After a red-hot run for fundraising and deal activity in 2021, growth managers are feeling the pinch. Year-on-year fundraising for growth capital fell by a third from $140.2 billion in 2021 to $93.5 billion in 2022, according to Private Equity International data.
Meanwhile, growth and late-stage venture deal value slid 28 percent to $644 billion last year, per Bain & Co analysis. Valuations have also been squeezed, with figures from Carta showing that down funding rounds (where venture and growth companies raise capital at a lower valuation) nearly quadrupled year on year in the first quarter of 2023.
The growth segment has been hit particularly hard by rising interest rates and inflation, with investors treading cautiously and pivoting to other asset classes. Lower valuations, meanwhile, have deterred some companies from coming to market for capital, limiting the scope to secure funding for future expansion.
“Growth has been a booming market for the past four to five years, but the current macroeconomic conditions mean that LPs are becoming more discerning about their investments,” says Alexis Saada, a managing director and head of growth at Ardian. “There has certainly been a flight to quality funds and those managers that have demonstrated consistent returns despite tougher market conditions.”
“In the bull market, lines between late-stage venture, buyouts and growth did blur”
But while the headline figures may paint a bleak picture for growth equity prospects, managers and investors are sanguine about the growth opportunity. Apax Digital partner Mark Beith says: “Growth fundraising and deal activity has slowed, and valuations have come down, but if you step back and take a longer view, growth equity remains attractive.
“Before the market turned, we saw higher and higher levels of investment as prices increased. This is a better market for disciplined investors. Valuations are not at bargain basement levels, but the market is less frothy.”
The slowdown has also impacted supply-and-demand dynamics. Brian Dudley, a growth equity partner at Adams Street Partners, says: “For the first time in almost a decade, we are seeing the demand for growth capital from companies far outweigh the supply of growth capital from investors, presenting a compelling investment environment where valuation multiples on entry are far more palpable than what we have seen in recent years.”
The growth reset is also expected to refocus minds on what1` growth investing is, and how it is differentiated from venture and buyout strategies. Growth equity encompasses elements of both buyout and venture strategies and can be broadly defined, but it has historically always been clearly positioned between the two on the risk-return spectrum.
“Different firms and investors have different definitions of growth,” says Sanjot Malhi, a partner at seed to growth-stage investor Northzone. “For us, growth capital means investing in companies that are genuinely at the growth stage. These businesses have product-market fit, a viable business model and a repeatable, scalable go-to-market strategy.”
At the peak of the market, with venture and buyout managers eager to deploy dry powder, firms that wouldn’t normally have pursued growth targets drifted into the space. As the macroeconomic backdrop has deteriorated, however, genuine growth expertise and track record has come to the fore, bringing investment discipline and clarity back to the segment.
“In the bull market, lines between late-stage venture, buyouts and growth did blur,” says Karen McCormick, chief investment officer at growth firm Beringea. “Venture managers were flush with liquidity and cut bigger and bigger cheques, while buyout firms were looking for growth and alpha in a low-rate environment, driving more overlap with pure-play growth strategies.
“The change in the cycle has changed the dynamics. Fund managers are taking pause and refocusing on core strategies.”
A broad opportunity set
Looking ahead to the next 12 to 18 months, growth managers are optimistic that the underlying fundamentals that drive growth dealflow and returns are strong, despite ongoing macro dislocation. Adams Street Partners’ Dudley notes that long-term trends in the technology space, a core component of growth portfolios, are robust, with consultancy Gartner forecasting that global spend on software will continue to grow, climbing from $807 billion in 2022 to $1.3 trillion by 2026.
Innovation, another key predictor of growth equity opportunities, is also robust, with patent issuance in the US continuing to set annual records thanks to developments in internet, smartphones, cloud computing, artificial intelligence, automation and robotics. “The sheer pace of technological innovation will only drive more disruption across numerous industries, which points to a consistently expanding pool of growth deal opportunities,” Dudley says.
Outside of the technology vertical, Ardian’s Saada sees strong growth potential in healthcare, where entrepreneurs have identified opportunities based on the needs of an ageing population and more health-conscious consumers, while Beringea’s McCormick sees value in counter-cyclical sectors such as consumer.
“Technology has accounted for an outsized share of growth deal volumes, as well as higher valuations… but other sectors continue to offer compelling growth opportunities,” McCormick says. “Counter cyclical sectors such as consumer have been a key theme for Beringea. Entry multiples are lower, and we have a track record of growing consumer companies through US expansion.”
Keeping growth in the mix
LPs are also looking through short-term market disruption, and even though allocations to growth may have recalibrated, the strategy remains a key part of the long-term asset mix.
“Pantheon’s allocation to growth strategies for some of our key strategies is around 20 percent, and we remain positive about the prospects for growth assets,” Pantheon partner Imogen Richards says. “There has been some rebalancing in the market, and revaluations have come with a slice of realism, but entry valuations are now attractive and there is still conviction that top-tier growth managers and growth companies will deliver returns over time.”
Haresh Vazirani, private equity senior investment director at abrdn, adds: “Private equity primaries always require long-term, stable thinking. It’s very hard to time making fund investments and it is important to remember that the market disruption themes that have driven the growth space in recent years are secular in nature and will persist across economic cycles.”