Tracking the history of the Hungarian venture capital market provides a glimpse of the difficulties that Eastern European countries encounter as they strive to develop more Western-style economies.
The Hungarian Venture Capital and Private Equity Association (HVCA) was formed in late 1991 with only five members. It was accepted as a member of the European Venture Capital Association (EVCA) in 1992, and simultaneously became the first Eastern European country to be surveyed in the EVCA’s Yearbook. Today the HVCA boasts a membership of 20 full members, 29 associate members and 11 individual members. The growth of the HVCA is largely due to its EVCA membership, the increasing popularity of VC in the region, and the country’s successful transition into a market economy.
In October 1993, the EVCA launched a private equity support program for Central and Eastern Europe. The program was financed by PHARE, the main channel for the European Union’s financial and technical cooperation with the countries of Central and Eastern Europe (Czech Republic, Hungary, Poland, Slovakia, the Republic of Slovenia, Romania and Bulgaria). Since adopting the acquis communautaire (guidelines for countries aiming for EU accession), PHARE has had an interest in developing the business support infrastructure in the above mentioned countries. In 1995, with additional support from PHARE, the EVCA extended the program to include Bulgaria, Estonia, Latvia, Lithuania and Romania and initiated a Country Policy Program which involved teams of private equity investors, policy makers, and other experts in seven Central European countries. The teams, in cooperation with the European Foundation for Entrepreneurship Research, analyzed market indicators for the development of a private equity investment industry in the region and produced country reports outlining prioritized action plans. These reports are available from the EVCA Secretariat.
Skeptics warn that this so-called “successful transition” has not been entirely successful, and it’s far from complete. Problems in the market include inefficient managers with minimal or no relevant experience in a VC environment.
The World Bank also concurs that the transition is not yet over, however the institution commends Hungary on its progress thus far. In its 1999 abstract on Hungary, the World Bank states, “Although far from complete, fiscal adjustment in Hungary has been successful not only in cutting the budget deficit but also in reducing less visible aspects of fiscal vulnerability. The government of Hungary has contained the main fiscal risks of the transition to a market economy. It has paid off and resolved most problems in the banking and enterprise sectors.”
HVCA President Peter Fodor firmly stands by Hungary’s stable investment environment. “By definition, venture implies risk. In 1991, when the association was formed, Hungary was on the road to political and economic sanity,” he said. Fodor added that capital investment into Hungarian enterprises was an adventure, but today Hungary has developed corporate governance. “Both the Central Bank and the capital market are the most highly regarded in the region,” he said. “It is no longer an adventure to invest in Hungary but rather a business venture.”
VC investment into Hungarian companies was minimal in the early 1990s and the lingering problems of the privatization process made the job of tracking such disbursements a difficult one. In August 1998, the domino effect of the Russian crisis put a damper on the investment environment in many Eastern European countries. The countries’ capital and equity markets were adversely affected in the immediate aftermath of the crisis, however Hungary, Poland and the Slovak Republic were insulated from any severe long-term problems due to their adaptation and affiliation with the Western economies. In fact there was a 22% increase in private equity and VC investing from $186 million in 1998 to $227 million in 1998.
Although a survey of 12 Eastern European countries revealed Hungary to be the least hit by the crisis, investments slowed down in its aftermath. In 1999, fund raising was down approximately 12% from 1998, totaling 57.7 million ($58.1 million). However 80% of that amount is expected to be allocated to VC, almost double 1998’s 42.1%. The EVCA suggests that the industry will be supported by the compulsory private pensions that were introduced in 1997, and that 2001 should see an increase in fund raising.
Indeed, the Hungarian VC industry seems to be prospering in the year 2000. The association signed on several new members, among them GE Capital and Arthur Andersen. According to preliminary numbers from Venture Economics, Hungary experienced its best year yet in the VC field. Through November, Hungary had captured 24% of investment dollars into Eastern Europe, representing 29% of the number of companies receiving VC there. Some major investors include GE Capital Equity; Dresdner Kleinwort Benson Private Equity; E.M. Warburg Pincus; Goldman, Sachs & Co. and Hungarian Innovative Technologies Fund.
It is expected that the 2000 numbers will illustrate Hungary’s comeback from the 1998 crisis. Fodor remains confident that Hungary’s skilled work force will allow it to continue to attract venture capital.
“One of Hungary’s most important [forms of] capital is intellect,” he said. “Hungary has given the World the most Nobel Prize winners per capita and now as venture capitalists we are asked to finance the offsprings of these individuals. While in Silicon Valley or Singapore creativity must be acquired, in Hungary creativity is a cultural inheritance.”
The HVCA held its second annual meeting in November, which was titled Venture Capital – A Catalyst for Change, to discuss the relationship between venture capital and private equity and the Hungarian economy.
Craig Butcher and Hubert Warsman, both of the European Bank for Reconstruction and Development, spoke on their experiences with venture investing in Hungary and Central Europe as a whole. They report that the best performance geographically has been in Hungary, with a country portfolio IRR of approximately 30%. They attribute these returns to the country’s active management and environment factors. The industries contributing most significantly to the portfolio are banking, telecommunications and pharmaceuticals, while the food processing industry has proved to be the most underperforming.
Dr. David Fisher, managing director and partner at INNOVA Capital, recommended trade sales as the most prosperous exit. He admits they are difficult, not only because trade buyers are scarce, but also because internal management of the portfolio company may object. Fisher cited several reasons why a trade sale can be even more beneficial than an initial public offering.
First, IPOs can be costly and time consuming compared to a trade sale. Secondly, an IPO requires appealing to an entire market instead of one buyer. Finally, trade buyers often not only pay a premium for a company, but often offer cash on the closing.
These factors are all magnified by the fact that the stock markets of Central and Eastern Europe are operating with a maximum of ten years of experience under their belt, a lack of experience further burdened by transition difficulties, all making for haphazard regulation and lack of liquidity. Although the Budapest Stock Exchange was the first to reopen after almost a half century hibernating behind the Iron Curtain, IPO’s accounted for only 22% of INNOVA’s 1999 Hungarian exits, while trade sales made up 56%. Butcher and Warsman agree that trade sales provide for constructive exits, stating that they are a “more conclusive and valuable source of exits than public listings.”