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 that are looking forward to some structural and transformational change or a large growth prospect in future or business operation expansion or for acquisition or entering a new market.
Growth equity is interchangeably used with growth capitalGrowth CapitalGrowth Capital, also called Expansion capital, is the amount of money offered to the fast-growing businesses requiring finances to expand their operations or new market ventures. All in all, it helps facilitate target firms for accelerating their growth rate. or expansion capital, which deals in minority investments and generally in preferred sharesPreferred SharesA preferred share is a share that enjoys priority in receiving dividends compared to common stock. The dividend rate can be fixed or floating depending upon the terms of the issue. Also, preferred stockholders generally do not enjoy voting rights. However, their claims are discharged before the shares of common stockholders at the time of liquidation.. The risk involved in such an investment is minimal, whereas the return on investment is very high. Therefore, this is the preferable form of investment.
Table of contents
- Growth equity is undertaken to push expansion capital for small investments made by mostly large corporates to bring about a structural change in their company proceedings.
- Such a type of equity is very different from asset classes and leveraged buyouts and is done by investors requiring minimum risk.
- Growth equity provides various benefits, such as it helps subsidize business operations, has higher growth potential, and restructuring the company’s balances.
- Growth equity has certain pitfalls, such as it is a long, tiring process and requires extensive research methodologies, including outsider selling, that can cause conflicts.
Growth Equity Explained
Growth equity is private equity asset classAsset ClassAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples. segment 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 capital loss is moderate as compared to other growth equity firms. The holding period is three to seven years, and the target for the internal rate of return is around 30-40 percent. The capital investedCapital InvestedCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc. can be targeted to multiple 3 to 7 times. The investors keep evaluating the risk-adjusted returnRisk-adjusted ReturnRisk-adjusted return is a strategy for measuring and analyzing investment returns in which financial, market, credit, and operational risks are evaluated and adjusted so that an individual may decide whether the investment is worthwhile given all of the risks to the capital invested. 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 the execution and management risk.
It is preferred by businesses to enter into a new market, expand their business in new operations, and boost the company’s revenue and acquisitions. Investors choose companies without debt history and low leverage policies as the risk potential is very low in such companies. Investors who invest in such companies are usually large investment firms such as mutual firms and hedge funds, private equity firmsPrivate Equity FirmsPrivate equity firms are investment managers who invest in many corporations' private equities using various strategies such as leveraged buyouts, growth capital, and venture capital. The top private equity firms include Apollo Global Management LLC, Blackstone Group LP, Carlyle Group, and KKR & Company LP., venture capitalists, etc.
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Why Growth Equity?
Growth equity investment is one of the best options for companies looking for capital for their business expansion or operation restructure. It provides an easy way of venturing into new markets and acquiring a significant position. Also, it helps to bring a transformational event in the life span of the businesses.
- Restructuring the Balance of a Company: It is used to restructuringRestructuringRestructuring is defined as actions an organization takes when facing difficulties due to wrong management decisions or changes in demographic conditions. Therefore, tries to align its business with the current profitable trend by a) restructuring its finances by debt issuance/closures, issuance of new equities, selling assets, or b) organizational restructuring, which includes shifting locations, layoffs, etc. the balance sheet of a companyBalance Sheet Of A CompanyA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. reduce the debt capital.
- Subsidize Business Operations: Most business houses use this investment to expand and subsidize their business operations, boost the company’s profitability and revenue expansion, and enter into a new market for further enhancement of the profit.
- High Growth Potential: Investors of growth equity benefit from high growth with moderate investment risk. The investment is very nominal and executed with preferred shares. Companies chosen for investments are generally debt-free or at low leverage.
Let us consider the following examples to understand how growth equity investment works:
Company A has been a consistently growing company in its region. Business X, which aspires to have some additional income to boost financing for its business operations, decides to invest in growth equity vehicles. It owns 20% shares of company A to ensure it has its own share of profits in whatever company A makes.
Mentioned below are the profits of a stabilized business and its chart showing net profits for different years:
The Excel chart for the above profits figures is as follows:
This is what the growing company’s statistics look like. Studying the chart can help any entity have a minority interest in it.
- 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 to the business.
- Since the funding is based upon the choice and level of interest 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-consuming 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 a lack of sufficient experience getting involved in the business.
Growth Equity Vs Venture Capital
Although both venture capitalVenture CapitalVenture capital (VC) refers to a type of long-term finance extended to startups with high-growth potential to help them succeed exponentially. and growth equity investors assume the risk involved while investing, these investments vary 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 structureCapital StructureCapital Structure is the composition of company’s sources of funds, which is a mix of owner’s capital (equity) and loan (debt) from outsiders and is used to finance its overall operations and investment activities.. Venture capital generally targets businesses at initial stages with less historical financials.
Companies have a high level of market, funding, technology risk, etc., in venture capital investment compared to growth equity investment. Also, a high risk of company failure is involved in venture capital, whereas in growth equity investment, a limited risk is involved. Companies usually have low revenue and usually negative cash flow in venture capital compared to growth equity, where there are sustainable revenues and positive cash flow.
In growth equity investment funds are based on growth, revenue, and cash flows, while venture capital returns are based on growth in the addressable market and company market share.
Frequently Asked Questions (FAQs)
Growth equity is a sort of extra capital required by corporates, so they purchase huge holdings in some other firms. However, private equity is when a large corporation buys out entire businesses, mainly small companies, to increase their assets.
Growth equity funds pitch to companies with higher growth potential and business prospects. Their goal is to stay in stock until profits are claimed, which is not true in buyouts.
Companies choose to invest in growth equity because it is an attractive tool with low risks, with major returns, as it means investing in highly potent businesses.
This has been a guide to what is Growth Equity. Here we explain it vs venture capital, reasons why choose it along with examples. You may learn more about financing from the following articles –