Playing Asia's PE field

PRIVATE EQUITY IS A PEOPLE BUSINESS as industry practitioners like to say. And in Asia there is a perception that it is more important so than elsewhere. A combination of local bias towards the big-boss presiding-founder corporate mentality, coupled with industry immaturity and a basic structure that favors small high-level teams, has led to a regional industry dominated by a small pool of pioneering individuals – with all the faults and problems that entails. Team instability, continuity, succession, rivalry are all concerns for investors into Asian private equity; but so can the penalties of not having such a person on board. As Asia Pacific private equity moves to surpass Europe and rival North America on some benchmarks, especially total funds raised, it is worth considering whether it carries this legacy and what the consequences are.
A stable situation?

Judging from the headlines, Asia Pacific private equity might indeed face a team stability challenge. Significant senior departures so far in this year alone include Sean Tong from Providence Equity Partners, to join Mary Ma, who recently left TPG Capital, in her new fund; Liang Meng, former Greater China head and Partner at DE Shaw; Daniel Klebes from Aetos Capital; Forrest Zhong and Michael Li from KPCB China; Rajeev Gupta at Carlyle India; Alok Gupta from Axis Private Equity; and virtually the entire senior bench of Sequoia Capital India, to essentially recreate the WestBridge Capital Partners platform they brought under the Sequoia umbrella in 2006 and reposition themselves for listed-markets investing. (The exit of Rajat Gupta from New Silk Route Partners, amid SEC insider trading allegations dating from his former tenure at Goldman Sachs, is not such an industry-related affair.)

Less dramatic but just as significant are the transition of Philip Bilden at HarbourVest from Managing Director and head of the firm's Hong Kong office to Senior Advisor status, and the retirement of Ashish Dhawan as GP at ChrysCapital, to focus on social issues. As David Pierce, CEO of regional fund of funds Squadron Capital, observes, "there is quite a lot of volatility in the teams in Asia."

At least one leading regional LP sees this as no different from private equity anywhere – during the earlier stages of its evolution. "Everywhere in the world, private equity firms started off with individuals or small groups," he says. "That's not different in Asia. What may be more pronounced here is the contrast with what's occurred in the West, where it's more institutionalized." However, there are some structural factors at play that may both increase the level of team instability and the underlying reliance on key individuals. And LPs are aware of the issue. "As elsewhere in the world, there is materially increased scrutiny of key persons and team stability," notes David Eich, Partner with Kirkland & Ellis.

Sources of stability

One consideration that increases the importance of key men is that, in the words of another LP is that "a lot of the investing is in growth capital, and a lot of that is pre-IPO, where relationships are very important." Structurally, this will give the whole Asia Pacific industry a bias towards influential individuals. Add to that the essential nature of Asia's business environment, where business families still control an outsize portion of the wealth and commercial power in the region, even within listed companies. It is, therefore, no surprise that personal ties and key figures will remain highly important for the foreseeable future in regional private equity's capacity to engage with business here.

Certain smaller, less developed markets, Indonesia being one example, may have even more difficulty with team stability. Places like these, where the ethos and long-term nature of private equity is less well understood, structures may not be in place to prevent even senior team members treating their posts simply as ‘jobs' and taken up or left on a normal employment contract basis. In China, meanwhile, the comparative strength and size of the local private equity environment has not brought with it any commensurate institutionalization and stabilization of team structures – rather the reverse. The new proliferation of RMB funds has added a fresh source of temptation to an environment already biased towards carving out one's own trail after a few years to learn the ropes within an existing team. And other market participants attest to the lack of a first-among-equals ethos that reinforces many Western notions of partnerships; instead, many Asian PE practitioners seem to operate on the assumption that they will either be their own boss or someone else's servant, with no middle way. Unsurprisingly, many opt for the former.

Market entry by the global firms has also triggered team stability problems with some Asian funds. Simply, big name newcomers are prepared to invest large sums for human capital as part of their cost of entry. They have been able to entice significant team members from established local players to join their Asian efforts. Leading local investment bankers or management consultants may be one usual starting point for building a new top-end Asian team from scratch, but there must always be a temptation to cut to the chase and hire away from potential future rivals – or co-investors.  As a LP remarked to AVCJ, "it's a natural thing. If you're an international player and arriving in the region, where are you going to recruit your people?" But for the incumbents, he adds, "every firm has to be worried about the possibility [that your team members join another firm]."

Rainmakers in sunshine

Another well-worn theme in Asian private equity that underlines the significance of individuals is that many firms that have been set up as essentially single-person vehicles headed by leading former dealmakers, in particularly those that work for investment banks or in a corporate development role. International firms entering the region for the first time are also recruiting high-profile rainmakers, such as when the Blackstone Group recruited Antony Leung for its Hong Kong office in 2004 or Bain Capital engaging Jonathan Zhu in 2006, are good examples. In the words of a leading LP, "there are large personalities that make a difference" in the business culture of the region.

Gorldman Sachs has been a launch pad for such spinouts, such as Hopu Investment Management, launched by former Goldman Sachs China partner Fang Fenglei, Mount Kellett Capital Management, created by the aptly-named Mark McGoldrick to apply Goldman-style risk appetite across a range of asset classes, and Fred Hu's China-focused vehicle, Primavera Capital, are just some of the examples of this trend. And in at least a few of the aforementioned examples, the results raise questions about the basic proposition, characterized in the words of another senior industry figure as investing in "door-openers where nothing much comes through the door once it's opened."

LP behavior around such funds can sometimes seem surprisingly forgiving of individual foibles. For instance, Temasek Holdings has continued to back RRJ Capital, launched by Richard Ong after his split with Fang Fenglei, despite a high-profile breakup that market intelligence attributed to personal differences. LPs may have felt that it was better to continue to receive at least some of the proceeds from their alumni's deals, rather than struggle to retain them in the in-house compensation structure. And Temasek is already investing alongside Ong, whose brother, Charles is a senior executive at the sovereign wealth fund, in deals such as FracTec.

Style and succession

Issues of investment style or differing priorities can often be the cause of splits between key figures and their firms. For instance, Ashish Dhawan's recent retirement from private equity coincides, according to market intelligence, with the ChrysCapital's public repositioning towards more mid market approach, as does the departure of the founding Sequoia India team from its franchise vehicle back to Westbridge. These events may be simply honest admissions of the realities of the Indian marketplace, but they definitely suggest a mismatch of understanding above all between GPs from within the region and the expectations of LPs. And at other, larger firms, there may have been a generational shift recently away from the pan-regional buyout themes of the past towards more growth-oriented developing-markets approaches.
Succession and changing of the guard can be closely involved with such shifts in style. But the mismatch of expectation and understanding may be even more important, particularly where a major firm is involved. The key men from the various firms mentioned at the beginning of this article who have spun out to form their own funds may have left to fulfill purely personal and financial ambitions, but they may also have reflected a sober assessment that the Western franchises have not always delivered much value, especially where the investment style or systems of the parent have not really achieved much when transplanted into an Asian context.

Recourse

When the primacy or actions of key individuals becomes an issue in a market, LPs naturally need to know where to turn to exercise their own rights. In private equity partnerships as in public companies, it is a legitimate question whether stakeholders' financial interests should be hostage to the personal ambitions and rivalries of the firm's leaders. And at least in general partnerships, the LPs in theory have a right of recourse and a defensible position through key man clauses and other provisions such as no-fault divorce protocols.
The Institutional Limited Partners Association (ILPA) guidelines on fund terms and conditions recommend automatic suspension of the investment period in the event of a key man event, with a two-thirds majority vote of LPs to reinstate this. The formal terms may seem very robust, but practice can be very different.

"You can have a clause that looks nice on paper and tick a box in your due diligence checklist that there is a key person clause, whereas in fact, if it has wrongly identified the key person or made it difficult to act if the real key person does depart, you don't have that protection," notes Pierce. "Then you enter the no-fault divorce protections, which are even nicer to have but even more difficult to enforce. And given the threshold for supermajorities that required, frankly they're often not practically enforceable." Even a two-thirds majority, he points out, it is hard to achieve.

LPs may not be able to expect a change soon, but they should be able at least to expect tougher and better terms on key man issues. "This has always been the nature of the financial services industry here," says another LP. "Where it differs in private equity is that we are long-term-oriented. We own businesses for a long period of time. It's not simply about conducting a transaction and getting the fee." 

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• Topics
• LPs
• People
• Providence Equity Partners
• TPG Capital
• The Carlyle Group
• KPCB China Management
• Sequoia Capital
• Bain Capital Asia