Understanding Growth Equity: Where It Fits & Why It Matters

In the private equity (PE) landscape, a variety of investment strategies exist, each catering to different stages of a company's lifecycle. One such strategy that has gained significant attention in recent years is growth equity. While it shares characteristics with both venture capital (VC) and buyouts, growth equity occupies a distinct niche in the investment world, focusing on scaling businesses that have already achieved some degree of market success.

In this article, we’ll explore what growth equity is, how it fits within the broader private equity ecosystem, and why it has become an important investment strategy for both companies and investors alike.

What is Growth Equity?

Growth equity refers to private equity investments made in mature, expanding companies that require capital to scale their operations, enter new markets, or fund acquisitions. Unlike venture capital, which typically targets early-stage startups, growth equity investments are made in companies that have a proven business model, consistent revenue growth, and an established market presence. These companies are typically past the riskier stages of development and are poised for substantial growth, but they still need funding to accelerate their expansion.

Growth equity investors provide capital in exchange for equity stakes in the business, often in the form of minority ownership (unlike traditional buyout deals, which usually involve taking a controlling stake). The focus of growth equity is on companies that have reached a point of stability but need further capital to fuel their growth, rather than turning around distressed or underperforming businesses.

Where Does Growth Equity Fit in the Investment Lifecycle?

Growth equity investments occupy a unique position in the investment lifecycle. They typically come after the venture capital phase and before a company matures to the point of being ready for an IPO or acquisition. Here’s a breakdown of the stages and where growth equity fits:

1. Seed and Early-Stage (Venture Capital)

• Venture capital investments focus on startups that are in the very early stages of development. These companies are often pre-revenue or in the process of product development. Venture capitalists take on significant risk, betting on the potential for these companies to disrupt industries and scale rapidly.
• Key focus: High-risk, high-reward investments in innovative, often unproven companies with the potential for exponential growth.

2. Growth Equity Stage

• Growth equity comes into play once a company has reached a certain level of maturity. By this stage, the company has demonstrated its ability to generate consistent revenue and has established a product-market fit. However, the company is still in need of capital to accelerate growth, such as expanding into new geographic markets, launching new products, or scaling its operations.
• Key focus: Providing capital to help businesses expand more quickly, typically with a proven track record of revenue but still needing support to scale significantly.

3. Buyouts and Mergers (Late-Stage Private Equity)

• Buyout firms typically focus on acquiring mature companies, often using significant leverage to finance the purchase. These companies are typically already established, but they might need restructuring, operational improvements, or strategic changes to increase profitability.
• Key focus: Acquiring control of mature businesses, improving operations, and eventually exiting through a sale or IPO.

4. IPO and Exit

• Once a growth equity-backed company reaches a critical mass, it may be ready for an initial public offering (IPO) or acquisition by a larger company. The growth equity investor’s exit typically comes through the sale of its stake during the IPO or to a strategic buyer.
• Key focus: The company exits via an IPO or is acquired, allowing the growth equity investor to realize their return on investment.

How Growth Equity Differs from Other Private Equity Strategies

Growth equity is often compared to both venture capital and buyout investing, but it differs in key ways:

1. Compared to Venture Capital

• Stage of Investment: Venture capital targets startups in the early stages of development, often with high uncertainty, while growth equity targets companies that are already generating revenue and have proven their business models.
• Investment Size: Growth equity deals are typically larger than venture capital investments, ranging from $10 million to $100 million, depending on the company's needs and stage of development.
• Risk Profile: Growth equity is less risky than venture capital since it is invested in companies that have already proven their ability to generate revenue and have reached product-market fit.

2. Compared to Buyouts

• Control: In buyouts, the investor typically acquires a controlling stake in the company, whereas in growth equity, the investor typically takes a minority position, meaning the original management team retains control of the business.
• Focus: Buyouts focus on mature, often underperforming companies that require restructuring or operational improvements. In contrast, growth equity focuses on companies that are growing rapidly and need capital to scale.
• Exit Strategy: Buyout firms typically aim for long-term value creation by improving operations and eventually selling the company, while growth equity investors are often looking for faster exits via IPOs or acquisitions.

Why Growth Equity Matters

Growth equity has become an increasingly important asset class in the private equity world for several reasons:

1. Supports Scaling for High-Potential Companies

Growth equity helps companies that have demonstrated early success but need capital to scale more quickly. It provides businesses with the resources to expand, develop new products, and enter new markets, which accelerates their growth and potential for profitability.

For example, companies like Byju’s, Ola, and Swiggy in India have all raised significant amounts of growth equity to fuel their rapid expansion. These companies had already established a strong customer base and revenue model but required additional capital to move to the next level.

2. A Faster Path to Returns

Since growth equity firms focus on more mature, stable companies compared to venture capital, the investment timeline can be quicker. Growth equity funds often look for companies that are close to profitability or at the cusp of significant expansion, which allows them to achieve exits in a shorter time frame compared to earlier-stage investments.

The ability to enter a company at a stage where it is already growing rapidly but still needs capital to scale presents an opportunity for investors to achieve attractive returns without taking on the same level of risk as venture capital investors.

3. Attracting Top Talent and Management

Growth equity investors often work closely with a company’s management team to refine strategy, streamline operations, and build long-term value. Since growth equity investors typically do not take control of the company, they tend to provide more collaborative support to management, allowing founders and executives to retain their vision while benefiting from the investor's resources and expertise.

4. Less Risky than Venture Capital

While growth equity is still an equity investment and therefore involves risk, it is typically considered less risky than venture capital, especially since the companies have already reached a stage where they can demonstrate revenue growth and market fit. This makes growth equity a particularly attractive option for investors seeking high growth but with a slightly lower risk profile.

The Growth Equity Investment Process

The growth equity investment process involves several key steps:

1. Sourcing Deals

• Growth equity firms typically source deals through their network of entrepreneurs, venture capitalists, and industry experts. Given that growth equity targets companies that are already established, identifying the right companies with significant growth potential is key.

2. Due Diligence

• Conducting thorough due diligence is crucial for growth equity firms. This includes analyzing the company’s financial performance, market position, growth trajectory, and management team. The firm also assesses the scalability of the business model and the potential for high returns on investment.

3. Structuring the Deal

• Growth equity deals are typically structured with a minority stake in the company. The investment is often in the form of equity, but sometimes convertible debt or other hybrid instruments are used. The goal is to provide enough capital for the company to scale while maintaining the existing management’s control over the company.

4. Post-Investment Support

• Growth equity investors work closely with portfolio companies to help them achieve their growth targets. This might involve advising on strategy, providing introductions to key partners, and helping the company expand into new markets.

5. Exit

• Exits typically occur through IPOs or acquisitions. Growth equity investors often look for companies that are ready for the public markets or that can be acquired by a strategic buyer looking to consolidate or expand in the sector.

Conclusion

Growth equity plays a crucial role in the private equity ecosystem, focusing on mature, high-potential companies that need capital to scale rapidly. It offers investors the opportunity to achieve attractive returns with a relatively lower risk profile compared to venture capital, while providing businesses the resources they need to expand and compete on a larger stage. By filling the gap between venture capital and buyouts, growth equity has become an essential investment strategy for both companies and investors seeking to maximize growth while managing risk.

FAQs

1. How is growth equity different from venture capital?
Growth equity targets more mature companies that are already generating revenue and need capital to scale, whereas venture capital focuses on early-stage startups that are in the development phase.

2. What types of companies attract growth equity investment?
Growth equity typically goes to companies with proven business models, steady revenue growth, and potential for rapid scaling in areas such as technology, healthcare, and consumer goods.

3. How does a growth equity firm typically exit an investment?
Growth equity firms generally exit through IPOs or acquisitions, allowing them to realize returns on their investment when the company reaches a scale that attracts public or private buyers.

4. Is growth equity more or less risky than venture capital?
Growth equity is generally considered less risky than venture capital, as the companies receiving growth equity have already proven their business models and are typically experiencing steady revenue growth.

5. Why is growth equity important for the startup ecosystem?
Growth equity provides startups with the capital needed to expand and scale their operations, which is crucial for companies that have outgrown their initial funding stages but need additional resources to reach their full potential.