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A cautious venture capitalist.

How does a venture capitalist view the opportunities in Eastern Europe? What better person to ask than Alan Patricof, founder of Alan Patricof Associates, one of the largest, most international and most experienced venture capital firms. He has more than 35 years of experience in the venture capital business, has played an important role in the founding of Silicon Valley, and has helped bring the modern concept of venture capital investing to overseas markets. In the midst of raising a new pan-European fund, he had just returned from a visit to Eastern Europe when Directors & Boards met with him in his New York office to gather a few of his impressions.

I am by no means an expert on Eastern Europe, but as an observer I'd say a viable venture capital operation is not the first thing that is going to happen. There is a cycle of development that is needed.

"Venture capital is something that operates best in an environment in which there is a viable secondary market. That is a condition that is absolutely crucial. You have that in the U.S., in England, in France. There is venture capital in Belgium, Holland, Finland, Sweden, and a variety of other places. It is developing slowly in those countries, but it's surviving and, in some places, prospering. In the last year, Japan's secondary market has become much more active, so Japan is becoming more viable as a venture capital location. But Germany is not even at least stage yet. The opening of the Hungarian stock market is a first step. You may have a primary market for the 10 or 20 largest companies, but it will be a long time before you have it for the smaller companies, which is what venture capital thrives on.

"Secondly, you don't have a spirit of entrepreneurship that is readily obvious. There are a lot of people who say there is a built-up reservoir of Eastern Europeans who can't wait to start doing their own thing. I realistically believe that it is going to start with small shops first. There are lots of those. There are very active conversations in Hungary now about turning over 30,000 small businesses to the people who are running them for the state. This doesn't lend itself to venture capital.

"While I was there, I met with an independent, privately owned company doing about $10 million in sales. It was in five different businesses. It would have been very difficult to figure out how to make an investment in that company. Because there hasn't been an infrastructure of suppliers in the country or an established array of distributors, companies became totally integrated. Being totally integrated makes you less efficient, but you had no choice. You had to make the whole thing yourself. So they tend to have businesses that are not really economically viable in a competitive environment. When I looked at this company, I was trying to be creative and imaginative and think of how we could make an investment or help them. In the end, I said, |I'm not sure it really is for us.'

"The needs are so basic at the moment. The infrastructure needs are first. When you talk to people in Hungary, you'll find that they want management skills more than money. Money is not their first priority.

"The accounting is different. Also, the legal principles are not all fully established yet -- rights of ownership, transfer, repatriation, corporate structure. Plus you have inflation problems, currency risk problems, language problems. All of this will be overcome, but it's not going to happen overnight.

"I want to raise money from U.S. institutions to put over there. My guess is that the U.S. institutions will be cautious. I know if I called up my venture companies that we have financed and made a survey on which of them would want to go to Eastern Europe, I'm not sure would find one.

"What we may see is less venture capital investing more industrial joint ventures, with some private ownership locally and some subsidized capital from the U.S.

"Everyone seems to feel there is going to be a bonanza. They're going to sell all these things that are just gold mine opportunities. Well, we saw first gold mine opportunity in Tungsram. General Electric found out very quickly things it hadn't expected in terms of what the real productivity, the real profitability, and the real state of the equipment are.

"At the moment, I think it's a big-company game. The first step is the IBMs, the GMs, the Ges. GE has the resources to keep pouring money until it works. But if you have a venture deal and you run out of money, where do you go? There are no other sources of capital.

"What would worry me most about making an investment over there? How get out of it. Forget about getting your capital out, which is a problem, but how do you recycle your capital? Venture capital, as a business, needs to be able to recycle its funds. That is first and foremost.

From cradle to grave

"We say the long-term horizon of venture capital is 10 years, but realistically it's probably five to seven. Any investment in Eastern Europe would have to be a long-term investment. One of the things we have in the U.S. is an infrastructure of raising debt. Over there, once you get into the first round of financing, where are you going to go for the second round? You have to be prepared to finance these businesses from cradle to grave. If it blips, you have to have the capital to sustain it.

"I'm sure there's going to be a lot of money pumped in to try to help get businesses started, but whether the venture capital industry per se is going to be in there, I just don't know. The early cowboys got arrows in their backs from the Indians. It's going to take a brave pioneer to rush into these countries. We have been approached to go into Czechoslovakia, Hungary, Yugoslavia, Poland. I am not rushing in. I'm testing the waters and learning about what's there."
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Title Annotation:Chairman's Agenda: Acquiring in Eastern Europe; evaluation of ventures in Eastern Europe
Author:Patricof, Alan
Publication:Directors & Boards
Date:Jan 1, 1991
Previous Article:'What's the value of this thing?' (valuation of Eastern European businesses)(Chairman's Agenda: Acquiring in Eastern Europe)
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