The Evolution of Private Equity and Venture Capital in Southeast Europe

The Current State of Private Equity and Venture Capital in Southeast Europe

The private equity and venture capital industry in Southeast Europe has come a long way in recent years, but still faces challenges as it strives to reach full maturity. This article examines the current state of the industry, the obstacles it faces, and the opportunities that lie ahead.

Stages of Market Development

According to Vivi Papazuli, mandate manager at the European Investment Fund, ecosystems typically go through three stages of development:

1. Early Stage: Characterized by:

   • Heavy reliance on public funding
   • Newly established fund management teams
   • Limited private investors
   • Enterprises needing significant education and mentoring
   • Business angels mostly consisting of friends and family

2. Maturing Stage: Features include:

   • Public financing reduced to less than 50%
   • Private investors becoming more interested
   • First success stories emerging
   • More good ideas and teams on the ground

3. Developed Stage: Marked by:

   • Investment focus shifting towards growth stage
   • Private investors taking the lead
   • Public funding serving mainly as an anchor investor
   • Established fund management teams
   • Numerous success stories

Currently, the Bulgarian ecosystem is transitioning between the second and third stages of development.

Funding Sources and Challenges

While more mature markets see significant investments from pension funds, Southeast Europe still lags in this area. According to European-level data, pension funds contributed 27% of the total €170 billion invested in private equity, venture capital, and buyout fundraising last year. However, in Southeast Europe, including Bulgaria, Romania, and Greece, pension fund participation is close to zero.

Attracting diverse funding sources, especially institutional investors like pension funds, remains a significant challenge for the region. Some key obstacles include:

• Small market size
• Poor reputation
• Lack of track record
• Geopolitical uncertainties
• Fragmented markets with different languages, cultures, and currencies

Elvin Guri, managing partner at Team Venue, highlights the difficulty of selling Southeast Europe as an investment destination: "Raising a fund for this region from private investors is one of the toughest sales jobs." Common responses from potential investors include skepticism about the region, long timelines for market entry, and past negative experiences.

Risk-Return Profile and Market Perception

Rosen Ivanov, managing partner at Black Peak Capital, points out that the risk-return ratio provided by the region over the past 15 years has been poor. This cannot be attributed solely to the quality of general partners (GPs) or funds, but also to the challenging environment, including political instability and macroeconomic uncertainties.

To attract investors who have a choice of where to allocate their capital, funds in Southeast Europe need to provide higher returns than what can be achieved in more established markets like Poland or Central Europe. However, delivering this premium is challenging given the current environment.

Market Environment and Industry Impact

The current market environment presents both challenges and opportunities for the private equity and venture capital industry in Southeast Europe.

Economic Uncertainties and Market Volatility

The industry is facing several headwinds:

• Increasing interest rates
• Higher inflation
• Reduced liquidity in public markets and banking debt markets
• Geopolitical uncertainties
• Market volatility

These factors have led to:

• Limited partners (LPs) becoming more risk-averse
• Some LPs leaving the market or shifting focus
• Valuations taking a hit, though not as severely as some might expect

Historical Performance During Economic Uncertainty

Despite these challenges, there's a silver lining. Historically, funds launched during periods of economic uncertainty have shown the best returns. This suggests that the current environment, while difficult, may present unique opportunities for savvy investors.

Market Trends and Deal Activity

While there has been a downturn in deal activity compared to the peak of 2021, it's important to maintain perspective. Vivi Papazuli notes that when compared to 2019, the amount invested in VC rounds in 2022 was still almost double. This suggests more of a market correction rather than a severe downturn.

The "Rocky Landing" Scenario

Rosen Ivanov describes the current environment as a "Rocky Landing," where different industries are experiencing crises at different paces. The challenge for investors is to identify which industries are at what stage of crisis and price opportunities accordingly.

Key observations in this environment include:

1. Valuation Expectations: Many companies have not adjusted their valuation expectations downward, creating a gap between buyer and seller expectations.

2. Growth Slowdown: Some companies that were previously growing rapidly have seen that growth stall, changing the nature of investment discussions.

3. Rapid Industry Cycles: The speed at which industries fall in and out of favor has increased, making long-term investment decisions more challenging.

4. Changing Exit Landscape: The nature of exits has shifted, with fewer strategic buyers and more exits to larger funds.

Strategies for Success in the Current Environment

Given these challenges, investors and entrepreneurs in Southeast Europe need to adapt their strategies:

1. Disciplined Approach: Investors should be prepared to walk away from deals if valuation expectations are unrealistic.

2. Focus on Operational Value Creation: In difficult times, the ability to bring operational improvements to portfolio companies becomes even more critical.

3. Regional Perspective: Expanding focus beyond individual countries to a more regional approach can make investment opportunities more attractive.

4. Embrace Funding Opportunities: Entrepreneurs should consider accepting funding at more reasonable valuations to fuel growth and take advantage of market opportunities.

5. Industry Selection: Investing in up-and-coming or fashionable industries may yield better returns than even excellent investments in declining sectors.

6. Value Creation Beyond Top-Line Growth: Focus on operational improvements, institutionalization, and margin expansion, not just revenue growth.

Regional Development and Future Outlook

The future of private equity and venture capital in Southeast Europe lies in regional cooperation and development.

New Funding Instruments

The European Investment Fund is launching new instruments to support the region's growth:

• €180 million allocated from the Ministry of Finance of the Republic of Bulgaria
• New funds in innovation, growth, and infrastructure (energy, climate, and digitalization)
• Call for expressions of interest to be launched in early June, open until the end of 2025
• Focus on supporting regional investment strategies

The Necessity of Regional Cooperation

Both Rosen Ivanov and Elvin Guri emphasize the importance of regional cooperation:

• Small individual markets necessitate a regional approach
• Building local and regional champions in industries with sustainable competitive advantages
• Showcasing the entire Southeast European region to global investors

Changing Perceptions and Building Success

To move beyond constant comparisons with Western markets, Southeast European markets need to:

1. Demonstrate ability to compete globally
2. Replicate Western success in smaller markets
3. Highlight unexploited opportunities in the region
4. Focus on industries that can be digitalized and improved
5. Aim for higher long-term returns compared to stable Western industries

Conclusion

The private equity and venture capital industry in Southeast Europe stands at a crucial juncture. While facing challenges such as limited institutional investment, economic uncertainties, and perception issues, the region also presents significant opportunities for growth and development.

By adopting a regional approach, focusing on operational value creation, and leveraging new funding instruments, the industry can attract more diverse investors and build successful companies that compete on a global scale. The journey ahead may be challenging, but with the right strategies and cooperation, Southeast Europe has the potential to establish itself as a vibrant and attractive market for private equity and venture capital investments.

As the industry continues to mature and evolve, it will play a crucial role in driving economic growth, fostering innovation, and creating regional champions that can compete on the world stage. The future of private equity and venture capital in Southeast Europe looks promising, and those who recognize and capitalize on its potential stand to reap significant rewards.

Article created from: https://www.youtube.com/watch?v=PzU82X_votY&feature=youtu.be