Central and eastern Europe overview

Author: | Published: 4 Jan 2001
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Central and eastern Europe is undergoing a private equity revolution and opportunities abound throughout the region.

The early arrival of overseas investors and private equity arms of major banks paved the way for domestic funds, such as Enterprise Investors in Poland. Enterprise Investors has four funds and has invested approximately $550 million in 70 operations in Poland.

The green field effect, the size of the region and the availability of deals have led to the rapid growth of regional funds and large institutional funds. Advent International, ING Barings, CSFB and Argus Capital Partners (a Prudential fund) were the first to arrive. Recently, Argus has invested $60 million in projects as diverse as NTV3 (a Czech television station) and a multiplex cinema joint venture across the region with UCI. Incubators are also beginning to appear. Notable examples include NEST in Romania and Charnation Internet Consulting in Hungary.

As you go further east, the market becomes slightly less developed and although there are opportunities, domestic funds are few and far between. In Romania, for example, CMS Cameron McKenna recently advised an international fund, Advent International, on its $20m investment in Monoply Media. Further stabilization of the Russian economy means that there are positive signs for future growth.

A number of factors have fuelled the growth of venture capital in the central and eastern European markets:

  • privatization of domestic businesses;
  • legislation, permitting foreign investment;
  • support from the European Bank for Reconstruction and Development, and local venture capital associations has promoted awareness and growth in the SME sectors;
  • the arrival of the new economy has, as in other parts of Europe, had a significant impact. A combination of low resource costs, a highly educated work force and abundant technical skills has led to a technology boom; and
  • perception of limited competition, opportunities galore and healthy returns should also not be forgotten. This has been played out, with some notable examples, including the recent sale of Czechonline for reportedly 32 times the money invested.

As in every region there are a number of issues of concern to investors. These include:

  • the relative scarcity of desirable deals and the increasingly heavy competition between investors to find viable investments;
  • the lack of liquidity in local public markets; and
  • the relatively under-developed legal infrastructure that makes investment more risky and increases the uncertainty of enforcing investor rights.

Legal infrastructures, however, are changing. In most jurisdictions a common law system of documentation sits on top of a civil law system. In certain jurisdictions, such as in Hungary, the government is introducing laws specifically to help private equity investment. Enforcement, however, remains a primary concern. The recent demise of Intercontact (a large retailer in the Czech Republic with significant private equity investment) demonstrates the problems posed for investors who are unable to maintain control.

We will now focus further on the key practical and legal issues which apply to specific jurisdictions in the region.


Poland is still a relatively new market for venture capital and private equity institutions. However, the sector is growing very quickly, attracting more capital and greater interest from big investors. Total funds raised in 1999 were Z1.09 billion ($245 million). Some projections contemplate investment of $15 billion by private equity funds over the next 15 years.

Positive signs for the development of local venture capital companies are connected with the legislative changes in Poland, especially the Investment Funds Act, which came into force in February 1998. This law has changed the previous inflexible legal construction, and filled the gap concerning closed-end investment funds. The process of consolidation in the banking sector and the creation of pension funds has had a positive effect on the Polish capital market and the capital supply. However, the efficient operation of the private equity market requires not only sufficient capital supply, but also the existence of attractive entities to invest in, and an environment conducive to its creation, as well as flexible means by which to exit from the investment.

In the early 1990s, the counterparty for all corporate sale transactions was invariably the government. The government adopted a 'take it or leave it' approach to transactions. As an increasingly large percentage of the economy is now in private hands, it is becoming easier to negotiate fuller contractual protections on acquisitions than was originally the case.

Owing to the large number of English and American law firms operating in Warsaw, a common law style of documenting share purchase transactions and shareholders' agreements has developed, which sits somewhat uncomfortably on top of the civil law system. The market practice seems to accept a fuller method of documenting deals than might usually be expected in other civil law countries, such as Germany.

This is also the case in the Czech Republic. For example equity ratchets were not particularly popular in the Czech Republic, mainly because there was a desire on both sides to keep deals relatively simple. This was particularly important where management was being advised by local lawyers without international experience. However this is changing and the insertion of an upwards only equity ratchets in a termsheet is becoming increasingly common.

Poland will be replacing its existing commercial code with a new Commercial Code with effect from 1 January 2001.

Under the new Commercial Code, preference shares can be issued both by limited liability companies and joint stock companies. This will help the structuring of private equity deals.

While the usual exit for a venture capital company may be by way of an initial piublic offering (IPO), this has been a fairly rare exit route in Poland. Nevertheless, if an exit is to be by way of an IPO, the company should be structured as a joint-stock company from the start. The lack of liquidity in local markets hampering the IPO exit route is also an issue in the Czech Republic. A common strategy there is to bundle complementary businesses into an offshore vehicle and float that vehicle overseas.

Polish company law does not contain anything comparable to Section 459 of the UK Companies Act 1985 (protection of minority shareholders against unfair prejudice). Consequently, share rights are fairly tightly prescribed both by the existing and the new Commercial Codes, so as to protect minority shareholders against the actions of the company and/or majority shareholders. A consequence of this is that providers of private equity do not have the same degree of flexibility when it comes to creating equity structures, which they are used to in the UK or US. Accordingly, it is not uncommon for offshore holding company structures to be used.

Poland has a system for taking security over movables and rights of personal property that is similar to most European civil law systems, the ordinary pledge being the simplest and best known form of security. In order to improve the protection of creditors, the Registered Pledge Law came into force in 1997 which has created a registration system for "registered pledges", allows for enforcement options other than court process and improves the priority position of a registered pledge holder in a bankruptcy as opposed to the holder of an ordinary pledge. In addition, the Registered Pledge Law provides creditors with the opportunity to take a pledge on the entire enterprise of the debtor. Unfortunately, many of the improvements created under the new law have not been realized as of yet. There are lengthy delays in getting registered pledges registered and there are significant uncertainties as to how some of the enforcement options will work in practice (regulations clarifying procedures have not been implemented as planned) as well as whether private enforcement options are suspended in bankruptcy and execution proceedings. There is no prohibition against a Polish company giving financial assistance for the acquisition of its own shares. Accordingly, leveraged structures are possible.

A foreigner can generally acquire shares in a Polish company without a permit. Permission is required from the Anti-monopoly Office for a merger which results in any person (whether a foreigner or a Pole) acquiring shares carrying 25% or more, 33% or more, or 50% or more, of the votes exercizable at a general meeting, if the combined turnover of the target group and the purchaser's group exceeds euros 25 million per annum. Depending on the corporate structure used, venture capitalists can sometimes trigger this notification requirement.

The acquisition of freehold property, or a right of perpetual usufruct by foreigners, is regulated by the Ministry of Interior and requires a permit.


In essence, a private equity deal in Romania is similar to a deal in the UK – both in terms of the structure of the transaction and in terms of the nature of the issues which arise.

There are, of course, differences, most obviously the use of offshore holding companies, the involvement of the Romanian competition authorities and the need to translate material transaction documents into Romanian.

In order to give more flexibility in respect of the capital structure and to help tax planning, offshore jurisdictions, such as Cyprus, are generally used as the location to establish the acquisition/investment vehicle.

With a Cypriot investment vehicle, the use of different classes of shares is largely equivalent to UK practice. Cypriot law is based largely on provisions equivalent to the English Companies Act 1948. For two transactions on which CMS Cameron McKenna recently advised Advent International, the Advent investors subscribed for preference shares with the associated preferred dividend and liquidation rights. Managers subscribed for ordinary shares. On the secondary investment round, the Advent funds subscribed for a separate class of preferred shares with separate dividend rights.

In comparison with the UK, statutory limitations on financial assistance in Romania are less developed. Cypriot law has a broadly equivalent financial assistance regime to that which is in place in the UK. However there is no whitewash exemption for private limited companies.

In contrast, in the Czech Republic, significant problems are presented by the financial assistance provisions of the Czech Commercial Code. The Code prohibits Czech companies from providing financial assistance for the purpose of acquisition of their own shares. Typically a Newco will be established by management, and financial and institutional investors. The Newco will take a loan which it will use to acquire the shares in the target and the target will provide security over its assets for that loan. The provision of this security is prohibited by the Czech Commercial Code. Unlike the United Kingdom, for example, there is no whitewash procedure permitting financial assistance in certain circumstances. There have been substantial amendments recently passed to the Czech Commercial Code, due to come into effect on January 1 2001. Despite intensive lobbying from the foreign investment community in the Czech Republic, no such whitewash procedure has been introduced. In certain situations, however, solutions can be found. These include transferring the business from the target to the Newco, thus allowing the Newco to provide security over the assets for the loan. Alternatively a merger between target and Newco can be considered. Both the solutions do however give scope for attack by minority shareholders and this aspect requires sensitive handling.

As both investors and managers tend to hold their shares through companies in offshore jurisdictions, suitable legal opinions are required from lawyers in the relevant jurisdictions, confirming the validity of those companies entering into the agreements. This issue aside, execution formalities are broadly equivalent to the UK procedure.

Where there is a substantive change in the ownership of a Romanian company, a submission (incorporating Romanian transactions of the principal legal documents) must be made to the Romanian Competition Authorities who can take many weeks to approve the transaction.

Generally, in order to register the transfer of ownership of shares in a Romanian company, a Romanian assignment contract (incorporating brief details of the nature of the transaction) needs to be submitted to the Romanian Trade Registry.


Since the fall of the communist regime, private equity funds have invested approximately $800 million in Hungary. Success stories include NABI, Euronet, Avonmore Dairies, Synergon and Elender.

In Hungary a feature of venture capital investment is to provide management with funds needed for further development, which cannot be obtained from local banks or the local capital markets.

One practical issue to bear in mind is that companies are not available off-the-shelf in Hungary. Company incorporations take at least one to two months. The company form of the acquisition vehicle is usually subject to financing and corporate governance considerations. The main vehicles are a limited liability company, a Kft (which is similar to the German GmbH) or a company limited by shares, an Rt. In both Rts and Kfts there is a degree of inflexibility.

In order to give more flexibility in respect of the capital structure of the Newco than is available with Hungarian companies, and to help tax planning, off-shore jurisdictions such as The Netherlands are often used to set up acquisition vehicles. Likewise, in the Czech Republic tax issues dictate the use of a Dutch BV as the acquisition vehicle. A Dutch BV also provides additional flexibility which generally cannot be found in Czech companies. For example, Czech law is quite limiting in respect of the rights which can be attached to preference shares. Where there is no buy-out element, a typical structure is a share swap. The founders of the target swap their shares in the target for shares in a Newco.

Only an Rt has shares representing the holding in the company. Beyond ordinary shares, there can be preference shares, employee shares and interest-bearing shares. It is important to emphasizeemphasize that no hybrids can be created by the mixing of the respective share classes. Preference shares may ensure (inter alia) a dividend, and voting preference, preference upon liquidation and pre-emption rights.

As regards the Kft, although it is not as sophisticated a company form as the Rt and does not have share capital, the voting and dividend rights can be regulated to some extent.

In comparison with the UK, statutory limitations on financial assistance in Hungary are less developed, creating almost no obstacle against leveraging. The restrictions are aimed at the protection of the (share) capital, prescribing only prior approvals from the supervisory board or the shareholders' meeting.

The concept of taking security has greater flexibility under Hungarian law than is generally envisaged by Western investors and is likely to be in addition to their agreement in respect of the underlying transaction. As a general rule, the security transaction will terminate if the underlying agreement falls away because such agreements are collateral to the underlying agreement.

It is clear that the market in Hungary is developing. There is great potential but in order to aid investment it is important that the issues above are dealt with in the near future.


The private equity market in central and eastern Europe is growing fast, and huge opportunities clearly exist for investors. As is evident, there remain significant legal hurdles in a number of jurisdictions that provide a challenge to investors. With the support of the relevant governments, however, there is optimism that further development of private equity markets will be encouraged, and that the huge potential of the region will be realized.

CMS Cameron McKenna

Mitre House
160 Aldersgate Street
United Kingdom

Tel: 44 20 7367 3000
Fax: 44 20 7367 2000