Liu Chuanzhi has been a pioneer in China's technology industry for nearly a quarter century. In 1984, with funding of $25,000 from the government-backed Chinese Academy of Sciences, he led 10 colleagues from China's Institute of Computing Technology in forming New Technology Developer Inc. That company became Legend Holdings, which in turn spawned Lenovo Group, now one of the world's top personal-computer companies and perhaps China's most prominent international brand.

Today, the 63-year-old is president of Legend Holdings Ltd., Lenovo's controlling shareholder, and chairman of several other Legend subsidiaries, including its private-equity arm Hony Capital. Founded in 2003, Hony is one of China's first domestic buyout firms, focused on privatizing and restructuring state-owned enterprises. Mr. Liu recently was interviewed by Yu Ning and Song Yanhua, reporters for Caijing Magazine, a business and finance publication based in Beijing.

Caijing: In recent years, private equity has been developing quickly in China. However, the environment for mergers and acquisitions in China is far from ideal -- there exist many hurdles. In addition, people in China still have a rather vague understanding of how private equity works. How do you view private equity's future in China?

Liu Chuanzhi: In my view, China's market environment has some special traits that make it very suited to the development of private equity, compared to the international market.

First, China's traditional industries all have huge room for growth, so the returns on private equity can be even higher than those on venture capital. In other countries, there are limits to the growth of traditional industries, which means higher risk for venture capital. But Chinese traditional industries like construction materials, textiles, or food and beverages have limited risk and very fast growth, so they are very suited to private-equity investment.

Second, because private enterprises in China lack resources, private equity can act like irrigation. So often private-equity investment causes qualitative change as soon as it enters.

Third, private equity provides a good tool for China to use in reforms to state-enterprise ownership and management-incentive systems. In cases of state-owned-enterprise privatization, especially those involving management buyouts, state asset loss is always a concern. However, private equity can value enterprises and management at market prices, allowing state enterprises to reform in a more acceptable fashion.

Under such circumstances, the rapid development of private equity here is very natural.

Caijing: Insiders doubt that private equity can really bring change to companies. Unlike industrial investors, private-equity investors aren't experts in industries, but financial investors with relatively short-term

goals to make profit.

Mr. Liu: Private-equity firms can help firms in multiple ways beyond just providing capital. As I mentioned, private equity can aid state-enterprise reform. Management incentives brought by state-enterprise restructuring can then motivate the company to perform better. Private-equity firms also provide experience for enterprises in setting strategic goals, since private-equity firms have many industry experts who understand corporate management. Even more, private-equity firms can aid merger-and-acquisition strategy and implementation.

For example, before China Glass acquired Blue Star Glass, conflicts were expected to surface because that usually happens when two big companies merge. In my experience, you make the leaders of the two companies friends first. After a year, the once-tough decisions of who should be chairman and who should be CEO will be settled smoothly. This is experience we gained from a long period of seeking, and it can save companies from making many detours.

Caijing: The hardest thing for M&A in China is integrating various different interests. Investors, management and various levels of government usually have contradictory interests, plus there are competitors who try to undermine each other. Usually the buyout ends in chaos. How does Hony Capital tackle this issue?

Mr. Liu: From Legend's own experience, starting from 1984, when the macro environment wasn't good for us, we tried to focus on the micro environment -- advantages and strengths within the company -- and steel ourselves for when the environment turned good, so we could step out and act. This is also how we do investment now.

When it comes to local governments, the main thing we look at is the government's key concern. Do they care about local development and tax revenue, or are they focused on their administrative power over the economy? If it's the latter, and the government is hard to push, we'll withdraw. Likewise, if the decision-making process is too complicated, such as when no one can make a final decision but everyone can veto one, or if we have competitors apparently favored by the local government, then we will think twice. As soon as it doesn't work out, we'll withdraw. Getting out at the right time is also an important ability.

Management is another key issue. First, we let them know we're in the trench with them, that we won't kick them out. Any company that needs to change its management, we just won't touch. We spend years training a promising manager, so how would we find so many managers qualified enough to take over? Management changes do happen, but only when we are forced to do so. Generally speaking, management changes lead to failure more often than to success.

Another issue is layoffs. We think ahead of time about whether the conditions are right to properly take care of workers who are going to be laid off. For example, we always suggest that the government retain some stake even after we invest, and that the government use its dividends from its stake to ensure those workers are taken care of.

These various aspects are all very subtle. Who you look for first, who you look for last, who plays a key role inside. You have to research all of this carefully before you make your move, if you want to achieve a satisfactory result. It's like jade: You don't want to destroy it when you're cutting it.

Caijing: When there isn't much competition, private-equity funds have freedom over whether to invest or not. But now there is more competition, and many private-equity firms select investments to gain government relationships and support. What is Hony's competitive edge?

Mr. Liu: First of all, we need to protect our brand. This is vital to winning deals. Second, we prefer to invest in areas that are more transparent and under better regulation. Third, we are able to use our understanding of China. Thanks to our past successful investments, we know which are knotty issues that can't be untangled and which issues we can solve if we have patience. Facing many competitors means we have to see whether our company has the capability and skill to stay on top. We also need to see how many issues need to be solved in the companies we may invest in. If they can't be solved, we won't touch them. Otherwise, we would not be living up to our reputation.

Caijing: Besides foreign-registered private-equity firms, we're seeing the development of similar homegrown funds. For instance, the industrial-investment fund that has been approved by the government, and securities firms and insurance firms are also stepping into this area. Compared with them, where is the future for private-equity firms such as Hony?

Mr. Liu: For private-equity investment, there are four stages: fund raising, project selection, assistance and exit. Of those, the core stages are selecting projects and providing assistance. To get a deep understanding of a company's management and its industry, private-equity firms with industrial backgrounds have some advantages.

For example, venture capitalists are bold about investing in start-ups as long as their managers are familiar with the operation and management of a certain industry, since venture capitalists can withdraw quickly. However, private-equity firms have higher requirements. The managers of the invested companies must not only have to understand operation and management, but they also need to understand strategy and have the capability to build corporate culture. Will the CEO respect the whole management team? Is management generous enough when dividing the benefits?

Hony offers much aid for the invested companies. We arrange a "CEO Club" once a year, and we not only help them to finish work, but give specific guidance and training. That needs teamwork, which is hard to achieve for foreign funds because they stress individual efficiency. Hony has an even larger vision for the future; that is why it values synergy among invested companies and their senior managements.

Hony's early projects were independent from one another, but gradually these investments will converge in industrial areas, such as pharmaceutical and construction materials, in which Hony can hold a leading position in the future.