Enterprise Funds for American Soft Power

Enterprise funds should be a much more robust instrument of American foreign policy. This tool deserves to be reconsidered given the changed world we are in. To be useful and relevant, enterprise funds will require some adjustments to the 25-year-old model. Enterprise funds are essentially U.S. government monies directed to private equity investments in emerging markets. Enterprise funds promote entrepreneurship abroad and generate a financial return that benefits the U.S. taxpayer at home. In addition, these funds indirectly advance U.S. security by promoting stability overseas by generating economic opportunity. The original model should be vastly replicated and scaled for a new era.

Enterprise funds were ahead of their time when they were set up in the early 1990s in Central and Eastern Europe and the former Soviet Union. Many of the original enterprise funds were financially and programmatically successful. The U.S. government invested $1.2 billion in several countries and in many of those countries received their money back in the form of profits. A study produced by the U.S. Agency for International Development (USAID) reports that enterprise funds produced as much as $1.7 billion of net proceeds from successful investments and raised $6.9 billion of private capital from outside the U.S. government. In addition, USAID reports that the enterprise funds were responsible for sustaining as many as 300,000 jobs in the region through investment and development activities at a time when the former Soviet countries desperately needed to rebuild and capital was scarce. By 2013, 9 of the original 10 funds had ceased making new investments and begun exiting their investment portfolios, leaving behind “legacy foundations.” However, some of the funds struggled for a variety of reasons, including poor leadership as well as macroeconomic and political problems. If this was a purely private-sector endeavor, where there are some successes and some failures, it would be fair to say that the overall financial and policy successes of the original enterprise funds deserve to be scaled and replicated. However, given the risk aversion often associated with government, this “mixed” track record has created some reluctance in Congress to create new enterprise funds.

To date, only two exceptions were made during the Obama administration. In 2013, the Egyptian-American Enterprise Fund (EAEF) and the Tunisian-American Enterprise Fund (TAEF) were established as part of the U.S. response to the Arab Spring.

Enterprise Funds 1.0

In 1989, President George H. W. Bush introduced a bold new concept in development assistance with enterprise funds. The initial funds targeted former Soviet countries that were transitioning from centrally managed states to free market economies. The revolutionary legislation approved by the U.S. Congress—Support for Eastern European Democracy (SEED) Act—formed the first two enterprise funds with a total of $300 million for Poland and Hungary. The SEED Act was expanded to additional countries in the former Soviet Union, Central and Eastern Europe, the Baltics, and Central Asia—through the FREEDOM Support Act (FSA). To say these funds were revolutionary is an understatement: they were given the unique and dual mandate of making money and “doing” development.

Enterprise funds were set up to operate similar to a venture-capital firm in developed countries: taking risks and providing equity and technical assistance to untested ventures. Enterprise funds invested and made loans to small and medium-sized enterprises (SMEs), provided technical assistance, introduced new financial products (mortgage lending, mortgage securitization, credit cards, and others), and supported sectors such as telecoms, finance, and construction among others. Like conventional investment firms, each enterprise funds had a board of directors to guide their strategy and provide oversight and a management team to run the investments. The funds were originally designed to have a limited life span (i.e., a 10- to 15-year period) and would end once their missions were accomplished. Enterprise funds invested in a wide range of ventures, from the Educational Enterprise Foundation and a micro-lending entity named Fundusz Mikro in Poland to the Bulgarian American Credit Bank and initiatives by the America for Bulgaria Foundation (e.g., agriculture technical assistance) in Bulgaria.

The original boards of directors of the early 1990s were appointed by President Bush on a pro-bono basis with professionals from both the United States and host country. Many of the boards were composed of prominent and experienced figures. For example, the Hungarian Fund’s chairman was John Whitehead, from Goldman Sachs, and the Polish Fund’s chairman was John Birkenlund, from Dillon Read & Co. The management team also needed expertise and knowledge about private-sector investments because of the vast challenges that former centrally controlled economies typically faced. For some of the enterprise funds, however, board members and management were selected for political reasons, which proved to be the wrong decision.

USAID was (and continues to be) the major implementer of enterprise funds. The relationship between USAID and the boards of directors was unclear at the beginning. There were concerns that USAID would be “too bureaucratic” or would not “understand the business,” so there the original link with the funds was tenuous. It turned out that the USAID’s involvement could be quite valuable. To address the early setbacks, a reporting structure and format was developed to satisfy necessary requirements for oversight: regular meetings between USAID and the boards, the creation of individual fund management teams, semiannual reviews, site visits, and independent evaluations, as well as independent audits to verify financial reporting. Thus, USAID allowed flexibility in funds’ investments and programmatic decisions. In addition, USAID played a supplemental role, mainly by providing technical advice where there were gaps related to private market expansion. For example, in the case of the Polish American Enterprise Fund (PAEF), USAID generated a technical assistance program on the principles of mortgage banking for a broader population.

In terms of the proceeds that enterprise funds generated, these profits went back to the U.S. Treasury, which mainly allocated a portion to legacy institutions (legacy foundations) in host countries. These legacy institutions continued promoting economic development and strengthening the private sector and civil society, as well as maintaining a meaningful partnership between the United States and host countries after the enterprise fund’s active investment phase was completed. For example, the PAEF returned $120 million to the U.S. Treasury, while the remaining profits were used to jump start private business activity in Poland—through the Polish National Capital Fund or the Krajowy Fundusz Kapitalowy (KFK)—with the goal of investing in small, innovative tech enterprises.

Enterprise Funds in Retrospect

Although enterprise funds faced many challenges, overall, they were successful financially and achieved economic impact in countries where the private sector was mainly incipient. The initial 10 funds returned over $200 million to the U.S. Treasury. The funds helped jumpstart enterprise development and helped stabilize the economies of transition countries. Among the positive development impacts of the initial enterprise funds are the introduction of modern technologies in developing countries, development of capital markets and of private equity in particular, management support and training for entrepreneurs in SMEs, and improved corporate social responsibility.

At the same time, funds faced many challenges operating in these new emerging markets, including corruption, the absence of rule of law, property rights, physical security, or acceptable business standards in host countries. In addition, there was difficulty in enforcing contracts, navigating too many regulations resulting in high business start-up costs, and time-consuming registration procedures. At the beginning, USAID was not well positioned with expertise in private equity, venture capital, or development of financial institutions in these countries. It was also hampered by politics and lack of authority. The unique trials presented USAID with operational and management challenges as each fund interpreted and addressed their development mandates differently. The private nature, unconventional structure, and unprecedented operating environments caused friction between enterprise funds and USAID. However, over the years, more expertise and local knowledge has been gained. The experiences from this first wave of funds represent opportunities to learn and make adjustments to the next iteration of enterprise funds.

Enterprise Funds Today

After the 2010–2011 Arab Spring, the Obama’s administration initiated two new enterprise funds in 2012: the Egyptian-American Enterprise Fund (EAEF) and Tunisian-American Enterprise Fund (TAEF). Both funds are relatively new, but they are providing essential capital and private-sector expertise in two fragile yet strategic countries.

The EAEF has invested $130 million in Egyptian businesses as of December 2017, attracting an additional $110 million in foreign direct investment (FDI). The EAEF invested in Fawry, Egypt’s largest electronic bill payment platform, drastically reducing transaction costs among the unbanked population. Instead of waiting hours in line, Egyptians without bank accounts are now able to send their payments using Fawry. In addition, the EAEF has expanded access to credit through its investment in Sarwa, a consumer finance company that provides loans to SMEs in Egypt. Increasing access to credit is a critical feature for job creation and ultimately upward income mobility. The EAEF has generated positive returns and created an estimated 500 jobs over the span of the two years it has been making investments.

However, these successes came with some challenges. At the onset of the EAEF, it was clear that very few Egyptians were willing to sell a minority interest in their business to an entity funded by the U.S. government. Therefore, it was very important to “Egyptianize”—or localize—the board to increase trust and the level of engagement from Egyptian customers. Perhaps the most significant innovation for the EAEF was seeding a management company owned by Egyptian professionals to manage EAEF’s investments. In doing so, EAEF aligned the interests of the different parties involved and enabled the establishment of a leading Egyptian asset management company that will outlive the EAEF. Cultural sensitivity remains important. And a business-friendly and supportive political environment impacts how quickly the funds see a return on investment.

The Tunisian-American Enterprise Fund operates in a more congenial context. Unlike Egypt, Tunisia has a political environment that is very friendly to the United States. However, there have been challenges in confronting crony capitalism and burdensome bureaucracy. On top of the regulations in place in Tunisia, there are U.S. government regulations to abide (i.e., “Dodd Frank” financial regulations). Nevertheless, the TAEF has made investments in the whole SME market spectrum, including startups, microenterprises, traditional family owned and small- to mid-cap SMEs, and the high-end segment of SMEs. As of 2016, TAEF has made investments of $10 million (with another $75 million in the pipeline, committed or approved) in diverse industries.

The Future: Enterprise Funds 2.0

There are dozens of other countries that could benefit from an enterprise fund. However, the world is vastly different from what it was when the first enterprise funds were set up. Many developing countries have moved up the development ladder and are richer, freer, healthier, and more self-sufficient. There is now an entire emerging markets private equity industry and tens of thousands of financial professionals from emerging economies, in part flowing from the success of the earlier enterprise funds. Private equity is now better known today, and most investors understand and appreciate opportunities in developing countries. There is now a lot more capital flowing into emerging markets than in 1990. Foreign direct investment to developing countries increased more than 10 times: from $60 billion in the mid-1990s to $800 billion in 2015. There is now no disagreement on the role that the private sector can play in fostering economic growth and prosperity around the world. Private capital (i.e., equity, debt, real estate, and other assets) has ballooned in the past 15 years. For example, the amount of FDI is now five times the amount of foreign aid. Enterprise funds should be a way to channel some U.S. monies, local and U.S. expertise for development and foreign policy goals.

The international development consensus is focused on the “billions to trillions” agenda, where the role of foreign aid has been redefined as a “catalyst” to mobilize additional investments—in the form of private capital and domestic resources—and especially among the so-called impact funds to meet international development challenges set out in the UN Sustainable Development Goals (SDGs). In addition, countries’ own domestic resources, such as savings, taxes, and other revenues, are growing. China has become a global player in trade, investments, and in exerting its own soft power. China’s new multilateral development banks—the New Development Bank and the Asian Infrastructure Investment Bank—are also competing with (and complementing) the financing and expertise provided by the Bretton Woods institutions.

All these developments require a rethink of the U.S. foreign assistance toolbox. Given the world we are in, it would make sense to revisit and adjust the enterprise funds instrument, replicate it and scale it. In a world where there will be limited foreign assistance dollars and where many of the challenges require more private-sector activity, enterprise funds should be an option “front and center” for U.S. policymakers. But given the changed world, future enterprise funds will require an updated model for the twenty-first century.

The 2.0 version of enterprise funds will probably require adopting more flexible business plans and leveraging additional resources by forging partnerships with other institutions. In this regard, enterprise funds have complementarities with development agencies such as the Overseas Private Investment Corporation (OPIC), the International Finance Corporation (IFC), and the equity funds these agencies support. In addition, technical assistance programs provided by nongovernment organizations also serve as a supplement for enterprise fund efforts. Sharing experiences and learning from other bilateral donors’ enterprise funds is equally important. Currently, the Arab Women’s Enterprise Fund (AWEF) in Jordan, Egypt, and Palestine, which promotes women’s economic empowerment, was set up by the UK Department for International Development in conjunction with the Islamic Development Bank to be implemented over the course of five years (2015–2020). The United States should evaluate whether sectoral or regional funds such as AWEF might be an option.

If enterprise funds are to be expanded, it is essential to think about the role of the boards of directors and the formal oversight mechanisms with the U.S. government. For 25 years, USAID has housed enterprise funds. In theory, there remains some expertise at USAID and—to the extent that USAID retains this expertise—it would be the logical agency to continue supervising them while ensuring that these funds maintain some degree of autonomy and avoid any micromanagement.

The new enterprise fund model will also need to have clearer liquidation (or “exit”) strategies once funds start exiting markets. Post-liquidation plans should be considered in advance. Finally, the new funds will have to balance financial returns and development impact.

An Instrument of American Foreign Policy

Enterprise funds fit into the Trump administration’s National Security Strategy (NSS) as they align with the objectives of advancing U.S. influence globally. Enterprise funds mobilize resources, capitalize on new technologies, and incentivize reforms. The Trump administration has also placed a priority on strengthening states where weaknesses or failures would magnify threats to the U.S. homeland. As the administration emphasizes protecting jobs at home, creating jobs abroad, and new export markets for the United States, enterprise funds can mitigate growing security threats by providing opportunities to people in fragile states who lack access to capital. It is time to revisit the concept of enterprise funds and adjust them to a new era.

Daniel F. Runde holds the William A. Schreyer Chair in Global Analysis and directs the Project on Prosperity and Development at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Romina Bandura is a senior fellow with the CSIS Project on Prosperity and Development.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2018 by the Center for Strategic and International Studies. All rights reserved.

Daniel F. Runde
Senior Vice President; William A. Schreyer Chair; Director, Project on Prosperity and Development
Romina Bandura
Senior Fellow, Project on Prosperity and Development, Project on U.S. Leadership in Development