Nothing ventured, nothing gained; a look at private equity in the Czech market
Risk capital, private equity or venture capital; whatever you choose to call it, investment in high-risk but high-yield start-up companies has been rather sluggish here, according to the Chairman of the Czech Venture Capital Association, Jaroslav Horak. According to a recent survey of the EVCA, the European venture capital association, there is plenty of room for improvement in the Czech legal and tax environment.
Let's start with the basics. Venture capital is private equity associated with start-up businesses where there is a higher rate of failure but also a promise of greater returns for investors. In a recent survey by the European Venture Capital Association (EVCA) of 21 European countries, the Czech Republic placed 15th in terms of favourability of legislation and tax regulations relating to venture capital.
So, what can you tell us, in general terms, about the conditions here on the Czech market for venture capital?
"The business has been developing here since the early 1990s. We believe that some 600 million euros have been invested in the Czech Republic. There are about 20 active funds; currently, most of the funds are regional, covering also countries like Poland and Hungary. And those funds, we think, have up to 3 billion euros to invest."
"The Czech Republic is attracting definitely less private equity than it could. Part of it is cultural, I would say — we are closer to German-speaking Central Europe than to the Anglo-Saxon countries — but part of it is also definitely about the conditions; the legal and tax environment."
"The study that you mentioned placed the Czech Republic in 15th place, which is not very encouraging. The problems that were underlined by the EVCA study included some tax problems; the tax treatment of private equity structures, efficiency of public administration, which is another set of criteria."
"On the one hand, the costs of establishing or liquidating a business are lower than the European average. However, the time that it takes to establish a business and register it, or to liquidate a business, are substantially higher. Another set of criteria where the Czech Republic didn't do very well was tax advantages for research and development."
"And finally, one thing that differentiates profoundly the environment here from Western Europe or the United States is that the funds that are active here are nearly exclusively financed by sources of external capital."
And from your point of view, has the situation improved at all since Czech entry into the European Union?
"Before the accession to the EU, the pension funds and insurance companies were basically prevented totally from investing in private equity. However, there are now some thresholds that would enable investment in private equity, but there are some other regulations which prevent it."
You mentioned Czech business culture as being one thing that's preventing venture capital from taking root here. So where does the Czech Republic sit in terms of Central Europe? You mentioned that most of these funds are regional and are exclusively backed by foreign capital. How does the climate here compare to Poland, Hungary, Slovakia...?
"I don't think that there are striking differences. I would say that Poland, obviously, is the largest market and is the market where most transactions take place. Hungary is a country where 'early-stage' and technological business seems to be stronger. The Czech Republic — we don't have enough of those funds focused on the small and technological sector. The Czech Republic traditionally had a strong industrial base so there is a potential for more industrial, private equity investments."
"When I said that the most striking difference between the Czech Republic and Western Europe is the lack of domestic capital, this holds for the three Central European countries."
"There is another striking difference, which is that we don't have an IPO [initial public offering] market as an exit route for private equity, which might, by the way, change thank's to [pharmaceutical company] Zentiva listing [on the Prague Stock Exchange]. But there is a difference between Poland on the one hand and Hungary and the Czech Republic on the other hand because the Polish IPO market is very, very active."
How much of the problem here is related to general business conditions? You mentioned the length of time it takes to start up a company and to close it down. But also, I see that a major concern is liability for the "body members" of a bankrupt firm.
"The most important obstacles are common to private equity as for any other business, which are the things like the registration courts, bankruptcy procedures and so on. There are some specific concerns for private equity business and you mentioned one, which is the responsibility of the directors."
"Normally, a fund invests in several companies and typically a director of a private equity fund is sitting on the board of five, ten companies. And statistically, at least one of those companies should go bankrupt — and if no company in the portfolio goes bankrupt, then the fund is not taking the right risks."
"So this is a real problem because under the current legal arrangement there are barriers for a board member of a bankrupt company to become a board member of other companies, which is obviously contrary to the logic of private equity."
In Czech, venture capital is usually called 'rizikovy kapital' — risk capital — which for some has a very negative connotation, bringing up the sort of 'Wild East' of the early 1990s, you know, corrupt fund managers and tunnelling of newly privatised companies and the like. Has 'risk capital' in effect been re-branded here as 'venture capital'?
"There are two issues. One of them is the image of risk capital: We like to replace this term by 'soukromy kapital' [private capital] instead of 'rizikovy kapital' in Czech, or to use 'private equity' without translating it. And it has meaning because our business is not about short-term wild speculation. It's a long-term, value-added investment."
"There were a couple of funds that added substantial value top their investments; a very deep involvement in the strategic management of the company. And we shall prove it in the later on in the year; there is a brochure to be published by the European Venture Capital Association called 'Central European Success Stories', which will show the value-added of the private equity investors in some of those companies — plus the financial success for the investors. One of those companies is going to be Zentiva, by the way."
