What is Growth Equity? | Workhorse Capital (2024)

Risk and return are inextricably linked. Growth equity investing works to minimize risk while achieving venture-like returns. The return profile of growth equity can be best understood by comparing it to the venture capital and leveraged buyout private equity asset classes.

Institutional investors who invest in private equity constantly evaluate the risk-adjusted return profile of their investment alternatives. The objective of institutional investors is to diversify but also to select investments that have an attractive risk-adjusted return. With the release of research analyzing growth equity returns, many institutional investors now consider growth equity to offer the most attractive risk-adjusted return profile in private equity. Whether this is a short-term phenomenon or a long-term trend is yet to be determined. However, there is no arguing that growth equity offers an attractive combination of downside protection and upside potential. After all, companies that receive growth equity are operating in established markets with proven products and are by definition growing. In a sufficiently large market, the upside potential of growth stage businesses can be significant and on par with venture capital, while featuring lower risk.

Venture capital, growth equity and leveraged buyout investors all assume risk when they make an investment. However, the risks that each is willing to take vary greatly. By understanding which risks each type of investor is willing to take, entrepreneurs can better target their fundraising efforts to focus on the investors that are the best fit for the entrepreneur’s business. The table below describes the risks inherent in each type of private equity investment.

The primary risks undertaken by growth equity investors are execution and management risk. In contrast, venture capital investors often assume market and product risk in addition to execution and management risk, making venture capital the highest risk asset class within private equity. Conversely, leverage buyout investors typically undertake a lower level of execution and management risk than growth equity investors, but also accept credit default risk associated with financial leverage that is not typical for growth equity investments. Growth equity offers a modest level of risk , which can be mitigated by the value creation and team development tools that growth equity investors typically employ to support their portfolio companies.

Venture capital, growth equity and leveraged buyout investors invest at very different stages of a company’s life-cycle. Venture capitalists typically target early-stage businesses with little financial history. By contrast, leveraged buyout investors seek investments in companies that are financially mature, with a long track-record of revenue and profitability that can be analyzed. Growth equity investors make investments at an inflection point in a company’s history, where there may not yet be a long history of financial performance, but the core economics of the businesses are proven and can be evaluated. These core economics are referred to as unit economics.

Ultimately, growth equity investors seek to invest in businesses that have established a repeatable and scalable customer acquisition process. When a customer acquisition process is repeatable and scalable, and the lifetime value of a new customer far exceeds the customer acquisition costs, growth equity investors gain confidence that incremental investment in customer acquisition will yield profitable revenue growth. In such cases, entrepreneurs and growth investors are well justified in partnering to accelerate a company’s growth.