Inside the GP: A question of reputation

Private equity firms in Asia increasingly look to gather comprehensive intelligence on any individual connected with a potential deal.

In Asia, private equity firms carry out some degree of reputational due diligence on individuals for every transaction, sources say. The region’s relatively high levels of corruption, weaker legal enforcement systems, lack of transparency and propensity for minority stake deals tend to make investors particularly cautious about entering into business relationships.

“The reputation of the individual is a critical issue in Asia private equity; in fact it is probably number one,” says one industry source at a global private equity firm that operates in the region. “The reason, in part, is [that] with a minority investment, for years you’re really dependent on the person who is running the show.”

Typically, a reputational check involves investigating a founder or entrepreneur to provide the deal team with a picture of the person they’re going to partner with.

Firms primarily want to be assured that the person has no criminal record, is competent, has been using adequate governance practices and has no undisclosed relationships. In other words: it’s all about integrity.

“Basically, we’re looking for somebody who does what he says,” adds William Hsu, head of compliance for CDH Investments. “From day one, we have to be comfortable with the entrepreneur.”

Who calls the shots?

The investment team will also want to know if the entrepreneur is the key decision-maker in the business, an issue that could potentially destroy the alignment of interest between founder and investor. For instance: in a family-owned business, the wife may be the one influencing or even making the decisions the husband appears to make (or vice versa). That’s important to know, particularly if the minority investor aims to influence strategic direction and eventually exit through a specific route.

Ben Wootliff, director of Control Risks, a risk consultancy, recalls a deal that involved a private equity client targeting a large Asian retail group. Control Risks identified the owner’s mistress (who was actually the secretary) as someone who controlled significant positions in corporate entities. “She appeared to be just an employee, but obviously her relationship and her importance in any transaction was significant,” says Wootliff.

Senior hires for a portfolio company or for the private equity firm itself also prompt reputational due diligence. This process requires not only a search for obvious red flags, but also some more nuanced intelligence-gathering.
Private equity in Asia has a greater dispersion between success and failure than in Europe, for example, where fantastic successes and horrible flame-outs are rarer, Wootliff says. That can flatter the role of an individual who has worked on a particularly good deal.

“Clients ask if the person has done brilliant work or if he was just in the right place at the right time. Did he have connections or a particular ability that was matched to a transformative deal?”

Another hiring pitfall in Asia is that people sometimes claim to have worked on deals in which they were never involved. “In China, it’s not unusual to find people who have substantially exaggerated their achievements, [or] sometimes entirely invented them,” adds Jason Wright, associate managing director at risk advisory firm Kroll.

A reputational check for any hire may also include interpersonal strengths and weaknesses, he adds. “We may look at how people operate in relation to other business partners or their own teams; whether they are they dealmakers, rainmakers or more competent operating within a team. It’s a mix of red flags and a more subtle form of profiling.”
Methods and practices 

Ten years ago, a pre-deal background check on a founder in China meant verification that the person had not been in jail or involved in bankruptcy proceedings. “It was a very straightforward, superficial and factually-driven process,” says Kelvin Yu, managing director and head of China at Partners Group.

Today, there are far more qualitative factors involved. Reputational checks go much wider, encompassing suppliers, customers, government and competitors – anyone who might contribute to a judgment of the person’s integrity.

“Even if he never officially committed a crime before, some people may still defraud investors or an individual could just be generally a very unpleasant person to work with,” Yu says. “As part of a more qualitative assessment, judgment calls made by a sufficiently local team become more critical. Very nuanced knowledge is important to have.”

To bring out those nuances, one GP told Private Equity International that his firm had embedded a reputation evaluator into the due diligence team. “After we signed the term sheet, we brought along our audit groups and the background evaluator as part of this team. The information he received from other members of the team helped put the individual in a broader context.”

Seeing the individual in relation to his business is crucial, adds the source. “Integrity will be reflected throughout the organisation: the quality of the numbers, how he treats his employees, [and] suppliers; how he deals with government officials.”

To vet an individual, firms tend to rely heavily on checks through their own extensive networks, which provide a natural filter since most business owners in a market are either known or only one step removed. 

These networks become particularly useful when the firm has consistently invested in specific industries, building up long relationships and deep sector knowledge over a series of funds, says Yong Kai Wong, head of legal & compliance at CITIC Capital, which largely does reputational due diligence in house. “The extensive CITIC network gives us a good sense if this person is someone we can deal with.”

CDH also does most reputational checks using its own connections in China to collect information from the entrepreneur’s colleagues, associates and others in the specific industry, Hsu says.

“A lot of people are linked to the person,” he says (this is particularly true since CDH tends to target large companies). “The suppliers and customers know about the individual and that includes people in the past who [have] had experience dealing with him.”

Of course, the information can also be wrong, Hsu admits. “You never know when people you speak with are not being up front with you. They may have a grudge against the person or they could be connected to a competitor. In the end, it’s definitely a judgment call. If we find anything we’re not comfortable with, we won’t do the deal.”


Information on individuals that turn into a deal-breaker would include indications of criminal involvement, misrepresentation or massive corporate governance failings, Wootliff says. He estimates that 5 to 10 percent of all the due diligence cases his firm does ultimately result in a deal-breaker.

Uncovering multiple business interests could also set the deal on shaky ground, according to PEI’s source; for example, if the owner is involved in areas outside the core business such as real estate or has stakes in unrelated companies (particularly if these are undisclosed). “In a tough environment, which business will he care more about?”

Less obvious reasons can also kill a transaction. Rather than any one piece of information, minor but repeated inconsistencies may emerge between what the entrepreneur says and what is found during due diligence, the source adds.

“You might have 40 people in the field – the deal team, accountants, lawyers, advisors – all going through the diligence process. Everyone is trying to uncover information and look for consistency. It’s an iterative process and certain aspects may become clear only as you get deeper into due diligence.”

If a firm uses a risk advisory outfit, the investigators will go through a variety of public and private sources and either present their findings to the compliance department, or, more often, engage directly with the deal teams. 

Wootliff argues that this can create a potential for conflicts of interest within some private equity firms, in that the investment team may have a bias toward a positive result of a reputational check. This could make them less risk-averse than a legal counsel, whose key role is to minimise the possibility of liabilities.

PEI’s source, however, argues that the reverse is often true – that the deal team has a stronger interest in filtering out risky individuals. “Not only will the deal team be responsible for working with the entrepreneur day in and day out for years; but an error on an investment stays with you for life. To some degree that’s reflected in the deal team’s risk threshold, which can be higher than legal.”

Kroll’s Wright believes that this sort of risky dynamic between departments is more prevalent within investment banks; in private equity, he argues, interests are more aligned. “Perhaps there is more incentive on the general counsel’s side [to find risk], but there is not such a misalignment as you think.”

Nonetheless, the ability to evaluate specific risks is always going to be be subjective. A risk advisory firm could present a report on an individual riddled with what they perceive to be red flags, but in the end the firm’s country knowledge and contacts may result in it taking a more practical view.

As Wright puts it: “These are commercial decisions, not [just] a question of compliance with various sets of legislation.”

Family values

In Asia, family and friends are often part of the ecosystem.

Asian societies tend to be more relationship-based than rule-based. That’s not necessarily a bad thing – but for compliance departments, the nature of these relationships needs to be disclosed and understood.

A typical situation involves having family and friends as business partners. Potential conflicts can arise when an entrepreneur’s relatives are running businesses that supply his company, for example.

“Family relationships through the supply chain can be a risk, because you never know if the numbers in company books are true or have been influenced by those relationships,” says William Hsu, head of compliance for CDH Investments. “We would tend to look at the numbers with suspicion.”

For private equity firms, disclosure is the key.

“If the founder was open about related-party transactions, the investor will look [to see] if there is any chance of disputes arising from the relationships,” says Kelvin Yu, Partners Group’s head of China.

“The main questions we would ask are: what is the nature of relationships; what were they used for; what is the company trying to accomplish; has the founder been up-front in sharing the information?”

Of course, a family business that has been growing fast may have by necessity used suppliers and distributors run by relatives – and that may be well-accepted within the culture. “Sometimes it’s a matter of perception,” says Ben Wootliff, director at Control Risks. “Relationships aren’t seen by all parties as an issue.”

Other commercial risks stemming from business relationships with friends and family include GPs soliciting kick-backs from friends in the investee companies and suppliers sending inflated invoices signed off by the manager who is controlling purchases, according to advisory sources.