Defining growth equity in today's private markets landscape.
Growth equity is an asset class that used to be defined by what it wasn’t. Situated between the more established categories of venture capital and traditional private equity, its classification arose from its inability to fit into traditional moulds. Often, growth equity (also known as growth capital or expansion capital) is described as another asset class with a modification, such as “VC with proven technology.” It typically refers to minority investments in mature startups that are looking to scale operations, but can also include control-oriented transactions. In recent years, growth equity has been carving out its own distinct space, increasing in popularity and entry prices, and defining its own unique parameters for success.
Its position between the two asset classes does, correctly, imply elements of their combination. Growth equity boasts attractive aspects of VC funding, such as a high potential upside, but with a lower risk profile, as well as little to no leverage. Holding periods also fall in between the two classes, being shorter than VC investments (5 - 10 years) and longer than traditional PE deals (3 - 5 years). However, this perspective of a blend, or a mix-and-match, ignores the distinctive nature of growth equity. In addition, while growth investors have skewed towards technology sectors, the asset class is more appropriately defined by a company’s stage rather than market segment. There is a specific mindset and skill set when it comes to targeting the right companies, and setting smart strategies for enhanced returns.
Targeting the right candidates
Sourcing candidates for growth equity investments means seeking organisations with proven business models and strong unit economics. Unlike many VC portfolio companies, whose nascent stages require a greater risk appetite and imply a more binary return profile, targets for growth equity investors have already proven and gained sufficient traction on their product, any underlying technology, and their market fit. Growth equity targets commonly have already amassed a sizable customer base, and maintain a customer acquisition cost that is lower than their customer lifetime value.
With a greater wealth of information at their disposal, growth investors can have a higher degree of confidence in the foundational elements of the business. Target companies should also have a history, however limited, of financial records — another factor that differentiates them from many VC-funded companies. These records should signal, if not a current state of profitability, assurance for a positive cash-flow in the near-term. It is worth keeping in mind that greater confidence often begets greater entry multiples, and as such, growth equity investors historically have taken smaller ownership stakes at higher prices than their VC peers.
As the sorts of high-potential companies favoured by growth investors could very well continue to grow without outside funding, GPs are expected to bring much more to the table than financing. A growth equity investor’s ability to source attractive targets is a function of their reputation for delivering value to a founding team. Growth equity investors, supported by large operational teams of former industry executives, will frequently work with management teams on defining the path to scalability, protecting profitability, upskilling management teams and sharpening the exit strategy.
From start-up to scale-up
With already multiple indicators for future success, why, then, would these companies seek outside funding? One of the key defining factors of a growth equity investment is that there is, in fact, no need. These businesses have already proven their success with little to no institutional investment so far, and are growing organically and rapidly — Cambridge Associates suggests an annual revenue growth at 10% at the very least, often more than 20% — in sectors that are, themselves, outpacing market growth.
The objective of outside investment is to provide an injection of capital for growth acceleration alongside expertise, often in the form of operational or managerial guidance. Generally speaking, the target company is prepared with a specific growth objective in mind, seeking an acceleration in areas such as international expansion, further technological developments, or operational efficiencies. In December 2020, for example, growth equity investment firm Edison Partners led a funding round for GoHenry, a British financial literacy app and linked debit card created to teach children safe spending habits. Already a category leader in the UK, the company took on growth equity to expedite their U.S. expansion. In the same month, Summit Partners led a $290 million USD growth equity round for Shipmonk, a direct-to-consumer fulfilment and technology solutions provider. The funds were allocated to fuel growth objectives in R&D, hiring, B2B fulfillment capabilities, and international expansion. Just a month later, in January 2021, Shipmonk announced a $90 million USD injection from Periphas Capital to accompany their “hyper scale” growth (doubling of annual revenue, and growth of 100% and 115% in customer base and order volume, respectively).
In some cases, growth equity financing can bridge funding gaps ahead of listing. Late stage startups with a clear path to IPO can often reduce the risk profile of investments for investors, albeit at the expensive of higher entry multiples. One significant bonus for investors of pre-IPO financing is increased velocity of returns (and resultant IRRs) due to shorter holding times. For example, instant-messaging juggernaut Slack closed a $427 million USD series H round back in August 2018, led by Dragoneer and General Atlantic, and successfully went public nine months later. A recent trend has shown companies are delaying listings longer than ever, choosing instead to rely on private funding. Goldman Sachs estimated the average age of a company at IPO has doubled from five years old 20 years ago to 10 years old today.
Beyond tech investing
For many investors, the term growth equity is synonymous with tech investing. In reality, the asset class spans a much broader range than pure technology companies. For example, fitness apparel brand Gymshark, one of the handful of UK companies achieving Unicorn status, recently received funding in a new partnership with General Atlantic. With a strong tech angle, Gymshark has demonstrated an exponential growth curve more akin to a software company than a retailer, making it an interesting candidate for expansion capital.
Interestingly, there has been a trend in recent years for tech buyout investors to employ growth equity strategies (minority, equity-only investments) to tap into high octane opportunities where their traditional leveraged buyout approach doesn’t fit a company’s stage of growth. Some buyout firms like Providence, CVC and Advent have even launched carved out dedicated growth funds to compete with top tier dedicated growth players.
Expectations on returns
Growth equity investments are investments in long-term scalability, such as systems, processes and organisational changes. As such, investors should not expect to see a quick turnaround on IRR. Returns, which take between 3-7 years with an expectation of 3 - 7x return on investment, do indeed sit between VC and LBO return timelines. However, growth equity returns have historically exhibited less variability, with fewer periods of underperformance when compared to VC and traditional PE returns.
Loss ratios for growth equity are lower than those seen in VC deals, and closer to the 10-15% typical of buyouts. Though this can partly be attributed to the risk mitigation of investing in a “proven” business versus an early-stage start-up, the inherent management risk remains. Growth equity investments aim to help a company scale, and the capabilities of a manager to sustain or accelerate the revenue growth post-investment are crucial when it comes to determining longer-term success.
Despite inherent distinctions in strategy, growth equity still finds itself sandwiched between two well-established asset classes, blurring its own lines by comparison. Benchmarking outcomes isn’t necessarily straightforward, and it can be tempting to develop new standards for an asset class that’s still on the path to defining itself. One thing is certain: with companies staying private longer than ever, growth equity is becoming increasingly attractive as a part of private markets allocation strategies for limited partners and general partners alike.
 Cambridge Associates, “Growth Equity: Turns Out, It’s All About the Growth” (2019)
 Summit Partners, “ShipMonk Raises $290 Million to Help Online Merchants Scale Operations, Meet Rapidly Growing Ecommerce Demand” (2020)
 Slack, “Slack raises Series H round of financing from new investors“ (2018)
 Goldman Sachs, “Tech IPO ‘Super Cycle’” (2019)
 General Atlantic, “Gymshark secures investment from General Atlantic valuing company at over £1 billion” (2020)
 Cambridge Associates, “https://www.cambridgeassociates.com/insight/growth-equity/” (2013)
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