oversight

Foreign Assistance: Enterprise Funds' Contributions to Private Sector Development Vary

Published by the Government Accountability Office on 1999-09-14.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                   United States General Accounting Office

GAO                Report to Congressional Requesters




September 1999
                   FOREIGN
                   ASSISTANCE

                   Enterprise Funds’
                   Contributions to
                   Private Sector
                   Development Vary




GAO/NSIAD-99-221
United States General Accounting Office                                                                 National Security and
Washington, D.C. 20548                                                                           International Affairs Division



                                    B-283261                                                                                        Letter

                                    September 14, 1999

                                    The Honorable Benjamin A. Gilman
                                    Chairman, Committee on International Relations
                                    House of Representatives

                                    The Honorable Doug Bereuter
                                    Chairman, Subcommittee on Asia and the Pacific
                                    Committee on International Relations
                                    House of Representatives

                                    In 1989, the United States authorized enterprise funds as an experimental
                                    model to support private sector development in selected countries of
                                    Central and Eastern Europe as they transition from centrally planned to
                                    market-oriented economies.1 The funds, which are private, nonprofit U.S.
                                    corporations, are supposed to make loans to, or investments in, small- and
                                    medium-sized businesses in which other financial institutions are reluctant
                                    to invest. With the breakup of the Soviet Union in 1991, enterprise funds
                                    were subsequently established in the newly independent states. Currently,
                                    10 funds operate in Central Europe and the former Soviet Union, covering
                                    19 countries with authorized funding of about $1.3 billion.2 Enterprise
                                    funds receive their funding through the U.S. Agency for International
                                    Development (USAID), and USAID has primary responsibility for
                                    monitoring the funds’ operations.

                                    At your request, we determined (1) whether enterprise funds are assisting
                                    private sector development; (2) what factors have affected the funds’
                                    ability to carry out their activities; (3) whether funds still have a role in
                                    private sector development, given other private investment and
                                    international donor efforts; (4) whether the funds are likely to recoup their


                                    1
                                     The Support for East European Democracy (SEED) Act of 1989 (P.L. 101-179) authorized the creation
                                    of enterprise funds in Poland and Hungary. Later, under the SEED Act and the FREEDOM Support Act
                                    of 1992 (P.L. 102-511), eight additional funds were established in Central and Eastern Europe and the
                                    former Soviet Union. We reported on the first four enterprise funds in March 1994; see Enterprise
                                    Funds: Evolving Models for Private Sector Development in Central and Eastern Europe
                                    (GAO/NSIAD-94-77, Mar. 9, 1994).
                                    2
                                     Four funds operate in multiple countries. The Baltic fund includes Estonia, Latvia, and Lithuania; the
                                    Central Asian fund covers Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan;
                                    the Czech-Slovak fund operates primarily in the Slovak Republic, but also covers the Czech Republic;
                                    and the Western Newly Independent States fund covers Belarus, Moldova, and Ukraine.




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                      authorized capital; and (5) whether the funds are complying with recent
                      changes in USAID reporting requirements. In a separate letter, we address
                      issues related to “spin-off” venture capital organizations that the Polish
                      fund helped establish as well as U.S. government plans to use funds
                      generated from the sale of Polish fund assets to help establish a foundation
                      for further private sector development in Poland and to return some funds
                      to the U.S. Treasury.3

                      Differing economic conditions and legal and regulatory environments in
                      each country and the length of time the respective funds have been
                      operational make comparisons across funds difficult. To gain additional
                      perspective and first-hand knowledge of fund operations, we visited the
                      Russian and Romanian funds’ in-country offices; toured investment sites;
                      and met with U.S., host government, and fund officials. Both funds have
                      been operational for about 4 to 5 years, with Russia being the largest fund
                      ($440 million in authorized capital) and Romania one of the smaller funds
                      ($50 million). Although the report contains information related to all 10
                      funds, we primarily relied on our examination of these 2 funds to address
                      your interest in the continued relevance of enterprise funds. We also
                      describe their investments, loans, and technical assistance activities in
                      appendixes I and II, respectively.



Results in Brief      To varying degrees, enterprise funds in Central Europe and the former
                      Soviet Union have engaged in investment activities that support private
                      sector development in their host countries. Taken together, the 10
                      enterprise funds have made investments and loans in and provided
                      technical assistance mainly to small- and medium-sized businesses totaling
                      about $809 million through fiscal year 1998, using capital authorized in U.S.
                      grants as well as investment proceeds. Nine funds have raised additional
                      investment capital from investment partners on individual deals or by
                      establishing private equity funds that attracted other investors. Capital
                      raised this way totaled about $744 million, according to USAID. Most of the
                      funds have taken steps to help strengthen financial institutions and
                      encourage economic reforms. For example, the Polish, Russian, and
                      Romanian funds trained bank personnel in credit risk evaluation and
                      provided financing to small businesses; the Polish and Russian funds
                      initiated residential mortgage programs that did not previously exist in


                      3
                        See Foreign Assistance: Issues Concerning the Polish-American Enterprise Fund
                      (GAO/OGC-99-61R, Sept. 14, 1999).




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their host countries; and the Polish, Romanian, and Albanian funds
invested in host-country banks.

Fund management and host-country legal, regulatory, and economic
climates were key factors in the funds’ ability to carry out their activities.
According to U.S. and fund officials, the Polish fund was able to invest in
the private sector and attract additional capital because, at least in part, the
board and senior fund managers worked well together from the outset in
managing the fund’s assets. In contrast, U.S. officials characterized the
Russian fund as slow to begin investing because its fund managers were
not initially located in-country and were not involved on a daily basis with
fund operations. Other key factors included the recent Asian and Russian
financial crises, which frightened away many private investors and
curtailed some of the funds’ investment activities, and, according to
Russian fund officials, frequent changes in Russia’s legal and tax codes,
which made it difficult for the funds to enter into timely investment
contracts.

Based on our analysis of financial and investment patterns in Russia and
Romania, the enterprise funds in both countries have a continuing
development role for the foreseeable future. Despite private and
international donor investments in these countries, the overall need for
foreign investment capital and western business expertise in Russia and
Romania continues unabated. For example, due in large measure to the
recent financial crises, International Monetary Fund (IMF) statistics
indicate that foreign direct investment in Russia decreased by 65 percent in
1998, underscoring the need for the fund’s continued involvement.
Furthermore, the nature of most foreign investment in Russia is different
from much of the Russian fund’s investments. Among other things, other
foreign investment is predominantly in stocks and bonds and does not
involve the direct transfer of western management skills. In contrast, the
Russian fund has focused on making direct investments in an attempt to
influence long-term business and management reforms in the private
sector.

Determining whether enterprise funds will recoup their authorized capital
is difficult because funds have 10- to 15-year life spans and, thus, long
maturity periods for their investments. Enterprise funds are venture
capital-type funds that involve an inherent risk of financial loss—individual
investments will fail, but, in the long term, successful ventures are
supposed to offset the losses. Although the Polish fund has not sold all its
investments, it has finished making new investments and is expected to



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             recover its original authorized capital. Similarly, USAID officials expect the
             Hungarian and Romanian funds to recoup their authorized capital as well.
             In contrast, while the Czech-Slovak fund has not finished making new
             investments, U.S. and fund officials say that its early losses make it unlikely
             that the fund can recoup its authorized capital.

             The enterprise funds were reporting financial and related information, as
             required. In 1997, USAID increased enterprise fund reporting requirements
             due to congressional concerns about the extent to which the U.S.
             government was monitoring fund progress, using a standard set of
             indicators. USAID now requires each fund to prepare a “strategic
             framework matrix” with multiyear investment projections and break-even
             analyses, as well as information on other key areas, such as investments in
             small- and medium-sized firms and other private capital raised.



Background   Enterprise funds are governed by boards of directors consisting of private
             citizens of the United States and host countries that have experience in
             areas such as investment banking or have geographical and other relevant
             expertise (see app. III). The fund boards are responsible for establishing
             their own operating and investment policies and directing their corporate
             affairs in accordance with U.S. legislation and grant agreements. The
             funds’ senior managers are generally American. The funds’ investment
             staffs, including senior investment officers and other investment
             professionals, are comprised of combinations of American, host-country,
             and third-country national employees. The funds are generally supposed to
             target viable small- to medium-sized private businesses in the funds’ host
             countries. However, the Russian fund has the flexibility to invest in
             medium- to large-sized companies as well.4 The funds can invest in start-up
             companies and privatized state-owned enterprises, and can invest solely or
             through joint ventures and separate private equity funds that attract other
             U.S., host-country, third-country, or multilateral organization investors.

             The Department of State Coordinators of Assistance for Eastern Europe
             and the New Independent States are responsible for overall coordination of
             assistance activities in the region and are responsible for overseeing


             4
              The Russian fund was created in 1995 through the merger of two already existing funds—the
             Russian-American Enterprise Fund and the Fund for Large Enterprises in Russia—incorporated in 1993
             and 1994, respectively. The first fund was supposed to operate like other enterprise funds, but the
             second focused on larger businesses and had less of a development focus than the others. When the
             two funds were merged, the new Russian fund assumed the roles of both.




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                          enterprise funds on policy and other matters arising outside of the funds’
                          grant agreements. USAID oversees the funds’ operations.



Funds Are Assisting       The enterprise funds have assisted private sector development in their host
                          countries primarily by making investments and loans in and providing
Private Sector            technical assistance to small- and medium-sized businesses, using capital
Development               authorized in U.S. grants and fund investment proceeds. Nearly all the
                          funds have also raised additional investment capital by finding investment
                          partners or establishing separate private equity funds that attract outside
                          investors; however, the amounts of capital varied widely. Most of the funds
                          have taken measures to help strengthen financial institutions and provide a
                          “demonstration effect” that encourages economic reforms through new,
                          market-oriented activities in their host countries, although the types and
                          extent of such efforts varied among the funds.


Making and Providing      The 10 enterprise funds in Central Europe and the former Soviet Union
Investments, Loans, and   have made investments and loans and provided technical assistance
                          primarily to small- and medium-sized businesses totaling about
Technical Assistance
                          $809 million as of September 30, 1998. Some funds have invested more
                          than their authorized capital, using additional monies generated through
                          their investment activities, while others have invested less than their
                          authorized capital. For example, as of September 30, 1998, the Polish fund
                          had received nearly all of its $264 million in authorized capital and invested
                          about $300 million, using a combination of its authorized capital and
                          monies generated from investment proceeds. The Polish fund has stopped
                          making new investments with U.S. grant funds and has begun liquidating
                          some of its investments. As of the same date, the Hungarian fund had also
                          received about 80 percent of its $72.5 million in authorized capital and
                          invested about $81 million, also using a combination of both authorized
                          capital and monies generated through investment activities. The Russian
                          fund had received over one-third of its $440 million in authorized capital
                          and invested about $125 million. The Romanian fund had received almost
                          70 percent of its $50 million in authorized capital and made investments
                          totaling about $35 million. It is important to note that the funds are at
                          varying stages of their life spans—in 1998, the Polish and Hungarian funds
                          were in their eighth years of operation, while the Romanian and Russian
                          funds were in their fourth and fifth years, respectively.

                          Most funds have also used funding to provide technical assistance to
                          businesses in which they invest. Funds have provided employee training,



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                                          upgraded management information and financial reporting systems, and
                                          provided advice and technical support in a variety of other areas to such
                                          firms. However, according to USAID officials, funds often do not identify
                                          technical assistance activities separately from their investment activities,
                                          when such assistance is provided in support of specific investments.
                                          Therefore, figures shown for technical assistance provided do not fully
                                          reflect some funds’ actual technical assistance activities. Table 1 shows the
                                          amount of capital authorized in USAID grants for each fund and the
                                          amounts that each of them invested or specifically identified as technical
                                          assistance provided as of September 30, 1998.



Table 1: Enterprise Fund Capital Authorized and Invested and Technical Assistance Provided as of September 30, 1998

Dollars in millions
                                                              Capital                                                 Total capital invested
Enterprise                                  Year         authorized in               Capital          Technical               and technical
Fund                                incorporated         USAID grants              investeda         assistance                  assistance
Hungary                                       1990                 $72.5               $75.0                 $6.2                        $81.2
Poland                                        1990                 264.0               284.0                 16.8                        300.8
Czech-Slovak                                  1991                  65.0                 39.3                  3.1                        42.4
Bulgaria                                      1992                  55.0                 49.0                  1.8                        50.8
Russia                                        1993                 440.0               123.3                   1.7                       125.0
Baltic                                        1994                  50.0                 25.1                  1.7                        26.8
Central Asia                                  1994                 150.0                 76.7                    0                        76.7
Romania                                       1994                  50.0                 33.7                  1.0                        34.7
Western Newly Independent States              1994                 150.0                 48.7                  3.5                        52.2
Albania                                       1995                  30.0                 18.3                  0.3                        18.6
Total                                                          $1,326.5               $773.1                $36.1                       $809.2
                                          a
                                           The amount of capital that funds invest can include monies generated through investment activities
                                          and, thus, can be larger than the amount of authorized capital received from USAID grants.
                                          Source: USAID.


                                          Most of the funds’ investment activities are focused on a wide range of
                                          small- and medium-sized enterprises. However, the Russian fund has the
                                          flexibility to invest in somewhat larger enterprises. For example, the
                                          Russian fund’s largest project was a $15.5-million direct investment in a
                                          brewing company. The average size of the fund’s 28 equity investments as
                                          of September 30, 1998, was about $3.5 million. The Russian fund has
                                          invested in diverse industries, ranging from agribusiness to
                                          pharmaceuticals. The average size of the Romanian fund’s 16 direct




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                                          investments as of the same date was $1.5 million. The Romanian fund has
                                          also invested in diverse areas, ranging from financial services to
                                          construction materials. Both of these funds also target much smaller
                                          companies through their various loan programs. For example, the average
                                          size of the Russian fund’s 282 small business loans was about $75,000, and
                                          the average size of the Romanian fund’s 61 such loans was about $63,000.



Raising Capital From Other                In addition to their authorized capital, nearly all funds have raised
Sources                                   additional outside capital through the involvement of other investors. For
                                          example, according to USAID, the Polish fund has raised additional capital
                                          of at least $328 million through a combination of finding outside investment
                                          partners for individual deals and helping establish separate private equity
                                          funds that attracted outside investors. The Romanian and Hungarian funds
                                          have raised $80 million and $50 million, respectively, through a similar
                                          combination of methods. The Russian fund raised capital from outside
                                          investment partners totaling approximately $244 million. In contrast, the
                                          Baltic fund has not raised any outside private capital. Table 2 details the
                                          amount of capital raised from outside sources by each fund as a percentage
                                          of its authorized capital in USAID grants.



Table 2: Fund Capital Raised From Other Sources as a Percentage of Authorized Capital as of September 30, 1998

Dollars in millions
                                                          Capital authorized          Capital raised   Other capital as a percent
Enterprise fund                    Year incorporated        in USAID grants      from other sources        of authorized capital
Hungary                                            1990                 $72.5                 $50.0                           69
Poland                                             1990                 264.0                 328.0                          124
Czech-Slovak                                       1991                   65.0                   3.4                           5
Bulgaria                                           1992                   55.0                 20.1                           37
Russia                                             1993                 440.0                 244.3                           56
Baltic                                             1994                   50.0                    0                            0
Central Asia                                       1994                 150.0                    2.9                           2
Romania                                            1994                   50.0                 80.0                          160
Western Newly Independent States                   1994                 150.0                  15.2                           10
Albania                                            1995                   30.0                   0.4                           1
Total                                                                $1,326.5                $744.3                           56
                                          Source: USAID and enterprise funds.




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Strengthening Financial                     Most of the funds have taken measures to help strengthen financial
Institutions and                            institutions and provide a “demonstration effect” that encourages
                                            economic reforms through new, market-oriented activities in their host
Encouraging Economic                        countries, although the types and extent of such efforts vary among the
Reforms                                     funds. All but the Western Newly Independent States fund have worked to
                                            strengthen financial institutions by undertaking activities such as training
                                            bank personnel and providing financing to businesses through partner
                                            banks. All but the Czech-Slovak fund have provided a demonstration effect
                                            through activities such as delivering capital to previously underserved
                                            segments of the economy or establishing previously nonexistent market
                                            institutions such as mortgage and micro-sized loan programs. Table 3 lists
                                            some of the activities in which funds have engaged.



Table 3: Examples of Fund Activities to Strengthen Financial Institutions and Provide a Demonstration Effect

                        Strengthening financial
Enterprise fund         institutions                                       Demonstration effect
Albania                 Established (and wholly owns) the American Bank Established the American Bank of Albania, the first
                        of Albania.                                     western-style bank in Albania.
Baltic                  Established a residential mortgage program that    Established a residential mortgage program that was
                        was replicated by banks.                           replicated by banks; also one of few lenders to provide
                                                                           small- and medium-sized loans,a emphasizing women and
                                                                           rural areas.
Bulgaria                Established (and wholly owns) the               Created Home Mortgage Lending Program; also one of
                        Bulgarian-American Credit Bank, which serves as few sources for medium-term financing (focusing on real
                        a conduit for fund investments.                 estate and hotels).
Central Asia            Established (and wholly owns) the Asian            Created micro- and small-sized loan programs.a
                        Crossroads Loan Company, which serves as a
                        conduit for loans to small- and medium-sized
                        businesses.
Czech-Slovak            Trained about 50 bankers in the loan application   None.
                        development process.
Hungary                 Created micro- and small-sized loan programs       Established the Hungarian Innovative Technologies Fund,
                        that have been replicated by commercial banks.     the first in the region devoted exclusively to funding small
                                                                           entrepreneurs and developing innovative technologies.
Poland                  Created First Polish-American Bank; also trained   Established Polish-American Mortgage Bank for residential
                        bankers in western-style corporate governance      mortgages; also provided capital to housing developers.
                        and financial management systems.
Romania                 Purchased Banca Romaneasca, which serves as Established micro-, small-, and medium-sized loan
                        a conduit for small- and medium-sized loan        programs,a the only such funding mechanisms available to
                        program; also trained bank personnel in cash-flow Romanian entrepreneurs.
                        lending techniques.
                                                                                                                              (continued)




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                     Strengthening financial
Enterprise fund      institutions                                          Demonstration effect
Russia               Used Russian “partner banks” for small- and       Established one of the first residential mortgage programs
                     medium-sized loan program; also trained bank      and the first auto loan program in Russia; also operates
                     personnel in credit methodology and underwriting. micro-, small-, and medium-sized loan programs. a
Western Newly        None.                                                 Received the first-ever license for a non-depository
Independent States                                                         financial institution to make loans and leases in Ukraine.
                                         a
                                          Enterprise fund micro-, small-, and medium-sized loans vary in size and other characteristics among
                                         the funds, including the two where we conducted case studies. The Russian fund’s micro-sized loan
                                         program involves loans of between $1,000 and $20,000 to enterprises with fewer than 20 employees,
                                         and its small-sized loan program involves loans of up to $150,000 to businesses with fewer than 100
                                         employees. The Romanian fund’s micro-sized loan program involves loans of between $2,500 and
                                         $15,000 (with no requirement regarding the number of employees), and its small- and medium-sized
                                         loan program involves loans of up to $150,000 to businesses with 200 or fewer employees.
                                         Source: USAID and enterprise funds.


                                         As illustrated in table 3, some funds have helped strengthen financial
                                         institutions by assisting selected banks. For example, the Russian and
                                         Romanian funds have developed relationships with “partner banks” and
                                         use these banks to implement loan programs. The Russian fund is
                                         providing technical assistance by training bank personnel in credit
                                         methodology and underwriting as well as other key skills. The Romanian
                                         fund has implemented training programs for bank staff that allow the
                                         consideration of a firm’s earnings history and profit potential rather than
                                         using only a company’s assets to determine loan eligibility, as Romanian
                                         banks had done in the past.

                                         Funds have also invested in host-country banks as a method of
                                         strengthening financial institutions. For example, the Polish fund bought a
                                         controlling interest in a Polish bank and then merged the bank’s operations
                                         with the fund’s small business loan program. The Romanian fund invested
                                         about $5 million and is now the majority shareholder in a private Romanian
                                         bank with 12 branches throughout the country. Since taking controlling
                                         interest in the bank in December 1998, the Romanian fund now utilizes the
                                         bank as its partner institution to implement its entire small- and
                                         medium-sized loan program. The Albanian fund recently opened a bank
                                         that is wholly owned by the Albanian fund.

                                         Funds have provided capital to previously underserved segments of the
                                         economy. For example, the small- and medium-sized loans that the Russian
                                         and Romanian funds offer address a segment of the economy not
                                         previously served by financial institutions. According to Romanian and
                                         Russian fund officials, banks in their host countries traditionally made little
                                         effort to provide loans to small entrepreneurs, preferring to make loans to




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                      large companies or to invest their capital in instruments such as
                      government securities.

                      Funds have also established previously nonexistent market institutions.
                      For example, the Polish fund pioneered the concept of home mortgage
                      lending in Poland and operates the Polish-American Mortgage Bank as a
                      subsidiary of the fund. The Russian fund also operates a residential
                      mortgage lending program and initiated the first auto loan program of its
                      kind in Russia. The Romanian fund established a micro-sized loan
                      program—a new lending mechanism in Romania. The fund implements the
                      program through two U.S.-based, nongovernmental organizations, which
                      have provided micro-sized loans to enterprises in many sectors of the
                      economy, such as manufacturing, trade, and services.



Fund Management and   Fund management’s early involvement in fund activities and host-country
                      conditions play key roles in the funds’ ability to execute their activities.
Host-Country          Fund management was a key factor in the success of the Polish fund and
Conditions Affect     the early losses of the Czech-Slovak fund, and affected the investment pace
                      at the two funds where we conducted case studies—Russia and Romania.
Funds’ Activities     The legal and regulatory environment and economic conditions in the
                      funds’ host countries affected fund operations as well.



Fund Management       USAID, State, and fund officials agreed that enterprise fund management
                      plays a critical role in the funds’ ability to execute their activities—
                      especially at the outset. According to USAID and State officials, the Polish
                      fund’s success was due in part to having a well-functioning board of
                      directors and good management from the beginning. Conversely, the
                      officials said that a poor investment strategy and mismanagement of the
                      Czech-Slovak fund’s resources were major factors in that fund’s early
                      losses. One USAID evaluation cited the fund’s decision to avoid the service
                      and retail sectors of the economy as one reason the fund had not
                      performed better financially. Another pointed to management’s insufficient
                      supervision of its investments and an operational strategy that emphasized
                      saving costs over maintaining staffing continuity. Eventually, the entire
                      board of directors was replaced, and the fund essentially terminated its
                      activities in the Czech Republic, concentrating its remaining activities in
                      the Slovak Republic.

                      Our case studies in Russia and Romania highlighted fund management’s
                      influence on investment pace. Fund officials in Romania told us that policy



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and operational disagreements by board members and management
delayed investment decisions and adversely affected staff morale.
However, after key changes in management and on the board of directors,
the pace of investment and staff morale improved. Russian fund officers
and USAID and State officials said that an absence of in-country leadership
and frequent senior management turnover contributed to the Russian
fund’s early slowness to invest. For example, fund officials in the United
States and Russia told us that leadership and management turmoil had
delayed the Russian fund’s investment progress from 12 to 18 months. The
current Chief Operating Officer of the Russian fund lives in-country, and
fund officers and USAID and State officials told us that the fund’s
operations had improved significantly as a result of this change.

In an attempt to measure management efficiency, we also examined the
funds’ operating expenses as a percent of their capital. Fund and private
sector officials told us that private sector venture capital funds typically
charge a management fee of 2 to 2.5 percent of authorized capital
throughout the life of the fund to manage the fund. The combined rate of
operating expenses for all enterprise funds was 2.8 percent during 1998.
However, as shown in table 4, the rates varied widely from fund to fund.
Fund and private sector officials said that operating expenses are normally
higher than 2.5 percent during the initial years of a fund’s existence
because of start-up costs and lower than 2 percent during the last few years
of a fund’s life.




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Table 4: Enterprise Funds’ Operating Expenses as a Percentage of Authorized Capital for 1998

Dollars in millions
                                                                  Capital authorized                                  Operating expenses as
Enterprise fund                      Year incorporated              in USAID grants        Operating expenses            a percent of capital
Hungary                                                1990                       $72.5                       $2.5                            3.4a
Poland                                                 1990                       264.0                         2.0                           0.8a
Czech-Slovak                                           1991                        65.0                         1.7                            2.6
Bulgaria                                               1992                        55.0                         1.8                            3.2
Russia                                                 1993                       440.0                         9.0                            2.0
Baltic                                                 1994                        50.0                         2.7                            5.4
Central Asia                                           1994                       150.0                         7.5                            5.0
Romania                                                1994                        50.0                         3.4                            6.8
Western Newly Independent States                       1994                      150.0                          6.2                            4.1
Albania                                                1995                        30.0                         0.8                            3.0
Total                                                                         $1,326.5                       $37.7                             2.8
                                          a
                                              Hungarian and Polish fund operating costs are shared with the funds’ associated private equity funds.
                                          Source: USAID and enterprise funds.




Host-country Conditions                   Economic conditions and host-country legal and regulatory environments,
                                          over which funds have little control, also affected fund operations.
                                          Immediately following the August 1998 Russian financial crisis, the Russian
                                          fund halted many of its activities for 30 days and focused its efforts on
                                          protecting its existing portfolio by restructuring loans and assisting its
                                          portfolio companies in developing post-crisis strategies and restructuring
                                          plans. Financial documents that we reviewed during our visit to Russia
                                          indicated that the 1998 Asian and Russian financial crises had substantially
                                          negative effects on nearly all of the Russian fund’s portfolio companies.
                                          For example, the fund had to increase its loss reserves to about 17 percent
                                          of its total direct investment portfolio and 22 percent of its small loan
                                          portfolio. As a result, the fund reported loan and investment losses totaling
                                          over $13 million for the fiscal year ended September 30, 1998.

                                          Romanian fund officials told us that high tax rates consume large amounts
                                          of private firms’ working capital and discourage investment in that country.
                                          Similarly, Russian fund officials told us that frequent changes in the
                                          Russian legal and tax codes make it time-consuming to address issues of
                                          law and taxation in investment contracts. USAID officials told us that poor
                                          economic conditions had caused a number of funds to exercise caution in




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                              making investments in order to safeguard fund assets. For example, the
                              Bulgarian fund pursued a cautious investment strategy in the early years of
                              its operations due to economic uncertainties in that country. Later, as
                              economic conditions improved, fund officials accelerated their investment
                              pace.



Russian and Romanian          The overall capital needs in Russia and Romania can accommodate the
                              activities of all investors, even with occasional competition. The Russian
Funds Have a                  and Romanian enterprise funds have a continuing development role,
Continuing                    despite other private investment flows and other donors that provide equity
                              and debt financing in those countries. For example, foreign investment by
Development Role              private investors in Russia is predominantly portfolio investment in stocks
                              and bonds, without the substantial influence on company operations and
                              transfer of western financial and management expertise that the Russian
                              fund’s direct investments entail. Also, the funds’ direct investment
                              programs employ different operating approaches and target different
                              market segments than those of other donors.


Capital Needs in Russia and   The overall capital needs in Russia and Romania are large. One way to
Romania                       view a country’s capital needs is by considering the country’s investment
                              levels in the context of its population. Per capita foreign direct investment
                              in Russia and Romania is relatively less than investment in other countries
                              in the region. For example, IMF statistics indicate that in 1997—the year in
                              which Russia’s foreign investment was at its peak—its foreign direct
                              investment was only $42 per capita compared to $127 in Poland, where the
                              enterprise fund is only beginning to curtail its operations. Romanian per
                              capita foreign direct investment was $54 in 1997, less than half of Poland’s
                              and slightly more than Russia’s.

                              In 1998, foreign direct investment in Russia decreased significantly due to
                              the Asian and Russian financial crises. The country’s $2.2 billion in foreign
                              direct investment during 1998 was 65 percent less than the $6.2 billion that
                              it received in 1997. On a per capita basis, 1998 foreign direct investment in
                              Russia was only $15, compared to $163 in Poland. USAID, State, and
                              Russian fund officials said that the dramatic drop in foreign direct
                              investment in Russia underscored the need for the fund’s continued
                              involvement in that country.

                              During the first 9 months of 1998, Romania’s foreign direct investment was
                              11 percent less than it was for a comparable period in 1997. However, the



                              Page 13                                     GAO/NSIAD-99-221 Foreign Assistance
B-283261




U.N. Economic Commission for Europe reported that the Romanian
government sold several large, state-owned enterprises at attractive prices
to foreign investors at the end of the year because of its need for funds.5
This skewed the 1998 year-end total of foreign direct investment in that
country upward to $1.6 billion, or 32 percent more than the $1.2 billion that
it received in 1997. Despite these unusual investment flows, per capita
foreign direct investment in Romania was only $71 in 1998, less than half of
Poland’s.

The funds have occasionally competed with other private investors and
donors in Russia and Romania. For example, Romanian fund officials said
that a private investor made an equity investment in a pharmaceuticals
packaging and distribution firm that the fund was prepared to make. The
Russian and Romanian funds’ small business financing programs’
approaches and targets are similar to those of other donors. For example,
the European Bank for Reconstruction and Development (EBRD)6 has
programs in Russia and Romania that provide loans to small businesses
through intermediary banks, as do the Russian and Romanian funds.
Officials for two companies that we visited in Russia said that they had
actively considered similar loans from an intermediary bank associated
with EBRD but that they chose the Russian fund’s loan because the terms
were better and the funding could be provided in a more timely fashion.
The International Finance Corporation (IFC)7 also has an in-country
program that provides loans to small businesses through intermediary
banks in Russia. IFC, which recently opened an office in Romania,
provided a $5-million loan commitment to assist the Romanian fund in
expanding its small loan program.

Officials from EBRD, IFC, the Russian and Romanian funds, USAID, and
State all said that the market for small business financing in Russia and
Romania is large enough for all donors. They added that some competition
among donor organizations is healthy and normal at the working level.
None of these officials said that the competition diminished the relevance
of any of their programs. Moreover, Russian fund officials said that the


5
Economic Survey of Europe, 1999 No. 1 (New York and Geneva: Secretariat of the Economic
Commission for Europe, United Nations, 1999), p. 169.
6
 EBRD promotes private sector development through lending, investment, and other activities in 26
countries in Central Europe and the former Soviet Union.
7
 IFC is affiliated with the World Bank and promotes the growth of the private sector through lending,
investment, and other activities in its 174 member countries.




Page 14                                                    GAO/NSIAD-99-221 Foreign Assistance
                        B-283261




                        competition for individual direct investments has greatly diminished since
                        the Russian and Asian financial crises, when many investors left Russia.


Foreign Investment in   Foreign investment in Russia has been dominated by portfolio investment
Russia                  (stocks and bonds), not direct investment. For example, in 1998, total
                        foreign investment in Russia amounted to $10.9 billion. Approximately
                        $8.7 billion, or about 80 percent of this amount, was comprised of portfolio
                        investment, which is oriented toward short-term profits and does not entail
                        investor participation in governing the recipient firms. During the same
                        year, only $2.2 billion, or about 20 percent of Russia’s total foreign
                        investment, consisted of direct investment, which targets long-term
                        opportunities and entails investor involvement in the recipient companies.

                        In contrast, the Russian fund’s equity investments are generally direct
                        investments. Russian fund officials told us that the fund normally attempts
                        to acquire a large enough share in recipient companies to have a significant
                        influence on their operations. The Romanian officials told us that they
                        follow the same approach.8 USAID and fund officials consider this type of
                        active involvement as an essential tool for influencing market-oriented
                        reforms in the recipient firms of transition countries.


Other Donor Programs    The funds’ direct investment programs tend to make smaller investments,
                        target smaller companies, or employ different investment instruments than
                        other donors. For example, in Russia and Romania, EBRD invests in large
                        infrastructure projects in the form of loans in sectors such as energy and
                        telecommunications as the core of its activity. These projects are generally
                        much larger than the Russian and Romanian funds’ equity investments. For
                        example, an EBRD official in Russia told us that the size of the bank’s
                        major infrastructure projects range upward to about $1 billion, whereas the
                        Russian fund’s investments range in size from $75,000 to about $15 million.
                        In Romania, EBRD’s average investment for similar projects is nearly
                        $64 million, while the Romanian fund’s investments range from about
                        $42,000 to almost $5 million.

                        In addition to large infrastructure projects, EBRD has regional venture
                        capital funds that operate in Russia and Romania. However, Russian fund
                        officials told us that the EBRD program targets firms smaller than those

                        8
                         Unlike Russia, foreign direct investment represents the largest share of foreign investment in Romania.




                        Page 15                                                    GAO/NSIAD-99-221 Foreign Assistance
B-283261




that the fund currently focuses on through its direct investment program.
Romanian fund and EBRD officials told us that, although the potential for
competition between the fund and EBRD exists because they are targeting
similar investments, it has not presented a problem to date because of the
large, unsatisfied demand for capital.

IFC has direct investment programs and offices in Russia and Romania.
However, according to IFC officials in Russia, IFC does not compete with
the Russian fund because IFC’s direct investment program targets larger
investments than the Russian fund. Further, IFC’s investments are in areas
such as energy and general manufacturing, which are not areas the fund
emphasizes. The largest part of IFC’s direct investment program in
Romania focuses on public infrastructure projects and other investments
that are larger than most enterprise fund investments. IFC provides
additional capital to existing private venture capital companies for
investments in Romania that are comparable in size to some Romanian
fund investments. However, Romanian fund and IFC officials said that
these private funds do not compete with the Romanian fund because, like
with EBRD, of the large, unsatisfied demand for private equity capital in
that country.

The Overseas Private Investment Corporation9 (OPIC) also has a private
investment fund program that operates in transition countries in Central
and Eastern Europe and the former Soviet Union. However, the objectives
and focus of its program are different from enterprise funds. OPIC
operates its program through existing American venture capital companies,
using long-term, secured loan guaranties and loans to help the firms
establish and capitalize regional investment funds.10 OPIC’s objective is
primarily to support and protect U.S. companies and investors, while
enhancing U.S. development objectives and furthering stability in foreign
countries. However, the individual private investment funds make
commercially based investment decisions in order to realize a profit and do
not have the same development mandate as enterprise funds.




9
 OPIC is an independent U.S. government corporation that assists U.S. investors overseas by providing
political risk insurance, financing, and other investment services.
10
  As of March 31, 1999, including accrued interest, OPIC had made loan guaranties and loans of about
$677 million in Russia and $22 million in Romania, of which about $330 million and $16 million,
respectively, had been invested.




Page 16                                                   GAO/NSIAD-99-221 Foreign Assistance
                         B-283261




Whether Funds Will       Current USAID guidance to enterprise funds is that the funds should aim to
                         have assets worth at least the amount of their original grants when they
Recoup Authorized        terminate their operations. This expectation has evolved over time. When
Capital Is Problematic   enterprise funds were first established, many U.S. officials did not expect
                         funds to recoup their original grants. In 1993 and 1994, USAID made
                         changes to its grant agreements with the funds, setting forth options for the
                         use of remaining fund assets upon termination of operations. Over time, as
                         the likelihood increased that some of the more mature funds might recover
                         their original authorized capital, USAID raised the target to the same level
                         for the other funds.

                         USAID currently expects that at least three funds will recover their
                         authorized capital through their investments and one will not. The Polish
                         fund has finished making new investments with U.S. government funds and
                         has begun to liquidate some of its investments. USAID expects the Polish
                         fund to recover its original authorized capital. The fund’s estimated net
                         worth was $270 million—$15.5 million more than the amount that it
                         received through its authorized grant—as of September 30, 1998.
                         Currently, USAID officials also expect the Hungarian and Romanian funds
                         to eventually recoup their original authorized capital. In contrast, although
                         the Czech-Slovak fund has not finished making new investments, it sold the
                         Czech portion of its portfolio at a loss of 92 percent of its invested capital in
                         1997, making it unlikely that the fund can recoup its original authorized
                         capital when it eventually ceases operations.

                         For the other funds, determining whether they will ultimately recoup their
                         original authorized capital is not reasonably possible until they are closer
                         to liquidating their investments. According to enterprise fund and other
                         private venture capital officials, markets for the funds’ investments—and a
                         way to determine “fair market” value—often do not exist in the transition
                         countries where the funds operate. Also, the funds have intended life spans
                         of 10 to 15 years, and, therefore, potentially long periods for their
                         investments to be profitable. Table 5 shows the funds’ assets as of
                         September 30, 1998.




                         Page 17                                       GAO/NSIAD-99-221 Foreign Assistance
                                         B-283261




Table 5: Enterprise Funds’ Grant Amounts and Estimated Asset Valuation as of September 30, 1998

Dollars in millions
                                                                         Capital authorized           Grant amount
Enterprise fund                           Year incorporated                in USAID grants                received           Net asset value
Hungary                                                   1990                           $72.5                  $56.6                    $28.2
Poland                                                    1990                           264.0                  254.5                    270.0
Czech-Slovak                                              1991                            65.0                    46.2                    12.5
Bulgaria                                                  1992                            55.0                    44.5                    28.7
Russia                                                    1993                           440.0                  165.0                     89.6
Baltic                                                    1994                            50.0                    31.1                    22.4
Central Asia                                              1994                           150.0                    87.0                    38.4
Romania                                                   1994                            50.0                    35.2                    28.2
Western Newly Independent States                          1994                           150.0                    64.3                    39.0
Albania                                                   1995                            30.0                    16.0                    14.0
Total                                                                                $1,326.5                  $800.4                   $571.0
                                         Source: USAID and enterprise funds.


                                         Enterprise fund investment decisions are supposed to balance financial
                                         soundness with the funds’ development mandate. Making investments
                                         where traditional financial institutions are reluctant to invest means some
                                         investments will not be successful, especially in the early stages of a fund’s
                                         operations. However, by the end of a fund’s operations, the successes are
                                         supposed to outweigh the failures. Individual investments made by the
                                         Russian fund illustrate the element of risk involved in enterprise fund
                                         investments.

                                         • In 1995, the Russian fund wrote off the entire amount of its $3.8 million
                                           investment in U.S. Global Health, which operated a western-style
                                           medical clinic in Moscow. The clinic failed because lower than
                                           expected revenues combined with start-up and operating costs depleted
                                           the firm’s capital before it was able to make a profit.11
                                         • In 1996 and 1997, the fund also wrote off approximately $3 million it
                                           invested in ZAO Giant, Ltd.—a supermarket chain in the Vladivostock


                                         11
                                           This investment was originally made in 1994 by the Fund for Large Enterprises in Russia, which
                                         merged with the Russian-American Enterprise Fund in 1995 to form the current Russian fund. The
                                         USAID Inspector General reported on the reasons for this investment failure in March 1997: Audit of
                                         the Request for Review of the U.S. Russian Investment Fund’s Investment in U.S. Global Health Limited,
                                         Audit Report No. A-00097-003P (Washington, D.C.: USAID, Office of the Inspector General, Mar. 26,
                                         1997).




                                         Page 18                                                   GAO/NSIAD-99-221 Foreign Assistance
B-283261




  and Nakhodka regions of the Russian Far East—before the company
  had ever stocked its stores with initial inventory. Fund officials said that
  it refused further support of the company when it became clear that the
  company had not put appropriate managers and financial controls in
  place to address serious operating and expenditure problems that were
  occurring in setting up the operation.12
• More recently, in 1999, fund officials feared that the fund’s 1998
  $2.4 million investment in Lomonosov Porcelain—a porcelain tableware
  producer in St. Petersburg—could deteriorate considerably in value
  because the company’s general director and senior managers opposed
  the fund’s and other investors’ takeover of the firm. However, fund
  officials said that they have since established a working relationship
  with the company’s managers and expect, along with other investors, to
  assume control of the company shortly. The officials added that the
  company now has an excellent opportunity to significantly increase its
  sales, production volumes, and profitability.

Similarly, investments made by the Romanian fund also demonstrate the
uncertain nature of enterprise fund investment operations.

• The fund’s 1996 investment of $471,000 in Multiprint—a commercial
  printing company in Northeast Romania—encountered financial
  difficulties due to factors such as late payments from the firm’s debtors
  and the overall decline of the Romanian economy.
• The fund’s 1996 investment of $229,000 in Doriela—a Bucharest farm
  equipment services and leasing firm—performed poorly because of a
  decrease in demand. The fund reported that the purchasing power of
  potential buyers had diminished and that expected agricultural
  subsidies had not materialized in Romania.
• The fund’s 1996 investment in Multicolor—a label and packaging plant
  in northeast Romania—demonstrated weak performance because of
  poor management, stronger than expected competition, and other
  factors. A fund-financed evaluation of Multicolor’s difficulties led the
  company to negotiate the rescheduling of its debt payments, replace its
  general manager, and completely restructure its maintenance
  department.




12
  The original commitment for this investment was made in 1995 by the Russian-American Enterprise
Fund.




Page 19                                                 GAO/NSIAD-99-221 Foreign Assistance
                      B-283261




Funds Are Complying   Since we reported on enterprise funds in 1994,13 USAID has increased fund
                      reporting requirements due to concerns about the extent to which the U.S.
With Increased        government was systematically monitoring fund progress using a standard
Reporting             set of indicators. In 1995, the USAID Inspector General reported that
                      USAID had not established a comprehensive set of specific objectives and
Requirements          measures by which the performance of the funds could be judged.14 In
                      1997, partly in response to these concerns, USAID strengthened its
                      semiannual reviews of the funds by asking the funds to submit a “strategic
                      framework matrix” providing data on fund activities in key areas, such as
                      investments in small- and medium-sized enterprises and capital raised from
                      other sources. The matrix also included other data, such as multiyear
                      investment projections and break-even analyses.

                      According to USAID and State officials, the economic conditions in each
                      host country, the length of time the respective funds have been operational,
                      and the substantial operational latitude that funds were given in responding
                      to their host-country situations make it difficult to establish clear and
                      objective standards that can be applied equally to all of the funds.
                      Therefore, USAID does not use the matrixes to hold funds to standardized
                      performance targets or to make comparisons across funds. However, it
                      does work with each fund to independently establish investment
                      projections and target dates for breaking even.

                      We found that the funds are providing the information requested, although
                      the information has not always been in the requested format. For example,
                      while some funds may not have fully completed sections of the strategic
                      framework matrix, they provided the required information in other
                      reporting documents.

                      USAID and State officials told us that the additional reporting requirements
                      had enhanced their ability to oversee the funds’ activities. Russian and
                      Romanian fund officials also told us that the current level of oversight is
                      appropriate. They said that they have a responsibility to safeguard U.S.
                      government funds that are provided to them in the form of grants and
                      added that the reporting requirements are not burdensome. In addition,
                      much of the information reported to USAID is data that the funds would


                      13
                       Enterprise Funds: Evolving Models for Private Sector Development in Central and Eastern Europe.
                      14
                        Audit of the Economy and Efficiency of Four Central and Eastern Europe Enterprise Funds, Audit
                      Report No. 8-180-95-015 (Washington, D.C.: USAID, Office of the Inspector General, Aug. 25, 1995).




                      Page 20                                                   GAO/NSIAD-99-221 Foreign Assistance
              B-283261




              collect in their normal course of managing fund activities and is similar to
              information that private investors would expect to have available.



Conclusions   The enterprise funds in Central Europe and the former Soviet Union have
              supported private sector development in their host countries. Most have
              also helped strengthen financial institutions and encouraged economic
              reforms. A fund’s success is largely dependent on its management’s early
              involvement in the fund’s operations and host-country legal, regulatory, and
              economic climates. Based on our analysis of financial and investment
              patterns in Russia and Romania, the enterprise funds in both countries
              have a continuing development role for the foreseeable future, and the
              overall need for investment capital in these countries continues unabated.

              Determining whether enterprise funds will recoup their authorized capital
              is problematic; yet, U.S. officials expect several funds to recoup their
              authorized capital and have raised expectations that other funds will do the
              same. Finally, due to congressional concerns about U.S. oversight of the
              funds, USAID increased enterprise fund reporting requirements in 1997.
              We found that the funds are providing the requested information, and
              USAID and State officials told us the additional information has enhanced
              their ability to oversee the funds’ operations.



Scope and     We reviewed the activities of all 10 enterprise funds in Central Europe and
              the former Soviet Union. To gain a first-hand view of fund operations, we
Methodology   also visited the Russian and Romanian funds’ U.S. and host-country offices;
              toured in-country investment sites; and met with U.S., host government,
              and fund officials. These funds were selected based on congressional
              interest, to provide geographical coverage in both Central Europe and the
              former Soviet Union, and to offer contrasting fund sizes. We traveled to
              Romania and Russia in January 1999.

              To determine whether enterprise funds are assisting private sector
              development and what factors have affected the funds’ ability to carry out
              these activities, we interviewed cognizant officials and analyzed program
              documentation. Specifically,

              • In Washington, D.C., we interviewed officials in the offices of the
                Department of State Coordinators of Assistance for Eastern Europe and
                the New Independent States, USAID’s Bureau for Eastern Europe and



              Page 21                                     GAO/NSIAD-99-221 Foreign Assistance
B-283261




  the New Independent States, and the Romanian fund’s U.S. offices. We
  also met with members of the Romanian fund’s board of directors and
  interviewed other private venture capital firm officials. We reviewed
  enterprise fund grant agreements, annual fund reports, fund semiannual
  review documents, and other reporting documents; USAID evaluations
  of enterprise funds; and USAID Inspector General reports. In New York
  City, we interviewed officials in the Russian fund’s U.S. offices and met
  with members of the Russian fund’s board of directors and other private
  venture capital firm officials. From our analysis, we determined the
  type and extent of enterprise fund activities that support private sector
  development in host countries as they progress from centrally planned
  to market-oriented economies as well as the critical elements that
  facilitated or impeded funds in executing these activities.
• In Russia and Romania, we interviewed enterprise fund senior managers
  and investment officers, reviewed the funds’ investment and loan
  portfolios and fund technical assistance activities, and visited fund
  investment sites. We also discussed the fund’s private sector
  development activities with senior officials at the U.S. embassies and
  USAID missions as well as host government officials. In addition, we
  attended the Russian fund’s January 1999 semiannual review meeting.

To determine whether funds still have a role in private sector development,
given other private investment and international donor efforts, we
primarily relied on our case studies of the Russian and Romanian funds.
We analyzed foreign investment flows in these two countries and discussed
with U.S. officials the activities of other private investors and international
donors there. We also interviewed Russian and Romanian fund officials,
recipients of Russian and Romanian fund assistance, host government
officials, and other international donors to determine the similarities and
differences among the various activities of the funds, other investors, and
other donors.

To determine whether the funds are likely to recoup their authorized
capital, we discussed with U.S. officials their expectations regarding the
ultimate financial outcomes of individual funds and discussed with private
venture capital firm officials the practice of valuing international venture
capital-type investment portfolios. We also reviewed annual fund reports,
fund semiannual review documents, other reporting documents, and State
and USAID documents.

To determine whether funds are complying with recent changes in USAID
reporting requirements, we interviewed State and USAID officials and



Page 22                                      GAO/NSIAD-99-221 Foreign Assistance
                  B-283261




                  reviewed enterprise fund reporting for the two most recent semiannual
                  review periods.

                  Also, in response to a specific question from your staff, we identified the
                  primary law firms that enterprise funds currently employ. This information
                  is in appendix IV.

                  We performed our work from September 1998 to August 1999 in
                  accordance with generally accepted government auditing standards.



Agency Comments   The Department of State and USAID provided written comments on a draft
                  of this report (see apps. V and VI, respectively). State said that the report
                  was a well-written and balanced analysis of the effectiveness of enterprise
                  funds; USAID noted that the report detailed many accomplishments and
                  development impacts of enterprise funds in Central Europe and the former
                  Soviet Union. USAID also provided technical comments that we have
                  incorporated, as appropriate.


                  Unless you publicly announce its contents earlier, we plan no further
                  distribution of this report until 30 days after its issue date. At that time, we
                  will send copies of this report to the Honorable Madeleine K. Albright, the
                  Secretary of State; the Honorable J. Brady Anderson, the Administrator of
                  USAID; and interested congressional committees. We will make copies
                  available to others upon request.

                  Please contact me at (202) 512-4128 if you or your staff have any questions
                  about this report. Other GAO contacts and staff acknowledgments are
                  listed in appendix VII.




                  Benjamin F. Nelson
                  Director, International Relations and
                   Trade Issues




                  Page 23                                       GAO/NSIAD-99-221 Foreign Assistance
Contents



Letter                                                            1


Appendix I                                                       28
Romanian Fund
Investments, Loans,
and Technical
Assistance

Appendix II                                                      30
Russian Fund
Investments, Loans,
and Technical
Assistance

Appendix III                                                     33
Romanian and Russian
Fund Boards of
Directors

Appendix IV                                                      37
Enterprise Fund Law
Firms

Appendix V                                                       38
Comments From the
Department of State




                       Page 24   GAO/NSIAD-99-221 Foreign Assistance
                    Contents




Appendix VI                                                                                   39
Comments From the
U.S. Agency for
International
Development

Appendix VII                                                                                  41
GAO Contacts and
Staff
Acknowledgments

Tables              Table 1: Enterprise Fund Capital Authorized and Invested and Technical
                      Assistance Provided as of September 30, 1998                            6
                    Table 2: Fund Capital Raised From Other Sources as a Percentage of
                      Authorized Capital as of September 30, 1998                             7
                    Table 3: Examples of Fund Activities to Strengthen Financial Institutions
                      and Provide a Demonstration Effect                                      8
                    Table 4: Enterprise Funds’ Operating Expenses as a Percentage of
                      Authorized Capital for 1998                                            12
                    Table 5: Enterprise Funds’ Grant Amounts and Estimated Asset
                      Valuation as of September 30, 1998                                     18
                    Table I.1: Romanian Fund Direct Investment Program as of
                      September 30, 1998                                                     28
                    Table I.2: Romanian Fund Loan and Other Small- and Medium-sized
                      Business Program Disbursements as of September 30, 1998                29
                    Table I.3: Examples of Romanian Fund Technical Assistance Projects 29
                    Table II.1: Russian Fund Direct Investment Program as of
                      September 30, 1998                                                     30
                    Table II.2: Russian Fund Loan Program Disbursements as of
                      September 30, 1998                                                     31
                    Table II.3: Examples of Russian Fund Technical Assistance Projects       32
                    Table IV.1: Enterprise Fund Primary Law Firms                            37




                    Page 25                                   GAO/NSIAD-99-221 Foreign Assistance
Contents




Abbreviations

EBRD       European Bank for Reconstruction and Development
IFC        International Finance Corporation
IMF        International Monetary Fund
OPIC       Overseas Private Investment Corporation
USAID      U.S. Agency for International Development



Page 26                                GAO/NSIAD-99-221 Foreign Assistance
Page 27   GAO/NSIAD-99-221 Foreign Assistance
Appendix I

Romanian Fund Investments, Loans, and
Technical Assistance                                                                                         Appenx
                                                                                                                  Idi




              As of September 30, 1998, the Romanian fund had made investments and
              loans in and provided technical assistance to Romanian businesses totaling
              about $30 million. Most of the fund’s investments (nearly $23 million) were
              in Romanian small- and medium-sized businesses, including agribusiness
              and manufacturing of chemical products, technical rubber, and machine
              parts. The average size of the fund’s 17 direct equity investments was about
              $1.3 million, but over 40 percent of its investments was concentrated in two
              firms. The fund’s largest investment was $5 million in a paint
              manufacturing company, and the smallest was $42,000 in a financial
              services firm. Table I.1 shows the fund’s direct investments, including the
              recipient firms, types of businesses, and amounts invested.



              Table I.1: Romanian Fund Direct Investment Program as of September 30, 1998

              Dollars in thousands
              Name of firm                         Type of business                          Amount invested
              Avicola Crevedia                     Agribusiness                                          $200
              Comtel                               Hotel development                                    1,300
              Connecticut Manufacturing            Machine parts manufacturing                          1,373
              Doriela                              Agricultural services                                  229
              Dunarea                              Textile manufacturing                                  500
              Hobas Tub                            Commercial pipe manufacturing                        1,700
              IPEC                                 Porcelain manufacturing                                680
              Logic Telecom                        Telecommunications services                          1,800
              MotorActive                          Leasing services                                       100
              Multicolor                           Label and package manufacturing                        345
              Multiprint                           Printing                                               471
              Policolor                            Paint manufacturing                                  4,988
              Regisco                              Financial services                                      42
              Rolast                               Technical rubber manufacturing                       4,125
              TEC Miaco                            Agribusiness                                         2,500
                           a
              Titan Mar                            Construction materials production                      800
              Transdata                            Telecommunications services                          1,442
              Total                                                                                   $22,595
              a
                  Includes purchase of Marmosim.
              Source: Romanian fund.


              As shown in table I.2, the Romanian fund had invested about $6.2 million in
              loans and other lending programs. Over half (about $3.2 million) of the



              Page 28                                                      GAO/NSIAD-99-221 Foreign Assistance
Appendix I
Romanian Fund Investments, Loans, and
Technical Assistance




investments were made through the fund’s small- and medium-sized loan
program.



Table I.2: Romanian Fund Loan and Other Small- and Medium-sized Business
Program Disbursements as of September 30, 1998

Dollars in thousands
Program                                                               Amount disbursed
Small- and medium-sized loans                                                         $3,171
Micro-sized loans                                                                      2,430
Other small- and medium-sized business programs                                         554
Total                                                                                 $6,155
Source: Romanian fund.


The Romanian fund had provided about $650,000 in technical assistance,
most of which supported the fund’s investments. Table I.3 offers some
examples of technical assistance activities in which the fund engaged in
support of its own investments or private sector development.



Table I.3: Examples of Romanian Fund Technical Assistance Projects

Name of firm             Description of assistance
Multicolor               Evaluated operations, finance, and human resource functions,
                         and recommended changes in management personnel and
                         inventory controls
Policolor                Trained managers and marketing and sales personnel in
                         marketing techniques and product distribution
Rolast                   Reviewed project planning and subsequently trained top
                         management in methods for instituting organizational changes
Titan Mar                Provided strategic consulting and advice on operations and
                         technology
Transdata                Evaluated human resources and helped establish
                         performance-based incentive packages for managers and
                         employees
Source: Romanian fund.




Page 29                                            GAO/NSIAD-99-221 Foreign Assistance
Appendix II

Russian Fund Investments, Loans, and
Technical Assistance                                                                                                                Appe
                                                                                                                                       nIx
                                                                                                                                         Idi




                                           As of September 30, 1998, the Russian fund had made investments and
                                           loans in and provided technical assistance to Russian businesses totaling
                                           about $125 million. Most of the fund’s investments were in small- and
                                           medium-sized businesses, but the fund had invested in some larger
                                           businesses as well. The Russian fund had made 28 direct equity
                                           investments totaling over $97 million in businesses in Russia, ranging from
                                           agribusiness to telecommunications. The average size of the fund’s direct
                                           investments was about $3.5 million, but over half of its total investments
                                           was concentrated in seven companies. The fund’s largest direct investment
                                           was $15.5 million in a brewing and bottling company, and the fund’s
                                           smallest was $75,000 in a dental clinic. Table II.1 details the fund’s direct
                                           investment program, including the recipient firms, the types of businesses
                                           they operate, and the amounts that the fund invested in them.



Table II.1: Russian Fund Direct Investment Program as of September 30, 1998

Dollars in thousands
Name of firm                                      Type of business                                                 Amount invested
Agribusiness Partners International L.P.          Agribusiness industry direct investment fund                               $5,000
Bitech Petroleum Corporation                      Petroleum production                                                         3,000
Dieselprom                                        Diesel engine manufacturing                                                  3,660
Financial Center                                  Financial services                                                             600
Frank’s Siberian Supreme                          Ice cream production                                                           211
FunTech                                           Xerox copy operations and distribution of Xerox products                     2,000
Genesee-Volkhov Connection, Inc.                  Photo processing center                                                        900
Independent Network Television Holding            Commercial network broadcasting                                              4,378
International Business Communication Systems, Inc. Telecommunications                                                          5,000
Interstom                                         Dental clinic                                                                   75
Invacorp                                          Pharmaceutical distribution                                                  5,000
Lomonosov Porcelain Factory                       Porcelain tableware production                                               2,375
Marine Resources Company International            Seafood production and fishing vessel refitting                              8,250
Nizhny Newsprint Holdings                         Newsprint and paper production                                               4,140
Phargo                                            Alphagraphics business services                                              2,500
Plyko L.L.C.                                      Plywood manufacturing                                                        5,825
Polygrafoformlenie                                Packaging                                                                    2,799
Russian Petroleum Investor, Inc.                  Publishing and information services for oil and gas industry                 1,950
Saint Springs Water Limited                       Production and distribution of bottled water                                 3,500
Segol RadioPage                                   Wireless messaging systems                                                   2,500
                                                                                                                          (continued)




                                           Page 30                                               GAO/NSIAD-99-221 Foreign Assistance
                            Appendix II
                            Russian Fund Investments, Loans, and
                            Technical Assistance




Dollars in thousands
Name of firm                        Type of business                                          Amount invested
StoryFirst Communications           Radio and television broadcasting                                     5,000
SUN Brewing Limited                 Brewing and bottling facilities                                      15,500
Time                                Women’s clothing production                                            204
TsUM                                Retail department store                                                500
U.S. Global Health                  Medical clinic                                                        3,770
Vita Plus                           Pharmaceutical distribution                                           5,000
ZAO Giant, Ltd.                     Supermarket chain                                                     2,980
Zapsibinvest                        Wood processing and packaging                                          970
Total                                                                                                  $97,587
                            Source: Russian fund.


                            The Russian fund had made over $25 million in small- to medium-sized
                            loans, consumer auto loans, residential mortgage loans, and micro-sized
                            loans to entrepreneurs. However, over 80 percent of the fund’s lending
                            activities were concentrated in loans to small businesses through the fund’s
                            partner banks. Table II.2 shows the amount of loans disbursed through the
                            fund’s various loan programs.



                            Table II.2: Russian Fund Loan Program Disbursements as of September 30, 1998

                            Dollars in thousands
                            Program                                                          Amount disbursed
                            Bank partner program and other small- and medium-sized loans               $20,863
                            Auto loans                                                                   4,000
                            Mortgage loans                                                                 250
                            Micro-sized loan program                                                       438
                            Total                                                                      $25,551
                            Source: Russian fund.


                            The fund had also provided about $1.7 million in technical assistance, most
                            of which was in support of the fund’s own investments. Table II.3 offers
                            some examples of technical assistance activities in which the fund engaged
                            in support of its own investments.




                            Page 31                                         GAO/NSIAD-99-221 Foreign Assistance
Appendix II
Russian Fund Investments, Loans, and
Technical Assistance




Table II.3: Examples of Russian Fund Technical Assistance Projects

Name of firm                Description of assistance
FunTech                     Installed management information and financial reporting
                            systems
Genesee-Volkhov             Installed a management information system
Connection, Inc.
Invacorp                    Upgraded the company’s existing management information
                            system
Plyko L.L.C.                Installed a management information system and retained
                            an engineering consultant to assist in the installation of a
                            new production line and recommend operational
                            improvements
Saint Springs Water Limited Trained company employees in management development,
                            strategic planning, and team building
Source: Russian fund.




Page 32                                            GAO/NSIAD-99-221 Foreign Assistance
Appendix III

Romanian and Russian Fund Boards of
Directors                                                                                    AppeInx
                                                                                                   Idi




                The members of the Romanian and Russian funds’ boards of directors are
                private citizens of the United States or the host country. Although the
                members’ backgrounds are varied, they generally have experience in areas
                such as investment banking and business or other relevant expertise.



Romanian Fund   The Romanian fund’s board of directors is comprised of 10 members. The
                members include several attorneys and others who have experience in the
                financial sector or investment banking, two former U.S. ambassadors, and
                one current and one former Romanian government official. Information on
                all 10 board members follows.

                Director and Chairman of the Board

                Mr. Harry G. Barnes, Jr.
                Director, Conflict Resolution Program and Chair, Human Rights
                 Committee, The Carter Center
                Former U.S. Ambassador to India, Chile, and Romania

                Director, President, and Chief Executive Officer

                Mr. I. John Klipper
                Former President of IVEX Corporation
                Romanian native
                Former insurance and venture capital company executive

                Directors

                Mr. Mugur Isarescu
                Governor, National Bank of Romania

                Mr. Robert D. Joffe
                Presiding Partner, Cravath, Swaine, and Moore
                Board Member, Lawyers Committee for Human Rights
                Executive Committee Member, Association of the Bar of the City of New
                 York

                Ms. Judy H. Mello
                President and Chief Executive Officer, World Learning
                Former Managing Director, Cambridge International Partners




                Page 33                                    GAO/NSIAD-99-221 Foreign Assistance
               Appendix III
               Romanian and Russian Fund Boards of
               Directors




               Mr. David M. Roth
               Managing Partner, Levy & Droney

               Ms. Ida F.S. Schmertz
               Co-Chair, Volkhov International Business Incubator and Training Center
                of the Alliance of Russian and American Women
               Principal, Strategic Investment International

               Mr. Theodor Stolojan
               Senior Economist, World Bank
               Former Prime Minister of Romania

               Mr. Richard N. Viets
               Vice President and General Manager, Web Tools Division, Secure
                Computing Corporation
               Former U.S. Ambassador to Jordan and Tanzania

               Mr. Gregory A. White
               Chief Operating Officer, ValueQuest/TA
               Former Executive Director, Massachusetts State Pension Fund



Russian Fund   The Russian fund’s board of directors is currently comprised of nine
               members. The members include several individuals with experience in
               investment banking, venture capital, and financial services and others who
               have experience in business, law, and government, including a former
               assistant secretary of state and a former U.S. ambassador at large. The
               fund does not currently include any host-country citizens. Information on
               all nine board members follows.

               Director and Chairman

               Patricia M. Cloherty
               President and General Partner of Patricof & Co., Ventures, Inc., a private
                venture capital company operating in six countries
               Former President and Chairman of the National Venture Capital
                Association
               Member of the Council on Foreign Relations




               Page 34                                    GAO/NSIAD-99-221 Foreign Assistance
Appendix III
Romanian and Russian Fund Boards of
Directors




Director, President, and Chief Executive Officer

David A. Jones
Former President of Clarendon Capital, an investment banking and
 consulting firm
Founding Partner of Dougery, Jones & Wilder, a venture capital firm
Former Vice President of Citicorp Venture Capital Ltd.

Directors

Frank J. Caufield
General Partner and Founder of Kleiner Perkins Caufield & Byers, a
 venture capital firm
Former President of the National Venture Capital Association
Former President of the Western Association of Venture Capitalists

Arthur DelVesco, Cofounder of Wind Point Partners, a venture capital firm
Former Director of Republic Telecom Systems Corporation
Former Senior Investment Manager at First Chicago Equity Group

D. Jeffrey Hirschberg
Vice Chairman and Senior International Counselor, Ernst & Young, LLP.
Former Special Attorney to the Deputy Attorney General
Director of the U.S.-Russia Business Council

Robert D. Hormats
Vice Chairman of Goldman, Sachs International
Board Member of the Council on Foreign Relations
Former Assistant Secretary of State for Economic and Business Affairs
Former U.S. Deputy Trade Representative

Karen N. Horn
Senior Managing Director and Head of International Private Banking at
 Bankers Trust Company
Former Chairman of the Board of Bank One, Cleveland, NA

J. Bruce Llewellyn
Chairman of Philadelphia Coca Cola Bottling Co.
Former President of OPIC
Former U.S. Ambassador at Large




Page 35                                    GAO/NSIAD-99-221 Foreign Assistance
Appendix III
Romanian and Russian Fund Boards of
Directors




Richard D. Turner
Executive Vice President of South Shore Bank of Chicago
Creator of Polish-American Enterprise Fund small loan program




Page 36                                 GAO/NSIAD-99-221 Foreign Assistance
Appendix IV

Enterprise Fund Law Firms                                                                                                                     Appenx
                                                                                                                                                   IV
                                                                                                                                                    di




                                         As shown in table IV.1, four law firms provide the primary legal counsel for
                                         9 of the 10 enterprise funds in Central Europe and the former Soviet
                                         Union.1 One such firm—Weil, Gotshal & Manges of Washington, D.C.—is
                                         the primary law firm for five of the funds, while another firm—Arnold &
                                         Porter of Washington, D.C.—is the primary law firm for two funds.
                                         According to U.S. Agency for International Development (USAID) officials,
                                         only the Albanian fund retains no primary law firm and, instead, contracts
                                         for legal services on an as-needed basis. In addition to their primary law
                                         firms, most funds employ host-country or other specialized law firms for
                                         individual investment deals and a variety of other legal matters requiring
                                         specific expertise that is not available from one firm. According to USAID
                                         officials, the funds have employed over 50 different law firms on a variety
                                         of legal matters since they began operations.



Table IV.1: Enterprise Fund Primary Law Firms

Law firm                               Corporate or business location                 Enterprise fund
Weil, Gotshal & Manges                 Washington, D.C.                               Baltic
                                                                                      Hungary
                                                                                      Poland
                                                                                      Romania
                                                                                      Russia
Arnold & Porter                        Washington, D.C.                               Czech-Slovak
                                                                                      Western Newly Independent States
Kirkland & Ellis                       Chicago, IL                                    Bulgaria
McDermott, Will & Emery                New York, NY                                   Central Asia
                                         Source: USAID.




                                         1
                                          Two additional enterprise funds that we did not include in our review—the Defense Enterprise Fund
                                         and the Southern African Enterprise Fund—also employ primary law firms. The Defense Enterprise
                                         Fund’s primary law firm is Weil, Gotshal, and Manges of Washington, D.C., and the Southern African
                                         Enterprise Fund’s primary law firm is Long, Aldridge, and Norman of Atlanta, GA.




                                         Page 37                                                  GAO/NSIAD-99-221 Foreign Assistance
Appendix V

Comments From the Department of State                          Appe
                                                                  nx
                                                                   Vdi




              Page 38        GAO/NSIAD-99-221 Foreign Assistance
Appendix VI

Comments From the U.S. Agency for
International Development                                      Appenx
                                                                    V
                                                                    diI




              Page 39        GAO/NSIAD-99-221 Foreign Assistance
Appendix VI
Comments From the U.S. Agency for
International Development




Page 40                             GAO/NSIAD-99-221 Foreign Assistance
Appendix VII

GAO Contacts and Staff Acknowledgments                                                           Appex
                                                                                                     V
                                                                                                     nIdi




GAO Contacts          Jess Ford, (202) 512-4268
                      A.H. Huntington, III, (202) 512-4140



Acknowledgments       In addition to those named above, Michael Courts, Lee Kaukas, Jim Strus,
                      George Taylor, Bruce Kutnick, and Richard Seldin made key contributions
                      to this report.




(711353)       Lte
                 rt   Page 41                                  GAO/NSIAD-99-221 Foreign Assistance
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