In December 2017, the Polish police raided the home of prominent businessman Przemyslaw Krych in Warsaw and arrested him. Krych, the founder of the Griffin Real Estate Investment Fund, which managed assets worth €5.6 billion and was a partner in the huge US funds Pimco and Oaktree Capital in Poland thought it was all a misunderstanding but it ended in six months imprisonment. The reason for his arrest has never been published but after he was released he sold his shares in Griffin and quit all his positions.
Piotr (the name has been changed), a serial investor in Polish startups, was spooked by the incident, which was extensively covered in the international financial media. "Bloomberg" ran a story "Has Poland's government become a threat to business?"
Piotr told "Globes" from his home in the US, "He was in administrative detention for so long with nobody understanding what they wanted from him, except for the fact that the values he held may not have been in line with the country's values. It was the moment when you feel that all the lines have been crossed, when what is happening before your eyes is done against all the values you grew up with. The moment when you reach a point where there is no fair legal process, where those who depend on the courts do not go through all the procedures of justice. You cannot take shortcuts in the judicial world because in the end the innocent person is the one who suffers. I was worried about my portfolio companies, especially the big ones, because this could reach them as well."
This didn't start in one moment, says Piotr, who grew up in Poland and several English-speaking countries, and declined to be identified by name. Even before the Law and Justice Party came to power in 2015, Piotr noticed a change in trend. "The previous decade in Poland was filled with a cosmopolitan and optimistic atmosphere. I never imagined that the LGBT community in Poland would encounter obstacles. Then strange phenomena began to emerge: someone burned a flag at the local pride parade. The nationalist marches became aggressive, to put it mildly. After that, the government decided to set up bureaucratic obstacles for the establishment of local companies, and then I already decided to leave."
Piotr still invests in early stage Polish startups but he takes various precautions. He will no longer invest in a company that will grow within Poland, but is engaged in locating promising entrepreneurs, opens a company for them in Delaware in the US, locates American or foreign partners for them, and helps them open centers in Berlin and Barcelona - which he defines as the friendliest European cities today for establishing early stage companies. Poland can still serve as a development center for them at one level or another, but the intellectual property in the companies will always be registered outside the country, and the bank accounts will also be managed in the US. Piotr was interviewed, albeit anonymously, but he was the only one among dozens of venture capital managers and tech investors from Poland and Hungary whom we approached who agreed to speak with us while promising not to identify him. He says, "The tech industry in Poland is only in its infancy and close to 90% of the capital that flows into tech still comes from the government. Unfortunately, people choose money over morality, and even though everyone thinks it's going in the wrong direction, they won't speak out. The memory of the communist era is still fresh and people remember all about authoritarian government - if they speak against the government, they might get a visit from an income tax official in their office the next day," he says.
Dependent on government financed funds
Even today, the tech industry in Poland relies on local investors who raise their capital from government and European financed funds. According to the Polish Investment Authority, 407 investment deals were carried out by local investors, and only 52 by foreign investors. With the exception of 2021, which was an anomaly year by any measure due to global investors who were looking for tech investments everywhere and were willing to pay dearly for it, most of the capital invested in Polish companies came from Polish funds or those that cooperate with foreign funds, and at least feed from the same source: PFR Ventures, which owns six funds that invest in Polish funds, and raises about €1 billion a year from Polish government funds and EU funds. Unlike the Israel Innovation Authority funds, for example, the capital injection does not depend on performance and does not require the portfolio companies to pay royalties after the transition to operating profit, nor does it restrict them from operating outside Poland, as long as there remains a development center in the country.
Polish government money, part of which comes from the EU, which largely maintains a democratic tradition, has also brought many Israeli investors to Poland over the years. One of them is Giza Polish Ventures, which in 2012 raised about $30 million for joint investments together with KFK, a Polish government investment body that no longer exists today. Giza recruited a local team that included the head of the mergers and acquisitions department of the PwC accounting firm in Poland Zygmunt Grajkowski, and Marek Borzestowski, the founder of the WP Group, which was the first Internet portal in Poland, while the Israeli side was managed by Giza founder Zeev Holtzman, the founder of Giza, and Shmuel Chafets, currently a partner in the Target Global Fund.
The fund has invested in about 50 companies, but ceased operations, after making its last investment in 2019, in the shadow of the breakup of the Giza parent fund. But political reasons were also behind the move - first the change of mindset in the country and then the judicial reform, according to at least two people who know the fund well. One of the investors, Borzestowski, left Poland and moved to Malaga in Spain, where he invests in local and Polish entrepreneurs.
The fate of the Pitango Fund in Poland was different. It began operating in Poland a year after the rise of the right-wing government of the Law and Justice Party, while cooperating with TDJ, a private investment company that coordinates a number of experienced investors, who had previously invested together with the government. Although Pitango's Chemi Peres is currently considered one of the leaders of the tech protest against the Israeli government's moves, and was even present at a closed meeting of businesspeople with Benjamin Netanyahu, "Globes" has learned that the fund in Poland is actually strengthening its hold on investments there, and in Hungary and other Eastern European countries such as the Czech Republic, Romania and Estonia with a new $50 million fund. Recently, the fund even changed its name from Pitango Poland to Fullspeed Ventures, which is managed by the Israeli Daniel Star while Pitango founding partner Rami Kalish is also significantly involved.
The fund relies on continued government capital injections - €1 billion was approved this year for PFR Ventures - while the cost of founding a startup is 2-3 times cheaper than in Israel. There is a constant flow of tech professionals to the country's high-tech centers in Warsaw, Krakow, and Wroclaw from 70 universities with faculties of sciences.
Although the fund chooses to work in authoritarian countries as well - it does not take risks. Today, most of the portfolio companies are registered in Delaware in the US, the UK or Singapore. Their intellectual property is mostly held in the US, and those that are not initiate a process in which the parent company in Poland becomes a subsidiary of a foreign company. The fund itself is registered in Luxembourg, and has just a small office in Poland and nothing else. In fact, most of the fund's portfolio companies initiate the process of becoming a subsidiary of a foreign company without waiting for foreign investors to ask them to do so.
Inflation is high, the currency is weak
The judicial reform in Poland didn't pass through the parliament in one session as the current Israeli government is trying to achieve. In practice it took the Law and Justice Party four years until the reform was finally enacted in 2019.
Among the laws passed - imposing penalties on judges who criticize political decisions and allowing the legislature to appoint the Supreme Court judges. By 2020, 14 out of 15 judges were directly elected by the lower house, until recently controlled by the party. At the same time, the government adopted anti-liberal moves such as promoting a law that prevents most abortions, taking over public television, and repressing visiting journalists. A comprehensive reform of pension funds reduced savings and significantly lowered the attractiveness of the local stock market in the eyes of foreign investors. According to estimates, the number of foreign private equity funds that invest in Poland has fallen from 100 to 70 over the past three years.
Not everything is black. Since Andrzej Duda was elected as Poland's President in 2015, Poland's GDP has jumped from €477 billion to €680 billion, three times larger than the growth in the Czech Republic and Ukraine, while unemployment has fallen to an all-time low.
But inflation in 2022 jumped higher compared with the EU average - 15.9% in Poland compared with 10% in the EU as a whole. The Polish zloty also weakened by more than 9% compared with the euro.
Reduced exposure to local industry
"Poland is a prosperous country as part of the global economy," Piotr explains. "It is still a cheap place compared with the world, where companies are looking to operate off-shore centers and outsourcing - even those who have a third of the salary of an average American can live a good life in the country. Local venture capital investors continue to invest from the state and EU funds, but private equity investors have already started to consider geopolitical risks and some of them decided it was too big for them. This is reflected in the instability of the local currency."
Piotr too, like many other investors, protects his investments in Poland by reducing exposure to the local industry. He specializes in locating outstanding Polish entrepreneurs, setting up local product teams, and helping them establish a US company and then locating salespeople in Western countries. Sometimes he matches Polish entrepreneurs with Americans. "The US is full of accelerators that Polish entrepreneurs can take advantage of, although it is difficult in terms of immigration. For this purpose I usually recommend Barcelona, which is a very cheap city that attracts young people or Berlin, which is a center for the creation of huge European companies such as AUTO1 and HelloFresh. Apart from the legal structure, there is nothing keeping you in Poland."
The concern: Conflict with the local partner
Israel's Ben Pasternak, CEO of software company Aman Group, has not withdrawn from Poland or even Hungary, despite the legal reforms in both countries. In Poland, he operates Integral, an integrator and software services company for banks, insurance firms and telecoms that employs about 300 people in Warsaw, and in Hungary he owns Veriest, an offshore software development services company that employs 100 people in Budapest.
He tells "Globes," "We continue to operate our businesses in Poland and Hungary. But if I have to get to the point where I wonder if I will increase my investment in this place - the answer is negative. In my opinion, this is also what will happen in Israel - the threat is not a massive expenditure of investments, but investors who will reach the point where they are considering investing in Israel and decide not to do so. The fear is of a local conflict in which inquiries by the authorities will be made, not in a serious manner, but based on considerations that cannot be gauged."
Adv. Yoav Etzion of the Amit Pollak Matalon law firm explains that the concern for investors in authoritarian countries is actually not related to over-interference of the authorities in businesses but more resolving disputes with local partners. "In authoritarian regimes you can't always know what political considerations are behind the legal system and the relationship of your local business partner to this system," he says. "That's why before I decide to do business in any country, I want to make sure first of all that the partner complies with it."
International disputes and independent arbitration centers
What is happening in Poland and Hungary today, Etzion saw in Russia more than a decade ago. "It was then an authoritarian country with an unreliable judicial system that could not be predicted where it would go," he says. From his experience in Russia, he shares the ways that foreign investors find to continue investing in the country, while minimizing the risk, such as by "internationalizing disputes," agreeing that business disputes will be resolved in courts in Western cities, such as in New York or London, transferring legal claims against the assets of the problematic partner abroad; liens on assets; and bank guarantees from Western banks, but these are expensive and may make deals unprofitable.
But there are some authoritarian countries like Singapore and the UAE, which is imitating it, that allow foreign investors to ease fears by establishing business arbitration centers that operate independently of the state. "These are generally Western-run institutions that provide arbitrators for hire - and as long as both parties agree, business disputes between a local and a foreign partner can be settled in them," says DLA Piper UK partner Adv. Alexander Kolmakov, which specializes in mergers and acquisitions, technology and represents investors in international deals. "But you should always remember that the state has the last word and in extreme cases it may intervene, although it knows that this may discourage investors and therefore has no interest in doing so. But in authoritarian countries if there is a conflict between the state and businesses - the state will always win.
In any event Kolmakov recommends that Israel refrains from passing the judicial reform. "For us lawyers who were brought up in a democratic environment, this is a clear sign that the state is losing its checks and balances. In dictatorial countries you can see how the ruling party dictates the conduct of the court and trust in the courts is low - and when there is no court that protects citizens and investors it simply does not work."
Piotr the expat Polish investor says, "You should do what you are doing today. Citizens want to wake up in the morning to a society where if something bad happens to them, they have a way back, they have a way to protect themselves, and I don't think anyone wants to give that up, because when checks and balances are removed, it's hard to put them back afterwards."
Published by Globes, Israel business news - en.globes.co.il - on March 8, 2023.
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