At some point in the lifecycle of a successful small business, it may need outside help — either in the form of an investment or guidance — to get to the next level.
Growth equity firms seek to offer both. These firms typically target young companies that have gained traction in their markets but have the potential to grow significantly more with the addition of capital and external guidance. In general, their investment “sweet spot” is a privately held company that is pre-initial public offering (IPO), but has finished its venture capital stage.
Both early-stage businesses and growth equity investors can benefit from this type of investment deal. However, both sides also face risks. Let’s take a closer look at what growth equity is, how it works, and what it offers both small businesses and profit-minded investors.
Key Points
• Growth equity firms provide capital to established businesses with proven revenue models, aiming to accelerate expansion, product development, or market entry without taking full control of the company.
• These firms typically invest in businesses with strong growth potential, scalable operations, and a need for funding to achieve the next level of growth.
• Growth equity investments often involve minority stakes, allowing founders to retain control while benefiting from strategic guidance and resources provided by the firm.
• Partnering with a growth equity firm offers access to capital, industry expertise, and connections to expand market reach, strengthen operations, and boost valuation.
• In addition to growth equity, businesses can find funding through angel investors, venture capitalists, private equity investors, or small business loans.
What Is Growth Equity?
Growth equity investors focus on purchasing minority stakes in fast-growing businesses that have surpassed the startup stage.
Key Characteristics
Growth equity players have a clearly defined role among investors and companies seeking funding. They generally get involved after a company’s early-stage investors have provided seed capital and the business has gotten some traction.
A typical growth equity investor:
• Targets companies with high growth potential and moderate risk
• Buys a minority, non-controlling stake in a private post-startup company
• Provides money for the company to expand its market reach without taking on more debt
• Has limited involvement in management, possibly in the form of board seats, an advisory role, or informal influence
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What Growth Equity Invests In
Growth equity investors typically look for firms that demonstrate strong revenue growth and robust industry potential. The following attributes often appeal to such investors:
• A revenue growth rate that is on the fast track
• A business model that favors technology-based goods and services
• A demonstrable customer base
• Robust cash flow and little or no company debt
• The founders are still with the company
• The ability to easily invest in the company as a minority partner
Industries Commonly Targeted by Growth Equity Firms
Growth equity funders generally target firms in such sectors as technology, consumer goods, and healthcare. These industries are known for their scalability and innovation. Among the companies that have flourished after growth equity deals are Facebook, Stripe, and the online marketplace Alibaba.
How Does Growth Equity Work?
Growth equity investors start the investment process with a thorough vetting of a potential funding target. Most often, the investor talks to industry insiders to learn as much as possible about the industry and make sure the company is a leader in the market, with potential for even more growth.
Growth equity deals generally imply minority investments and are commonly executed using preferred shares.
Any money invested by a growth equity investor is generally restricted to company growth. For example, it might be used to subsidize the expansion of operations, enter into new markets, or make acquisitions to boost revenues and profitability.
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Typical Deal Structures in Growth Equity
Growth equity managers usually acquire minority stakes (less than 50%) of a privately-held company that shows signs of future growth. The investors generally leave control to current owners, but they may negotiate some rights, such as board representation and change-of-control provisions.
Pros and Cons of Growth Equity
Getting a growth equity firm to invest in your business has both benefits and drawbacks. Here’s a look at how they stack up.
Pros of Growth Equity
• It offers an infusion of capital that can help an early-stage company buy new equipment, expand production facilities, research and develop new products, and begin new marketing campaigns. The company can thus avoid taking on additional debt from small business loans.
• Investors may bring significant experience and new contacts to the business that can help to fuel growth beyond the capital they invest.
• Unlike debt financing, growth in equity does not require making regular fixed payments. Returns are paid based on the needs and growth of the company, rather than according to a fixed schedule.
Cons of Growth Equity
• Due to the minority interest and lack of a guaranteed rate of return with growth equity, it can be difficult to find a growth equity firm willing to invest in your company.
• A company generally needs to have a strong track record and be able to submit a large amount of data and research in order to secure a growth equity investment.
• Bringing in new stakeholders can lead to potential conflicts. Plus, there is no guarantee that growth equity investors will have experience in the company’s industry.
| Pros of Growth Equity | Cons of Growth Equity |
|---|---|
| Offers an infusion of capital | Can take a lot of time and effort to secure a growth equity investment |
| Access to expertise and contacts that can expedite growth | Growth equity only invests in early-stage companies with a strong track record of success |
| Does not require making regular repayments | Bringing in additional stakeholders can lead to conflicts |
Growth Equity vs Venture Capital and Private Equity
Growth equity generally comes into play later than venture capital but sooner than private equity buyout funds.
Venture capital investors fund early-stage startups, targeting breakthroughs despite the company’s previous losses. The principle is “high risk, high reward.”
Growth equity provides capital to established companies with proven products and business models, in order to fuel expansion and profitability. Investors at this stage are seeking steadier returns and lower risk than VCs.
Private equity firms typically acquire mature companies, aiming to restructure them and improve their operations to increase value.
Growth Equity vs Venture Capital
Both growth equity and venture capital target fast-growing businesses and take a minority stake. However, these two types of investments differ in several key ways.
One is that venture capital firms typically invest much earlier than growth equity firms, as noted above. Venture capital firms will often get involved even before a company has a commercially viable product or customers. Growth equity, on the other hand, typically invests after a company has proven its business model and has a significant customer base.
That’s why growth equity investments are generally considered moderate risk, while venture capital deals are typically considered high risk.
Because early-stage companies typically need more time to realize their potential than mature companies, holding periods differ as well. Growth equity investors tend to hold companies for three to seven years, whereas venture capital holds investments around five to 10 years.
The source of returns also differs. Venture capital generally gets its returns from the profitable introduction of the company’s products or services to the market. Returns for growth equity investments, by contrast, primarily come from the company’s ability to scale its operations.
| Venture Capital | Growth Equity | |
|---|---|---|
| Stage of investment | Early-stage | Late-stage |
| Risk | High | Moderate |
| Holding period | Five to 10 years | Three to seven years |
| Returns | Introduction of products and services to market | Ability to scale operations and increase profits |
| Stake | Minority stake | Minority stake |
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Growth Equity vs Private Equity
While growth equity and private equity have a lot in common, they are not the same thing. Here’s a look at how they differ.
• Investment levels: Growth equity investors typically invest more cash than private equity investors.
• Risk exposure: Private equity investment is lower risk because they typically target more mature companies that have lower growth but more stable cash flows. Growth equity investors, on the other hand, are focused on growth, which may or may not occur, exposing them to higher risk.
• Present vs. future: Private equity firms usually invest in companies that are well-established in their industries and have a proven record of profitability over the long haul. Growth equity investors are more focused on future growth.
• Levels of debt: Private equity firms often fund the purchase of controlling stakes in companies using significant amounts of debt (called a leveraged buyout). By contrast, growth equity transactions usually involve little or no debt.
Growth Equity Investment in Your Business
Though growth equity investors only take a minority stake, they can still offer a lot of value to your company. Besides capital, growth equity firms can provide business growth strategies and other areas of expertise, including:
• Capital structure optimization
• Mergers & acquisitions (M&A)
• IPOs
• Professionalization of internal processes
• Business development
• Market expansion
• Connections to institutional investors, lenders, and investment bankers
The Takeaway
Growth equity funds take a minority interest in late-stage companies that have potential for scalable and renewed growth. These investors add value to companies by providing capital for growth and expansion, along with operational expertise and access to their business network.
If you’re interested in getting growth equity funding for your company, keep in mind that securing this type of investment can be a time-consuming and challenging process. And, unlike debt funding, growth equity funding will involve giving up some control of your business.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What is the definition of growth equity?
Growth equity involves acquiring minority interests in late-stage companies exhibiting high growth with the goal of funding their plans for continued expansion.
Is growth equity the same as private equity?
No; growth equity firms typically only invest minority stakes, whereas private equity firms often acquire entire companies. Also, growth equity invests with the purpose of growth and expansion, whereas private equity isn’t solely focused on growth activities and strategies.
What is growth equity vs private equity?
Both growth equity and private equity make capital investments in companies that are not publicly traded. Growth equity firms acquire minority interests, however, while private equity firms often acquire entire companies. Growth equity is also more focused on growing already profitable companies, whereas private equity may be looking to turn around a troubled firm and make it profitable.
How does a company qualify for growth equity funding?
There’s no across-the-board checklist that will guarantee access to growth equity funding, but there are some things you can do to boost your company’s chances, such as:
• Present a clear, comprehensive plan for how the capital will be used.
• Define timelines and outcomes for the action plan.
• Show detailed business metrics such as year-over-year growth and market position.
• Network with many potential investors before seeking capital.
What are examples of growth equity investments?
Two examples are eyewear retailer Warby Parker and meal-prep service Blue Apron. Warby Parker received growth capital and used it to sustain rapid expansion into new markets and enhance its online retail platform. Blue Apron used growth capital to bring new offerings to market and optimize its delivery systems. The goals were to improve customer experience and make the company more competitive.
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