Two specifically identifiable strategic approaches to investing in private companies are as follows: growth equity investment and venture capital investment. Despite all these apparent similarities, they are fundamentally different investment approaches with clear distinctions.
Is growth equity really different? This article seeks to compare and contrast growth equity with venture capital by analyzing areas like customer traction, positive unit economics, and primary risks of investments, fund sizes, holding periods, and types of deals.
Growth Equity vs. Venture Capital
The key distinctions between the two investment opportunities from private equity industry include the following:
1. Investment and Risk
In venture capital, one usually puts money in young companies that offer more returns, though accompanied by risks. Such a type of investment risk originates from the fact that such companies are often new and have not yet developed tested models of revenue generation.
On the other hand, growth equity investments are targeted towards those companies which have already started showing signs of success in their particular domain. Although these companies may still be considered ‘growing,’ they are usually much more established than early-stage start-ups; these companies have been vetted and trusted by investors in most cases due to their record.
The challenge that relates to debt is different in both categories of investment. In venture capital, a company may have little or no debt, for they source capital through financial instruments or in their early stages of operation, they source capital through equity.
During this stage, companies may employ new and more debt for investment in additional expansion while exploring new ways of retaining shareholders’ equity for both new and existing investors. It can also assist in controlling default risk since the companies with more of them are typically more mature and possess larger revenue and usually stronger balance sheets.
2. Customer Traction: Scaling vs. Disruption
Specifically, when it comes to growth equity, investors focus on the path that supports customer traction, which would allow them to scale known models of business. It targets companies that are already built in the market and, therefore, can meet the needs of the available customers. While this, business owners prefer to show a high level of customer demand that interests growth equity investors since it reflects a viable, proven business strategy and market receptiveness towards that new venture. Such investors supply funds required for growth as well as continued growth for companies and other institutions.
On the other hand, venture capital investors, while they seek to have greater control over the start-ups they support, are willing to fund companies in their infancy that may not yet have much customer appeal. They look for businesses that would disrupt standard operating practices and those with high growth prospects. VC investments are intended to support vigorous market growth in a short period. From the perspective of business owners, it is understandable that with venture capital investments, new fast-growing companies are given the means to fund an appealing concept or idea.
3. Holding period
The holding period for typical growth equity investment is relatively short – usually, 3-7 years – as compared to venture capital investments that take 5-10 years on average. The logic behind this is that start-ups or early-stage companies usually just require additional time to generate higher revenues than already established firms.
4. Profitability and Revenue Growth
In this stage, the proprietor has targets of even expanding the business operations as well as markets or other sources of revenue. Therefore, growth equity can positively impact your firm’s ability to direct operations to greater profits and increased revenues, operational efficiencies, and sustainable cash flows.
Venture capital investment, on the other hand, is generally aimed at young companies that have not achieved profitability or may even have a limited revenue track record. Such companies usually have an orientation based on high revenue growth as the priority factor in investing in the production of new goods or services, expanding the market share, and, correspondingly, market space. Especially in venture capital-backed firms, profits are not driven by traditional views, with the priority of increasing top-line revenues. This strategy simply tries to win more market share with the idea that when the company has grown deep into the market, it can reap more increment in the profits earned.
5. Exit Strategies
For venture capital firms, exits consist of the realization of capital investments through the sale of stakes, which can be done through public offers or another party buying out the venture. Venture capital firms can also exit ventures to achieve high returns on their investment and to replenish their capital for other business activities.
However, growth equity firms need not focus on IPOs and sell-side acquisitions alone as their exit strategies in private equity. However, some growth equity investment exits are also realized through IPO or buyouts, while other exit strategies include partial sales, secondary sales to other financial investors, and recapitalization. Growth equity firms would expect to exit while still having an interest in the company to capture the growth and success of this venture.
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Conclusion
It is, therefore, significant that when reminiscing about success in the areas of growth capital and venture capital, the differences between the two are apparent. While both growth equity and venture capitals are significant forms of investment in the financial world, they are characterized based on how they finance businesses and, therefore, are different in terms of risks and returns. Comprehending this distinction between the two types of investing will enable one to decide which path is most appropriate for attaining their career objectives.