Growth Equity, the Bright Spot in Private Equity

Cambridge Associates recently released its fund benchmarking report which substantiated what many of us in the transaction world were well aware of – Growth Equity is where the action is. The study revealed that Growth Equity funds outperformed both Venture and Buyout Funds over the last 5 & 10 year periods. As an advisor to companies, we have seen a massive shift over the past 5 years away from early stage investors and away from traditional leveraged buyout funds. The emergence of Growth Equity, which sits between the two, has been the result. Growth Equity firms do not invest in ideas on a napkin, nor do they look to financially engineer deals using maximum leverage. Growth Equity firms look for well run, growing businesses with proven business models and solid management teams looking to continue driving the business. Growth Equity capital is often used to accelerate growth (both organic and inorganic) and often to provide some level of liquidity to the current owners. These are typically non-control deals allowing founders to remain majority shareholders while providing them some level of liquidity and additional capital to invest in the future growth of the business. Allowing founders some freedom to take on more risk than in the past to invest in strategic growth initiatives for the business (because they now have some liquidity/diversification and the investments in future growth is not 100% their dollars) is a major driving force behind these transactions.

As opposed to the typical Venture model where 1 in 10 investments will “make” the fund, Growth Equity investors are typically looking for more modest consistent returns from their investments in the 3-4x return range. As a result, the terms associated with Growth Equity investments are much less onerous and typically much closer align incentives between founders and investors. We have seen a dramatic increase in founders’ willingness to consider a growth equity deal when they don’t feel it is quite time to sell, but also realize it is prudent to seek some level of liquidity.  We expect the trend of growth equity firms outperforming their PE brethren (VC and LBO funds) to continue and LP capital to disproportionately flow to these “hybrid” funds.  With that in mind, we expect to see several traditional early stage funds continue to push into the later stage growth game and also expect the larger LBO firms to continue to move down market into the unlevered game. This explosion in new growth equity pools of capital makes it even more interesting for companies to be deliberate in how they go about strategically seeking the right investor on the right terms.