Editor’s Note: In April 2020, Singapore instituted a “circuit-breaker” to reduce the contagion of a global pandemic wreaking havoc on humanity’s health and livelihood. While our magnificent city-state stares down this scourge, the following is an attempt to provide insight while the world endures global quarantines in this century’s ultimate victory for humankind.
Asian Private Equity – A Powerful Type of ESG
Private Equity, oftentimes synonymous with the American lexicon of Leveraged Buyouts, offers Investors several investment strategies that it deploys on their behalf.
Specifically, in the Asian context, Private Equity usually refers to growth capital (or growth equity). This genre of private equity fosters all sorts of great outcomes for the continent, and specifically within the South East Asian and ASEAN regions. These outcomes are a powerful type of ESG in their own right.
Finally the natural tension between professional capital and unconstrained growth leads to an alignment stronger than the basic framework supported by ESG.
In Volume VIII, we discuss how ingenuity and innovation declines as a result of the export of manufacturing replaced by financial arbitrage, most notably in the example of America, due to its entry in the World Trade Organization (“WTO“). Yet Growth Capital, discussed in this volume, is precisely what is needed to kick start innovation and is the reason why Asia continues to have an enduring and sustainable outlook despite the Great Pandemic of 2020.
ESG: Environmental, Social, Governance
Before we get into Asian Private Equity and its principal investment strategy of Growth Capital, first we contextualize ESG. The basic tenets of ESG foster an appreciation of:
- the environment,
- positive relationships (social) from the standpoint of business, social, and governmental, and
- good business governance.
The world’s collective scientific evidence suggests that the Earth is currently in a period of natural warming which occurs every 50,000 years, followed by a period of natural cooling for the next 50,000 years, only to be repeated all over again in an 100,000-year Ice Age cycle.
Nevertheless scientific measurements are correctly capturing that the planet is currently in the warming phase, and hypothesize that this warmth has been recently accelerated by human activity.
As a result, the Environmental aspect of ESG is concerned with reducing and leaving a limited amount of waste as a byproduct of business production, which collectively leaves the world and its environment better for future generations.
The Environmental consciousness is primarily focused on leaving the world better than we found it for future generations.
This has to do with how a business focuses on its stakeholders and promotes a long-term view towards the company’s continuing endurance. Working with scrupulous suppliers and agents, protecting the interests of employees, serving customers well, are all hallmarks of this.
Ultimately, the intent is to create a favorable ecosystem both inside the company as well as outside.
Governance has to do with how a company is run. Business controls that mitigate risk and fraud, provide clear reporting to investors, and that are well-run are the requirements here.
Governance fosters professionalization to the benefit of all stakeholders, and most notably, business owners, so that the business can grow rapidly and efficiently.
A more detailed description is provided on Investopedia.
Growth Capital is an investment strategy within Private Equity that is oftentimes deployed in Asia and seeks to invest capital to make a return from the financial performance of the portfolio company. Growth Capital is a form of Primary Capital which is directly invested into the portfolio company. This form of capital enables the company to hire employees, build factories, acquire new technologies or assets / resources, enter new markets, or do a combination of all of these activities.
Primary Capital is the most beneficial form of capital because $1 of capital invested can have significant network effects creating $3 of value directly plus another $7 indirectly.
That’s a total of $10 dollars for each dollar invested!!
The fundamental point about Growth Capital is that it represents professional capital invested into a company unlike other forms of invested capital.
Asian Growth Capital – The Environmental Angle
One (Hu)Man’s Trash is a Another (Hu)Man’s Treasure
This age-old English proverb represents the truth of business practice.
An efficiently run company should seek to exploit all areas of its production cycle. While discharge and effluent (“trash“) may not be usable for the company’s internal production, it certainly oftentimes has value to an external party, particularly as all sorts of matter, chemicals, vapors, and byproducts have value in an economic marketplace.
And the best part of capturing and re-selling or re-using the proverbial trash as it relates to business output is that none of this has to be done at a loss! Rather, trash recycling can be done either via third party consolidators or as a new business line, if not directly usable to the company itself.
The principal stewards in Private Equity recognize the value in all parts of a business, including discharge and waste. More importantly, they recognize that financial value derives from many aspects of a portfolio company and ancillary revenues. Specifically with respect to waste, the principal stewards understand that waste can be transformed and recycled into cash within the company to boost future growth prospects which creates a more enduring business in the long-run.
As long-term investors, Private Equity and its principal stewards seek to ensure the durability of the businesses they invest and partner with, to generate value for their Investors.
Asian Growth Capital – The Social Angle
As the principal stewards in Private Equity provide professional capital to a portfolio company, they want to see that the company continues to focus on the big long-term picture. Because these investors do not invest for the short-term, their companies should also not be geared for the short-term.
By focusing on the long-term outlook, Private Equity also requires their companies to focus on the long-term opportunity as well, including for all parts of the company. This naturally includes themselves (the investors) as well as owners, employees, customers, suppliers, consumers, and the government.
Forgetting about any one stakeholder could lead to a loss of long-term value.
For example, not working to promote customers’ productivity could mean that the products are not useful and therefore become commoditized.
By focusing the portfolio company’s energies on the larger outlook and the enduring business opportunity, they ensure that the company will become incredibly valuable and drive returns for the principal stewards and all alike. It’s a positive symbiotic relationship and one that Asia-focused investors value.
Asian Growth Capital – Governance
Probably the most pressing need of principal stewards that their professional capital brings is the focus on strong corporate governance. Because the principal stewards are actively invested in the company for the long-term, they want to see their capital used efficiently and with maximum productivity towards the long-term goals of the business.
As a requirement, if a portfolio company does not have strong governance standards, the investors will institute them as a means of increasing efficiency and safeguarding their investment.
Governance entails adding measures that reduce risk and thereby add value to the company.
A principal steward would be remiss to not value the benefit of strong governance within a portfolio investment. This is moreso in regimes and nations which have developing institutional systems and business practices that while becoming stronger, do not adequately protect against poor controls.
Aligning the Natural Tension between Asia-focused Growth Capital & ESG
The focus of private equity is to create returns for investors. In Growth Capital-focused strategies, it does so by investing directly into the productivity of the investee business. But this focus on value necessarily means that professional capital balances the needs of business with the requirements of its Investors. However, try as it might, no private equity firm can guarantee an investment or business outcome.
Rather, the principal stewards follow a rubric, including best practices, that have been shown to directly generate value at the investee company and indirectly enhance investment performance.
The most fundamental of these within the context of Growth Capital is to increase the value of the investee business so that it will consequently increase the financial returns on the principal capital invested.
Growth Capital in Asia – Beyond ESG
As we discussed in Volume VI, the Emerging Markets and Asia primarily operate on Primary Capital-based investments and specifically with Growth Capital. As a result, oftentimes overlooked is that Growth Capital in Asia is synonymous with the basic tenets of ESG, because without this focus, the investment would carry unnecessary risk much to the detriment of Investors.
But fundamentally important is what Asia-focused Growth Capital represents. It represents capital that ultimately: creates jobs, builds factories, develops resources for local communities, and ultimately adds to the generation and vibrancy of local ecosystems.
The network externalities of Asia-focused Growth Capital ultimately leads to self-sustaining businesses that generate employment, tax revenues, and create all sorts of positive opportunities for other businesses and stakeholders within the community.
Rather than being a vacuous attempt to appease far-away investors, Asia-focused Growth Capital promotes outcomes far better than simply ESG, as it supports the creation and enhancement of ecosystems already enjoyed in the Developed World.
This is an important concept because oftentimes, ESG is promoted as a feel-good mechanism that has its adherents following reports of compliance with arbitrary rules but does not necessarily create the same real enduring impact on the local ecosystem where the investee business is located.
Mort importantly, however, is that Asia and Emerging Market focused Growth Capital provides all of the following:
- employment both directly and indirectly,
- opportunities for various stake holders throughout capital formation,
- development capital in the form of physical and self-sustaining projects,
- value to customers and consumers alike,
ultimately creating growth for the ecosystem and local society. This growth is more powerful for future generations, where the wealth generated by all parties enables education, growth, and and a new round of opportunities for all, and helps the citizens of these societies attain the same levels of sophistication as Developed Markets.
Volume X: Vietnam – Emerging Asia’s Exciting Frontier
In Volume X, we start to delve into the first of several economies that make up Emerging Asia.
The first examines the opportunity afforded to Primary Capital and Private Equity in Vietnam due to the nation’s strong demographic, economic, macroeconomic, and geopolitical factors.
Note: the above reflects compiled work and neither represents the views nor perspective of any entity. In addition, all views are subject to change based on the changing economic landscape and additional inputs. Finally, this does not represent any solicitation to act in any market. Should you wish to take an action in any arranged or un-arranged market, consult your adviser.
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