Uptick in Growth Equity Activity Helps Signal a Thaw

May 2024

The fundraising environment is seeing green shoots in 2024 and growth equity investment is powering part of that trend. Fund managers and their investors are eager to reengage in sectors and asset classes where they can find attractive quality and pricing, even in a persistently high interest rate environment, and growth-stage companies check those boxes. Growth equity enterprises were among the hardest hit by the perfect storm of the tech downturn, the rise in interest rates, challenges in the banking industry and geopolitical headwinds. The companies that were able to survive those hostile conditions and emerge with durable businesses and sensible valuations are naturally highly attractive targets, driving an uptick in growth equity activity.

The numbers tell the story. Growth equity’s share of total private equity deal value increased last year to 12.7% (up from 9.9% in the prior year) and represented 21.5% of all sponsor deals, compared with a five-year average of 18.0%. As Pitchbook noted, last year marked the first time that growth equity deals accounted for a higher share of private equity transactions than LBOs. This increase in growth equity deal activity comes despite the fundraising challenges faced by the private equity industry overall, which, as McKinsey reported, saw a 30% reduction in fundraising for growth equity from the prior year.

Growth equity investors target relatively mature, privately-held companies – oftentimes with an exit on the horizon through a sale, direct listing or IPO. Typically, these are minority investments, but they can take other forms depending on the investment strategy of the particular fund. While the line between venture capital and growth equity continues to blur, traditionally, venture capital invests at earlier stages in the company lifecycle and casts a wider net of investments with longer hold periods. In contrast, growth equity investors focus on later-stage companies where operational improvements and revenue growth can be achieved with minimal leverage. In addition, growth equity investments often come with more complex preference structures [compared to venture capital investments] and guaranteed minimum returns.

A number of factors have made growth equity investing increasingly appealing to sponsors. These transactions are typically equity financed, removing the uncertainty currently posed by high interest rates in the debt markets. The greater maturity of these companies also allows sponsors to build off of their existing strengths to improve operations and thus yield better returns.

From 2020 through early 2022, many companies were in a position to command very friendly fundraising terms. Today, however, the market has shifted downward, particularly in the technology sector. Companies that are now running out of runway are increasingly turning to private equity for financing. Financial sponsors typically take a more robust approach on structure and governance which, in a down market, becomes more palatable than it was just two years ago. Many venture investors who financed earlier rounds are also increasingly more comfortable with having a private equity sponsor write the bigger check needed to get the company to a successful exit.

Despite these market shifts in favor of investors, a valuation gap—albeit one that is thinning ever slowly—continues to exist between founders and management, on the one hand, and growth investors, on the other. We expect to see that maturing companies that are not positioned to weather the continued storm of a down market will increasingly turn to sponsors as a source of financing.

Private Equity Report Spring 2024, Vol 24, No 1