March 29, 2019

What You Need to Know About the Emerging Field of Growth Equity

"Growth Equity" is a relatively new term. Without a definition fixed by law or regulation, it's not necessarily clear how you differentiate a venture capital transaction from a growth equity transaction. Is it entirely a matter of who the Investors are, (venture capital funds make venture capital investments and private equity funds make growth equity investments)? Is it a question of whether the target entity (hereafter an 11 lssuer") has (or foresees having) positive EBITDA? Of how far along the Issuer is in its development? Whether the Issuer is a limited liability company, as opposed to the C corporations that are the traditional recipients of venture capital investment? Most would agree that the term 11growth equity" is usually used to denote an infusion of equity in a relatively mature Issuer that does not constitute a change in control. 

There is no debate however that growth equity is a rapidly growing tool being used by Issuers, private equity firms and their counsel. According to year-end 2019 data released by Thomson Reuters, roughly $50 Billion was invested in 2019 in U.S. Private Equity Minority Interest Activity, which number was up from the roughly $20 Billion invested in this category in 2015 and the roughly $5 Billion so invested in 2009. 

Before looking at particular terms, both investors and the Issuer (and its owner) have to make sure that their interests are sufficiently aligned. Assuming that control of the Issuer is staying with the current owner, this burden primarily falls upon the Investor. A growth equity investor, used to controlling its investments, must consider whether it can fulfill its primary goals without control (and what terms it may need to do so). Do all parties have the same view of distributing versus reinvesting profts? Are their respective timeframes for an exit similar? If not, can the Investor obtain contractual rights, whether the right to force a redemption or otherwise, to achieve its exit timing? What about risk tolerance? Does the Investor in its portfolio generally take big risks and hope for big rewards? What if the PE firm running the Issuer looks to take less risk and hit singles and doubles? PE firms moving from buy-outs into growth equity may not be used to asking these questions.