By Murat Soycengiz

INTRODUCTION

This last crisis shows us the very important fact that you can not develop an independent regional or national strategy if you have to depend on outside investors and institutions for that strategy. When mortgage owners in the U.S. couldn’t pay their bank debts it ended up having a trickle down effect where Turkish textile producers couldn’t sell their trousers to Kazakhstan, and Turkey had difficulty buying natural gas from Kazakhstan. To claim that this is an unavoidable result of globalization is a simplistic way of thinking. We believe we can turn this crisis into an opportunity; to create more stable and prosperous relations between our countries because we have enough common points to develop a common strategy.

In this paper I propose an alternative tool for developing economic coordination between our countries. My aim is to propose an institution that can help us;

i)                    Immunize our economic relations from external shocks, and

ii)                   Create more fundamental relations between our economies without political interference.  The model I propose is an amalgamation of different practices of private placement taken from different countries and reformulating the concept to fit the needs and realities of our countries.

To underline the four main points of the proposition:

1) This model targets mainly mid-size companies

2) The role of states has to be more facilitating than governing, more supervising than planning.

3) Main shareholders have to be national organizations of the entrepreneurs, such as Chambers of Commerce and industries as well as some international organizations such as development banks, etc...

4) It has to finance the joint ventures or M&A of mid-sized companies between our countries’

5) The institution will finance the trans-border operations of the mid-size companies between our countries’ through private placement, and after a predetermined period the company will exit from the investment.

Why Mid-Size Companies?

Mid-size companies typically have annual sales between 20 million USD and 150 million USD.  These companies are the most dynamic part of a national economy and have an enormous appetite for growth, but they currently find themselves squeezed by the effects of an increasingly tough global competitive environment, namely downward pressure on prices, rising input costs and consolidation. Although mid-sized firms are already venturing into new geographic markets, they are also very local. They are managed by the founding owner and/or family and their growth is organic, thus they keep their local identity and links. These local links help the spread of economic growth to the different parts of society. Their size is proof of their success and it also permits them to adopt new techniques more easily than small companies. Their contribution to employment is stronger than large sized companies (per person employed per unit of capital). As an investment target with their growth potential they are much more promising than a big-sized company, have an ability to adopt new techniques of management and transparency, and have a proven track record as compared to small-sized companies. They are the most modern part of the local economy and the best candidates for international co-operation which can create local impacts.

What Are The Weak Points Of These Companies?

The large majority of these companies are owned by either a founding owner or a family and the owners are very active in management. This creates a lack of institutionalization, transparency of management and especially accounting, and lack of corporate governance with stake holders and minority share holders.  Although they know their local market very well they have little knowledge about foreign operations and much less about Trans-border company management.  As well as these disadvantages their biggest problem is their systematic lack of capital and inability to reach the same financial markets as big companies.  Because of their patron based management, consolidation in its industry, which is necessary for effective competition, is also very difficult.

Why Private Equity?

Private placement markets have developed quite strongly over the last 15 years, especially in western countries. In Europe the total amount of private placement investment fund raising has grown from 20 billion in 1997 to 112 billion € in 2006.

The most important problem with mid-sized companies is their limited capital base.  This limitation not only makes them weak in global competition with the big multinationals it also limits their growth. Their limited access to financial markets makes them very vulnerable to the natural volatility of financial markets.  Banks will cut their credit before that of the bigger companies. Government support for these companies is also very limited since they are usually too big for their support, so they’re stuck in the middle.

The type of private equity that I am proposing here is not passive equity participation but an active participation for the value creation of these companies. One Japanese asset management company, Jafco, is a good example of this practice; its motto is “value creation through private placement”. In the U.S. similar types of companies exist and are called small company investment corporations but they do not have the systematic approach to investment as Jafco. In the U.S. they are regulated by Small Business Administration (SBA). SBIC is the most common source of financing for fast-growing existing businesses (rather than startups) that need a substantial amount of financing to keep up with its rapid expansion. For our model it is more suitable to look at Jafco as an example.

Example; JAFCO

Following investment, Jafco carries out VA (Value Added) activities which include assisting portfolio companies with the expansion of sales channels, arranging tie-ups with other companies, and introducing key personnel necessary for expansion with the aim of contributing to higher corporate value over the medium and long term. In addition, through their wholly owned subsidiary JAFCO Consulting Co., Ltd., they provide specialist consulting services in areas such as the building of internal control systems and preparation for IPO screening.  Jafco not only operates in Japan but also abroad in countries such as the USA, south east Asia etc.

 Jafco obtains its investment capital by launching closed end funds based on different themes and bundles the participations in those funds. To sell those closed end funds they use the distribution power of Nomura Securities. These funds are closed end funds for 10 years and they allow the ability of making long term Commitments.   The exit strategy of Jafco is by IPO.

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How Can We Structure the Investment Company?

In our case we can not apply the Jafco model directly because our countries’ infrastructures are not as developed, neither the corporate law system, nor the judicial systems, financial markets, nor the flow of information between and about companies’. Another important aspect of this fund management company is it will be mission specific as well as have a profit targeted structure.  The Mission is to promote economic co-ordination between participant countries. Then we can discuss the most critical point; who will be the founding members of this structure?  My proposition is that it will be the Chamber of Commerce and Industries of the participating countries. Of course some financial institutions will also be part shareholder with their participation putting local financial knowledge into the system.

The Chambers participation will help with four main points: 1) In case of conflict between parties Chambers can be used as an arbiter 2) Chambers are good sources of information on their members and because they are also shareholders they will ensure the accuracy of information. Initial information about the company is a crucial part of investment. Participation of local financial institutions will also help with understanding this information and for the distribution of the funds between their local investors. 3) In our countries’ community control is more effective then the state control. 4) Chambers can create a more influential line with respective governments against bureaucratic difficulties.   

How Will Be The Investment Management Company Structured And Work?

First of all the aim of the asset company has to be profit maximization for itself and its fund investors.  Without this goal it will not be able to attract the investment capital and can not channel funds to its mission. The Mission of the company is to develop economic co-ordination between participating countries by promoting joint ventures of the private sector companies’ of the participating countries.

Thus the company must have in house company management consultancy units as well as an investment management structure. The reasons for this are as follows: first, to help with the legal problems of the joint venture. Second, this consultancy structure will help the invested companies to meet international standards and accounting rules, have good governance practices, and transparent and auditable management. Third, it will actively support the strengthening of the core business of invested companies by using its share holders, chambers, and network. This activity includes new customer creation, new export market development, technology transfer, creating operational ties with third parties etc... . Fourth, to be a mediator between the joint venture partners based on predetermined rules. Fifth, to increase the value of the company through value creation as the main aim of the management company during its investment period. This kind of approach will not only help with the exit strategy of the fund but also with creating world class competitive companies with strong local ties. 

Another important part of the company is its asset management side. This part has to work as a classical asset management company to make investments for the profit of its investors with one very important limitation - to develop economic co-ordination between participating countries. These two points are crucial for balance.  To neglect either of them will bring failure by not satisfying its own shareholders or fund shareholders. On one hand it will lose all its networks on the other hand it will lose the capital that it invested.

The last important part of the company has to be its distribution unit and structure, not only to raise capital but also for exit strategies. Local and international financial institutions participation will help greatly at this point.

How will the investment procedure work?

Local companies or projects can be proposed by the Chambers according to the rules which will be decided by the board of the Fund Management Company.  The projects investment committee will choose the eligible companies from the proposed candidates and after assistance the investment process will begin. The important point here is the role of the fund management company. It will not play the role of a silent passive investor but the opposite, as an active member of the board which has veto power on all board decisions. At the same time the invested company will apply all the predetermined conditions such as accounting and corporate governance rules. All other value added consultancies are facultative and depend on the specific invested company’s management decision. If they do not want to use the marketing facilities of the management company they do not need to use them. The one thing that has to be obligatory is that in case of conflicts between parties the Chambers arbitration will be accepted.

The asset management company will invest in a company for a limited period of time and during this period the shares will be a closed end fund but the management company will have the proxy of those shares. When the closed end fund sells its shares in the company the asset management company will leave the board of the invested company immediately.

The exit strategy from the investment is very important.  The investment period has to be a minimum of 5 years and a maximum of 10 years. Exit from the investment can be done three ways. First by IPO, second by trade or sale, and third to sell back to the actual share holders. Which method of exit used depends on different variables but we can say that the main aim is by IPO.

Role of Government

This kind of project needs the support of participating countries but this support has to be facilitating and supervising. Some of the points that need help from political authorities include taxation of investment, ownership of the funds, legal responsibilities of the board members, taxation of capital gain, legal base of foreign ownership, etc... . Assistance from political authority is also needed with regards to bureaucratic difficulties.  The important point to note here is that in all cases state participation as a share holder in the management company has to be avoided. This kind of participation will give the wrong signals to the financial markets and can change the vision and mission statements.

Conclusion                                                        

The European Union started with Coal and Steel Union. It showed us that economic and political co-ordination has to have concrete projects with concrete results in daily life.  Our project has several targets such as developing joint ventures between our countries’, helping our local companies become regional and even global players, creating a world class modern company structure which will be good example for other local companies’. To channel financial capital to the real economy and transform the real economy to have more productive and more efficient structures, and make them globally competitive entities.