Growth EquityDefined along with Examples
What is Growth Equity?
Growth equity is an investment that involves purchasing a minority interest in a mature company that is experiencing rapid growth so as to help fund the company’s continued expansion.
There are certain attributes that most growth equity investments will have.
The business will generally be growing very fast.
Also, a number of these companies are providing tech-enabled services or products, and they generally have a proven business model and are profitable.
Additionally, in most cases, the business is managed or owned by the people that started it.
Then, the investors will typically acquire a substantial minority investment in the company.
This money is generally used to fund growth.
Although, it can also be used for shareholder liquidity.
Growth equity investments do not use a lot of debt, and the investors expect the returns to be the result of business growth rather than leverage.
How Growth Equity Is Used
Growth equity is used by companies to fund the expansion of the business.
This could mean entering new markets or acquiring another business in order to increase the profitability or revenue of the company.
Growth equity investors tend to have the advantage of a moderate level of risk along with the potential for a high level of growth.
Typically, growth equity investments involve a minority investment, and the investment is made by purchasing preferred shares.
Generally, growth equity investors want to invest in companies that have little or no debt.
Growth equity investors are often investment funds, private equity firms, or late-stage venture capitalists.
What Types of Companies Receive Growth Equity?
Growth equity investors generally prefer to offer growth equity to companies that have at least a short established track record of revenue generation in an established market.
The companies that are most suited for growth equity investments are those that can demonstrate the potential for achieving revenue growth through scaling operations.
The owners of these companies will generally not be ready to sell a majority stake in the enterprise yet seek to offer some level of interest in return for the capital to grow.
In other words, the companies that are most suited for growth equity are those that do not need it in order to continue operations but instead simply seek it in order to grow at a faster rate.
This generally occurs in a growth stage business that is seeking to expand quickly and claim a greater share in a competitive sector.
Generally, a company that does not “need” financing and does not have a large existing debt will be a positive signal for growth equity investors.
Differences Between Venture Capital and Growth Equity
There are some similarities between venture capital and growth equity, but they are actually highly different types of investments in several ways.
Here are the primary difference between these investment types.
Level of Risk
Venture capital investments tend to be very risky.
In contrast, growth equity investments are considered to have a moderate level of risk.
The reason venture capital investments are considered risky is that venture capital operates in a non-established market.
Generally, by investing in venture capital, an investor is taking the risk of a company’s management team developing a new product and successfully navigating a new market.
Though this generally comes with a larger stake in the profits, should the company become profitable, the risks of failure are high.
In contrast, growth equity deals are generally with an already established company in a mature existing market.
As a result, these are typically minority investments often offering preferred stock, and investors in these deals will typically prefer to invest in companies that are not highly leveraged.
This means that the risk in growth equity investments will typically be low.
Investment Holding Period
Venture capital holding periods will often be for a longer span of time compared with growth equity investments.
Venture capital is generally offered to companies in an early stage of development that may need a longer period of time to reach their full earning potential.
In contrast, growth equity is typically offered to established companies that can offer returns relatively quickly.
Origin of Returns
With venture capital, returns on investment primarily come from bringing a company’s new products or services to market.
In contrast, growth equity generally earns a return through scaling up its existing operations.
Advantages & Disadvantages of Growth Equity
Advantages of Growth Equity
- Growth equity offers an infusion of capital that can help to expand production facilities, purchase new equipment, research and develop new products, and begin new marketing campaigns.
- Growth equity investors may bring significant experience and new contacts to the business that can help to fuel growth beyond the capital they infuse.
- In contrast to bonds and other sources of debt financing, growth equity does not require a company to make regular payments to investors. This means that returns can be paid based on the needs and growth of the company rather than a fixed schedule.
Disadvantages of Growth Equity
- Due to the minority interest it offers and lack of a guaranteed rate of return, among other factors, it can be difficult and time-consuming to find willing growth equity investors.
- Potential investors may demand a significant track record and amount of data and research before making an investment. This can be a difficult and burdensome activity for a company seeking growth equity.
- The introduction of new stakeholders into an existing company can always lead to potential conflicts, and there is no guarantee that potential investors will have experience in the company’s industry.
Growth equity can offer growing businesses a way to acquire capital to quickly expand or restructure their operations.
The infusion of capital it offers can allow a company to enter a new market, grow its existing product line, and expand its position in its industry.
Growth equity can also offer investors a long-term equity investment with a relatively low-risk profile.
Growth equity can be a powerful tool for both investors and companies, with significant advantages over alternative forms of equity and debt financing.
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Harvard Law School "The Rise of Growth Equity—Connecting PE and VC" Page 1. August 11, 2022