Growth equity firms have been one of the fastest growing segments of the private equity industry. This industry lies somewhere at the intersection of the private equity and venture capital industries, carrying elements of both. In many ways, they offer the best of both worlds. They fall in between private equity and venture capital on the risk-return spectrum.

Overview of Growth Equity

Growth equity involves investing in privately-held, growth-oriented companies. An investment of this type is a private equity transaction sponsored by a growth equity investment firm. The sponsor firm invests in the illiquid, non-publicly traded securities of the growth-oriented company in question.

Growth equity investments can be either majority or minority investments in a company, depending on the percentage of voting securities acquired. Typically, these funds make large minority investments.

Some notable companies that accepted minority investments from growth equity firms include Duolingo, Quizlet, Box, and Club Pilates. These firms are keen on investing in companies focused on technology, healthcare, financial services, and consumer goods and services.

Companies that seek growth capital often intend to finance an extraordinary company event in order to further accelerate growth. Examples of such events include expanding product development, building new factories, entering new markets, or undergoing financial restructuring. These steps may provide the foundation for an eventual merger or IPO.

How Does Venture Capital Differ?

While venture capital firms tend to focus on high-growth companies at the earlier stages of their development, growth equity firms invest in high-growth companies at more mature stages of their life cycle. In other words, these companies are approaching profitability or positive cash flows, yet they are still in a phase of rapid growth.

As a result, this type of investing requires a different mindset from venture capital investing. Venture capitalists usually have a portfolio of early-stage startups, most of which will ultimately fail. They are betting that a couple of the startups in their portfolio will soar through the roof. In the case of growth equity, the companies have already passed the earlier stage of testing the feasibility of their business model. The companies usually have a specific growth activity in mind for which they need funding.

Distinguishing Growth Equity from Traditional Private Equity

In a traditional private equity transaction, the PE firm almost always acquires either a 100% interest or a majority stake in a company. PE firms typically invest in more established companies with longer histories. They intend to maximize their returns through financial engineering, restructuring, or operational changes to the companies in their portfolio. In contrast, growth equity firms usually take minority stakes in companies. They focus on later stage startups that already have achieved some success with additional capital to fuel expansion.

As a result of differences in the investment stake, investors often have more limited control over a given company compared to investors in private equity buyout deals. Since they are making minority investments, the growth equity firm is usually only granted one board seat and limited influence over founder management. Such firms focus on robust management teams since the companies they invest in are going through significant phases of growth and scalability.

Growth Equity Investing: Investors and Recent Trends

More than 4,000 growth equity funds are in the market today, as the asset class continues to gain momentum. Some notable firms include General Atlantic, H.I.G. Growth, Summit Partners, TPG Growth, and Trident Capital.

The negotiated deal terms often reflect a hybrid of traditional PE buyout and emerging company terms. For example, growth equity investors often request a participating preference to protect themselves in a downside scenario. This means they will be entitled to receive preferred dividends before any dividends are paid to common stock holders.

The average annual revenue growth rate for these companies is 17.2%. That is more than double the growth rate of companies that undergo a leveraged buyout. Growth equity companies also experience significantly lower impairment and capital loss compared to venture capital companies. In other words, these investments are often able to capture upside return potential similar to venture capital with lower risk of losses similar to PE buyouts.

Returns of growth equity firms primarily stem from their ability to identify and invest in companies able to scale operations, enhance product development, and expand corporate functions. The holding period of growth equity investments averages 3-7 years. By comparison, the holding period for venture capital investments typically is 5-10 years.

Notable Examples

One of the biggest growth equity firms is General Atlantic. Founded in 1980, General Atlantic focuses on making large minority investments in technology, healthcare, financial services, and consumer companies. In addition to the United States, General Atlantic has offices and investments in companies in several strategic growth markets. These include Europe, China, India, Brazil, and Southeast Asia. With $40 billion assets under management, the firm has minority investments in companies such as Reliance Industries, Jio, Duolingo, Opendoor, Uber, and Airbnb.