Cambridge Associates last week announced that it will begin posting quarterly performance benchmarks for “growth equity” as it has matured into its own distinct asset class. Russ Garland mentioned it WSJ’s Venture Capital Dispatch on August 7, 2013 and wrote:
“… The data make clear why growth equity is popular—it outperformed venture capital over the crucial 10-year window by nearly six percentage points. The annual return to limited partners by growth-equity funds for the 10 years ended Dec. 31 was 12.7% versus 6.9% for venture funds.
On top of that, growth equity was much less risky, generating a capital loss ratio of 13.4% compared with 35.4% for venture capital between 1992 and 2008. Significantly, its loss ratio was lower than buyouts’ 15.1%.
Cambridge Associates, in a market commentary, defines growth equity as a strategy that sits between late-stage venture and leveraged buyouts. It flows to companies that need money for growth, most of them founder-owned with no prior institutional investment and a proven business model. Investors typically take minority stakes and use little if any leverage. -“
What is Growth Equity?
Growth equity is one of three asset classes in PE: buyouts,(VC) and growth equity.
Here is what it does/what it’s used for:
- Capital extension (cushion to reach next milestones/additional milestones).
- Company, asset, or intellectual property acquisition financing.
- Convertible, subordinated and mezzanine loans.
- Management buy-outs and corporate spinout financing.
- Revenue acceleration (sales and marketing development/entering new markets, manufacturing/corporate expansion, etc.)
- Vendor financing.
In general, the characteristics of growth companies are:
- Fluid Financials (wild swings in earnings from year-to-year and quarter-to-quarter)
- High Market Value with a disconnect to revenues/earnings, with earnings that can be negative.
- Lower debt than more established companies.
- Low/no dividend yield
Why is Growth Equity perhaps the best asset class among the three?
Larry Cheng, Managing Partner/Founder of Volition Capital puts it nicely (link):
1. The equity of the Buyout firm is not the senior security on the cap table. Growth equity investments are traditionally done in companies that haven’t taken prior institutional investment and don’t require future institutional investment and even as mezzanine, will be senior to equity. [/quote]
2. Growth equity invests in a minority equity share while Buyouts typically are controlling shares.
Buyouts invest in companies where revenues/profits are steady, while growth equity invests, as noted above, at milestones/spikes up in revenues.
“As far as comparing it to VC, venture investments are often done at the very early stages of a business’ lifecycle where the risks are high and little is proven. It’s a high risk asset class with moderate reward potential at the fund level.”VCs are beaten by the law of numbers and as, already stated, unknown future capital requirements/dilution.:
Recommended further reading:
Matthew Stewart of Fenwick & West LLP explains growth equity characteristics and protective provisions here. (All Rights Reserved)
Brian Rich (Catalyst Investors) speaks with Deirdre Bolton on Bloomberg Television’s “Money Moves.” (Source: Bloomberg) Video link