If you were seeking to locate growth equity on a spectrum of private investment strategies, you would most likely place it somewhere between late-stage venture and leveraged buyouts—established companies that can benefit from additional capital to accelerate growth. Most portfolio companies will have a number (if not all) of the following traits:
- No prior institutional investment
- Proven business model (established product and/or technology and existing customers)
- Substantial organic revenue growth (usually in excess of 10%, and often more than 20%)
- EBITDA-positive or expected to be so within 12 to 18 months
Given that target companies have, by definition, grown materially over a number of years without needing outside institutional capital, why would they now take it on? There are several potential reasons, mostly including the desire to accelerate growth by investing in new product development, human capital, infrastructure, or new geographic regions; other reasons include making add-on acquisitions or to monetize a portion of management’s ownership.
Growth equity investments will typically be minority stakes using little if any leverage at investment, and often are expected to be the last round of financing needed. They often have built-in safeguards for investors as well. For example, growth equity is typically placed in a more senior position than common equity, and often comes with negotiated negative control provisions and approval rights to mitigate the risks of owning a minority position. For instance, investors may receive the right to approve the annual business plan, new acquisitions or divestitures, and/or the issuance of new debt or equity. Additionally, a growth equity investor will often have the right to participate in or initiate a liquidity event following a certain period of time, typically three to five years.
It is instructive to contrast growth equity deals with buyout and venture capital transactions. Leveraged buyouts, for example, also typically involve companies with a stable earnings stream, perhaps growing less aggressively, and in this case used to facilitate the assumption of debt, which is expected to be a material contributor to the investment return. Venture capital investors, meanwhile, generally receive preferred equity positions similar to those given to growth equity funds, but because of the nascent stage of most venture-funded companies, the downside protections outlined above are typically lacking. Further, venture investors usually share control with a syndicate of other institutional investors that can have conflicting interests and priorities—a situation that growth equity investors often avoid.