Often referred to as the intersection between venture capital and leveraged buyouts,[i] growth private equity investment (“growth equity”) has skyrocketed in recent years and continues to draw the attention of limited partners seeking exposure to emerging technology companies with potentially lower risk profiles than those financed at earlier stages of development.[ii] In 2018, growth equity investment reached record levels, with $66.1B invested across 1,057 deals in the United States (“U.S.”) alone.[iii] 2018 also saw the largest-ever growth equity fundraise with the close of New York-based Insight Venture Partners’ $6.3B technology-focused growth equity fund.[iv] This article will provide an overview of growth equity as an alternative investment asset class, and will also discuss its increasingly important presence in the financial technology (“Fintech”) sector.[v]
I. Defining Growth Equity
To date, there is no universally accepted definition of growth equity (also commonly referred to as growth capital or expansion capital) due, in part, to its similarity to other forms of alternative investment. The U.S. National Venture Capital Association (“NVCA”) and its Growth Equity Group have described growth equity as a “critical component” of the venture capital industry, and have defined growth equity investments as those that exhibit some, if not all, of the following characteristics: investors typically acquire a non-controlling minority interest in the company; investments are often unlevered or use only light leverage; the company is founder-owned and/or founder-managed with a proven business model, positive cash flows and rapidly growing revenues; and, invested capital is geared toward company expansion and/or shareholder liquidity, with additional financing rounds typically not expected until the growth equity investor’s exit.[vi] The European Bank for Reconstruction and Development has defined growth equity in a similar way, but has included mezzanine financing within its definition as a result of private equity investment patterns in the emerging Europe and Central Asia regions, which typically consist of combinations of venture, growth and buyout strategies.[vii]
From the company perspective, growth equity investment, in its varying shapes and sizes, fundamentally serves as a financing mechanism that fuels later-stage expansion into new product and/or geographic markets, often in preparation for a future merger, acquisition or initial public offering. In contrast to multi-investor early-stage venture financing rounds, growth equity investment may provide the company with the benefit of a higher-stake single investor who can provide strategic business and operational guidance that can translate into greater market share and profitability. This benefit, however, can become a double-edged sword for founders as a result of the growth equity investor's potentially more significant influence over management decisions.
II. Growth Equity Investors
Growth equity investors include, but are not limited to, traditional private equity and venture capital firms that offer growth equity as one of several investment strategies, specialist growth equity firms, strategic corporate investors, and non-traditional institutional investors, such as pension funds and single family offices, which historically have not invested in emerging companies. According to Pitchbook data, the ten most active growth equity investors in 2018 were Business Growth Fund, Bpifrance, Foresight Group, Warburg Pincus, Kohlberg Kravis Roberts, The Blackstone Group, CM-CIC Investissement, Caisse de dépôt et placement du Québec, TPG Capital and General Atlantic. Of the 24 most active growth equity investors in 2018, the majority were concentrated in the U.S., France and the United Kingdom (“UK”), respectively.[viii]
III. Growth Equity Investment in Fintech
From an industry perspective, technology startups are considered attractive growth equity investment targets as a result of their perceived revenue stability and high growth potential.[ix] Software startups in the Fintech sector, in particular, received an aggregate of $11.9B in funding in 2018,[x] and are projected to attract continued interest from growth equity investors in 2019.[xi]
In the UK alone, growth equity investment in the Fintech sector rose by 57% to $1.6B in 2018,[xii] including General Atlantic’s $250M investment in lending startup Greensill Capital and Banco Bilbao Vizcaya Argentaria’s £85.4M investment in mobile-banking platform Atom Bank. In the U.S., recent examples of growth equity investment in Fintech include DST Global’s lead investment into Chime Bank, Goldman Sachs Principal Strategic Investments’ lead investment into Nav Technologies, and Edison Partners’ lead investment into YieldStreet.
With injections of growth equity financing, Fintech startups are able to deepen their domestic market share, as well as their international reach. Growth equity investment in UK Fintech startups, in particular, has contributed to their expansion into the U.S. market. One such example is UK-based small and medium-sized enterprise lending platform Oak North, which plans to launch in the U.S. in 2019 following a $440M growth equity investment from Softbank Vision Fund and the Clermont Group.[xiii]
Growth equity is projected to continue its upward trend as an investment strategy of choice for later-stage investors in the Fintech sector. With higher levels of growth equity invested in promising Fintech startups, Fintech M&A and IPO activity is likely on the way. Private equity and venture capital attorneys should therefore pay close attention to developments in this space.
The views and opinions expressed in this chapter are those of the author alone, and do not necessarily reflect the views of the American Bar Association, Crowell & Moring LLP, Stanford University or the University of Vienna. The material in this chapter has been prepared for informational purposes only and is not intended to serve as legal or investment advice.
[i] PitchBook, 3Q 2018 US PE Breakdown (2018). Available at: https://pitchbook.com/news/reports/3q-2018-us-pe-breakdown.
[ii] Preqin, Growth Equity: Return Expectations and Prospects in Growth PE Investing (November 15, 2017).
[iii] PitchBook, 4Q 2018 Pitchbook–NVCA Venture Monitor (2019). Available at: https://pitchbook.com/news/reports/4q-2018-pitchbook-nvca-venture-monitor.
[iv] PitchBook, 3Q 2018 US PE Breakdown (2018). See also Insight Venture Partners, Software Investor Insight Venture Partners Closes $6.3 Billion Fund X (July 19, 2018). Available at: https://www.insightpartners.com/about-us/news-press/software-investor-insight-venture-partners-closes-6-3-billion-fund-x/.
[v] A further detailed report will be featured in the International Comparative Legal Guide to Fintech 2019, to be published in May 2019.
[vii] European Bank for Reconstruction and Development, EBRD Transition Report 2015-16 (2015). Available at: https://www.ebrd.com/news/publications/transition-report/ebrd-transition-report-201516.html https://www.ebrd.com/news/publications/transition-report/ebrd-transition-report-201516.html
[viii] PitchBook, 2018 Annual Global League Tables (January 31, 2019). Available at: https://pitchbook.com/news/reports/2018-annual-global-league-tables).
[ix] PitchBook, 1Q 2018 Pitchbook–NVCA Venture Monitor (April 9, 2018). Available at: https://pitchbook.com/news/reports/1q-2018-pitchbook-nvca-venture-monitor.
[x] American Banker, Money Keeps Flowing to Fintechs (March 14, 2019). Available at: https://www.americanbanker.com/list/money-keeps-flowing-to-Fintechs.
[xi] CB Insights, Fintech Trends to Watch in 2019 (February 2019). Available at: https://www.cbinsights.com/research/report/Fintech-trends-2019/.
[xii] Innovate Finance, 2018 Fintech VC Investment Landscape (February 2019). Available at: https://cdn2.hubspot.net/hubfs/5169784/Innovate-Finance-2018-FinTech-VC-Investment-Landscape.pdf.
[xiii] Finextra, OakNorth raises $440 million for US expansion (February 8, 2019). Available at: https://www.finextra.com/newsarticle/33346/oaknorth-raises-440-million-for-us-expansion