Note: This article is part of my growth equity industry primer series
While both growth equity and venture capital investors target growing businesses, they differ in several important respects. In this article, I’ll outline the key similarities and differences.
Differences between growth equity and venture capital
The major distinction between growth equity and venture capital is the stage of company development.
While venture capital firms invest as early as possible in the company’s lifetime (usually, at or near the very beginning), growth investment rounds typically occur after several years of development once the company has proven its business models, established positive unit economics, and has a significant customer base.
In this way, growth equity investment tends to follow venture capital investment. While there is no exact dividing line in terms of when a company’s “early venture stage” ends and its “growth stage” begins, many point to the following as key factors in telling the difference:
- Customer traction or “product-market fit” – while early stage venture firms invest in companies who are still attracting their first customers, growth equity firms invest in companies that have found initial traction and are now “scaling” their customer acquisition
- Positive unit economics – Early venture stage companies have often not yet proven positive “unit economics,” while this is often a key criteria for growth stage investors as they seek to help the business scale
- Type of primary investment risk – Related to above, venture capital firms take “market” and “product” risk (will this work at all?), while growth investment firms take “management” or “execution” risk (can we scale what’s working?)
- Size of investment – Growth equity firms tend to invest much larger amounts of capital (and at higher valuations), while venture capital firms invest smaller amounts commensurate with the company’s earlier stage of development
- Holding period – Venture investors tend to “hold” their investments for much longer periods (e.g. 10+ years), given the fact they invest so early in a company’s life, whereas most growth investors are more accustomed to hold their investments for a more standard 5-year period
Similarities between growth equity and venture capital
While there are key differences between growth equity and venture capital, it’s worth mentioning there are many similarities as well:
- Private companies – Both venture capital and growth equity firms target privately-held companies that are not yet publicly-traded
- Debt is rarely used – Most early stage and growth stage investments do not have significant debt burdens and financial engineering is not a key driver of returns
- High growth companies – Given growth is the primary driver of returns, both venture capital and growth equity firms target fast growth enterprises; however, due to the law of large numbers, it’s usually the case that growth equity investments will be growing somewhat slower than early stage venture investments (which are literally starting from zero)
- Minority ownership stake – Both investment strategies usually seek to acquire a significant non-controlling minority ownership stake (sub-50%)
- Deal structure – Both kinds of investors are likely to request “preferred equity” shares (as opposed to “common equity” typically held by employees) with special rights pertaining to dilution, information-sharing, etc.
Asset class risk-return profile
The return expectations and risk profile differ significantly between growth equity and venture capital investing.
While venture investors seek investments that could potentially “return their fund” (e.g. 50-100x return), growth stage investors target a more normal return of 3-5x. Of course, the key distinction is that venture investors accept a much higher “loss rate” for their investments. Each individual venture capital investment must have really high potential because the most likely outcome for each is to “fail” or go to “zero.”
In this way, the expected “loss rate” for growth investors is much lower than venture investors and is akin to that of private equity, where the standard expectation is that each investment will perform reasonably well. It would be quite a (negative) surprise for any growth or private equity investor if one of their portfolio companies failed. While venture investors do not enjoy this outcome, it is expected to occur with high frequency.
This dynamic drives the difference in compensation structure between growth equity firms and venture capital firms.
Growth equity vs. late-stage venture capital
Whereas the difference between growth equity and traditional venture capital is relatively easy to define, the difference between growth equity and venture capital is more subtle and less obvious.
Indeed, the two types of investments seemingly have lots in common. They both involve taking minority stakes in high growth, relatively young private companies. Both investment styles aim to generate their returns from growth.
In practice, “growth equity” and “late-stage venture” are used somewhat interchangeably, making any discussion of the distinction between them somewhat academic. Many growth equity firms have even marketed themselves as “late-stage venture capital.” Interview candidates interested in growth investing should certainly target both growth equity firms and late-stage venture firms (Series B/C or later).
That said, if one HAD TO draw distinctions between the growth equity and late-stage venture, it’d likely be along the following vectors:
- Degree of profitability – while both late-stage venture and growth equity focus on positive unit economics, some might distinguish the two by the fact that companies receiving a growth equity investment may be more likely to be profitable overall, whereas late-stage venture capital companies may still be operating with large losses
- Expectation of future dilution – since growth equity investments are at or near profitability, there is an expectation that they will not require additional fundraisings in the future and therefore investors will avoid future dilution
- Use of proceeds – venture capital investors tend to focus on primary transactions and have traditionally had a strong aversion to providing founder liquidity via secondary share purchases; meanwhile, growth equity investors are usually less averse to deal structures involving secondary purchases, in part because the trajectory of the business is more secure so a potential loss in motivation among founders is less of a concern (note, this is situation dependent)