The Rise of Growth Equity
Over the past decade a new term in the alternative investment space has seen quite the increase in usage – growth equity (GE). Falling under the umbrella of private capital, growth equity investments are often seen as a middle ground between traditional venture capital and private equity strategies. With many VC and PE firms raising growth equity funds of their own, the space has seen tremendous growth since the financial crisis and is poised to continue the trend in the coming years. Today we delve deeper into the topic.
A Blurred Distinction
There is no formal definition of the growth equity space, with each investment varying significantly from another in its respective structure. Typically, growth equity investors take minority stakes in significantly mature companies; targets are often boot-strapped and entering a growth stage requiring significant capital resources. In addition, growth equity investors significantly reduce their risk profile by making all-equity investments (note the absence of leverage) into sound, proven businesses with positive cash flows and near positive EBITDA. In doing so, growth equity funds distinguish themselves in their risk-reward tradeoff with IRR returns consistently situated between (if not greater than) those of VC and PE funds, as seen in the graph below:
Figure 1 – IRR Returns by Investment Vertical (CAN & US)
Source: Pitchbook.
Also, growth equity deals will often include specific clauses such as redemption rights and protective provisions, aspects respectively found in VC and PE transactions. It should therefore be of no surprise that these funds will often participate in late-stage VC deals and leveraged buyouts.
Take the example of OMERS. Since last year, the Ontario-based pension fund has been developing out their growth equity arm, leading 3 investments in the last twelve months. In late-2019, they led a C$227mm Series F round for Coveo, an AI powered search platform for businesses. To name a few, some of their co-investors in the round were IQ Venture Capital and Investissement Quebec, two venture capital firms (IQ Ventures is now closed). This is a most-current example of growth equity’s overlapping role in today’s market.
Growth and Firepower
Given its appealing risk-return profile, growth equity has experienced significant growth across most metrics since the end of the 2008 financial crisis, seeing a strong increase in capital invested, deal count, median deal size and available dry powder.
As observed in the chart below, capital invested in Canada and the US by growth equity funds has consistently been on the rise, albeit for a few down years (2016 and 2019). Already, 2020’s level of capital invested has reached that seen in 2019, though the true test of resilience for the vertical is whether the record of $55bn set in 2018 will be broken despite the advent of COVID-19.
Figure 2 – Capital Invested and Deal Count (CAN & US)
Source: Pitchbook.
As we begin the second half of the year, it is apparent that overall deal count is trending lower. Based on the current amount of 327, we can extrapolate an estimated number of 654 deals at year end, significantly under past volume figures. On another note, the fact capital invested has comparatively kept up to previous year highs has translated into a much larger median amount of capital invested per deal ($50mm/year) in Canada and the US, as observed below.
Figure 3 – Median Deal Size (US$mm)
Source: Pitchbook.
Overall, this should be a positive for the investment vertical given its relationship to fund size and that it is indicative of growth equity’s rising firepower in the private markets. An alternative metric to further evaluate their present/future capacity to act is to assess so called dry powder, consisting of funds’ raised capital which they have yet to deploy. Though representing a minority of the dry powder in the private capital space, growth equity’s share has more than doubled from 6.5% to 16.3% over the past 15 years, with is now sitting at US$190.3bn for North America and Europe. Safe to say there are sufficient reserves to fuel many additional investments once deal appetite resumes.
Conclusion
As the economic shocks caused by COVID-19 significantly challenge the returns generated for highly levered PE-backed businesses, it should be expected to see the overall metrics covered in this post continue their positive trends over the coming years. As a leading indicator, the share of dry powder should rise further as LPs reconsider their overall capital allocations and more PE and VC firms enter the space in a bid to diversify their offerings to investors – translating into additional deal activity in the space. Considering these factors, perhaps GE will truly become a mainstream term of its own.
About Sampford Advisors
Sampford Advisors is a boutique investment bank exclusively focused on mid-market mergers and acquisitions (M&A) for technology, media and telecom (TMT) companies. We have offices in Toronto, ON, Ottawa, ON, and Austin, TX and have done more Canadian mid-market tech M&A transactions than any other adviser.