Growth equity (also known as growth capital or expansion capital) is a type of investment opportunity in relatively mature companies that are going through some transformational event in their lifecycle with potential for some dramatic growth.
Uses of Growth Equity
Growth capital is utilized by businesses to subsidize the expansion of their operations, entrance into new markets, and acquisitions to boost the company’s revenues and profitability. Growth equity investors benefit from the high growth potential and moderate risk of the investments.
Growth equity deals generally imply minority investments. Such deals are commonly executed using preferred shares. Note that growth equity investors tend to prefer companies with low leverage or no debt at all.
Typical investor profiles in growth equity include private equity firms, late-stage venture capitalists, as well as investment funds (mutual or hedge funds).
Growth Equity vs. Venture Capital
Although growth equity may seem similar to venture capital, the two types of investments are different in a few ways. The key distinctions between the two investment opportunities include the following:
1. Holding period
Growth equity investments generally come with a lower holding period (on average, 3-7 years) compared to venture capital investments (average is 5-10 years). The rationale behind it is that early-stage companies simply need more time to realize their potential relative to more mature companies.
2. Source of returns
The primary source of returns for venture capital investments is the profitable introduction of the company’s products or services to the market. The source of returns for growth equity investments is the company’s ability to scale its operations, which results in significant revenue and profitability growth.
3. Risk profile
Unlike venture capital deals that come with a high level of risk, growth equity deals are generally considered investments with moderate risk. The high risk nature of venture capital investments is determined by the number of risk characteristics, most notably market and product risks. Such risks are associated with operations in new markets (market risk) and the absence of a commercially viable product.
Conversely, companies targeted in the growth equity deals generally operate in established and mature markets with a commercially viable product. However, the execution and management risks of such types of deals are still high.
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