Growth Equity

Growth equity is a type of private equity investment in companies that have a proven product and rising revenue and need capital to expand. The investor typically buys a significant minority stake, sometimes a majority, and the money is used to enter new markets, build sales capacity, make acquisitions or buy out early shareholders. It is also called growth capital or expansion capital.

The strategy sits between venture capital and the buyout. Venture investors back young companies whose product or market is still uncertain; a leveraged buyout acquires control of a mature business using a large amount of debt. Growth equity investors take on less technology and market risk than venture investors, and use little or no borrowing, relying on the growth of the business itself for their return. The boundaries have blurred, as late-stage venture rounds, growth funds and buyout firms' growth arms often compete for the same deals.

Target companies usually have an established customer base, revenue growing well above the rate of the wider economy and a business model that is profitable or has a clear route to profit. Many are founder-owned and have taken little or no outside capital before. Software, healthcare, financial technology and consumer brands are common sectors.

Because the investor often does not control the company, the terms of the investment carry much of the protection. Typical features include the following.

• Preferred shares. The investment is commonly made in preferred stock with a liquidation preference, which returns the investor's money ahead of ordinary shareholders in a sale or winding up.
• Governance rights. The investor receives board seats and consent rights over major decisions such as budgets, new share issues, acquisitions and a sale of the company.
• Anti-dilution and information rights. Protection applies if shares are later issued at a lower price, and the investor receives regular financial reporting.
• Exit rights. Redemption rights, drag-along provisions or the right to require a sale or listing after a set number of years give a path to liquidity.

The price is set by negotiation on the basis of revenue or earnings multiples and growth forecasts, and is recorded in a term sheet before full legal documents and due diligence.

A buyout investor earns returns from growth in earnings, from paying down debt and from selling at a higher multiple. A growth equity investor depends mainly on the first: the company must become substantially larger. Investors support this through introductions to customers, help with recruitment and acquisitions, and preparation for a sale. The exit is usually a sale to a strategic buyer, a sale to a buyout firm, or an initial public offering, commonly three to seven years after investment.

Funds are organised like other private equity funds. A manager raises commitments from institutions as limited partners, draws the money through a capital call when a deal is made, charges a management fee and earns carried interest on profits above a preferred return. Returns are reported as an internal rate of return and as a multiple of invested capital.

The main risk is that growth does not materialise at the rate assumed in the price. Since entry valuations are high relative to current earnings, a slowdown can sharply reduce the value of the stake even if the business remains sound. Minority investors cannot replace management or force a change of strategy without the contractual rights to do so, and may find it hard to exit if the founders do not wish to sell. Valuations of unlisted growth companies are estimates and tend to adjust slowly; the fall in technology valuations after 2021 led to markdowns, fewer exits and financing rounds at reduced prices across the sector.

Growth equity expanded strongly from the 2000s, helped by companies staying private for longer and by large pools of capital, including sovereign funds, hedge funds and mutual funds, investing in late-stage private rounds. Institutional investors now commonly treat it as a distinct allocation within private markets, alongside venture, buyout and private credit. Related structures include minority investments by a venture capital fund at later stages and the continuation vehicle, which some managers use to hold growing companies beyond the life of the original fund.