What is Growth Equity?
Growth Equity is also known as expansion capital is a form of capital investment usually undertaken in the form of minority investment in relatively mature and large corporates which are looking forward for some structural and transformational change or a large growth prospect in future or for business operation expansion or for acquisition or entering a new market.
Growth equity is interchangeably used with growth capital or expansion capital, which deals in minority investments and is generally dealt with in preferred shares. The risk involved in such type of investment is minimal, whereas the return on investment is very high. Therefore, this is the preferable form of investment. It is preferred by the businesses to enter into a new market, expand their business in new operations, and to boost the company’s revenue and acquisitions. Basically, companies without debt history and low leverage policies are chosen by the investors as the risk potential is very low in such companies. Investors who invest in such types of companies are usually large investment firms such as mutual firms and hedge funds, private equity firms, and venture capitalists, etc.
Mentioned below are Profits of a stabilized business and its chart showing net profits for different years:
Excel chart for above profits figures is as follows:
How Does it Work?
Growth equity is a segment of a private equity asset class that is very distinct and separate from venture capital or leveraged buyouts. It works to provide ventures like providing high returns with minimum risk. The risk of the capital loss is moderate as compared to other investment firms. The holding period is three to seven years, where the target for the internal rate of return is around 30-40 percent. The capital invested can be targeted to multiple 3 to 7 times. The investors keep evaluating the risk-adjusted return profile of various investment alternatives. The companies involved in investment are already operating in an established market with proven products. The risk involved is only of the execution and management risk.
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Use of Growth Equity
- Restructuring the Balance of a Company: It is used to restructuring the balance sheet of a company and also to reduce the debt capital.
- Subsidize Business Operations: Most business houses use this investment to expand and subsidize their business operations, to boost the company’s profitability and revenue expansion and to enter into a new market for further enhancement of the profit.
- High Growth Potential: Investors of growth equity benefits from high growth with a moderate risk of investment. The investment is very nominal and executed with preferred shares. Companies chosen for investments are generally debt-free or at low leverage.
Growth Equity vs. Venture Capital
Although both venture capital and growth equity investors assume the risk involved while investing, both of this investment varies greatly in different aspects like the extent of risk, cash flow perspectives, growth, etc. In comparison, venture capital investment does not include debt in its capital structure. Venture capital generally targets business at initial stages with less historical financials. Companies have a high level of the market, funding, technology risk, etc. in venture capital investment as compared to growth equity investment. Also, a high risk of company failure is involved in venture capital, whereas in growth equity investment, the limited risk is involved. Companies are usually having low revenue and usually negative cash flow in venture capital as compared to growth equity, where there are sustainable revenues and positive cash flow. In growth equity investment returns are based on growth, revenue, and cash flows, while venture capital returns are based due to growth in the addressable market and company market share.
- This investment helps in facility expansion, equipment purchases, product development, sales, and marketing initiatives.
- Apart from higher financial growth equity investment also provides access to business expertise by adding a valuable source of guidance and consultation into the business.
- Since the funding is based upon the choice and level of interest that investors have in the business, there is no limit to the capital to be raised.
- It is not required to make monthly payments to investors; hence the sole focus shifts to the needs of the business and its rate of growth.
- It may be a frustrating and time compelling process to attract potential investors.
- A rigorous research exercise must be carried out beforehand, investing in new business.
- The investors may sell shares of the company to someone outside the business, which leads to opposing views and lack of sufficient experience getting involved in the business.
Growth equity investment is one of the best options for the companies that are looking for the capital for its business expansion or operation restructure. It provides an easy way of venturing out into new markets and acquire a significant position. Also, it helps to bring the transformational event in the life span of the businesses.
This has been a guide to what is Growth Equity and its definition. Here we discuss uses, funds, and how does growth equity work along with advantages and disadvantages. You may learn more about financing from the following articles –