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RESOURCES:

PRIVATE EQUITY

WHAT IS GROWTH EQUITY?

Growth equity has long been described as the private investment unlike buyout firms who frequently replace CEOs as part of their
strategy occupying the middle ground between venture capital value enhancement strategies. As the growth equity asset class
and traditional leveraged buyouts. While this is true, the asset class has evolved, however, these firms have begun to establish in-
has evolved into more than just an intermediate private investing house benches of operational talent and other more traditional
approach. Growth equitys unique risk-return profile, driven by a private equity resources that can help portfolio companies increase
focus on organic growth, low leverage, and downside protection, profitability.
has resulted in the creation of dedicated allocations across many
portfolios and made the asset class one of the brightest spots in An attractive growth equity investment target will tend to be
todays investment landscape. growing faster than both its industry competition and the broader
economy. This is because, unlike many venture capital firms who
GROWTH EQUITY INVESTMENT TARGETS take a view on potentially industry defining trends and make small
investments in several companies in the same space, growth equity
Growth equity funds seek to invest in companies that have proven investors generally wait until the landscape is more mature in an
out their business models and exhibit significant revenue growth, effort to back the market leader. Similar to venture capital, however,
usually in excess of 10% and often more than 20%.1 The fact that growth equity firms focus their sourcing on sectors positioned for
these companies are generating revenue and have established meaningful secular growth (in contrast to traditional LBOs, where
product or service offerings minimizes technology and adoption the emphasis is often more on improving operational efficiencies
risk, and differentiates them from the typical venture capital and the use of debt to generate returns). This has resulted in a high
investment. At the same time, typical growth equity investment proportion of tech investments within growth equity portfolios,
targets have significant scope to organically scale their businesses, which, combined with growth equitys comparatively low risk, has
and cash flows that generally are not yet large or stable enough to made the asset class very appealing in todays macroeconomic
support much debt, distinguishing them from leveraged buyout environment.2
candidates which tend to be characterized by incremental growth
and steady cash flows. DOWNSIDE PROTECTION

Unlike venture capital deals, which are often made on fairly Growth equity investments are typically minority stakes using little
speculative Total Addressable Market and other assumptions, to no debt. The lack of financial leverage allows these businesses
growth equity investments are typically underwritten on relatively
defined profitability milestones and are either already EBITDA- FIGURE 1

positive or expected to be so in the near term. Companies seeking


growth equity capital tend to have limited, quantifiable future VENTURE GROWTH BUYOUT
CAPITAL EQUITY
funding needs to achieve their goals, in contrast to companies
seeking VC financing (who are too early stage to be able to
DEBT No Limited Yes
project the timing or quantum of their future funding needs with
any certainty). The two, not mutually exclusive, imperatives that
often catalyze a growth equity financing are (i) founders desire
CONTROL No No Yes
to monetize a portion of their stake, and (ii) the need for capital
to accelerate growth through new product development, add-on
CONSENT
acquisitions, geographic expansion, enhanced marketing, or more RIGHTS & OTHER Generally
Yes Yes
robust human capital and other business infrastructure.
PROTECTIVE no
PROVISIONS

Companies considering overtures from growth equity investors CASH FLOW Generally Generally
Yes
are often still owned by their founders or early management teams
POSITIVE no yes
and have not yet taken any institutional capital. As such, growth
equity investors are essentially betting on existing management,

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to be more flexible in the face of cyclical headwinds and mitigates a distinct risk-reward profile that offers investors target returns
risk for investors. between those of VC and PE with a modest loss ratio.3 Growth
equity investors do not have to deal with leverage or technology
In addition, while both VC and growth investors will almost always / market adoption risk, while they enjoy the security of existing
take preferred equity or otherwise structure the investment to cashflow, comprehensive shareholder rights, reduced cyclicality
be senior to managements ownership, growth equity investors and higher average secular growth rates given the sectors in
typically also benefit from a set of protective provisions and which they invest. This combination of factors is compelling in any
redemption rights. While these rights will vary from investment to environment, and even more so in the latter stages of the market
investment, they generally include the right to approve material cycle. Especially in light of its favorable risk-adjusted dynamics,
changes in business plans, new acquisitions or divestitures, growth equity may be one of the best strategies to capture true
capital issuance, the hiring or firing of key employees, and other economic value creation today.
operational matters. Redemption rights are heavily negotiated END NOTES
and generally based on either time elapsed since investment or
testing business results against pre-set performance milestones or
1. Cambridge Associates, US Market Commentary, Growth Equity is All Grown
financial covenants. Up, June 2013.

2. Cambridge Associates, US Market Commentary, Growth Equity is All Grown


These built-in safeguards can significantly reduce the risk Up, June 2013.
associated with a minority stake in a not-yet-mature business. The 3. Cambridge Associates, US Market Commentary, Growth Equity is All Grown
unique characteristics of growth equity, shown in Figure 1, drive Up, June 2013.

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