Article

How PE firms can stand out from the crowd

Private equity success in China rests on a clear investment thesis, industry expertise and spending quality time with quality companies.

By Weiwen Han

Published on November 18, 2011
min read


Private equity firms scouting for opportunities in China are flush with money but they’re less successful in finding—and winning—compelling deals. In such a highly fragmented market where PE buyers usually end up with minority stakes, increasingly sophisticated Chinese business owners expect more from their investors. Entrepreneurs are no longer strangers to the capital markets and over the past decade have gained a better understanding of the investor community. Private equity firms must respond to this by positioning themselves so that they can access companies in which their distinctive capabilities can be brought to bear. The challenge is to convince both the management of potential targets and their own limited partners that they possess skills that set them apart from other PE firms. What should PE firms do to stand out from the crowd and ensure that they’re able to spot the most attractive opportunities? Based on our experience advising PE firms throughout the world, five criteria set the leaders apart. Take a more focused investment approach. Leading PE firms become experts at screening target industries in order to identify the most attractive deals ahead of competitors. Instead of waiting for deals, they reach out for them, drawing up lists of main industry players and deciding which to follow closely. This “top down” approach needs to be complemented by building up skills within the firm that allow it to take full advantage of priority deals. Develop a proprietary investment thesis. Successful PE firms have a clear articulation of their preferred approach to investing, whether it is looking for challenging turnaround situations or buying strong companies with strong managements in search of a breakthrough. They put a well-honed investment premise to the test. A prime example is Headland Capital Partners’ investment in Fujian-based Yonghui Superstores, a small but expanding chain. Many firms considered the deal but only Headland, formerly HSBC Private Equity Asia, made the move. It used the due diligence process to validate its belief that Yonghui presented a good fit with Headland’s investment strategy that targets China’s growing consumer class. Due diligence focused on answering two critical questions: Could Yonghui maintain its foothold in Fujian while expanding into new markets, and did it have strong growth potential? In addition to reviewing the company’s fundamentals, a consumer survey conducted by Headland helped confirm the chain’s solid market position as well as revealing impressive loyalty among shoppers, inspiring confidence in Yonghui’s future. Headland’s investment in due diligence paid off: In the space of four years, Yonghui’s revenue and profit increased five-fold and 11-fold, respectively. Build sector or industry expertise. In a world of generalists, earning a reputation as a specialist increases the odds of not only landing top deals but also delivering on the investment’s promise. To hone their expertise, firms invest in experienced management teams with deep knowledge of priority industries, foster a close relationship with the government and ensure that they have the required up and downstream resources. Sector specialization enables PE firms to mobilize proprietary insights about sector trends and tap networks of industry insiders to give them an edge in sourcing and screening good deals and winning the best ones. Following an acquisition, it helps PE firms quickly set the right strategic direction to improve performance and build value, recruit seasoned professionals and challenge management to hit operational targets. Cultivate relationships with entrepreneurs at potential target companies. Leading firms also make a mid to long-term investment in building and maintaining a network of premier entrepreneurs across industries. The management teams of some PE firms now spend much of their time in tier two and tier three cities, using their connections to look for and approach potential targets. This is a more time-intensive approach, but by establishing mutual trust with target companies before competitors even notice them, these investors are one step ahead of the pack. They are also positioned to win again if a portfolio company needs future funding. Post-investment, Headland provided Yonghui with valuable services, including assistance with strategic planning, operations and human resources. Recruit industry specialists to support value creation in portfolio companies. Bain & Company research shows that the earlier private equity firms provide subsequent management support, the higher their return. But since the majority of PE deals in China involve minority stakes, firms often have no management authority and limited influence, putting the deal’s success at risk. To serve as a bridge, leading firms may bring in industry specialists who have management’s trust and work to ensure that crucial value creation plans are successfully deployed. At the same time, investors need to demonstrate their own commitment to the portfolio company by devoting the necessary time and providing the things the company lacks, including wisdom based on years of accumulated experience. Weiwen Han is a Bain & Company partner based in Shanghai.

Private equity firms scouting for opportunities in China are flush with money but they’re less successful in finding—and winning—compelling deals. In such a highly fragmented market where PE buyers usually end up with minority stakes, increasingly sophisticated Chinese business owners expect more from their investors. Entrepreneurs are no longer strangers to the capital markets and over the past decade have gained a better understanding of the investor community.

Private equity firms must respond to this by positioning themselves so that they can access companies in which their distinctive capabilities can be brought to bear. The challenge is to convince both the management of potential targets and their own limited partners that they possess skills that set them apart from other PE firms.

What should PE firms do to stand out from the crowd and ensure that they’re able to spot the most attractive opportunities? Based on our experience advising PE firms throughout the world, five criteria set the leaders apart.

Take a more focused investment approach. Leading PE firms become experts at screening target industries in order to identify the most attractive deals ahead of competitors. Instead of waiting for deals, they reach out for them, drawing up lists of main industry players and deciding which to follow closely. This “top down” approach needs to be complemented by building up skills within the firm that allow it to take full advantage of priority deals.

Develop a proprietary investment thesis. Successful PE firms have a clear articulation of their preferred approach to investing, whether it is looking for challenging turnaround situations or buying strong companies with strong managements in search of a breakthrough. They put a well-honed investment premise to the test.

A prime example is Headland Capital Partners’ investment in Fujian-based Yonghui Superstores, a small but expanding chain. Many firms considered the deal but only Headland, formerly HSBC Private Equity Asia, made the move. It used the due diligence process to validate its belief that Yonghui presented a good fit with Headland’s investment strategy that targets China’s growing consumer class. Due diligence focused on answering two critical questions: Could Yonghui maintain its foothold in Fujian while expanding into new markets, and did it have strong growth potential? In addition to reviewing the company’s fundamentals, a consumer survey conducted by Headland helped confirm the chain’s solid market position as well as revealing impressive loyalty among shoppers, inspiring confidence in Yonghui’s future. Headland’s investment in due diligence paid off: In the space of four years, Yonghui’s revenue and profit increased five-fold and 11-fold, respectively.

Build sector or industry expertise. In a world of generalists, earning a reputation as a specialist increases the odds of not only landing top deals but also delivering on the investment’s promise. To hone their expertise, firms invest in experienced management teams with deep knowledge of priority industries, foster a close relationship with the government and ensure that they have the required up and downstream resources. Sector specialization enables PE firms to mobilize proprietary insights about sector trends and tap networks of industry insiders to give them an edge in sourcing and screening good deals and winning the best ones.

Following an acquisition, it helps PE firms quickly set the right strategic direction to improve performance and build value, recruit seasoned professionals and challenge management to hit operational targets.

Cultivate relationships with entrepreneurs at potential target companies. Leading firms also make a mid to long-term investment in building and maintaining a network of premier entrepreneurs across industries. The management teams of some PE firms now spend much of their time in tier two and tier three cities, using their connections to look for and approach potential targets. This is a more time-intensive approach, but by establishing mutual trust with target companies before competitors even notice them, these investors are one step ahead of the pack. They are also positioned to win again if a portfolio company needs future funding. Post-investment, Headland provided Yonghui with valuable services, including assistance with strategic planning, operations and human resources.

Recruit industry specialists to support value creation in portfolio companies. Bain & Company research shows that the earlier private equity firms provide subsequent management support, the higher their return. But since the majority of PE deals in China involve minority stakes, firms often have no management authority and limited influence, putting the deal’s success at risk. To serve as a bridge, leading firms may bring in industry specialists who have management’s trust and work to ensure that crucial value creation plans are successfully deployed.

At the same time, investors need to demonstrate their own commitment to the portfolio company by devoting the necessary time and providing the things the company lacks, including wisdom based on years of accumulated experience.

Weiwen Han is a Bain & Company partner based in Shanghai.