Rob Whitford and Nicholas Watson -

The announcement on Tuesday that the US-managed private equity fund Trans-Balkan Bulgaria Fund plans to exit several of its investments via IPOs on Bulgaria's stock exchange over the next year shows how far the local bourse has developed. It also points to the likelihood that the flow of private equity into this new member of the EU is set to accelerate.

"We will try over the next year to do this with part of our companies," Danail Danailov, senior investment officer at Trans-Balkan Bulgaria Fund, was quoted by SeeNews as telling an international conference on private equity this week. "This is a wonderful opportunity for us to sell dear something that we bought cheap."

For now, though, private equity – both buyouts and venture capital – is still very much in its infancy in Bulgaria. There's no clear information on private equity in Bulgaria, but industry insiders say that apart from one local fund, all the other players were established and funded abroad.

As well as the Trans-Balkan Bulgaria Fund, these include Greece's Global Finance private equity funds, the Balkan Accession Fund, the Bulgarian-American Enterprise Fund, Equest Partners and Spain's GED Group. The total amount of capital raised exceeds €500m, but only a share of it is actually invested.

"Many foreign venture capital and private equity funds have Bulgaria on their radar screens, but I would say that three to five of them are actually investing at present," says Hristo Valev of Advance Equity Holding, the single local private equity fund.

However, that number will undoubtedly increase as the conditions for private equity steadily improve. As well as the developing local stock market offering private equity an indispensable exit route – four companies have conducted IPOs on the bourse so far this year – other favourable factors include Bulgaria's high economic growth rate (GDP grew 6.1% in 2006), its joining of the EU in January, a good legal environment and favourable tax regime.

"Bulgaria has the lowest corporate income tax rate in the EU, at 10%; a low tax of 7% on dividends; no tax at all on capital gains; and double taxation treaties with the EU, the US and Switzerland," says Valev.

The entrepreneurial culture may also be immature in Bulgaria, but there are signs that it's developing and some entrepreneurs are learning the benefits of having a financial partner, not just a lender. Anecdotally, Bulgarians are well known for their creativeness and industry players say there is a huge pool of undiscovered future star-performing companies, as well as continuously emerging new interesting ventures.

Uncovering the gems

Given that the Bulgarian economy is still too small for a specialised approach, the funds operating in the country are generally open to projects and business plans from every sector.

"We have preferences, based on our view of what is competitive on the single European market," says Valev. "So we're generalist, but we have some preferences."

Advance Equity Holding — or ADVEQ to its friends and to the Bulgarian Stock Exchange – was incorporated in January 2006 with a capital of around BGN2m and successfully carried out a capital increase to BGN12m with an IPO in July 2006. The fund is planning a second capital increase of at least another BGN12m and is about to start a roadshow in the usual financial centres of Western Europe - Zurich, London, Luxembourg – in search of institutional investors, as well as high net worth individuals

ADVEQ is a publicly quoted company, which is unusual for a private equity fund, though not unparalleled – there are 17 listed private equity firms in Western Europe and one in Poland. The reason is simple: there's no Bulgarian law specifically regulating private equity, which means that the only practicable form that a private equity investment vehicle could take was the PLC. Otherwise pension and insurance companies — typical investors in developed private equity markets — wouldn't have come on board as shareholders.

ADVEQ is positioned, says Valev, somewhere between venture capital and larger-scale private equity investment. Its business model focuses on the start-up, development and expansion phases. At present, the first two – where typical venture capital firms invest – predominate in ADVEQ's activity.

"But expansion will become more important as time goes on and the funds at our disposal get bigger. So we will be moving more towards a larger-scale private equity investing, without, however, neglecting the high potential of start-up ventures," says Valev.

And which parts of the Bulgarian economy is ADVEQ looking at?

Energy is one. Almost a quarter of the 61 business plans it has reviewed were in the energy sector. So are half of the six companies in its portfolio. There's Enesy, a specialist in distributing compressed natural gas in bottles — a growth area since piped distribution has some way to go in Bulgaria. That's been going since 2003: ADVEQ holds 34% and, counting debt and equity, has invested €383,000 since entering it last year.

There's Energy Invest, which has built one wind-farm in north-eastern Bulgaria and is working on another. There, ADVEQ has a 100% share and €687,000 worth of investment. This is in a very promising area: the government (and the EU) are determined to develop renewables production, so there's a guaranteed purchase price for power produced by wind farms — and a very nice EBRD credit line, which allows bank finance at reasonable interest and with a 20% grant element.

Finally, there's Energy Effect (100% owned, €696,000 invested), which specialises in energy consumption audits and energy saving renovation of buildings. Bulgaria isn't short of old and energy-inefficient buildings and there are government incentives in place and more to come, so that's good business too.

Food for thought

Agriculture's another promising area, especially given the benefits that modern farms will derive from EU membership. Sure enough, ADVEQ is in there too: at end-2006, Agro Terra North (90%, €835,000) acquired an important farm in north-western Bulgaria — complete with a good management team — and is busily renting additional land. Agro Terra North leases around 5,000 hectares of Advance Terra Fund's total stock of 16,000 hectares, though relations are on a strictly market basis, emphasises Valev, with third-party evaluations determining rents.

And finally there's telecommunications, where, says Valev, "we think Bulgaria has exceptionally good potential based on its human resources." That accounts for ADVEQ's flagship project, SEP Bulgaria (70%, €1.79m). SEP stands for "System for Electronic Payments" and the company's engaged in the very cutting-edge task of integrating such a system on the basis of mobile technology.

The company was established in 2003 by the well-known Bulgarian software developer SIRMA, but ADVEQ's entry in 2006 brought a welcome injection of finance. And not only finance: one reason SIRMA chose ADVEQ over other international venture capital firms that were also interested, thinks Valev, was the experience of ADVEQ’s CEO Ventzeslav Petrov, former top executive at the local Encouragement Bank, in the intricate procedure of securing financial licences. SEP is at present in the process of getting an operating licence from the central bank.

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