector, industry, forwarding companies, etc.

Companies focusing on voice and data transmission. This industry

Telecommunications encompasses landline and mobile telecommunications.

Others Not classified under the abovementioned industries.

Source: Own work based on the research by PricewaterhouseCoopers/Thomson Venture

Economics/National Venture Capital Association (www.pwcmoneytree.com)

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SCHEDULE 5
OVER-THE-COUNTER MARKETS IN OECD COUNTRIES

Market name Country, city Launch Number of IPOs Number of listed companies Share of market capitalisation
date in GDP (%)

1999 2000 2001 2002 1999 2000 2001 2002 1999 2000 2001 2002

North America
248
NASDAQ USA, New York 1971 485 397 63 40 4 829 4 734 4 109 3 725 56,5 36,9 28,9 16,5
249
Canadian Venture Exchange Canada, Toronto 1999 2425 403 330 122 2 358 2 598 2 688 2 504 1,7 10,2 12,7 9,7

Europe

O-List Sweden, Stockholm 1988 - - 24 9 150 228 240 235 28,3 24,0 23,3 18,5

Alternative Investment Market Great Britain, London 1995 67 203 109 78 347 524 629 704 1,5 1,6 1,2 1,0

Le Nouveau Marché France, Paris 1996 32 52 9 2 111 158 164 154 1,1 1,7 1,0 0,5

Euro-Nm Belgium Belgium, Brussels 1997 6 3 - - 13 16 - - 0,3 0,2 - -

Euro-Nm Amsterdam Holland, Amsterdam 1997 1 2 - - 13 15 - - 0,3 0,2 - -

250
Neuer Markt Germany, Frankfurt/Main 1997 132 132 11 1 201 338 326 240 5,7 6,0 2,4 0,5

Nuovo Mercato Italy, Milan 1999 6 32 5 0 6 40 45 45 0,6 2,2 1,2 0,6

EASDAQ Belgium, Brussels 1996 - - - - 56 62 - - - - - -

NM List Finland, Helsinki 1999 - - - - - 17 16 15 - 0,7 0,3 0,2

248
As at the end of October 2002.
249
Data covers both the shares of companies ensuring potentially high profits and the shares in investment funds.
250
Neuer Markt was closed in late 2003.

220
 251
Austrian Growth Market Austria, Vienna 1999 - - - - 2 2 - - 0,01 0,01 - -

SWX New Market Switzerland, Zurich 1999 6 11 1 0 6 17 15 9 - 3,0 0,9 0,2

Dansk AMP Denmark, Copenhagen 1999 3 0 1 3 3 3 4 7 0,1 0,1 0,1 0,1

Nuevo Mercato Spain, Madrid 2000 - - - - - 12 - 14 - 3,4 - -

SMB List Norway, Oslo 1992 3 7 7 3 78 77 79 79 4,2 1,8 1,5 1,2

ITEQ Ireland, Dublin 2000 - - - - - 7 8 8 - 3,6 1,7 0,7

252
Nasdaq Europe Belgium, Brussels 2001 - - - - - - 49 43 - - - -

Asia

Herkules Japan, Osaka 2000 - - 43 - - - 32 - - - 0,3 -

Mothers Japan, Tokyo 1999 2 27 7 8 2 29 - - 0,2 0,1 - -

KOSDAQ South Korea, Seoul 1996 160 250 181 176 453 604 721 843 22,0 5,6 9,5 5,0

Source: Baygan Günseli, Venture Capital Policy Review: United States, STI Working Paper 2003/12, p.13, OECD

251
Since spring 2001 AGM is a part of the Vienna Stock Exchange and has been functioning. Companies listed on AGM where transferred to the stock exchange segment
under the name Specialist Segment.
252
In 2001 Nasdaq Europe purchased a majority stake in EASDAQ.

221
SCHEDULE 6
Examples of completed private equity investments in Central and Eastern Europe
No Country Industry Invested capital Investment IRR for Multiplier Investment
. Company name stage Investor’s name investors period

1 @Entertainment Poland Media. Cable TV operator USD 66mn Development Advent International Over 40% no data 1996-1999
capital (leader), Copernicus Capital,
Innova Capital

2 Avonmore Paszto Hungary Food processing. Hungary’s EUR 2.2mn MBO Euroventures Hungary, 53% 2,4 1997-1999
largest diary producer. Equinox (affiliated with
Advent)

3 Brewery Holdings Romania Brewing industry USD 28mn Development Advent International, Jupiter no data 4,2 1996-2000
capital Asset Management, Oresa
Ventures

4 Casu Alus Latvia Brewing industry EUR 216,600 Turnaround Norway-Latvia Business 297% 3,4 1997-1999
Development Fund

5 ComputerLand Poland Computer sales USD 4mn Partial buyout Enterprise Investors 148% 7,4 1994-1997
and
development
capital

6 Czech On Line Czech Internet, telecommunications EUR 6.4mn MBO DBG Eastern Europe 566% 31 1998-2000
Republic

7 Eldorado Poland Retail and wholesale USD 3.3mn Development Enterprise Investors 28% 2,8 1999-2003
capital

8 Elender Informatika Hungary ISP, Internet services USD 3.2mn Development Advent International, 281% 2,7 1998-1999
supplier capital Equinox

9 Enigma Hungary Mobile payments EUR 1.4mn Seed capital Euroventures Hungary, Fast 70% 2,0 2002-2004
Ventures BV

10 Euronet Worldwide Hungary Financial services USD 8.8mn Development Euroventures Hungary, 125% 11,3 1994-1997
capital Hungarian-American (Euroventur
Enterprise Fund, Innova es)
Capital, Advent International

222
11 GZ Digital Media Czech Optic disks replication EUR 7.5mn LBO Winslow Partners, Patria 40% and 1997-1999
Republic Asset Management, 45% (Patria),
Croesus 2000
(Croesus),
Winslow – in
part

12 HTL Group Poland Medical instruments USD 3mn Development European Renaissance 40% 3,0 1997-2001
manufacturer capital Capital LP (in part)

13 Hungarocamion Hungary Transport, logistics EUR 13mn MBI DBG Eastern Europe, BA 2.8 (DBG), 3.5 1998-2002
Capital Partners Europe (BA Capital
Partners)

14 Keravit Czech Ceramics manufacturer EUR 1.25mn MBO Czech Venture Partners 31% 5,4 1995-2003
Republic

15 Lukas Poland Financial services USD 15mn Development Enterprise Investors 52% 5,6 1997-2001
capital

16 Mineral / Slezske Czech Construction materials EUR 1.1mn MBI Czech Venture Partners 50% 4,1 1995-2001
izolacni zavody Republic manufacturer

17 Overseas Express Croatia Transport, logistics EUR 1.3mn Development Copernicus Capital (through 45% 3,5 2000-2003
capital Croatia Capital Partnership)

18 Polfa Kutno Poland Pharmaceuticals industry USD 14.3mn Buyout/ Enterprise Investors 23% 5,4 1995-2003
Development
capital

19 Semilab Hungary Manufacturer of EUR 0.85mn Development Euroventures Hungary, 21% 3,44 1992-1999
semiconductors components capital Hungarian-American
Enterprise Fund, Innova
Capital, Advent International

20 Slovpack Slovakia Plastic packaging EUR 1.1mn MBO Raiffeisen Ost Invest 32% 3,3 1998-2002
manufacturer

21 Spofa Dental Czech Dentistry products USD 8.9mn LBO Riverside Central Europe 24% 3,0 1998-2003
Republic manufacturer Fund

22 Stomil Sanok Poland Rubber parts manufacturer USD 8.7mn Buyout/ Enterprise Investors 25,1% 6,8 1993-2003
Development
capital

223
23 Town & City Poland Outdoor advertising USD 5mn Development Innova Capital 84% 4,0 1996-1999
capital

24 Uproar Hungary Internet USD 1mn Seed capital Euroventures Hungary 227% 6,0 1996-1998

25 Zentiva Czech Pharmaceuticals industry USD 125mn MBO Wartburg Pincus no data 5,25 1998-2004
Republic (in part)

Source: Own study based on Central and Eastern Europe Success Stories, EVCA Central and Eastern Europe Task Force, October 2004

224
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