In the forty years since growth equity investing first started, much has changed. The investment strategy of growth equity GPs has been refined and expanded. The growth industries of the 1980s are not quite the same as the growth industries of today. Software hadn’t quite eaten the world back then.
Now, providing capital has become increasingly commoditized. With financing readily available, founders have more power when it comes to choosing partners and aligning terms. GPs too have shifted where they focus their attention. Growth Equity firms now take minority and majority positions. The most differentiated strategies include a significant focus on operational improvements and providing resources – not just capital – to portfolio companies so that they can expand rapidly but in a way that is more sustainable over the long term.
Ultimately, these shifts have created a growth equity industry that is stronger throughout all types of market cycles and the result is companies that are as well. But it hasn’t been easy. GrowthCap took a look back at the industry’s first days and spoke with several pioneers in the field to get their impressions on how growth equity has evolved.
When Chuck Feeney, co-founder of Duty Free Shoppers, established General Atlantic in 1980, his goal was to invest in founders and companies like his. Growth equity would help businesses between venture and traditional private equity expand their footprint. These companies weren’t startups, but they weren’t decades-old mature businesses either. They were companies that had a steady business and were ready to go to the next level. Founders benefitted by having capital available to grow and investors could get into a company early, but with less risk than coming in at the venture capital stage.
As growth equity investing got off the ground, it attracted firms like TA Associates, which had previously been investing in venture stage companies and opted to start pursuing investments in more mature companies exclusively. By the 1990s, new firms like JMI Equity were coming to market solely focused on growth equity. And in the 2000s, traditional large private equity firms such as TPG, KKR and Blackstone started entering the space.
“When we started in growth equity, we were focused on founder-owned companies that were profitable,” explains Brian Conway, Chairman of TA Associates. “We were invited guests and we offered advice.”
For Peter Arrowsmith, General Partner of JMI Equity, when the firm started, “it was a small fund, therefore we did not write big checks. But our strategy has always been to find companies that had established themselves far enough along for us to have confidence that what they were doing, the problems they were solving, were big enough and clear enough that you could build a real business around them.”
Co-Managing Partner at TPG Nehal Raj, provided his take on the early days of growth equity tech investing in a GrowthCap interview a few years ago, “I remember back in 2002 there were only a handful of firms investing in technology at all in any large scale. There were always the VCs but not many doing either large scale growth equity or buyout type deals. Francisco was one, TPG was another, and there have been just a couple of other firms.”
In many ways, growth equity has evolved with the broader economy. The industries that are well suited for this type of investing – consumer, financial services, healthcare, life sciences, technology are all known for being centers of innovation and disruption. Within each of these sectors, new industries and business models are defining the future economy. Growth equity is designed to support those innovations and help the companies leading the way create durable revenue and service delivery models. In order to do that effectively, GPs have also had to innovate and expand their approach.
“In the beginning, it was more common to be a minority investor,” Conway says. “Now there’s a spectrum in our portfolio – we are minority and majority investors. We’re levered and unlevered investors. In some cases, we might just be focusing on the go-to market strategy of a given company. In other cases, we are much more active, driving M&A and enhancements throughout the organization. Our role now is a lot more active, but customized, a lot more tailored to a given opportunity.”
Growth equity GPs now commonly offer access to a network of operating partners that can provide services like marketing or administrative support. They also help identify ways to optimize and expand revenue streams as well as finance bolt-on acquisitions.
For firms like JMI Equity which invest solely in software companies, making growth equity investments in software was centered mostly around license/maintenance. Now, “95% of what we invest in is 90% or above recurring revenue businesses,” explains JMI’s Arrowsmith. “The good news about those is that they’re just hardier businesses…and they take a bit longer to grow…and therefore the opportunities to get involved as an investor have widened.”
The evolution with growth equity has institutionalized the industry and made it more comprehensive. Dave Welsh, KKR’s Head of Technology Growth Equity, commented in a past GrowthCap interview, “Now it is becoming well established, meaning there is a group of firms where growth equity is their focus and growth equity is what they do. It has matured into a real industry over the last 10 years. I think it is here to stay, and I think that is a good and necessary part of the overall ecosystem as companies mature from start-ups all the way through to public entities and beyond.”
Looking ahead, nascent trends are beginning to foreshadow what the next phase of growth equity might be. The rise of subscription revenue models, for example, is creating durable revenue not just for software companies but also for consumer goods. Companies like Birchbox and StitchFix have adapted subscription models for cosmetics and clothes. The rise of FinTech and services like robo-advisory are opening up new investment opportunities in financial services. Telehealth could change how most people access the healthcare system and create new revenue models within that sector of the economy.
Growth equity GPs are also adapting their financing models once again to take advantage of how the industry is evolving. Jon Korngold, Global Head of Blackstone Growth, tells GrowthCap that much of the focus now is on minimizing the execution risks that are often part of high growth expansion. That may mean being more flexible with holding periods or financing terms. Sponsors are also working more closely with founders on the long-term vision. “We’re often working with businesses that don’t really need our capital,” he explains, noting that this creates unique opportunities to work with management on how to grow in all market cycles. “We’re taking a curated approach to our portfolio and putting more resources behind a smaller number of companies.”
For companies that have a long runway for growth ahead, more sponsors are considering continuation funds or single asset funds so that they can continue to participate in that growth and provide expertise.
The nature of exits in growth equity is also changing. “What we’re doing more of now is retaining a stake in the company or doing a 50/50 deal with another firm,” says Conway. “That way we can still support the company and participate in future growth. These types of transactions have become common in growth equity and I think they will continue. There’s a risk mitigation component to them, achieving partial liquidity, but also continuing to benefit from sustained growth.”
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