Growth equity is an investment that can help established businesses grow to the next level. Situated between venture capitalism and leveraged buyouts, it is sometimes referred to as growth capital, growth expansion, or expansion capital.
Growth equity is not used to keep a business afloat. Instead, it's used to help a business expand into new markets, acquire other companies, find new customers, or scale operations.
What type of business qualifies for growth equity?
Private firms invest growth equity in companies that are mature and have the potential for large growth. These companies already have a solid customer base, strong business plan, viable product, and driven management team.
Businesses qualifying for growth equity are profitable and feature a positive cash flow. They also have low leverage or no debt.
Companies interested in growth equity are stable in proven markets, and are equipped with strategies to expand business, but need more capital to do so. Growth-stage companies may need extra capital for enhancing existing or developing new products, supporting or scaling sales and marketing, or funding acquisitions.
Expansion capital also allows for gaining new customers, paying new employees, buying buildings or equipment, or liquidating early for existing shareholders.
What's the deal?
Expansion capital comes from growth equity firms, private equity firms, and some venture capital firms. Growth capital may also come from mutual funds and hedge funds. The goal of growth equity is to increase the company's revenue and profitability, typically by planning, funding, and growing operations. The process minimizes risk while working to maximize returns. Investors help create value with profitable revenue growth, and want consistent and modest returns for their effort.
Firms invest in the millions in exchange for a minority or majority stake in the company. The invested amount can range anywhere from $2M to $50M, depending on the industry. Investments in growth equity are held for a short amount of time, usually between 3 years to 7 years, from purchase to return.
Less than venture capital and more than private equity, the amount of money returned compared to the amount of money invested is about 3 to 5 times, known as the money-on-money multiple. The performance measure of growth capital, the internal rate of return, is typically between 30% and 40%.
What's the risk?
The beauty of growth equity is the overall moderate level of risk, unlike venture capital, which comes with higher risk. Growth capital is attractive to investors since companies are well established in their field and bring in consistent revenue. Thus, there is no market risk.
Likewise, established businesses are already selling a marketable and proven product, and do not have product risk.
Growth stage businesses don't carry large amounts of debt, so there's no default risk, either. The highest risk for growth equity comes from execution, which is unavoidable across most investments. Other risks include capital loss, and management, as the business grows.