From early-stage venture capital to executing a buyout of a long-established company, private equity investing can take many forms. In this article, we’ll be zooming in on growth capital.
Sometimes called growth equity or expansion capital, growth capital is a form of investment that tends to target already profitable companies, with the explicit purpose of helping them to grow — to expand, access new markets and reach the next stage of their development.
Read on to learn what growth capital is, what benefits it can provide to businesses that receive it — and why investing in private equity growth capital transactions can be attractive to investors.
What is Growth Capital?
Growth capital, also known as growth equity or expansion capital, is the name given to investments in already mature companies to help those companies grow (as opposed to venture capital which typically targets pre-profit companies). Growth capital investments are usually applied to enable a company to accelerate an established expansion plan.
Key features of growth capital:
- Targets mature, profitable companies
- Used on projects to drive growth
- Can be of any scale
- Private equity investors typically take a minority stake rather than a majority
Unlike in a buyout, where investors acquire ownership of the target company, growth capital sees investors take a smaller stake — although, as we’ll see, they will still expect significant influence over how the business deploys the proposed investment and in terms of the ongoing operations of the company.
Investors usually seek to exit once the business they have invested in hits a set of predetermined growth targets. When this time comes, growth equity investors can seek an exit through a range of routes, including an initial public offer (IPO) to take the company public, a share buyback, or a sale to another private equity fund or trade buyer.
Who is Growth Capital For?
Unlike venture capital, which goes to early-stage pre-profit companies and start ups with the potential for very rapid growth — but also very significant risk — growth capital is a source of funding for businesses at a more mature stage in their life cycle.
Growth equity investors tend to target companies that are already profitable and which demonstrate potential for scalable growth moving forwards, but that nonetheless, need more funding to achieve that potential.
Businesses may seek growth capital to enable them to:
- Enter new markets and reach new customers
- Expand their operations and infrastructure
- Develop new hardware/software or technology
- Grow or upskill their teams
- Make acquisitions
For investors, meanwhile, growth capital can provide a great way to acquire a stake in a company without the uncertainty and higher risks of early-stage venture capital investment, but still with attractive growth prospects. In many cases, growth capital investors are the same, they target buyouts in companies of a comparable scale as the challenges of growing companies of that level are similar, irrespective of the type of investment taken.
How Do Growth Capital Investments Work?
As noted above, growth equity tends to be suited to businesses that have already proven themselves to be profitable, but which need some more funding to progress to the next stage of their development. Typically, the company will have an established track record of delivery that gives credibility to the potential return it can deliver from this additional financing. For example, a software development firm with an established product and customer base may seek growth capital to enable it to evolve its software platform onto its next generation or introduce a new product targeting the same customers.
To attract investors, a business that meets these criteria should develop an expansion plan. Investors will review and may wish to challenge these plans to ensure that they are realistic and capable of delivering the growth required to generate the investment returns targeted.
Once investors have decided where to put their money, they draw up legal arrangements and transfer the funds.
From there, they can begin working with the business to add value. As we’ll explain below, growth equity investors add value by working with existing management as trusted partners to develop and realise growth strategies, as well as provide the funding for them.
Benefits of Growth Capital
The main benefit of growth capital is the most obvious one: it can provide businesses with the funds needed to expand, extend and outcompete their rivals. Having access to more capital allows businesses the opportunity to make bigger plays and potentially progress further than without that capital injection.
In addition, although it results in equity dilution, growth capital has benefits over other sources of funding such as commercial loans or debt financing, where the costs and frequency of repayment can cause cash flow issues for businesses in the longer term. Taking on growth capital is a lower risk to the company.
From the investor perspective, growth capital can potentially deliver high returns, as a well-executed expansion strategy can take an already profitable company to new heights. This is especially attractive to those investors seeking less volatility of returns than those typical in early-stage venture capital investments but still looking for attractive growth profiles.
Of course, growth equity investment can provide businesses with more than just money.
One major benefit of growth capital for businesses is the access it can provide to experienced professional investors, who can use their knowledge, expertise and network to help develop expansion strategies and advise on operational matters.
Again, it is important to note how growth equity differs from buyouts. In a buyout, investors acquire a majority stake, and so have rights commensurate with being the majority owner. In the case of growth capital, they will usually take a minority stake, hence the rights they expect will be in line with that minority position.
Typically, this takes the form of consent over actions taken by the company rather than the right to directly make changes, with final strategic and operational decision-making authority remaining with the management team/majority owners. A growth equity investor will expect to help professionalise a business in the same way as an MBO investor would, and will require the same quality and regularity, such as frequent reporting and board meetings.
In addition to advice and support, growth capital investors can also provide businesses with access to the investors’ network.
At Connection Capital, for instance, we often draw on our own 1,500-strong client network, which includes experts from multiple industries, including entrepreneurs and non-executive directors, who can help businesses receiving expansion capital make new hires, develop new partnerships, acquire new clients and ultimately to grow faster.
How and Why to Invest in Growth Capital
With the potential to work with already profitable and established businesses with a track record and clear, credible plans to accelerate their growth, it’s easy to see why growth capital would be attractive to investors.
But, as with many classes of private equity investment, it can be difficult for private individuals to gain access. Most private equity transactions tend to be funded by funds accessible only to institutional investors, such as pension funds, sovereign wealth funds or family offices.
But this doesn’t need to be the case. Here at Connection Capital, we take an alternative approach. We raise capital to invest in UK SMEs from our network of private individual clients. This way they can access private equity investment and seek to diversify their investment portfolios, in the same way that much larger investors are able to.
We hope this article has helped you to get to grips with what growth capital is and the benefits it can provide. From funds to finance acquisitions and expansion to expert advice and networking, growth equity can be a huge boon to businesses. At the same time, investors in growth capital may realise significant returns by working in partnership with established companies that have proven themselves to be profitable, with strong potential for future success.
If you’d like to explore getting into growth capital or other forms of private equity investment, don’t hesitate to explore the options we can offer aspiring investors.
Private equity investments are high risk and speculative which means there is no guarantee of returns and investors should not invest unless they are prepared to lose all of their money. Past performance is not a reliable indicator of future performance. This type of investment is illiquid so can’t be easily accessed until the exit point. The investor is unlikely to be protected if something goes wrong.