PEI 300: Growth equity offers best of both worlds

Growth equity is, pardon the pun, a growth story. Of the top 10 firms in the PEI 300, half have either launched or raised capital for dedicated growth funds in the last two years. The largest among them is the debut growth fund from Blackstone (1), which closed on its $4.5 billion hard-cap in March.

Meanwhile, KKR (2) raised $2.2 billion last year for its second technology growth fund, while Carlyle Group (4), Thoma Bravo (5) and EQT (6) are all in market with growth funds targeting $2 billion, $3 billion and €2 billion, respectively.

Growth equity sits in the space between buyouts and late-stage venture capital, investing in high-growth companies typically in healthcare, technology and financial services.

PEI research found 52 growth equity funds hauled in $32 billion in the first quarter of this year, up from 44 growth funds that raised $21.9 billion in Q1 2020.

“Investors are attracted to growth funds because they usually clean the cap table – enabling a lot of venture firms and investors from different rounds to exit, resulting in an easier-to-understand shareholding structure,” says Jean-François Le Ruyet, a partner at Paris-based fund of funds Quilvest Capital Partners.

Above-average growth

Exposure to fast-growing companies is an attractive element of growth equity, according to a 2019 report from Cambridge Associates. Cambridge found companies backed by growth equity generated an average annual revenue growth rate of 17.2 percent, more than double that of companies acquired in buyouts and more than triple that of public companies, based on data from 2008 through 2017.

Growth’s risk-return profile is another part of its appeal because its “upside return potential is more akin to venture but with the lower losses of buyouts”, the Cambridge report states. Research by the investment advisory firm shows rates of return for growth equity funds have been stronger than venture capital in all time periods of 15 years and fewer, and about 2 percent higher, or roughly similar to buyouts.

Some are approaching growth equity with caution. “There’s a lot of demand for growth equity funds, but it’s still basically new, so some investors are trying to see what the rest are doing first and whether that investment case is proven out,” says the CIO of a US pension fund.

Quilvest’s Le Ruyet recommends that investors “scrutinise these funds heavily and really understand what the team is doing and what the equity story is, and make sure it’s not just the hype of doing growth and tech for the sake of it”.