TITLE:   Foreign Assistance:  Issues Concerning the Polish-American Enterprise 
                Fund, GAO/OGC-99-61R, B-283261, September 14, 1999
BNUMBER:  B-283261
DATE:  September 14, 1999
**********************************************************************
Foreign Assistance: Issues Concerning the Polish-American Enterprise
Fund, GAO/OGC-99-61R, B-283261, September 14, 1999

B-283261

September 14, 1999

The Honorable Benjamin A. Gilman
Chairman, Committee on International Relations
House of Representatives

The Honorable Doug Bereuter
Chairman, Subcommittee on Asia and the Pacific
Committee on International Relations
House of Representatives

Subject: Foreign Assistance: Issues Concerning the Polish-American
Enterprise
Fund, GAO/OGC-99-61R

In 1989, Congress enacted the Support for East European Democracy (SEED) Act
to provide assistance for political and economic development in Eastern
Europe. [1] Instead of providing more traditional types of foreign
assistance, the Act, among other things, authorized enterprise funds to
promote private sector development in Poland and Hungary through grants,
loans, equity investments, and other measures. [2] This letter addresses
issues raised by your staff regarding structural changes undergone by the
Polish-American Enterprise Fund (Polish Fund) and its management company to
enable them to operate more like private venture capital companies. [3]
Specifically, we determined (1) whether these structural changes were
permitted by law, (2) whether the purchase of the Polish Fund?s management
company by its employees at book value [4] was permitted by law and whether
it favored the employees, (3) whether monies earned by Polish Fund
management company employees contravened a $150,000 salary cap, and (4) how
proceeds from the sale of the Polish Fund's assets will be distributed.

For the reasons discussed in this letter, we concluded that structural
changes to the Polish Fund and its management company were consistent with
applicable legislation. We also concluded that the purchase of the Polish
Fund?s management company by its employees at book value was consistent with
existing law and that, under the circumstances, the terms of the purchase
were reasonable. Furthermore, we concluded that Polish Fund management
company employees can earn more than $150,000 in annual salary as long as
additional amounts are derived from sources other than U.S. funds. Finally,
regarding distribution of Polish Fund proceeds, the administrations plans to
return $120 million to the U.S. Treasury and to provide the balance to a
foundation for additional private-sector development in Poland.

CHANGES IN STRUCTURE TO THE POLISH
FUND AND ITS MANAGEMENT COMPANY
WERE CONSISTENT WITH THE SEED ACT

A. Background

Under the SEED Act, the Polish Fund was formed in 1990 as a private,
nonprofit entity. The Fund is governed by a board of directors composed of
both U.S. and host country citizens. The U.S. Agency for International
Development (USAID) has provided grants to and oversees the Fund, and the
Department of State is responsible for overall coordination of U.S.
assistance under the SEED Act, including the enterprise fund program. USAID
has authorized $264 million in grants to the Polish Fund.

As early as 1991, USAID, State, and Fund officials began discussing altering
the Polish Fund?s structure. These changes involved spinning off the
management of the Fund into a separate management company that would manage
both the Fund?s investments and those of an affiliated private fund. A vital
part of the plan was to have Polish Fund employees leave their positions and
become employees of the management company.

According to USAID, these changes were made to set up a structure that more
closely paralleled a private-sector investment company that manages multiple
investment funds. Polish Fund and USAID officials stated that this kind of
structure would better attract private investors who would otherwise be
reluctant to provide capital to an entity like the Polish Fund, which could
have been perceived as being affiliated with the U.S. government. The
changes also were intended to provide former Polish Fund employees with
additional compensation incentives. Finally, according to USAID, the changes
would lower the Polish Fund?s management costs because management fees would
be spread over two funds.

After the Polish Fund board of directors approved these changes to the
Fund?s structure, Enterprise Investors, L.P., was formed in 1992 to manage
investments of both of the Polish Fund and a new private investment fund
named the Polish Private Equity Fund. The Polish Fund and the European Bank
for Reconstruction and Development owned 60 percent and 40 percent,
respectively, of Enterprise Investors. The Polish Private Equity Fund was
capitalized at approximately $150 million-$50 million from the Polish Fund,
$50 million from the European Bank for Reconstruction and Development, and
the rest from other investors.

On September 25, 1996, USAID, with State?s concurrence, approved a further
elaboration of the process begun in 1992 by allowing employees of Enterprise
Investors to purchase the company from the Polish Fund and European Bank for
Reconstruction and Development. It also approved formation of a second
private fund, the Polish Enterprise Fund, L.P., capitalized at an additional
$150 million. According to State, these changes were intended to (1)
emphasize U.S. policy to expand trade and investment ties with Poland; (2)
bring more money under Enterprise Investors? management, which would further
reduce the fee charged to the Polish Fund; [5] (3) attract additional
capital; and (4) increase compensation possibilities for Enterprise
Investors? employees and thereby reduce the risk of loss of staff.

The employees of Enterprise Investors purchased their company, which had
been renamed Enterprise Investors Corporation, on April 30, 1997. This
entity currently manages the Polish Fund, the Polish Private Equity Fund,
and the Polish Enterprise Fund. [6] According to the Polish Fund, the total
management fees for 1998 were $7.5 million, with $1.5 million paid by the
Polish Fund and the remainder paid by the two private funds. [7]

B. Legal Discussion

The Polish Fund?s structural changes were permitted by the SEED Act. The Act
indicates that the Polish Fund is a private, nongovernmental entity that
received funds to develop the Polish private sector. The act authorized the
Polish Fund to engage in transactions that would attract U.S. private
venture capital; establish financial instruments that would enable
individuals to invest in the private sector in Poland; and distribute to
private investors returns on investments that include private venture
capital. These authorities were intended to maximize the effectiveness of
Polish Fund activities and multiply the impact of U.S. grants. [8] USAID
attorneys concluded that the private character of the Polish Fund, as well
as these authorities, allowed it to make the described changes in structure.

As a private entity, the Polish Fund could establish a management company
staffed by its former employees, who would also manage affiliated private
investment funds. The SEED Act clearly intended that the Fund enter into
financial arrangements, including attracting private capital, that would
enhance private-sector development in Poland. Consistent with this
intention, in 1994 USAID amended its grant agreement with the Polish Fund to
allow it to establish, invest in, or finance subsidiaries and affiliates,
which have substantially the same directors, managers, and employees,
provided it receives USAID?s prior written approval. According to USAID, the
Polish Fund received the required approval regarding the purchase of
Enterprise Investors by it employees. [9]

EMPLOYEES? PURCHASE OF ENTERPRISE INVESTORS
WAS CONSISTENT WITH APPLICABLE LEGISLATION

A. Background

Before USAID approved the sale of Enterprise Investors to its employees,
USAID, State, and Polish Fund officials had a number of discussions about
the details of the purchase. State was concerned about the appearance of a
conflict of interest because the two individuals who were to serve as
directors of the employee-owned management company would also continue to
serve as Polish Fund directors. Thus, State wanted to ensure that the
directors would not be involved in valuing Enterprise Investors for the sale
to its employees. To deal with this problem, the two directors agreed to
recuse themselves from any votes of the Polish Fund board of directors
concerning Enterprise Investors, and State and USAID agreed that the Polish
Fund should obtain an independent valuation of Enterprise Investors that
would be used to negotiate a fair and equitable price.

Initially, USAID and State considered a number of pricing elements for the
independent valuator to consider, including the book value of Enterprise
Investors, the market value of all its assets, prices in comparable
transactions involving professional fund managers, and its net present
value. Ultimately, however, the

Polish Fund board decided, and State and USAID agreed, that the purchase
price should be based solely on book value. The Fund asked the independent
valuator to determine the book value of the company.

USAID also considered publicly bidding the sale of Enterprise Investors but
eventually abandoned this idea. According to USAID and State officials, this
approach risked losing Enterprise Investors? staff, which was making the
company successful. Furthermore, though USAID officials were aware that
other venture capital firms were operating in Poland, no such groups had
indicated any interest in purchasing Enterprise Investors.

Subsequently, an independent auditor concluded that, as of April 30, 1997,
the book value of Enterprise Investors was approximately $485,000. [10] The
book value assets included furniture, computers, and telephones in leased
space. Enterprise Investors? employees purchased their company, on April 30,
1997. The terms of the sale called for Enterprise Investors? employees to
pay $485,000 to the Polish Fund and the European Bank for Reconstruction and
Development, the former owners of Enterprise Investors, in four equal yearly
installments with no interest. The first payment was to be made on April 30,
1998, 1 year after the sale. According to the Polish Fund, the payments have
been made for 1998 and 1999.

B. Legal Discussion and Valuation Issue

USAID, State, and the Polish Fund board of directors were acting within
their authority in arranging to sell Enterprise Investors at book value and
not publicly competing the sale. Neither the SEED Act nor any other law
required any particular method of valuing Enterprise Investors. Moreover,
the sale of Enterprise Investors to its employees was an entirely private
transaction that was not subject to federal procurement laws and
regulations.

Although the terms of the sale were advantageous to Enterprise Investors?
employees, under the circumstances, they were reasonable. The facts indicate
that Enterprise Investors? employees purchased an established, successful
entity at the book value price of $485,000. Furthermore, as a consequence of
the purchase, these employees became managers of a second private fund, the
Polish Enterprise Fund, from which they could earn additional salary and
profits on investments. [11] Venture capital experts that we interviewed
said that sales of venture capital management companies are rare and that
there is no fixed method of valuation when they do occur; however, most
agreed that, at least as a general matter, valuation of such entities with a
portfolio of successful investments should include some amount based on
potential future income in addition to book value. Finally, the other terms
of the sale-no public competition, payments over 4 years at no interest, and
the first payment due a year after the sale-appear favorable to Enterprise
Investors? employees.

Notwithstanding these factors, USAID?s and State?s approving the sale under
these circumstances was reasonable. According to USAID and State officials,
the primary reason for limiting the valuation to book value was the need to
preserve continuity of Enterprise Investors? staff, which was critical to
the success of the Polish Fund and to the raising of further capital for the
second private fund, the Polish Enterprise Fund. If the purchase price
exceeded book value, all or part of Enterprise Investors? staff could have
been lost to a competing entity. USAID and State officials cited the lack of
continuity of management in the Czech-Slovak Enterprise Fund as causing
major disruptions of its operations and did not want to risk that happening
to the Polish Fund. USAID and State officials also stated that any goodwill
[12] value that accrued to Enterprise Investors was due to the skill and
experience of its employees rather than its name or the services it
provided. Thus, it was not appropriate to charge Enterprise Investors?
employees for the value of their own experience.

The State and USAID position was supported by several venture capital
experts who agreed that book value was an appropriate method of valuation
when necessary to ensure the continuity of management company staff. They
also emphasized that the principal value-the goodwill-in any venture capital
management company lay in the expertise of its personnel. If valued
employees left a management company, private investors would have no
interest in continuing their relationship with it.

COMPENSATION RECEIVED BY ENTERPRISE
INVESTORS? EMPLOYEES DOES NOT
CONTRAVENE SALARY CAP

A. Background

Although the SEED Act itself does not place a specific dollar limit on
compensation, [13] the Polish Fund grant agreement precludes salaries of its
employees, and employees of organizations in which the Fund owns a majority
interest, from exceeding $150,000 on monies payable from grant funds. [14]
USAID and Fund officials agree that this limitation extends to salaries paid
to Enterprise Investors? employees from management fees attributable to the
Polish Fund, even though the Fund has no ownership interest in Enterprise
Investors. USAID monitors the salary cap by reviewing the Polish Fund?s
semiannual report, which contains the Fund?s statement that the Fund is
complying with the salary cap. [15]

When Enterprise Investors was formed in 1992, Polish Fund employees
terminated their employment with the Fund and became employees of Enterprise
Investors. At that point, the former Fund employees began receiving salary
through management fees the Polish Fund and the Polish Private Equity Fund
paid Enterprise Investors for management services. This new arrangement
afforded these employees two sources of additional compensation: first, they
could earn additional salary through management fees paid by the Equity
Fund; and second, they could share in profits on Equity Fund
investments-commonly referred to as carried interest. [16] Similar
compensation benefits were again provided to Enterprise Investors? employees
when the Polish Enterprise Fund was formed in April 1997.

USAID and the Polish Fund have indicated that no employee of Enterprise
Investors currently earns more than $150,000 from Polish Fund contributions
to salary. They also indicated, however, that a number do earn substantially
more from management fees attributable to the Polish Private Equity Fund and
the Polish Enterprise Fund. [17]

Although carried interest payments derived from investments of these two
private funds will probably be made to Enterprise Investors? employees in
the future, the Fund indicated that none have been made to date. Neither
USAID, the Polish Fund, nor Enterprise Investors could provide us with any
estimates about how much carried interest might eventually be paid.

B. Legal Discussion

The additional compensation payments resulting from the changes in structure
to the Polish Fund and Enterprise Investors do not contravene the $150,000
salary cap set forth in the Fund?s grant agreement with USAID. The grant
agreement clearly indicates that compensation or profit-sharing that exceeds
$150,000 per year may be paid from earnings or sources other than U.S. grant
funds. Since the salary payments to employees of Enterprise Investors that
exceed $150,000 are derived from private sources, they are not subject to
the agreed salary cap for Enterprise Investors? employees. The same would be
true for any profits on investments that may be paid in the future.

DISTRIBUTION OF POLISH FUND PROCEEDS

A. Background

The SEED Act did not provide for termination of the Polish Fund (or the
Hungarian Fund) or describe how its assets were to be distributed upon
liquidation. The only reference to this issue in the legislative history is
a Congressional Budget Office estimate included in the accompanying House
Report. [18] The report states that the estimate of costs of providing
grants to the two enterprise funds assumed "full disbursement . . . and no
repayments, dividends, or recoveries to the federal government from the
Funds? activities." When these enterprise funds were first established, many
U.S. officials did not expect them to recoup their original grants.

In part because of the success of Polish Fund investments, as early as 1992,
administration, congressional, and Polish Fund officials concluded that a
plan was necessary to terminate the Fund. Accordingly, after consulting with
congressional appropriators, in 1994 USAID amended the Polish Fund grant
agreement, and the Polish Fund amended its certificate of incorporation, to
provide for termination of the Fund and liquidation and distribution of its
assets. The amended certificate of incorporation states that the President
of the United States is to determine how liquidated Polish Fund assets will
be distributed. Distributions are to be made to a nonprofit entity or
entities for assistance in Poland, the U. S. government, or a combination of
both. The amended certificate also included a proviso stating that the
intention of the amendment was to have "the proceeds from the sale of . . .
[Polish Fund] assets be used in Poland, unless there are reasons to do
otherwise."

In 1996, the Polish Fund board began discussions with the administration
about disposition of the proceeds from the sale of Polish Fund assets.
Subsequently, the administration developed a distribution plan that called
for Fund proceeds to be divided between the U.S. Treasury and the endowment
of a foundation whose purpose would be the further development of the Polish
private sector, a goal consistent with that of the Polish Fund under the
SEED Act. [19] Under the plan, $155.3 million was to be returned to the U.S.
Treasury and a maximum of $130 million was to be provided to the foundation.
Whereas the Polish Fund focused exclusively on the business sector, the
foundation was intended to focus on the broader private sector, including
nongovernmental organizations. The proposed foundation was to be a Delaware
corporation with operations in Poland.

B. Current Plan

The administration?s current plan, [20] which, to some extent, was based on
the 1996 proposal, was submitted to Congress on May 11, 1999, consistent
with a notification requirement in the Omnibus Consolidated and Emergency
Supplemental Appropriations Act for fiscal year 1999. [21] Under the plan,
$120 million of the estimated $270 million in returns on Polish Fund
investments is to go to the U.S. Treasury in amounts of $40 million each in
fiscal years 1999, 2000, and 2001. The $120 million represents one-half the
amount of the initial $240 million in grant funds that USAID was authorized
to provide to the Polish Fund. The Polish Fund will provide the balance, an
estimated $150 million, to a U.S. entity named the Polish-American Freedom
Foundation, as a grant in the form of an endowment. The Foundation will be a
nonprofit Delaware corporation, and its principal business will be conducted
through a wholly owned and controlled subsidiary organized under Polish law.

After the administration submitted its plan to the Congress, the Polish Fund
drafted a grant agreement setting forth the relationship between the Polish
Fund and the Foundation and describing the scope of the Foundation?s
activities. Concurrently, USAID drafted amendments to its grant agreement
with the Polish Fund to provide for the grant relationship between the
Polish Fund and the Foundation. Drafts of these documents have been reviewed
and approved by USAID, State, other relevant U.S. agencies and the Polish
Fund.

The grant agreement between the Polish Fund and the Polish Foundation
provides that the Foundation?s endowment, estimated to be $150 million, will
be used to support private sector development in Poland [22] in the areas of
economic reform, leadership development, civil society, local government and
business development, and legal reform, consistent with section 201(a) of
the SEED Act. The grant agreement also authorizes the Foundation to support
assistance programs in other countries in Central and Eastern Europe and the
Western newly independent states in their transition to democracy and free
markets, but only after legislative authority is obtained. Administration
officials said they would seek legislation to authorize Foundation
activities outside of Poland because the SEED Act only authorizes Polish
Fund activities for private sector development in Poland. Both the grant
agreement and the amendments to the USAID-Polish Fund grant agreement
provide that for its first 5 years the Foundation must restrict its
activities to the five areas described in the grant agreement. [23]

The Foundation will be managed by a board of directors composed of six U.S.
and five Polish citizens, some of whom will be Polish Fund board members,
according to State. The initial board will be appointed by the Polish Fund,
and the board members will select a chairman. Board members will serve
staggered 3-year terms, and subsequent board members will be elected by the
Foundation. The U.S. Ambassador to Poland will be a permanent, nonvoting
liaison to the Foundation board.

The U.S. members of the Foundation?s board of directors will not be
compensated for their services but will be reimbursed for reasonable
expenses. The Polish members, however, will be compensated. Foundation
employees will be subject to a $150,000 salary cap much like that covering
Polish Fund employees and employees of Enterprise Investors. Compensation
exceeding $150,000, however, can be paid from sources other than the
Foundation endowment and endowment proceeds. According to State and USAID
officials, the additional salary could come from contributions to the
Foundation from private entities. These officials also stated, however, that
there are no plans for the Foundation to undergo the kind of structural
changes made to the Polish Fund, with the attendant enhanced compensation
possibilities.

The Foundation?s grant agreement with the Polish Fund provides the Polish
Fund, the USAID Inspector General, and the Comptroller General of the United
States with a right to audit and resolve all questions regarding endowment
expenditures. This audit right includes access to Foundation records
necessary to complete an audit. The grant agreement also includes conflict
of interest provisions imposing disclosure and recusal requirements on
Foundation directors and officers when considering transactions with
entities in which they hold a financial interest. These provisions also
preclude Foundation directors, officers, and employees from using
confidential or privileged information for financial gain or other
advantage.

Finally, both the grant agreement and the amended grant agreement between
USAID and the Polish Fund authorize the Polish Fund to terminate, or USAID
[24] to cause the Fund to terminate, the grant agreement for (1) the
Foundation?s failure to comply with the grant agreement, (2) foreign policy
reasons, (3) insolvency, (4) unauthorized changes in structure, and (5)
improper Polish taxation of U.S. foreign assistance. Should termination
occur, Foundation funds are to be returned to USAID. [25] According to
State, this right of termination will both protect the U.S. interest in the
Foundation and allow the United States to direct the use of any returns.

SCOPE AND METHODOLOGY

To address the questions raised, we reviewed the SEED Act and its
legislative history as well as other relevant legislation, regulations, and
congressional correspondence. We also discussed the issues raised with
State, USAID, and Polish Fund officials and attorneys, and reviewed
documentation provided by each. For further information concerning the
valuation of the sale of Enterprise Investors to its employees, we
interviewed a number of graduate business school professors and private
venture capitalists.

AGENCY COMMENTS
AND OUR EVALUATION

State, USAID, and Polish Fund officials provided written comments on a draft
of this report (see enclosures I, II, and III, respectively). They also
provided technical comments that we have incorporated, as appropriate. State
and USAID characterized the report as thorough and balanced.

In the Polish Fund?s written comments to this report, the Fund disagreed
with our conclusion that the terms of the sale of Enterprise Investors to
its employees were advantageous to the employees. The Fund concluded that
valuing the sale at book value was appropriate and, thus, the terms of the
sale were fair and reasonable. We agree that the sale of Enterprise
Investors to its employees at book value was a reasonable way of preserving
continuity of the Enterprise Investors? staff and avoiding disruption in
management. Nevertheless, arranging a sales price without including some
potential for future income, and allowing purchase payments over 4 years at
no interest with the first payment due a year after the sale, was
advantageous to Enterprise Investors? employees.

                                 - - - - -

Unless you publicly announce its contents earlier, we plan no further
distribution of this letter until 30 days after its issue date. At that
time, we will send copies to the Honorable Madeleine K. Albright, the
Secretary of State; the Honorable J. Brady Anderson, Administrator of USAID;
and other interested congressional committees. We will also make copies
available to others upon request.

If you or your staff have any questions concerning this report, please
contact me on (202) 512-5400 or Richard Seldin on (202) 512-4094. Other GAO
contacts and staff acknowledgments are listed in enclosure IV.

Robert P. Murphy

General Counsel

ENCLOSURE IENCLOSURE I

COMMENTS FROM THE DEPARTMENT OF STATE

United States Department of State

Chief Financial Officer

Washington, D.C. 20520-7427

Aug. 25, 1999

Dear Mr. Hinton:

We appreciate the opportunity to review your draft report "FOREIGN
ASSISTANCE: Issues Concerning the Polish Enterprise Fund," GAO/OGC-99-61R,
GAO Job Code 711353.

The Office of the Coordinator of Assistance for Eastern Europe has reviewed
the above-referenced draft report. We consider this report regarding the
structural changes undergone by the Polish-American Enterprise Fund (PAEF),
which was referred to as the "Polish Fund" in the report, to be thorough and
balanced. We note that the structural changes enable the PAEF to raise more
than $262 million in non-U.S. Government (USG) capital, and to reduce the
cost to U.S. taxpayers to mange its USG grant. The structural changes
enabled the PAEF to retain their investment team, whose efforts are expected
to return an estimated $270 million in reflows, which will be split between
a payment to the U.S. Treasury and the planned establishment of the
Polish-American Freedom Foundation.

If you have any questions concerning this response, please contact
Mr. Donald Sheehan at (202) 647-1183.

Sincerely,

Bert T. Edwards

Cc: GAO/OGC - Mr. Seldin

State/EUR/EEA - Mr. Sheehan

Mr. Henry L. Hinton, Jr.,

Assistant Comptroller General

National Security and International Affairs,

U.S. General Accounting Office

ENCLOSURE IIENCLOSURE II

                     COMMENTS FROM THE U.S. AGENCY FOR

                         INTERNATIONAL DEVELOPMENT

August 19, 1999

Mr. Henry L. Hinton, Jr.

Assistant Comptroller General

National Security and International Affairs Division

U.S. General Accounting Office

441 G Street, N.W. - Room 4039

Washington, D.C. 20548

Dear Mr. Hinton:

I am pleased to provide the U.S. Agency for International Development?s
(USAID?s) formal response on the GAO draft report entitled "FOREIGN
ASSISTANCE: Issues Concerning the Polish Enterprise Fund" [August 1999].

Your report on the issues raised regarding the structural changes undergone
by the Polish-American Enterprise Fund (Polish Fund) and its management
company is thorough and balanced. The structural changes enabled the Polish
Fund to mobilize $262 million in non-U.S. Government capital, (more than
their USAID grant), and to reduce the cost to U.S. taxpayers to manage the
grant. The changes enabled the Polish Fund to retain their investment team,
one that will likely return about $270 million to be split between the U.S.
Treasury and a philanthropic foundation in Poland.

USAID appreciates the efforts of the GAO to address the issues covered in
this report. Thank you for the opportunity to respond to the GAO draft
report and for the courtesies extended by your staff in the conduct of this
review.

Sincerely,

Terrence J. Brown

Assistant Administrator

Bureau for Management

ENCLOSURE IIIENCLOSURE III

                      COMMENT FROM THE POLISH-AMERICAN

                              ENTERPRISE FUND

                      Polish-American Enterprise Fund

Robert G. Faris

President and Chief Executive Officer

August 26, 1999

Richard Seldin, Esq.

Senior Attorney

Office of General Counsel

National Security and International Affairs Division

U.S. General Accounting Office

441 G Street, N.W.

Room 7662

Washington, D.C. 20548

Dear Mr. Seldin:

The Polish-American Enterprise Fund requests that the following comments be
included in the forthcoming General Accounting Office report on "Issues
Concerning the Polish-American Enterprise Fund":

The goal of establishing a private management company and raising private
funds was to help in meeting the overall PAEF (and USG) objectives of (1)
leaveraging USG money; (2) replacing USG money with private sector funds;
and (3) reducing PAEF operating costs.

The results are that (1) USG money has been leveraged. PAEF invested and
loaned $655 million through September 30, 1998 after receiving only $240
million of investment funds from the USG; (2) PAEF has replaced USG funds
with private funds, and thus can return $120 million to the USG and provide
approximately $150 million to a USG-approved foundation to assist Poland;
and (3) because PAEF?s overhead costs have been shared with the private
funds, PAEF?s operating costs are less than 0.7% of its assets, resulting in
savings to the USG of an estimated $25-30 million.

Now on pp.5-6With respect to pages seven and eight of the report, the PAEF
agrees with the position of the State Department, USAID, and the venture
capital community, that book value is the appropriate method of valuing an
entity such as Enterprise Investors. Therefore, the terms of the sale of
Enterprise Investors to its employees were fair and reasonable, and not
advantageous to them, as the GAO suggests on page seven. The apparent
inconsistency between page seven (where venture capitalists conclude that
book value was "not an appropriate measure") and page eight (where venture
capitalists conclude that the valuation was appropriate) is the difference
between a theoretical view of the venture capital world by
non-practitioners, and the real world.

Sincerley,

Robert G. Faris

                    President and

                    Chief Executive Officer

cc: Robert Murphy, Esq.

General Counsel

ENCLOSURE IVENCLOSURE IV

GAO CONTACTS

Sheila K. Ratzenbeger, (202) 512-8244

Mark C. Speight, (202) 512-8231

ACKNOWLEDGMENTS

In addition to those named above, Michael J. Courts; A.H. Huntington, III;
James M. Strus; and George A. Taylor, Jr. made key contributions to this
report.

(711451)

Notes

1. P.L. 101-179, 103 Stat. 1299, codified at 22 U.S.C. sect.sect. 5401-5495.

2. 22 U.S.C. sect. 5421.

3. In a separate report, Foreign Assistance: Enterprise Funds? Contributions
to Private Sector Development Vary (GAO/NSIAD-99-221, Sept. 14, 1999), we
address a number of broad issues regarding 10 U.S. enterprise funds,
including the Polish Fund, in Central Europe, and the newly independent
states of the former Soviet Union.

4. Book value is the residual value of an entity?s assets after deducting
its liabilities.

5. When compared with its capital, operating expenses of the Polish Fund are
the lowest of the 10 enterprise funds discussed in the report mentioned in
footnote 3.

6. The Polish Fund has indicated that an additional private fund might be
formed, which would also be managed by Enterprise Investors Corporation.

7. In September 1997, the Hungarian Fund implemented structural changes
similar to those of the Polish Fund. At that time, MAVA Investment
Management Kft. was formed to manage both the Hungarian Fund and a private
fund sponsored by the Hungarian Fund, Hungarian Equity Partners, which was
capitalized at $50 million to invest in the private sector in Hungary. MAVA
is owned by former Hungarian Fund employees. At this point, the Hungarian
Fund is associated with only this one private fund. USAID has tentatively
approved similar changes for the Russian Fund and Bulgarian-American
Enterprise Fund, and the Department of Defense has approved them for the
Defense Enterprise Fund, but none have been fully implemented. Although it
is likely that other enterprise funds will make similar changes in the
future, this will depend on how well the private markets are operating in
the area covered by each.

8. 22 U.S.C. sect.sect. 5421(i) and (j).

9. According to USAID, Congress was notified of these changes.

10. The independent valuation was performed as part of an audit of
Enterprise Investors? consolidated financial statements as of April 30,
1997.

11. The formation of the Polish Enterprise Fund was linked to the purchase
of Enterprise Investors by its employees. According to State, without
privatization, the Polish Fund could not assure private investors that
Enterprise Investors was stable; that is, that it could pay competitive
compensation to retain key investment staff.

12. Goodwill value represents the excess of the purchase price of an entity
over the fair value of all identifiable net assets at the time of
acquisition.

13. 22 U.S.C. sect. 5421(l).

14. The same provision is included in the grant agreements of the other
enterprise funds.

15. USAID does not directly audit the Polish Fund?s books and records to
determine compliance with the salary cap.

16. To avoid conflict of interest problems about Enterprise Investors
steering investments away from the Polish Fund, from which carried interest
could not be earned, the limited partnership agreement of the Polish Private
Equity Fund stated that investment opportunities had to be presented to both
entities simultaneously. The amounts invested by each entity were to be
determined in proportion to monies available for investment from each fund.

17. The Polish Fund and Enterprise Investors stated that their contracts
with private investors precluded them from providing us with specific
information about private salaries. The Hungarian Fund informed us that one
MAVA employee was paid more than $150,000 in 1998, but that it did not
contribute more than $150,000.

18. H. Rep. 101-278, at 17, 19-20 (Pt. 2 1989).

19. In formulating this plan, the administration considered but rejected a
proposal to return all Polish Fund proceeds to the U.S. Treasury because it
would have been politically unpopular in Poland, with the Polish American
community, and with Poland?s supporters in Congress. The administration also
considered a proposal to provide all the proceeds to a Polish entity, but
decided that turning close to $270 million over to a new and untested
foundation would have been unwise and would not allow for the first
substantial return to U.S. taxpayers on an assistance program. The
administration also concluded that such a plan would not be well received by
members of the Congress who wanted a substantial portion of the proceeds
returned to the United States.

20. State and USAID considered several variations of the current plan. Thus,
the administration dropped a proposal (1) dividing reflows between the
United States, a Polish foundation, and several trust funds supporting
activities in Central Europe and the Baltic states; (2) returning to the
United States an amount based on the original $240 million U.S.
capitalization of the Polish Fund; and (3) terminating the Fund.

21. P.L. 105-277, 112 Stat. 2681-200.

22. As a general matter, the Foundation cannot spend the endowment?s
principal for its activities. Foundation activities must be financed by
earnings generated by the endowment or funds obtained from outside sources.
Endowment principal can only be used under extraordinary circumstances and
must be restored as soon as practicable.

23. An amendment to the Polish Fund-USAID grant agreement indicates that the
Polish Fund will continue to exist as long as the Foundation is operating.

24. USAID must first consult with the Polish Fund?s board of directors
before exercising this right.

25. A USAID attorney indicated that the return of the funds to USAID instead
of directly to the U.S. Treasury was primarily for convenience and that
USAID would have to return the money to the U.S. Treasury.