Advice from the other side of the table

China's CEOs have a message for GPs: manage the people as well as you do the balance sheet.

It’s not often that we get to hear about the private equity experience from the point of view of the founders, entrepreneurs or senior management of portfolio companies. So it was refreshing to listen to five top Chinese executives of private equity-backed businesses in Beijing last week, speaking on a panel to a packed room of delegates at PEI’s Value Creation Forum: China 2013 in Beijing.

The executives were outspoken both in their praise and their criticism. None of them had any specific issues with their private equity owners; in particular, they were very complimentary about their owners’ work on company financials. However, they all agreed that there were two key areas of vulnerability for any GP investing in China to consider: understanding people and managing relationships. In China, this can matter much more than contracts.

One example came from Gejun Wang, chief information officer of Shanghai LaiYiFen, a packaged snack retailer backed by SAP, who said private equity should be aware of the change in mindset required by the top person, post-investment. He recalled one founder of a high-growth company who wanted to buy a sports car – but since his company was now under private equity ownership, he needed to get permission from the GP to buy it.

The reason why a lot of international private equity firms don’t get good deals in China is because many don’t understand the founder or senior management team of a company

Gejun Wang, CIO, Shanghai LaiYiFen

This might seem like a small thing. But in China, it’s not. The founder had built the business from scratch by making his own decisions, and status among peers carries a lot of weight. 

Another example came from Edwin Choon, CEO of Hony Capital-backed department store operator Century Ginwa Retail, who was talking about the differences between minority and majority stake deals (a hot topic at the Forum). A Chinese founder will often find the idea of a buyout counterintuitive, he suggested – precisely because he thinks more in terms of the relationship than the possible financial rewards. “It’s like you want to marry a girl, but you also want to divorce her in five years on exit.”

The role of shareholders, customers, suppliers and distributors is also a sensitive area, Choon added. The relationships with these parties are key to the company’s health, and the GP should include them in the process. “Private equity involvement is not only financial but also must have a human side.”

Speaking to PEI after the session ended, Wang from LaiYiFen said GPs need to carefully manage the dynamic between them, the founder and the management team. “Private equity has to take the lead to make sure these relationships are balanced, make the three parties feel they’re on same boat. The reason why a lot of international private equity firms don’t get good deals in China is because many don’t understand the founder or senior management team of a company.”

Dongchen Cai, chairman of China Shijiazhuang Pharmaceutical Group (CSPC), was particularly excited to tell the story of Hony’s involvement in his company’s transformation from a loss-making unit of a state-owned enterprise to one of China’s top three pharmaceutical companies.

Between 2007 and 2011, Hony helped CSPC grow revenues 19 percent annually and add thousands of employees, eventually facilitating a listing in Hong Kong. The company is now considering expanding outside of China (Hony won a PEI Operational Excellence Award last year for its value creation work with CSPC). 

The CSPC story was driven by Hony’s understanding of what made the people in the business tick: Hony incentivised the management team to carry out the transformation by giving them 20 percent equity. 

“Hony changed not only the fate of the company, but my personal fate,” Cai said on stage – a pithy way of emphasising the Chinese balance between the financial and the personal. GPs in China should take note.