Venture Capital and Banking: Prospects for Cooperation - presentation by Mr. Mikhail Lomtadze to the round-table discussion promoted by the Russian Association of Venture Investment (RAVI)
Funds, set up by Baring Vostok Capital Partners (BVCP), have a proven track record of serving banking institutions, thereby enabling us to both improve our investment quality and structure and help develop our companies under management schemes. First of all, let me say a few words about Baring Vostok Capital Partners. The aggregate value of funds managed by BVCP is $400 million. To date, we have invested in 15 entities. If a direct investment fund is seen as sort of a "conglomerate", then our investees have assets worth approximately $800 million and turnover of around $600 million, and provide between 14,000 and 15,000 jobs. The bottomline idea is that a fund is a solid financial group and partner. Funds are entities which may be relied upon by any financial institution as a challenging partner. Banks and funds alike focus on earning money. In most cases, all funds, including direct investment and venture funds, seek to invest in companies which already are or tend to become industry leaders. In view of the above, commercial banks would find it interesting and profitable to cooperate with both venture and direct investment funds in order to get access to them. BVCP professionals assess proposed projects using ten formal benchmarks which are largely in line with benchmarks relied upon by commercial banks to assess corporate projects, including team qualifications, a clear and well-founded business plan, competitive strengths, and a stable and predictable financial status. There are a few benchmarks which make a difference between direct investment funds and commercial banks. When investing in a corporate entity, funds expect to earn an annual margin in excess of 40% and assume certain risks which would not be usually assumed by commercial banks. Also, funds do not consider any asset pledge schemes because they invest in equity. Despite major differences which exist between commercial banks and funds, they are by and large those investment institutions whose financial instruments complement each other: funds invest in equity, and commercial banks help improve balance-sheet quality and invest in debt. For this matter, in terms of possible areas of cooperation, there is a common trend of interest. Judging from Western practices, almost every direct investment fund cooperates closely with five to six commercial banks. In other words, a given direct investment fund is supported by only a few commercial banks which are engaged to perform particular transactions. This paves the way for mutually beneficial cooperation. On the one hand, the fund becomes able to be more flexible in structuring its investments because the raising of debt through investment or corporate growth ultimately builds up the fund's profitability. On the other hand, banks, acting through successful funds, become able to lend to companies which already are or expect to be industry leaders. Specific areas of cooperation include, but are not limited to, raising finance for portfolio entities, refinancing or recapitalization of entities, and raising debt finance for corporate acquisitions. While working with the Funds in the course of raising finance for a portfolio company, a bank is able to get a clearer idea of the company's development strategy and the funds' own general development plans with respect to the portfolio company. A review of the balance-sheet structure of our portfolio companies shows that borrowed long-term financial instruments approximate $85-90 million. Short-term financial instruments total at least the same amount, depending on the period of time. The recapitalization of companies and the financing of company acquisitions, which are inherent in direct investment funds' performance and very popular with Western investment funds, may also be potentially challenging financial instruments in Russia. We usually buy companies which are poised to grow. Therefore, when investing in a company, we "enter" it for a period of five to six years in order to develop it and then try to find a strategic investor. Over that period of time, the company tends to grow, improve its financial performance and begin generating stable cash flows. In certain cases, it is worth recapitalizing a company by raising debt finance and, for that matter, improve its balance-sheet structure and, instead of earning, say, $1 annually over ten years, earn as much as $10 during year one. On the one hand, this is important for the fund because a key performance indicator consists in maintaining investment liquidity and earning significant amounts of money after managing the company during four to five years, and, on the other hand, the bank would become able to lend to the company exposed to low risks because it had been managed by professional managers and investors for a few years already. If it relies upon the company acquisition financing tool which is also very popular in the West, the fund would be able to buy an asset through the bank, and the bank would then be able to lend to the company. A quick look at Western statistical data on those transactions shows that around 45% of the cost of acquisition is currently financed by banks through borrowings. BVCP has been working hard to develop relations with its existing banking partners and establish ties with newly created commercial banks and other financial entities. BVCP forms part of Baring Private Equity Partners, an international fund with an equity of $2 billion. BVCP manages three funds with an aggregate equity of $400 million. The fund has invested in successful companies such as Vympelcom, Golden Telecom, Borzhomi, Syktyvkar Timber Mill, STS and others. Two thirds of the first fund ($160 million) were invested in companies and one third was invested in equities. Some 18 "exits" have been accomplished, with an average margin of 55%. To date, dividends of some $302 million have been paid to investors. It is essential for commercial banks to find common ground among themselves and identify possible options for mutually beneficial cooperation with both venture and direct investment funds.
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