Growth Equity vs Private Equity: Key Differences and Investment Strategies

Private equity encompasses many types of assets and strategies, including growth equity. Understanding the key differences is important when comparing traditional private equity vs growth equity.

Although a broad asset class, the term “private equity” often refers to “buyout” strategies which involve acquiring controlling stakes in more mature companies, with an emphasis on restructuring and improving operations.

Growth equity typically refers to minority investment stages in younger companies to support expansion initiatives. Like buyout, growth equity investing involves investing in privately-held businesses with established business models and proven revenues.

The level of risk, the industries they target, and their investment approaches vary between growth equity and private equity. By taking a closer look at these key distinctions, investors can make more informed decisions about which strategy suits their goals and risk tolerance.

Growth Equity is a type of Private Equity

Growth equity is sometimes referred to as “growth capital” or “expansion capital” and is an investment strategy typically focused on acquiring minority stakes in late-stage companies that exhibit high growth potential. This infusion of capital aims to fund the companies’ continued expansion plans. Growth equity investors typically include private equity firms, late-stage venture capitalists, and investment funds (such as mutual or hedge funds)¹.

While growth equity is a type of private equity, it is distinct from the more common buyout strategy that many people associate with private equity. Buyout strategies typically involve acquiring controlling stakes in mature companies, whereas growth equity investments are targeted at established, growing companies. To further clarify the differences between growth equity and other private equity strategies, consider the following comparison:

Key Differences: Growth Equity vs. Buyout

Growth equity investments are made in return for equity stakes in the companies and are typically expected to generate significant returns through exponential growth². Growth equity investments carry a higher degree of risk compared to more traditional private equity buyouts, but they also offer the potential for higher returns as the underlying companies grow and succeed³.

In short, growth equity is a type of private equity that targets established, high-growth companies in need of additional funding to fuel their expansion plans. While it shares some similarities with other private equity strategies, growth equity notably differs from buyouts in terms of ownership, growth rate, company maturity, risk and return, and the focus on leverage. By understanding these key distinctions, one can better appreciate the unique characteristics and potential benefits of growth equity as an investment strategy.

Footnotes

1. Growth Equity – Overview, Uses, and Characteristics: https://corporatefinanceinstitute.com/resources/knowledge/finance/growth-equity/ ↩
2. 3 Key Types of Private Equity | HBS Online: https://online.hbs.edu/blog/post/types-of-private-equity ↩
3. Growth Equity vs. Private Equity: Understanding Key Differences: https://www.pehub.com/growth-equity-vs-private-equity-understanding-the-key-differences/ ↩

Private Equity vs Growth Equity: Key Differences

Investment Focus

Buyout: In a buyout strategy, investors acquire a controlling stake in an existing company, typically with the goal of improving operational efficiency and financial performance. This can involve restructuring the company, divesting non-core business units, or implementing new management practices.

Growth Equity: Growth equity, which is a type of private equity, focuses on providing capital to fairly established companies with potential for high growth. These investments often take the form of a minority stake, aiming to accelerate the growth of the company by funding expansion initiatives such as entering new markets or making strategic acquisitions.

Risk Profiles

Buyout: Buyout strategies are generally considered to be lower risk due to the fact that buyout has performed well historically, despite notoriously high debt loads. Generally, buyout investors due okay even if the companies do not.

Growth Equity: Growth equity investments are generally considered more risky than buyouts, due to the fact that the companies are less mature. This is despite the fact that growth equity targets companies that are already producing revenues and experiencing growth, even if not yet profitable.

Investment Horizons

Buyout: Investment horizons for buyout strategies are typically longer. This allows for the necessary time to execute operational improvements and exit strategies.

Growth Equity: Growth equity investments, on the other hand, have shorter investment horizons. As their investments aim at accelerating growth, the investors expect to exit when IPO window is receptive and rewarding.

Leverage

Buyout: Leverage is a common component in buyout transactions, with debt often used to finance a significant portion of the acquisition. The use of leverage can amplify returns if the company’s performance improves, but also increases the risk of bankruptcy if the company struggles to service its debt.

Growth Equity: Leverage is less common and less significant in growth equity investments. While debt may still be utilized, the focus remains on equity financing to fuel the company’s growth.

Company Maturity

Buyout: Buyout strategies target more mature companies that often have established revenue streams, a solid market position, and a well-defined business model. The focus is on unlocking value through operational improvements and financial restructuring.

Growth Equity: Growth equity investments are directed towards younger, high-growth companies. These companies may not yet be profitable but are achieving significant revenue growth and demonstrating a scalable business model. The focus is on supporting and accelerating the company’s growth trajectory.

Pros and Cons of Growth Equity

Advantages

Growth equity investments have several advantages for both investors and companies:

1. Higher Growth Potential: Since growth equity targets late-stage, high-growth companies, there is significant potential for rapid revenue and valuation increases.
2. Risk and Reward Balance: Compared to venture capital, growth equity investments are less risky due to the proven business models and market positions of the target companies. However, they still offer attractive upside potential compared to traditional private equity buyouts.
3. Exit Flexibility: Investments in growth-stage companies can lead to various exit options like acquisitions, public offerings, or secondary sales.

Disadvantages

Despite the benefits, there are challenges and potential downsides associated with growth equity investments:

1. Higher Valuations: High-growth companies can command premium valuations relative to buyouts, which can lead to more expensive investments and lower returns for investors, especially during market downturns.
2. Competitive Deal Sourcing: Since growth equity investments are targeted by many types of investors, there can be increased competition which drives up prices and risk.
3. Unpredictable Market Forces: The success of growth equity investments can be influenced by external market factors, such as economic cycles and changes in industry regulations. Such factors can introduce risk and affect a company’s growth trajectory. A volatile stock market may also close the IPO market.
4. Execution Risk: High-growth companies may face challenges related to scaling their operations, managing working capital, and adapting to new market conditions. Growth equity investors need to be prepared to address these challenges and support their portfolio companies through potential complexities.

Pros and Cons of Buyout

Advantages

Buyout investments, a type of private equity investment, offer several benefits for companies and investors.

• Increased efficiency: A buyout can eliminate overlapping services or product offerings, reducing operational expenses and potentially increasing profits. Companies can compare processes and select the most efficient ones.
• Access to capital: Buyouts often provide companies with access to substantial capital, allowing them to finance growth initiatives, develop new products, and make strategic acquisitions.
• Management expertise: Private equity firms typically have experienced management teams that can help improve the operational performance of a company. This expertise can lead to better decision-making and business strategy execution.
• Alignment of interests: Private equity firms usually have a significant ownership stake in their portfolio companies, fostering a close alignment of interests with management. This can lead to better long-term planning and more effective implementation of improvement initiatives.

Disadvantages

Despite the benefits, buyout investments also have some drawbacks that should be considered.

• High leverage: Buyouts often involve substantial amounts of debt, which can increase the financial risk for companies. High leverage can lead to higher interest expenses, making it more challenging for a company to achieve its financial objectives.
• Control & influence: Following a buyout, the private equity firm may exert significant control over the company’s operations and decision-making. This influence can lead to disagreements between the private equity firm and the current management team.
• Short-term focus: Some buyout investments may have a relatively short time horizon. A short-term focus can sometimes result in decisions being made with an eye towards exiting the investment quickly, rather than long-term value creation.
• Fees: Private equity firms charge management fees and carry interest, which can reduce the overall return for investors. These fees can be substantial, and it is essential to weigh them against the potential returns when considering buyout investments.

Private Equity vs Growth Equity: What To Invest In?

To choose the right investment strategy, investors should also examine how each type of investment aligns with their objectives. Growth equity and private equity investments each present unique opportunities and risks. For example:

• Growth equity investments can offer higher potential returns due to the faster growth rate of the target companies. However, they also come with a higher level of risk, as these companies may not yet be profitable and may require additional capital to continue their growth trajectory.
• Private equity investments often target companies with a proven track record of profitability, which can provide more stable returns. However, the potential for significant capital appreciation may be limited as these companies are typically more mature and have slower growth rates.

In summary, the right investment strategy will depend on an investor’s risk tolerance, return expectations, and overall investment objectives. By carefully evaluating the differences between growth equity and private equity, and considering the factors mentioned above, investors can make informed decisions that align with their goals.