BMG interview with Mr. Les Nemethy

15 Oct 2012

1. How to strenghten the SME's (Small&Medium Enterprise, SME) in Croatia?

Part of the task is up to Government. Most is up to the owners and managers of SME's. Given the limited space, I will deal with both in an oversimplified manner.

As for Government, there are too many taxes, their administration is rigid and cumbersome. The Government is quick to collect from SME's, but slow to pay. I am aware of VAT refunds that have taken a year or more.

As for SME owners/managers, most treat their businesses as «lifestyle businesses.» In other words, the priority is to fund the lifestyle of owners/managers and their families, with fancy cars, travel expenses, etc., rather than maximizing earnings and reinvesting them. The competitive position of such companies gradually erodes, compared to those companies that do maximize and reinvest profits.

But SME owners/managers also need to learn how to improve in creating better business models, strategies and business plans, and to learn how to tap into outside capital, and to compete in international markets.

2. At this point of time Croatia wants to privatize the biggest insurer Croatia osiguranje company and the only bank in Croatian property Hrvatska poštanska banka. On the other hand, Slovenians also plan to privatize their biggest oil distributor company Petrol as well biggest insurance company Zavarovalnica Triglav. According to your knowledge, is that smart or not? Why?

It is conventional wisdom that the Government is a bad shareholder. More often than not, senior appointments are made on the basis of political connections, rather than under strictly meritocratic conditions. Under such circumstances, the value of Government owned companies cannot be maximized.

When there are private businesses competing against a Government business, there is every possibility that the playing field will not be level. There is potential for an unlevel playing field in many areas, ranging from laws and regulations to explicit or implicit subsidies.

Also, businesses such as insurance an petroleum are no longer optimized on a national scale. They must typically be at least regional, if not global. There is even less justification for a Government to be involved in businesses outside its own national borders.

As you can see, I am not a supporter of Governments owning and running commercial enterprises. Just as businesses must focus on their core activities, so must Government. Throughout the region, for example, core areas such as medical care and education leave a huge amount to be desired.

3. What is the reason why advisors are necessary in a course of privatization?

There are numerous reasons why advisors are necessary. I will describe an ideal scenario.

Restructuring. Often a business needs to be restructured prior to privatization.

Information disclosure. There is a huge amount of information required by investors, from the information to the data room.

Running a competitive sale process. The advisor should try to invite as many bidders as possible, with proactive marketing. The advisor should also help to ensure a level playing field among the bidders, ensuring that they all have access to the same information.

Assistance with the negotiation of agreements and closing. These agreements are complex, and can stretch into the hundreds of pages for large companies.

In fact, a large privatization involves not only one advisor, but a whole team of advisors—lawyers, accountants, financial advisors, etc.

4. Can the SME's soundly hope for the funds coming from the EU? What are your experiences?

It is a fact that there will be SME funding in Croatia from the EU. However, in my opinion, this is not a panacea for SME owners. Throwing money at things, in and of itself, does not make a company more competitive. I have several concerns with EU and Government funding:

First, it focuses the energies of SME owners and companies on how to «tick the boxes» on funding applications, lobbying efforts, etc., rather than focusing them on how to create and implement a world-beating strategy.

Second, the flow of funding is often very slow. I am familiar with one situation in Romania for example, where EU funding flowed through one of the Government ministries, creating a delay of 6-12 months in disbursement, which created huge difficulties for the companies expecting the funds.

5. What do the SME's need to know before entering the EU in order to get prepaired for that market.

You must be prepared to compete in a vastly larger, more competitive market. This means that if you are uncompetitive, you will be trounced by competition much stronger than your current competition. But if you are internationally competitive, you will have even greater opportunities to compete in the single largest market in the world, the European Union. For those companies who have the potential to be competitive on a European scale, it will usually require a paradigm change in the way a company is managed, and a significant infusion of capital.

6. If you are familiar to that extent with the situation in the Republic of Croatia, do you find that the Croatian SME's are prepared for the EU? Have you heard for entrepreneurial impulse coming from minister Gordan Maras. Does this Croatian Government implements good measures for the SME's?

I have talked to over a hundred of the more attractive mid-sized companies in Croatia over the past five years, and I would say that there are only a handful of these are prepared to compete internationally or who have any idea of how to raise capital.

Ronald Reagan had a famous saying, that the nine scariest words for a businessman are: «I'm from the Government and I'm here to help.» I'm sceptical of Government initiatives to make a real difference in the way SME's operate. There is some gathering and dissemination of information, training, strengthening of organizations supporting businesses, etc., but my feeling is that this will make a very marginal impact.

The real initiative has to come from business owners/managers themselves. They have to learn how to build a better business model, better strategy, better execution. It is a race against time to gain the knowledge necessary to be competitive. And yet most business owners are too «busy» to read a business book, or to get themselves out of day-to-day operations, to really building a business.

I would be much happier if Government paid its debts to the private sector on time, refunded VAT quickly, offered an efficient administration and tax regime, rather than pretend that it has the expertise that will make the private sector competitive.

7. Do you see any perspective in state institutions (example Hrvatska banka za obnovu i razvoj -HBOR) financing the SME's? What are your experiences and is that sustainable?

My experience is poor. There have been very few deals. And the few deals that are in process are not handled well. I am familiar for example with one particular example when HBOR turned down a funding application, when all of the private investors in a particular fund would have approved the investment, but HBOR turned it down, essentially for non-business reasons. This is unhealthy and unsustainable.

8. Five of the most important advices to the SME's?!

I don't claim that this list is exhaustive, but here are five things that come to mind:

1. Objectives must be defined, both for the company, and the shareholder(s). These are not always the same.
2. Visualize the end game. How do you get to where you want to go? Create a strategy and business plan to get you to where you want to go, that should be based on something that makes your company truly unique, figure out your unique selling proposition.
3. Once you have your plan, stick to the execution. Don't let yourself get distracted. Focus, and obtain the necessary resources, raising capital if necessary. If you are truly interested in building a business with value, do not let your business become a «lifestyle business», funding fancy cars and personal travel.
4. As owners/managers are not immortal, what is your exit plan going to be? Are you going to sell, do an Initial Public Offering, Management Buyout, pass it on to your children? Visualize the end game. Chess masters can usually forecast the end game within a few moves.
5. Build your business with the end game and investor in mind. Every decision you make, whether it's buying a new piece of equipment, starting a new office, or a new line of business, either adds to or detracts from the value and liquidity of a business. Value is not some theoretical number, but what a willing investor is willing to pay to a willing seller.

9. Can the SME's persist monopolies?

I am not sure I understand the question.

10. How have you become one of the world's leading experts for SME's matters?

While I appreciate the compliment, I do not consider myself as an SME expert, rather an expert in helping medium-sized companies raise capital, find strategic or financial investors, help owners sell minority or majority interests, in short, all kinds of equity transactions. In order to raise investment, I often have to advise managers/owners how to better manage the company overall, restructure the company, implement better corporate governance, cut costs, refine the strategy, etc.

There is a joke about a tourist in New York city who rolls down the window of his car and asks a New Yorker how to get to Carnegie Hall. The New Yorker answers: «practice, practice, and practice.»

I have been practising for 25 years, and have been involved in 200+ transactions. You spend long enough doing something, there's something wrong if you don't get good at it!

11. What advice would you give to the experts in the Republic of Croatia who are consultants to the SME's?

You are agents of change. The entire culture surrounding business has to change. Business creates wealth, and affords us whatever standard of living we enjoy. Yet the societal status of business owners/managers is low. Business is looked at as something primitive, as simple as «buy low, sell high», or worse, cheating. Consultants can play a role in accelerating the numerous paradigm shifts that need to take place.

Some other paradigm shifts: (a) bankruptcy is not a final failure, but an intensive learning experience, for good entrepreneurs a stepping stone to a better venute; (b) exit is not a bad thing. «Exito» in Spanish means success—there's a society that has got it right! (c) there is plenty of capital out there—not a shortage of capital—if you know how to build the right kind of business and prepare the business appropriately.

12. What is your favorite privatization project in which you have participated?

I am perhaps most proud of my leading the initial phase of providing the Hungarian incumbent telecom operator, while heading the transactions department in the Hungarian privatization agency. The privatization resulted in over $2 billion in fresh investment, and within a few years the twelve year waiting list for new phone lines vanished.

13. Are you a person thinking 'out of box' and how do you succeed to determine the right moment for selling the company since we are living in the times of the moment ruled by the Kairos (God of the supreme moment)?

Most business owners have never done an equity transactions before, and are completely unprepared. Most investors, whether strategic or financial investors, have dedicated teams, who are extremely knowledgeable on how to do transactions. Business owners/managers can compensate for this imbalance only by building the appropriate team of internal staff and external advisors, and extensive preparation.

Hence the issue of timing is extremely important. If the owner/manager puts a company on the market before these elements are in place, the process begins on the wrong foot. For me the alarm bells ring when an owner/manager says «bring me an investor, then we can talk.» Without the proper preparation, in my experience that is an invitation for disaster. You might say this is counter-intuitive our outside-the-box.

14. In which segments of the market do you think the state should invest more?

The answer to your question depends on political philosophy. What is your perception of the role of Government? My view is that Government should compensate on a few core functions, such as defense, education, health, etc. (and even within those sectors, there is a great role for the private sector). But what legitimate role is there for Government with investments in insurance, petroleum, etc., when they are not even covering their core functions well? I would definitely say that there is more Government investment required in health care and education. But it's not just a question of throwing money at things. How do you make the work force more competitive through education? How do you create incentives for the health sector to offer more prevention? These are just a few examples of the types of difficult questions that Governments throughout Central Europe, not just in Croatia, have great difficulty in answering. Or often are not even asking the right questions.

15. What is your opinion on the global state of the SME's? Are you of the opinion that conglomerates as Lidl, Apple and similar companies influence SME's situation? Do they suffer from negative effects or do they benefit from the monopoly-oriented development?

Some countries, even in Central Europe, such as Poland and Slovenia, have surprisingly vibrant and strong SME sectors. The German «mittelstand» is world famous. Northern Italy has very strong SME clusters. These are admirable examples.

Competition always influences any business, including SME's. As with most businesses, SME's have to get used to reinventing their business models every few years, in light of the rapidly evolving competitive situation. There are also threats by companies such as Lidl, who will make the situation more competitive for food retailers, but there may still be other opportunities, such as niche retailing, or becoming a supplier to Lidl.

16. Today Croatian agriculturist cultivates on average 3.3 hectares of the land. Do they have any chances on the free market?

Not if you are growing wheat or corn. But if you are growing more labour intensive niche products, there might be hope.

17. Do you think that cooperatives which would unite small farmers' capital should be established? In that way, would they manage to defend their interests or does that remind you too much on the planned economy.

I do not have sufficient expertise to answer this question!

18. What do you think of the post-war privatization in the Republic of Croatia?

As everywhere in Central Europe, it could have been done much better. From an economic efficiency point of view, assets have not always ended up under the ownership of those who could most efficiently manage those assets. My book talks not about privatization, but about how private owners might sell their companies. To the extent we didn't get it right the first time around, perhaps we can get it right in the second round, where private parties sell to other private parties. Because of the unpreparedness of business owners with respect to transactions, there is a risk that succession issues will not be solved, and businesses will be unsuccessful in raising capital, which could result in missed opportunities, or worse, implosion of businesses. The jury is still out.