What is growth equity?

Two recent publications do a very nice job of describing “growth equity” and distinguishing it from early-stage venture capital and buyouts.

This piece at Inc.com explains that due to Sarbanes-Oxley young high-growth companies are delaying IPOs, staying private longer, and seeking other sources of capital to fuel their growth:

What makes a growth-stage company? Generally, it has its first product or service in the market and is getting traction. At this stage, investors like to say that the dogs are eating the dog food.  Product development continues to be very important, but sales, marketing and customer service are now center stage. The founding management team is still in place, but new faces and skill sets are needed. The amount of money needed to maximize the company’s opportunity outstrips the company’s ability to generate free cash.

Growth investors cover a wide spectrum. Some growth-stage investors prefer the early stage of expansion. This investor generally has been rooted in the venture capital industry, or he or she may be a successful entrepreneur-turned-investor. These investors tend to be active and more hands-on. They will make available their extensive networks and years of experience. You may want seasoned growth-capital investors as board members or advisors, as they will be able to open doors and help you solve problems that may be new to you but that they’ve seen repeatedly.

At the other end of the field are the financial engineers. They tend to be passive investors who engage much later in the growth cycle, when a big exit is not too far over the horizon. Most will write jumbo checks — $50 million and up — to be well-positioned for an IPO. They generally will have no interest in being on your board or offering operational assistance…

Similar to your hunt for early-stage investors, compatibility with your aspirations and personal chemistry are essential ingredients.  If your company is doing well, you should have the luxury to pick and choose whom you work with.

This report from Cambridge Associates argues that growth equity has developed into its own unique asset class:

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…

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…

In summary, while growth equity shares some characteristics with both venture capital and leveraged buyouts, it should be viewed as a separate strategy with its own risk-reward profile, distinguishable by its minimal use of leverage and portfolio companies with strong organic growth. Simply put, growth equity offers a similar return profile to leveraged buyouts but without the leverage, and could also be viewed as a low-octane venture proxy,with far less dispersion among company returns given the lower risk of loss, but also little chance for the fabled ten-baggers integral to venture’s long-term success.

Both these pieces describe fairly accurately the strategy that BPV has pursued since our founding:  our investment is a “growth accelerator” for companies at or nearing profitability and in the early stages of rapid expansion.  Our entrepreneur partners benefit from our network and experience with high growth companies, and our limited partners benefit from the fact that our strategy entails a lower risk of loss of capital and is not reliant on a frothy IPO market for an attractive exit.  We have pursued this investment approach since the founding of our predecessor firm, South Atlantic Ventures, over thirty years ago. and we are pleased that Cambridge Associates has recognized the unique aspects of this asset class.

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