It’s no secret that private equity firms are drawn to high-growth companies. However, doing this in China can involve walking into an organizational nightmare. Operational inefficiency does spell opportunity for investors but there is a lot of clearing up to do first.
“As a general rule, the finances are not reliable,” said Stephen Scott, managing director with Alvarez & Marsal (A&M) Asia, a group that specializes in improving underperforming assets acquired by private equity firms. “It’s not always the case that there has been rampant fraud. Rather, the business has grown faster than the infrastructure supporting it.”
The likes of A&M are routinely called in to make sense of the accounts. This may be prior to the investment being made or as some kind of post-acquisition interim management team.
“First of all, we make sure that we have reliable financial data,” said Stewart Winspear, a senior director at A&M and previously CFO of IBM Asia Pacific. “Then it is a matter of establishing a system to manage the information and provide visibility to the investors through key performance indicators.”
This involves scrutinizing a wide range of functions within an organization from IT infrastructure to human resources management. In the latter category, Winspear finds there are often aspects that can be improved.
“Compensation and benefits are sometimes not aligned with corporate objectives. Incentive structures need to be tied to key performance metrics.”
As part of pre-investment research, background checks on the target company’s management team are typically required. In China, this includes a risk assessment based on senior figures’ political connections, Scott said.
Chris Gradel, managing partner and co-founder of Pacific Alliance Group, believes these background checks are vital. “It may be a good business but a bit messy with too many third-party transactions,” he said. “When the management has multiple businesses and is not focused on what it is supposed to be doing, that’s when we lose interest.”