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Guide to Growth Equity Firms

Guide to Growth Equity Firms
Brian O'Connell
Brian O'ConnellUpdated September 29, 2022
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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. Typically, their investment “sweet spot” is a privately held company that is pre-initial public offering (IPO), but has finished their venture capital stage.Both early-stage business 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.

What is Growth Equity?

Growth equity investors focus on purchasing minority stakes in fast-growing businesses that have surpassed the startup stage. This type of funding generally comes into play later than venture capital funds, but sooner than buyout funds. For the investor, growth equity offers an opportunity to earn big profits if the target company continues to grow and expand. For the company they invest in, a growth equity investor can bring much-needed funds into the firm, giving it more financial flexibility and muscle to accelerate growth.Growth equity managers will also typically look to add value by providing strategic advice to management teams and helping them scale operations. They may also help with the exit process either by way of an IPO, share buyback, or sale to another private equity fund.

How Growth Equity is Structured

Growth equity managers acquire minority stakes (less than 50%) of a privately-held company that shows signs of future growth and generally leave control to current owners. However, they may negotiate some rights, such as board representation and change of control provisions.

What Growth Equity Invests In

Growth equity investors typically look for firms that demonstrate strong revenue growth and robust industry growth potential. The following attributes often appeal to growth equity 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

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 their operations, enter into new markets, or make acquisitions to boost revenues and profitability. 

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

  • 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.
  • 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, equity growth 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.
Recommended: How to Find Angel Investors

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 investment differ in several key ways.One is that venture capital firms typically invest much earlier than growth equity firms. 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.As a result, venture capital deals are typically considered high risk, while growth equity investments are generally considered moderate 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.

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 offer expertise in many areas, 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
Recommended: How to Find an Investor for Your Business 

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 (such as taking out different types of business loans), growth equity funding will involve giving up some control of your business.

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  1. Online lenders generally offer fast application reviews and quick access to cash. Conveniently, you can compare small business loans by filling out one application on Lantern by SoFi. 
  2. If you need to borrow money to cover seasonal cash flow fluctuations, a business line of credit, rather than a term loan, provides the flexibility you likely need.
  3. SBA loans are guaranteed by the U.S. Small Business Administration and typically offer favorable terms. They can also have more complicated applications and requirements than non-SBA business loans.

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Frequently Asked Questions

What is the definition of growth equity?
Is growth equity the same as private equity?
What is growth equity vs private equity?

About the Author

Brian O'Connell

Brian O'Connell

Brian O’Connell is a freelance writer based in Bucks County, Penn. A former Wall Street trader, he is the author of the books CNBC's Creating Wealth and The Career Survival Guide. His work has appeared in multiple media platforms, including TheStreet.com, Bloomberg, CBS News, Yahoo Finance, and U.S. News & World Report.
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