Foreign Assistance: Issues Concerning the Polish-American Enterprise Fund

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

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

    AAccountabiity * Integrity * Reliability

United States General Accounting Office                                                    Office of the General Counsel
Washington, DC 20548


               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

               Subject: Foreign Assistance: Issues Concerning the Polish-American Enterprise

            In 1989, Congress enacted the Support for East European Democracy (SEED) Act to
            provide assistance for political and economic development in Eastern Europe.'
            Instead of providing more traditional types of foreign assistance, the Act, among
            other things, authorized enterprise funds to promote private sector development in
            Poland and Hungary through grants, loans, equity investments, and other measures. 2
            This letter addresses issues raised by your staff regarding structural changes
            undergone by the Polish-American Enterprise Fund (Polish Fund) and its
            management company to enable them to operate more like private venture capital
           companies. 3 Specifically, we determined (1) whether these structural changes were
           permitted by law, (2) whether the purchase of the Polish Fund's management
           company by its employees at book value 4 was permitted by law and whether it
           favored the employees, (3) whether monies earned by Polish Fund management
           company employees contravened a $150,000 salary cap, and (4) how proceeds from
           the sale of the Polish Fund's assets will be distributed.

           'P.L. 101-179, 103 Stat. 1299, codified at 22 U.S.C. §§ 5401-5495.

           222 U.S.C. § 5421.

           :'In a separate report, Foreign Assistance: Enterprise Funds' Contributions to Private Sector
           Development Vary (GAO/NSIAD-99-221, Sept. 14, 1999), we address a number of broad issues
           regarding 10 U.S. enterprise funds, including the Polish Fund, in Central Europe, and the newly
           independent states of the former Soviet Union.
               Book value is the residual value of an entity's assets after deducting its liabilities.

                                                                                     GAO/OGC-99-61R Polish Fund Issues

For the reasons discussed in this letter, we concluded that structural changes to the
Polish Fund and its management company were consistent with applicable
legislation. We also concluded that the purchase of the Polish Fund's management
company by its employees at book value was consistent with existing law and that,
under the circumstances, the terms of the purchase were reasonable. Furthermore,
we concluded that Polish Fund management company employees can earn more than
$150,000 in annual salary as long as additional amounts are derived from sources
other than U.S. funds. Finally, regarding distribution of Polish Fund proceeds, the
administration plans to return $120 million to the U.S. Treasury and to provide the
balance to a foundation for additional private-sector development in Poland.


A. Background

Under the SEED Act, the Polish Fund was formed in 1990 as a private, nonprofit
entity. The Fund is governed by a board of directors composed of both U.S. and host
country citizens. The U.S. Agency for International Development (USAID) has
provided grants to and oversees the Fund, and the Department of State is responsible
for overall coordination of U.S. assistance under the SEED Act, including the
enterprise fund program. USAID has authorized $264 million in grants to the Polish

As early as 1991, USAID, State, and Fund officials began discussing altering the Polish
Fund's structure. These changes involved spinning off the management of the Fund
into a separate management company that would manage both the Fund's
investments and those of an affiliated private fund. A vital part of the plan was to
have Polish Fund employees leave their positions and become employees of the
management company.

According to USAID, these changes were made to set up a structure that more closely
paralleled a private-sector investment company that manages multiple investment
funds. Polish Fund and USAID officials stated that this kind of structure would
better attract private investors who would otherwise be reluctant to provide capital
to an entity like the Polish Fund, which could have been perceived as being affiliated
with the U.S. government. The changes also were intended to provide former Polish
Fund employees with additional compensation incentives. Finally, according to
USAID, the changes would lower the Polish Fund's management costs because
management fees would be spread over two funds.

After the Polish Fund board of directors approved these changes to the Fund's
structure, Enterprise Investors, L.P., was formed in 1992 to manage investments of
both the Polish Fund and a new private investment fund named the Polish Private
Equity Fund. The Polish Fund and the European Bank for Reconstruction and
Development owned 60 percent and 40 percent, respectively, of Enterprise Investors.
The Polish Private Equity Fund was capitalized at approximately $150 million-

Page 2                                                 GAO/OGC-99-61R Polish Fund Issues

 $50 million from the Polish Fund, $50 million from the European Bank for
 Reconstruction and Development, and the rest from other investors.

 On September 25, 1996, USAID, with State's concurrence, approved a further
 elaboration of the process begun in 1992 by allowing employees of Enterprise
 Investors to purchase the company from the Polish Fund and the European Bank for
 Reconstruction and Development. It also approved formation of a second private
 fund, the Polish Enterprise Fund, L.P., capitalized at an additional $150 million.
 According to State, these changes were intended to (1) emphasize U.S. policy to
 expand trade and investment ties with Poland; (2) bring more money under
 Enterprise Investors' management, which would further reduce the fee charged to the
 Polish Fund;5 (3) attract additional capital; and (4) increase compensation
 possibilities for Enterprise Investors' employees and thereby reduce the risk of loss
 of staff.

 The employees of Enterprise Investors purchased their company, which had been
 renamed Enterprise Investors Corporation, on April 30, 1997. This entity currently
 manages the Polish Fund, the Polish Private Equity Fund, and the Polish Enterprise
 Fund.6 According to the Polish Fund, the total management fees for 1998 were
 $7.5 million, with $1.5 million paid by the Polish Fund and the remainder paid by the
 two private funds.7

 B. Legal Discussion

The Polish Fund's structural changes were permitted by the SEED Act. The act
indicates that the Polish Fund is a private, nongovernmental entity that received
funds to develop the Polish private sector. The act authorized the Polish Fund to
engage in transactions that would attract U.S. private venture capital; establish
financial instruments that would enable individuals to invest in the private sector in
Poland; and distribute to private investors returns on investments that include private
venture capital. These authorities were intended to maximize the effectiveness of
Polish Fund activities and multiply the impact of U.S. grants. 8 USAID attorneys
6When compared with its
                        capital, operating expenses of the Polish Fund are the lowest of the 10
enterprise funds discussed in the report mentioned in footnote 3.

'The Polish Fund has indicated that an additional private fund might be formed, which would also be
managed by Enterprise Investors Corporation.

7InSeptember 1997, the Hungarian Fund implemented structural changes similar to those of the Polish
Fund. At that time, MAVA Investment Management Kft. was formed to manage both the Hungarian
Fund and a private fund sponsored by the Hungarian Fund, Hungarian Equity Partners, which was
capitalized'at $50 million to invest in the private sector in Hungary. MAVA is owned by former
Hungarian Fund employees. At this point, the Hungarian Fund is associated with only this one private
fund. USAID has tentatively approved similar changes for the Russian Fund and Bulgarian-American
Enterprise Fund, and the Department of Defense has approved them for the Defense Enterprise Fund,
but none have been fully implemented. Although it is likely that other enterprise funds will make
similar changes in the future, this will depend on how well the private markets are operating in the
area covered by each.

822 U.S.C. §§ 5421(i) and (j).

Page 3                                                              GAO/OGC-99-61R Polish Fund Issues

concluded that the private character of the Polish Fund, as well as these authorities,
allowed it to make the described changes in structure.

As a private entity, the Polish Fund could establish a management company staffed
by its former employees, who would also manage affiliated private investment funds.
The SEED Act clearly intended that the Fund enter into financial arrangements,
including attracting private capital, that would enhance private-sector development in
Poland. Consistent with this intention, in 1994 USAID amended its grant agreement
with the Polish Fund to allow it to establish, invest in, or finance subsidiaries and
affiliates, which have substantially the same directors, managers, and employees,
provided it receives USAID's prior written approval. According to USAID, the Polish
Fund received the required approval regarding the purchase of Enterprise Investors
by its employees 9


A. Background

Before USAID approved the sale of Enterprise Investors to its employees, USAID,
State, and Polish Fund officials had a number of discussions about the details of the
purchase. State was concerned about the appearance of a conflict of interest
because the two individuals who were to serve as directors of the employee-owned
management company would also continue to serve as Polish Fund directors. Thus,
State wanted to ensure that the directors would not be involved in valuing Enterprise
Investors for sale to its employees. To deal with this problem, the two directors
agreed to recuse themselves from any votes of the Polish Fund board of directors
concerning Enterprise Investors, and State and USAID agreed that the Polish Fund
should obtain an independent valuation of Enterprise Investors that would be used to
negotiate a fair and equitable price.

Initially, USAID and State considered a number of pricing elements for the
independent valuator to consider, including the book value of Enterprise Investors,
the market value of all its assets, prices in comparable transactions involving
professional fund managers, and its net present value. Ultimately, however, the
Polish Fund board decided, and State and USAID agreed, that the purchase price
should be based solely on book value. The Fund asked the independent valuator to
determine the book value of the company.

USAID also considered publicly bidding the sale of Enterprise Investors but
eventually abandoned this idea. According to USAID and State officials, this
approach risked losing Enterprise Investors' staff, which was making the company
successful. Furthermore, though USAID officials were aware that other venture
capital firms were operating in Poland, no such groups had indicated any interest in
purchasing Enterprise Investors.

'According to USAID, Congress was notified of these changes.

Page 4                                                         GAO/OGC-99-61R Polish Fund Issues

 Subsequently, an independent auditor concluded that, as of April 30, 1997, the book
 value of Enterprise Investors was approximately $485,000.'° The book value assets
 included furniture, computers, and telephones in leased space. Enterprise Investors'
 employees purchased their company on April 30, 1997. The terms of the sale called
 for Enterprise Investors' employees to pay the $485,000 to the Polish Fund and the
 European Bank for Reconstruction and Development, the former owners of
 Enterprise Investors, in four equal yearly installments with no interest. The first
 payment was to be made on April 30, 1998, 1 year after the sale. According to the
 Polish Fund, the payments have been made for 1998 and 1999.

 B. Legal Discussion and Valuation Issue

 USAID, State, and the Polish Fund board of directors were acting within their
 authority in arranging to sell Enterprise Investors at book value and not publicly
 competing the sale. Neither the SEED Act nor any other law required any particular
 method of valuing Enterprise Investors. Moreover, the sale of Enterprise Investors to
 its employees was an entirely private transaction that was not subject to federal
 procurement laws and regulations.

Although the terms of the sale were advantageous to Enterprise Investors'
employees, under the circumstances, they were reasonable. The facts indicate that
Enterprise Investors' employees purchased an established, successful entity at the
book value price of $485,000. Furthermore, as a consequence of the purchase, these
employees became managers of a second private fund, the Polish Enterprise Fund,
from which they could earn additional salary and profits on investments." Venture
capital experts that we interviewed said that sales of venture capital management
companies are rare and that there is no fixed method of valuation when they do
occur; however, most agreed that, at least as a general matter, valuation of such
entities with a portfolio of successful investments should include some amount based
on potential future income in addition to book value. Finally, the other terms of the
sale-no public competition, payments over 4 years at no interest, and the first
payment due a year after the sale-appear favorable to Enterprise Investors'

Notwithstanding these factors, USAID's and State's approving the sale under these
circumstances was reasonable. According to USAID and State officials, the primary
reason for limiting the valuation to book value was the need to preserve continuity of
Enterprise Investors' staff, which was critical to the success of the Polish Fund and to
the raising of further capital for the second private fund, the Polish Enterprise Fund.
If the purchase price exceeded book value, all or part of Enterprise Investors' staff

'°The independent valuation was performed as part of an audit of Enterprise Investors' consolidated
financial statements as of April 30, 1997.

"The formation of the Polish Enterprise Fund was linked to the purchase of Enterprise Investors by its
employees. According to State, without privatization, the Polish Fund could not assure private
investors that Enterprise Investors was stable; that is, that it could pay competitive compensation to
retain key investment staff.

Page 5                                                           GAO/OGC-99-61R Polish Fund Issues

could have been lost to a competing entity. USAID and State officials cited the lack
of continuity of management in the Czech-Slovak Enterprise Fund as causing major
disruptions of its operations and did not want to risk that happening to the Polish
Fund. USAID and State officials also stated that any goodwill' 2 value that accrued to
Enterprise Investors was due to the skill and experience of its employees rather than
its name or the services it provided. Thus, it was not appropriate to charge
Enterprise Investors' employees for the value of their own experience.

The State and USAID position was supported by several venture capital experts who
agreed that book value was an appropriate method of valuation when necessary to
ensure the continuity of management company staff. They also emphasized that the
principal value-the goodwill -in any venture capital management company lay in
the expertise of its personnel. If valued employees left a management company,
private investors would have no interest in continuing their relationship with it.


A. Background
Although the SEED Act itself does not place a specific dollar limit on compensation,'
the Polish Fund grant agreement precludes salaries of its employees, and employees
of organizations in which the Fund owns a majority interest, from exceeding $150,000
on monies payable from grant funds.' 4 USAID and Fund officials agree that this
limitation extends to salaries paid to Enterprise Investors' employees from
management fees attributable to the Polish Fund, even though the Fund has no
ownership interest in Enterprise Investors. USAID monitors the salary cap by
reviewing the Polish Fund's semiannual report, which contains the Fund's statement
that the Fund is complying with the salary cap.' 5

When Enterprise Investors was formed in 1992, Polish Fund employees terminated
their employment with the Fund and became employees of Enterprise Investors. At
that point, the former Fund employees began receiving salary through management
fees the Polish Fund and the Polish Private Equity Fund paid Enterprise Investors for
management services. This new arrangement afforded these employees two sources
of additional compensation: first, they could earn additional salary through
management fees paid by the Equity Fund; and second, they could share in profits on

"Goodwill value represents the excess of the purchase price of an entity over the fair value of all
identifiable net assets at the time of acquisition.

'322 U.S.C. § 5421(1).

'4The same provision is included in the grant agreements of the other enterprise funds.

I"USAID does not directly audit the Polish Fund's books and records to determine compliance with the
salary cap.

Page 6                                                              GAO/OGGC-99-61R Polish Fund Issues

 Equity Fund investments-commonly referred to as carried interest.'6 Similar
 compensation benefits were again provided to Enterprise Investors' employees when
 the Polish Enterprise Fund was formed in April 1997.

 USAID and the Polish Fund have indicated that no employee of Enterprise Investors
 currently earns more than $150,000 from Polish Fund contributions to salary. They
 also indicated, however, that a number do earn substantially more from management
 fees attributable to the Polish Private Equity Fund and the Polish Enterprise Fund. ' 7
 Although carried interest payments derived from investments of these two private
 funds will probably be made to Enterprise Investors' employees in the future, the
 Fund indicated that none have been made to date. Neither USAID, the Polish Fund,
 nor Enterprise Investors could provide us with any estimates about how much
 carried interest might eventually be paid.

 B. Legal Discussion

 The additional compensation payments resulting from the changes in structure to the
 Polish Fund and Enterprise Investors do not contravene the $150,000 salary cap set
 forth in the Fund's grant agreement with USAID. The grant agreement clearly
indicates that compensation or profit-sharing that exceeds $150,000 per year may be
paid from earnings or sources other than U.S. grant funds. Since the salary payments
to employees of Enterprise Investors that exceed $150,000 are derived from private
sources, they are not subject to the agreed salary cap for Enterprise Investors'
employees. The same would be true for any profits on investments that may be paid
in the future.


A. Background

The SEED Act did not provide for termination of the Polish Fund (or the Hungarian
Fund) or describe how its assets were to be distributed upon liquidation. The only
reference to this issue in the legislative history is a Congressional Budget Office
estimate included in the accompanying House Report.'8 The report states that the
estimate of costs of providing grants to the two enterprise funds assumed "full
disbursement ... and no repayments, dividends, or recoveries to the federal

'6To avoid conflict of interest problems about Enterprise Investors steering investments away from the
Polish Fund, from which carried interest could not be earned, the limited partnership agreement of the
Polish Private Equity Fund stated that investment opportunities had to be presented to both entities
simultaneously. The amounts invested by each entity were to be determined in proportion to monies
available for investment from each fund.

'7The Polish Fund and Enterprise Investors stated that their contracts with private investors precluded
them from providing us with specific information about private salaries. The Hungarian Fund
informed us that one MAVA employee was paid more than $150,000 in 1998, but that it did not
contribute more than $150,000.

'8H. Rep. 1-01-278, at 17, 19-20 (Pt. 2 1989).

Page 7                                                             GAO/OGC-99-61R Polish Fund Issues

government from the Funds' activities." When these enterpiise funds were first
established, many U.S. officials did not expect them to recoup their original grants.

In part because of the success of Polish Fund investments, as early as 1992,
administration, congressional, and Polish Fund officials concluded that a plan was
necessary to terminate the Fund. Accordingly, after consulting with congressional
appropriators, in 1994 USAID amended the Polish Fund grant agreement, and the
Polish Fund amended its certificate of incorporation, to provide for termination of
the Fund and liquidation and distribution of its assets. The amended certificate of
incorporation states that the President of the United States is to determine how
liquidated Polish Fund assets will be distributed. Distributions are to be made to a
nonprofit entity or entities for assistance in Poland, the U.S. government, or a
combination of both. The amended certificate also included a proviso stating that the
intention of the amendment was to have "the proceeds from the sale of... [Polish
Fund] assets be used in Poland, unless there are reasons to do otherwise."

In 1996, the Polish Fund board began discussions with the administration about
disposition of the proceeds from the sale of Polish Fund assets. Subsequently, the
administration developed a distribution plan that called for Fund proceeds to be
divided between the U.S. Treasury and the endowment of a foundation whose
purpose would be the further development of the Polish private sector, a goal
consistent with that of the Polish Fund under the SEED Act.' 9 Under the plan, $155.3
million was to be returned to the U.S. Treasury and a maximum of $130 million was
to be provided to the foundation. Whereas the Polish Fund focused exclusively on
the business sector, the foundation was intended to focus on the broader private
sector, including nongovernmental organizations. The proposed foundation was to
be a Delaware corporation with operations in Poland.

B. Current Plan

The administration's current plan, 20 which, to some extent, was based on the 1996
proposal, was submitted to Congress on May 11, 1999, consistent with a notification
requirement in the Omnibus Consolidated and Emergency Supplemental
Appropriations Act for fiscal year 1999.21 Under the plan, $120 million of the

'In formulating this plan, the administration considered but rejected a proposal to return all Polish
Fund proceeds to the U.S. Treasury because it would have been politically unpopular in Poland, with
the Polish American community, and with Poland's supporters in Congress. The administration also
considered a proposal to provide all the proceeds to a Polish entity, but decided that turning close to
$270 million over to a new and untested foundation would have been unwise and would not allow for
the first substantial return to U.S. taxpayers on an assistance program. The administration also
concluded that such a plan would not be well received by members of the Congress who wanted a
substantial portion of the proceeds returned to the United States.
  State and USAID considered several variations of the current plan. Thus, the administration dropped
a proposal (1) dividing reflows between the United States, a Polish foundation, and several trust funds
supporting activities in Central Europe and the Baltic states; (2) returning to the United States an
amount based on the original $240 million U.S. capitalization of the Polish Fund; and (3) terminating
the Fund.

Page 8                                                             GAO/CGC-99-61R Polish Fund Issues

    estimated $270 million in returns on Polish Fund investments is to go to the U.S.
    Treasury in amounts of $40 million each in fiscal years 1999, 2000, and 2001. The
    $120 million represents one-half the amount of the initial $240 million in grant funds
    that USAID was authorized to provide to the Polish Fund. The Polish Fund will
    provide the balance, an estimated $150 million, to a U.S. entity named the Polish-
    American Freedom Foundation, as a grant in the form of an endowment. The
    Foundation will be a nonprofit Delaware corporation, and its principal business will
    be conducted through a wholly owned and controlled subsidiary organized under
    Polish law.

 After the administration submitted its plan to Congress, the Polish Fund drafted a
 grant agreement setting forth the relationship between the Polish Fund and the
 Foundation and describing the scope of the Foundation's activities. Concurrently,
 USAID drafted amendments to its grant agreement with the Polish Fund to provide
 for the grant relationship between the Polish Fund and the Foundation. Drafts of
 these documents have been reviewed and approved by USAID, State, other relevant
 U.S. agencies and the Polish Fund.

The grant agreement between the Polish Fund and the Polish Foundation provides
that the Foundation's endowment, estimated to be $150 million, will be used to
support private sector development in Poland" in the areas of economic reform,
leadership development, civil society, local government and business development,
and legal reform, consistent with section 201(a) of the SEED Act. The grant
agreement also authorizes the Foundation to support assistance programs in other
countries in Central and Eastern Europe and the Western newly independent states in
their transition to democracy and free markets, but only after legislative authority is
obtained. Administration officials said they would seek legislation to authorize
Foundation activities outside of Poland because the SEED Act only authorizes Polish
Fund activities for private sector development in Poland. Both the grant agreement
and the amendments to the USAID-Polish Fund grant agreement provide that for its
first 5 years the Foundation must restrict its activities to the five areas described in
the grant agreement.3

The Foundation will be managed by a board of directors composed of six U.S. and
five Polish citizens, some of whom will be Polish Fund board members, according to
State. The initial board will be appointed by the Polish Fund, and the board members
will select a chairman. Board members will serve staggered 3-year terms, and
subsequent board members will be elected by the Foundation. The U.S. Ambassador
to Poland will be a permanent, nonvoting liaison to the Foundation board.

"P.L. 105-277, 112 Stat. 2681-200.

'LAs a general matter, the Foundation cannot spend the endowment's principal for its activities.
Foundation activities must be financed by earnings generated by the endowment or funds obtained
from outside sources. Endowment principal can only be used under extraordinary circumstances and
must be restored as soon as practicable.

2'An amendment to the Polish Fund-USAID grant agreement indicates that the Polish Fund will
continue to exist as long as the Foundation is operating.

Page 9                                                         GAO/OGC-99-61R Polish Fund Issues

The U.S. members of the Foundation's board of directors will not be compensated for
their services but will be reimbursed for reasonable expenses. The Polish members,
however, will be compensated. Foundation employees will be subject to a $150,000
salary cap much like that covering Polish Fund employees and employees of
Enterprise Investors. Compensation exceeding $150,000, however, can be paid from
sources other than the Foundation endowment and endowment proceeds. According
to State and USAID officials, the additional salary could come from contributions to
the Foundation from private entities. These officials also stated, however, that there
are no plans for the Foundation to undergo the kind of structural changes made to
the Polish Fund, with the attendant enhanced compensation possibilities.

The Foundation's grant agreement with the Polish Fund provides the Polish Fund, the
USAID Inspector General, and the Comptroller General of the United States with a
right to audit and resolve all questions regarding endowment expenditures. This
audit right includes access to Foundation records necessary to complete an audit.
The grant agreement also includes conflict of interest provisions imposing disclosure
and recusal requirements on Foundation directors and officers when considering
transactions with entities in which they hold a financial interest. These provisions
also preclude Foundation directors, officers, and employees from using confidential
or privileged information for financial gain or other advantage.

Finally, both the grant agreement and the amended grant agreement between USAID
and the Polish Fund authorize the Polish Fund to terminate, or USAID24 to cause the
Fund to terminate, the grant agreement for (1) the Foundation's failure to comply
with the grant agreement, (2) foreign policy reasons, (3) insolvency, (4) unauthorized
changes in structure, and (5) improper Polish taxation of U.S. foreign assistance.
Should termination occur, Foundation funds are to be returned to USAID.2 5
According to State, this right of termination will both protect the U.S. interest in the
Foundation and allow the United States to direct the use of any returns.


To address the questions raised, we reviewed the SEED Act and its legislative history
as well as other relevant legislation, regulations, and congressional correspondence.
We also discussed the issues raised with State, USAID, and Polish Fund officials and
attorneys, and reviewed documentation provided by each. For further information
concerning the valuation of the sale of Enterprise Investors to its employees, we
interviewed a number of graduate business school professors and private venture

2USAID    must first consult with the Polish Fund's board of directors before exercising this right.

5A USAID attorney indicated that the return of the funds to USAID instead of directly to the U.S.
Treasury was primarily for convenience and that USAID would have to return the money to the U.S.

Page 10                                                              GAO/OGC-99-61R Polish Fund Issues


 State, USAID, and Polish Fund officials provided written comments on a draft of this
 report (see enclosures I, II, and III, respectively). They also provided technical
 comments that we have incorporated, as appropriate. State and USAID characterized
 the report as thorough and balanced.

  In the Polish Fund's written comments to this report, the Fund disagreed with our
  conclusion that the terms of the sale of Enterprise Investors to its employees were
  advantageous to the employees. The Fund concluded that valuing the sale at book
 value was appropriate and, thus, the terms of the sale were fair and reasonable. We
 agree that the sale of Enterprise Investors to its employees at book value was a
 reasonable way of preserving continuity of the Enterprise Investors' staff and
 avoiding disruption in management. Nevertheless, arranging a sales price without
 including some potential for future income, and allowing purchase payments over 4
 years at no interest with the first payment due a year after the sale, was advantageous
 to Enterprise Investors' employees.

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

If you or your staff have any questions concerning this report, please contact me on
(202) 512-5400 or Richard Seldin on (202) 512-4094. Other GAO contacts and staff
acknowledgments are listed in enclosure IV.

Robert P. Murphy
General Counsel

Page 11                                                  GAO/OGC-99-61R Polish Fund Issues
 ENCLOSURE I                                                                        ENCLOSURE I


                                                       United States ])epartment of State

                                                          Washington, D.C. 20520-7427

                                                             AUG 2 5        .:

           Dear Mr. Hinton:

                We appreciate the opportunity to review your draft report, "FOREIGN
           ASSISTANCE: Issues Concerning the Polish Enterprise Fund,"
           GAO/OGC-99-61R, GAO Job Code 711353.

                   The Office of the Coordinator of Assistance for Eastern Europe has
           reviewed the above-referenced draft report. We consider this report
           regarding the structural changes undergone by the Polish-American
           Enterprise Fund (PAEF), which was referred to as the 'Polish Fund" in the
           report, to be thorough and balanced. We note that the structural changes
           enabled the PAEF to raise more than S262 million in non-U.S.
           Government (USG) capital, and to reduce the cost to U.S. taxpayers to
           manage its USG grant. The structural changes enabled the PAEF to
           retain their investment team, whose efforts are expected to return an
           estimated $270 million in reflows, which will be split between a payment to
           the U.S. Treasury and the planned establishment of the Polish-American
           Freedom Foundation.

                 If you have any questions concerning this response, please contact
           Mr. Donald Sheehan at (202) 647-1183.

                                              Bert T. Edwards

            GAO/OGC - Mr. Seldin
            State/EUR/EEA - Mr. Sheehan

           Mr. Henry L. Hinton, Jr.,
              Assistant Comptroller General,
                 National Security and Intemational Affairs,
                    U.S. General Accounting Office.

Page I'1                                                    GAO/OGC-99-61        R Polish Fiund Issues
  ENCLOSURE II                                                                         ENCLOSURE I

                         COMMENTS FROM THE U.S. AGENCY FOR
                            INTERNATIONAL DEVELOPMENT


     U. S. .GE\C   FOR                                                           -

                                                                          August 19, 1999

              Mr. Henry L. Hinton, Jr.
              Assistant Comptroller General
              National Security and International Affairs Division
              U.S.- General Accounting Office
              441 G Street, N.W. - Room 4039
              Washington, D.C. 20548

              Dear Mr. Hinton:

                   I am pleased to provide the U.S. Agency for International
              Development's (USAID's) formal response on the GAC draft report
              entitled "FOREIGN ASSISTANCE: Issues Concerning the Polish
              Enterprise Fund" [August 1999!.

                   Your report on the issues raised regarding the structural
             changes undergone by the Polish-American Enterprise Fund [Po:ish
             Fund) and its management company is thorough and balanced. The
             structural changes enabled the Polish Fund to mobilize $262
             million in non-U.S. Government capital, (more than their US.AD
             grant), and to reduce the cost to U.S. taxpayers to manage the
             grant.   The changes enabled the Polish Fund to retain their
             investment team, one that will likely return about $270 million
             to be split between the U.S. Treasury and a philanthropic
             foundation in Poland.

                  USAID appreciates the efforts of the GAO to address the
             issues covered in this report. Thank you for the opportunity to
             respond to the GAO draft report and for the courtesies extended
             by your staff in the conduct of this review.


                                                Terrence           J.   Brown
                                               Assistant Administrator
                                               Bureau for Management

                                   1300 PE\S\YL\\ANZ   A AVENLE.   N.WV
                                      -WSHINTOr\.      D.C. 20523

Page 1i                                                             GAO/OGC-99-61R Polish Fund Issues
  ENCLOSURE I                                                                                    ENCLOSURE III

                         COMMENTS FROM THE POLISH-AMERICAN
                                 ENTERPRISE FUND

                                       Polish-Amnerican Enterprise Fund
          Roblrx    ;. FRln
                          il& E
          P'rrid.cnr~s: e hict'        Artfi'cr

                                                         August 26, 1999

                   Richard Seldin, Esq.
                   Senior Attorney
                   Office of General Counsel
                   National Security and International Affairs Division
                   U.S. General Accounting Office
                   441 G Street, N.W.
                   Room 7662
                   Washington, D.C. 20548
                   Dear Mir. Seldin:

                          The Polish-American Enterprise Fund requests that the following comments be
                   included in the forthcoming General Accounting Office report on "Issues Concerning the
                   Polish-American Enterprise Fund":
                       The goal of establishing a private management company and raising private funds
               was to help in meeting the overall PAEF (and USG) objectives of(1) leveraging USG
               money; (2) replacing USG money with private sector funds; and (3) reducing PAEF
               operating costs.

                        The results are that (1) USG money has been leveraged. PAEF invested and
               loaned S655 million through September 30, 1998 after receiving only 3240 million of
               investment funds from the USG; (2) PAEF has replaced USG funds with private funds.
               and thus can return S120 million to the USG and provide approximately S150 million to a
               UISG-approved foundation to assist Poland; and (3) because PAEF's overhead costs have
               been shared with the private funds, PA.EF's operating costs are less than 0.7% of its
               assets, resulting in savings to the USG of an estimated S25-30 million.

                                            FUND .DVISORS.   ENTERPRISE INVESTORS
               3- ; Park Avenue. Suite 1902. Nexw York. N-Y 101'2. LSA   Tel. (212) 359-3.(30 FL,x ('212) 339,-; 3
          Atrium Tower. Al. ana Pawh i I 25. 0-85-I.  Xarzawa. Pland     Tel. (-iS-22) (0-54;t)0 FLX(-22) o;-.;5

Page 14                                                                  GAO/OGC-99-61R Polish Fund Issues
       ENCLOSURE IlU                                                                      ENCLOSURE HI

                  Richard Seldin, Esq.
                  August 26, 1999
                  Page 2

Now on pp. 5-6           With respect to pages seven and eight of the report, the P..EF agrees with the
                 position of the State Department, USAID, and the venture capital community. that book
                 value is the appropriate method for valuing an entity such as Enterprise Investors.
                 Therefore, the terms of the sale of Enterprise Investors to its employees were fair and
                 reasonable, and not advantageous to them, as the GAO suggests on page seven. The
                 apparent inconsistency between page seven (where venture capitalists conclude that book
                 value was "not an appropriate measure") and page eight (where venture capitalists
                 conclude that the valuation was appropriate) is the difference between a theoretical view
                 of the venture capital world by non-practitioners, and the real world.


                                                      Robert G.Faris
                                                      President and Chief Executive Officer

                 cc:    Robert Murphy, Esq.
                        General Counsel

     Page 15                                                       GAO/OGC-99-61R Polish Fund Issues
ENCLOSURE IV                                                       ENCLOSURE IV



Sheila K. Ratzenberger, (202) 512-8244
Mark C. Speight, (202) 512-8231


In addition to those named above, Michael J. Courts; A.H. Huntington, mII; J;ames M. Strus;
and George A. Taylor, Jr. made key contributions to this report.


Page 16                                             GAO/OGC-99-61R Polish Fund Issues