The key to persuading a Chinese entrepreneur to give up control of a company is not to approach him as a private equity firm, but as someone who knows how to run the business, says Derek Sulger, a partner at mid-market consumer buyout firm Lunar Capital.
“We can do that because the types of companies we are acquiring tend to be in quite similar sectors,” he explains. “If we own a babywear business we can have our babywear operating professionals approach kidswear businesses or maybe even womenswear businesses, or even sportswear businesses. They are all run in a similar fashion, they have similar partners and they have similar business models.”
Company founders are increasingly open to such change-of-control discussions because they are ageing and face a succession challenge. Even if there are family members who could take over the business, these people may not be willing or able to do so. Private equity therefore becomes a viable alternative. A greater focus on quality of life is also making founders consider their options.
“Many of them have worked extremely hard for 60-65 years and they are looking for a way to put their business in good hands and continue to enjoy some legacy involvement, maybe by being a minority shareholder, but having the flexibility to go off and maybe finally start to enjoy life,” Sulger says.
Through this transition in ownership, Lunar can bring its operational resources to bear. The companies it targets are often reasonably well-established but as founder-led businesses they lack professionalized management. While Sulger notes that having the ability to change management is essential to ensuring operational improvements are made, there is an emphasis on retention. This is not necessarily as challenging as it might seem when working with long-term employees who are loyal to the founder.
“What we've found is that once we have taken over a business and begun that process of transitioning and professionalizing, employee satisfaction has actually risen quite dramatically,” Sulger says. “It is very rare that we end up with situations where we feel employees are left conflicted between the past and the future.”
Control also puts a private equity firm in charge of its own destiny. Citing Lunar's babywear business as an example, Sulger says that the company has multiple options in terms of an IPO or trade sale exit, with plenty of inbound inquiries from strategic players and other GPs. Moreover, Lunar has already made distributions from the investment to LPs.
“The number one challenge for Chinese private equity is cash-on-cash returns. It's an open secret there is tremendous disappointment overall with Chinese private equity when it comes to distributions. I think the way we address that challenge is through having control,” Sulger adds.”