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 Mergers Acquisitions M&A Process This guide takes you through all the steps in the M&A process. Learn how mergers and acquisitions and deals are completed. In this guide, we'll outline the acquisition process from start to finish, the various types of acquirers (strategic vs. financial buys), the importance of synergies, and transaction costs 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 Preferred Shares Preferred shares (preferred stock, preference shares) are the class of stock ownership in a corporation that has a priority claim on the company’s assets over common stock shares. The shares are more senior than common stock but are more junior relative to debt, such as bonds. . 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 Top 10 Private Equity Firms Who are the top 10 private equity firms in the world? Our list of the top ten largest PE firms, sorted by total capital raised. Common strategies within P.E. include leveraged buyouts (LBO), venture capital, growth capital, distressed investments and mezzanine capital. , 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.
Additional Resources
Finance is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ FMVA® Certification Join 350,600+ students who work for companies like Amazon, J.P. Morgan, and Ferrari certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
- Business Life Cycle Business Life Cycle The business life cycle is the progression of a business in phases over time, and is most commonly divided into five stages: launch, growth, shake-out, maturity, and decline.
- Compound Growth Rate Compound Growth Rate The compound growth rate is a measure used specifically in business and investing contexts, that indicates the growth rate over multiple time periods. It is a measure of the constant growth of a data series. The biggest advantage of the compound growth rate is that the metric takes into consideration the compounding effect.
- Pessimist vs. Optimist Investors Pessimist vs. Optimist Investors Differentiating between pessimist vs. optimist investors is best done by using the phrase “a pessimist is an optimist with experience.” An optimist is hopeful and confident that things will turn out for the better. On the other hand, a pessimist always keeps in mind the possibility of the worst outcome.
- Stock Investing: A Guide to Growth Investing Stock Investing: A Guide to Growth Investing Investors can take advantage of new growth investing strategies in order to more precisely hone in on stocks or other investments offering above-average growth potential.
