Battles averted?

Tensions came to a head in May 2012 when Changjiang Wu, the CEO and chairman of the Hong Kong-listed lighting company, resigned.

Investors had accused him of making related-party transactions and presiding over a culture of weak corporate governance. The chairman's allies claimed that his departure was part of a plan formed by international investors, led by SAIF Partners, to take control of the board.

Wu was replaced as chairman by Andrew Yan, SAIF's managing partner, and shortly afterwards a war of words between the two found its way onto SinaWeibo. NVC's workers demanded the reinstatement of their leader, suppliers refused to business with the company, and there were executive-level departures.

Profit warnings ensured due to the disruption and, deedless to say, NVC stock took a hit.

By September, a compromise appeared to have been thrashed out, with Wu appointed head of a temporary operations committee tasked with day-to-day management of NVC. He returned to the role of CEO in January 2013 and Yan resigned as chairman four months later.

"They should have settled it earlier and in a quieter manner," one LP observed to AVCJ when the tensions were at their height.

Conflicts between entrepreneurs and PE investors are not unknown in China's personality-driven economy - corporate governance issues are often cited, but so too is a basic failure to ensure that interests remain aligned.

In 2011, Lan Zhang, founder of restaurant franchise South Beauty, told media that one of the company's biggest mistakes was selling a stake to CDH Investments, which took a minority position alongside China International Capital Corporation in 2008. Expansion plans failed to come to fruition, which may explain the discord.

Last year CVC Capital Partners acquired majority control of South Beauty, facilitating the exit of the existing backers.

If NVC represents the worst case scenario in GP-entrepreneur relations, then the South Beauty buyout arguably reflects where private equity in China is going next, with founders gradually becoming more willing to cede control to third-party investors. In many cases, that step up in scale or product sophistication can only be achieved though a substantial capital investment and the introduction of more management expertise.

Assuming control, at board or shareholder level, doesn't necessarily make investments any easier. As the NVC case illustrates, a deposed chairman can still exert influence over the business (he has deep-rooted supply chain relationships, if nothing else) why a disaffected middle management can be unmanageable.

Many China private equity investors take every opportunity to stress their value creation credentials but bring about meaningful change the incumbent staff must buy into the value proposition. In this context, choosing the right executives to bring in is crucial.

As one GP put it to AVCJ recently, the transition is the most difficult part. "Once you bring in people they must have new ideas and systems and you have to blend the existing and the new," he said. "The risk of bringing in professional management is they require hands-on experience of executing strategy in private companies and the people below them are not MIT and Yale graduates."

The second stage of the transition involves understanding how to incentivize these people. If the founder retains a minority stake in the business, what role - if any - can be accommodated for him in day-to-day management in order to ease the handover of power? As for the middle management, do they want equity in the business or are they looking for something else?

Establishing key performance indicators is part of every business plan but it must be complemented by more empirical man management. This includes establishing clear guidelines for all stakeholders as to what is required of them.

An effective investment professional doesn't have to dirty his hands with boardroom or shop floor arguments; wherever possible, he anticipates them before they happen.

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• Topics
• Buyouts
• Greater China
• Expansion
• Operating partners
• buyout
• China
• Growth capital