STARTUP FUNDING 101: GROWTH EQUITY
Growth equity is generally for later-stage startups and is invested at Series C, D, E, and beyond.
GROWTH EQUITY FUNDS EVENTS
A startup may eventually reach a point where it needs to expand or restructure, enter into new markets, hold an initial public offering (IPO), merge with another company, or be acquired. To reach its next stage, the company may need additional funds to purchase new equipment, expand facilities, hire sales representatives, invest in marketing, develop new products, or or pay for costs associated with an acquisition or IPO.
Growth equity (also called expansion capital or growth capital) is a type of equity investment in more mature startups with the purpose of facilitating one of these transformational events in the company's lifecycle, but without affecting a change in control.
Generally, the company will be the (or one of the) market leaders in their industry with at least a few million in revenue, decent revenue growth in the last few years, a proven business model, and a clear path to profitability, Even if the company is already profitable, it will tend to have lower free cash flow (FCF) after core expenses (paying employees, cost of business), and therefore lack sufficient cash flow to fund the event without outside capital.
Growth equity investments range from $10 million to $500 million, depending on the Series and intent for the funds. Since growth equity enters when the company is already established, there is much less risk than earlier-stage venture capital deals. With less risk and less potential upside comes a lower expected ROI (usually between 3 - 5x).
GROWTH EQUITY ≠ PRIVATE EQUITY
Note that growth equity is often referred to as private equity, which is confusing because they are not the same type of investment. Because the purpose of growth equity (and VC) is to help the company reach a specific milestone without resulting in a change in control, the growth equity firm can only take a minority stake (less than 50%) in the company.
Adversely, private equity firms generally seek to purchase entire companies (not just a percentage of equity) at a discount if possible, scale them for about 4 - 7 years, and then sell to a strategic buyer for a few million to tens of billions. These are wholly different business models.
Of course, today, this is a little more confusing as some private equity firms will fund growth equity events. With more money going into private companies, lines have been blurred.
The most important take away for a negotiation, is that the firm investing in a company will treat the deal more like the type of transaction they predominately or traditionally perform. For example, a private equity firm financing a growth equity event may expect more of a discount, and may possibly structure the deal so that they can take control of the company if things unexpectedly go downhill. It's important to understand the mindset of the particular investor.