Wednesday, August 7, 2013

What Is Growth Equity?

Today, Cambridge Associates came out with benchmarks for U.S. growth equity funds, which they acknowledge has a murky definition somewhere between venture and buyout.  So what is growth equity then?  Everyone seems to love it because it's like venture in that you should be able to get a venture-like 3-5x return multiple but also like buyout in that growth equity managers are investing in more mature companies that have meaningful revenue (maybe profitable) and were most likely bootstrapped by their founders prior to raising institutional capital.

Summit Partners calls their growth equity strategy: "Financing that helps exceptional companies accelerate their growth.  By providing capital, strategic guidance at the board level, and operational support, growth equity investors can help companies realize their full revenue, profit and market-value potential.  Many growth equity investors will make minority investments and prefer that current managers continue running their businesses."  That sounds exactly like venture capital, right?  Invest money, add value, make money...

In having met with managers across the entire spectrum of self-proclaimed "growth equity" managers, there is a noticeable delineation between managers that blur the lines with late stage venture and managers that blur the lines with buyout.  With notable exceptions, I think growth equity managers are minority investors and are investing in growth companies with meaningful traction and little debt coverage.  

In theory, growth equity should be the dream date for private equity LPs.  If you can take the value-added board leadership and entrepreneurial operational experience of venture capitalists and combine it with the investment banking financial modeling, low loss rates and shorter duration to liquidity of the buyout space, what more can you ask for.  If you can do a 3.0x net TVPI over an 8-year investment period consistently, wouldn't you invest in that fund all day, every day?  

As late stage venture capital has become overheated and the irrational exuberance of piling into the latest and greatest tech company in the Valley subsides, we're seeing more VC firms who do later stage investing become "growth equity firms".  Moreover, we're seeing more buyout firms seeking proprietary dealflow and alpha by chasing high growth venture-backed companies.  I don't see any difference between a buyout fund doing a minority investment and calling it growth equity, or a venture fund doing a later stage deal with no previous venture money in the company, and calling it growth equity.  

What really defines growth equity is the sourcing.  If there is no proprietary deal any more in the venture ecosystem, there certainly are proprietary deals in the growth equity space.  That's why there isn't a huge ecosystem of managers and it's hard to say who does growth equity and who doesn't.  Direct outbound calling programs are the biggest differentiators for growth equity managers are the reason why firms like Summit, TA and Insight are among the very best.  

Therefore, I don't think there is such a think as a growth equity manager, but only a growth equity deal. Growth equity may be the last bastion of proprietary deals.  

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