Tim Gosling in Prague -

Succession issues stalk thousands of companies in Central Europe that sprang up in the wake of the collapse of communism 25 years ago. The region's slimmed down private equity industry is eagerly awaiting a chance to benefit, but the complexities thrown up by friendships and families make it a tricky business.

Once a darling of PE, Central and Eastern Europe has lost ground to bigger beasts in recent years. Ahead of the 2008 global financial crisis, large funds piled in, chasing high growth rates, the privatisation story and the EU accessions of 2004 and 2007. Since then, with the weight of capital only antagonising the situation, times have been tough.

Yet PE players claim the region's prospects are now perking up. Many big funds have backed off because of lower potential returns in CEE, plus the temptations of bigger markets such as China. That leaves smaller funds with a clearer field, says Brian Wardrop at Arx Equity Partners.

"For the last couple of years Central Europe has been back on the radar of limited partners," says the co-managing partner of the company, which operates three funds dedicated to the region with current assets under management of around €150mn. "In the last 12 months they've begun to look seriously again at Central Europe."

Facing tightened yields across the globe, investors are ready to look again at Central and Eastern Europe, which is still playing catch up with EU states to the west. Growth rates may not top 5% anymore, but Poland and the Czech Republic are now recording economic expansion of around 3%, with a good push provided by EU structural funds.

The Eurozone, by way of contrast, is likely to see growth capped at 1.5% over the next five years, according to PE specialist PR agency Equus, while CEE's risk profile offers an advantage over the BRICS or Africa. The likes of Enterprise Investors, Mid-Europa and KKR have all raised new regional funds in the last three years or so.

With the potential returns on offer in CEE having tightened, however, investors' focus has sharpened, Wardrop adds. They're looking more closely at individual countries rather than treating the region as a homogenous lump, and deal size and the motivations of target companies are being closely eyed.

Keep it in the family?

That puts  "succession" companies at the top of the list for many funds. Wardrop estimates there are around 8,500 such potential targets in Poland, 4.500 in the Czech Republic, and 2,500 in Hungary.

With the economies in the region freed from state control in the early 1990s, thousands of entrepreneurs flew to start up their own companies. Whether strictly family affairs or partnerships involving several friends joining up with enthusiasm to try capitalism, those companies are now facing inevitable change, as time ticks on and founders eye retirement.

Libor Musil started his Czech building materials company immediately after the revolution in 1990 alongside his father-in-law, the founder and CEO of Liko-S told a recent roundtable on family business presented by the IMD Business School. He started to hatch plans to retire and hand on the business to his children five years ago.

However, as Dr Denise Kenyon-Rouvinez, Director of IMD's Global Family Business Centre points out, succession can be tricky. "The dream of every family business leader is always to hand it on to family, but that's not always easy – or possible." Over 600,000 jobs are lost in Europe each year because transitions are not handled properly, she claims.

That's the kind of point Arx hopes to leverage. "At some point in the coming years, every one of these entrepreneurial companies must face some kind of transition," Wardrop points out. He notes that those companies founded with several partners are prime targets.

"Several partners means several differing visions," he says. "It's difficult for them to agree to one partner buying the others out, or for them all to agree a sale to a strategic investor."

Meanwhile, family businesses can throw up all kinds of obstacles to a straightforward inheritance. Alessandro Pasquale worked alongside his father at Karlovarske Mineralni Vody, the biggest producer of mineral and spring water in the Czech Republic, for a decade, before finally taking over as CEO in 2008. He inherited ownership last year. "It was a tough decision to try to live up to his standards, rather than just sell up," he admits.

Given the myriad issues, it's a fertile segment in which to hunt for Wardrop. Succession targets – generally with a valuation of $10mn-50mn – constitute over 80% of Arx Funds II and III. "They're by far the biggest driver of deal flow today," he says. "They make up at least half of all regional flow."

Yet the nature of these beasts makes them tricky to deal with. Selling control in a family business can be just as hard on an entrepreneur as handing it on. "A family has very deep emotional ties to a family business," Kenyon-Rouvinez points out.

That has Wardrop and his rivals often needing to wear different hats when dealing with succession companies, and especially family businesses. Sometimes they have to act more like a psychologist and counsellor.

Arx' purchase of DC Bled – a Slovene operator of diagnostic clinics – is a typical example of the opportunities and challenges, he says. After the founder passed way several years ago, his family saw the company as not only a business but also a family legacy.

That made them very specific about who they would sell to. Wardrop says it was Arx' strong track record in Slovenia and the recruitment of a well-known healthcare company founder as a co-investor that "provided the necessary comfort". Still, the deal took 18 months of negotiation to push through.

"It can be a long slog," he says of succession targets, "and due to opportunity costs we need to decide quickly whether a deal is actionable." At the same time, there's potential out there and sometimes patience is rewarded. Arx has been talking to one Czech company for five years now.