Growth Equity vs. Venture Capital: Differences & Similarities
Venture Capital (VC) offers financing for innovative enterprises, often generating huge profits and facilitating economic growth. It is a fund invested by individuals or investors in start-ups or small enterprises that cannot raise their funds from the public sector.
VC investment provides details related to high risk with support from new and top-qualified entrepreneurs. VC firms help uplift many businesses in their initial steps before making them public. It is also one of the most popular funding processes and usually needs raising money for bank loans, capital markets, or other debt instruments.
Growth equity is a kind of VC that modulates the risk by investing in a private start-up enterprise’s last stretch before it becomes public or sells itself. Here, investors prioritize scaling already presented business models with proven customer traction. They emphasize more profitability and sustainable revenue growth.
Differences between Venture Capital and Growth Equity
The private equity industry often considers doing both for investment. Growth equity is part of VC and shares similar compensation, ownership structures, and legal. There are a few essential differences between them:
· Time Frame for Investment
VC firms invest as early as possible in the enterprise’s lifetime (mainly at or near the start). The growth investment rounds usually happen after many years of enhancement once the enterprise has proved its business model, formed positive unit economics, and possesses a crucial customer base. It also holds a shorter time frame between the initial investment and exit. It can be just two to three years against seven to 10 years for traditional VC investments. And the reason illiquidity is less problematic for growth equity.
· Risk Involved in Primary Investment
Growth equity is less risky in comparison to traditional VC. While traditional VC possesses a failure rate of 75 percent, the figure is usually less. However, there is less data to rely on for verification. It also considers “management” or “execution” risk, whereas the VC firms make “market” and “product” risks.
· Potential Reward
Less risk directly indicates lesser reward. Traditional VC investors look for investments that can potentially “return their fund” (For example, 50–100x return) for an Internal Rate of Return (IRR) of 60 to 80 percent. However, a growth-stage investor aims for a return of 3–5x for an IRR of 30 to 40 percent. The main difference is that venture capital investors usually withstand a much higher “loss rate” for their investments because the results will be “fail” or go to “zero.”
· Size of Investment
Growth equity investments involve massive amounts of capital (at higher valuations), with a holding period (3–7 years), and minority ownership stakes with preferred equity shares. VC investments have smaller investment sizes, shorter holding periods (3–5 years), similar deal structures to growth equity investments, and are commensurate with the enterprise’s earlier stage of advancement.
· Positive Unit Economics
Growth investors usually consider enterprises that exhibit positive unit economics, holding a potentiality on profitability and sustainable revenue growth. They look to invest in enterprises that have formed a solid financial base. VC investors are free to invest in enterprises with negative or unclear unit economics because they focus on market share acquisition rather than instant profits, quick growth, and capturing market opportunities.
· Period of Holding
Venture capital investors usually “hold” their investments for much longer (For example, 10+ years). They invest in the initial stage of an enterprise’s life. Most growth investors got accustomed to holding their investments for a more standard 5-year period.
· Areas of Funds
Growth investors focus on financing-specific initiatives. These efforts are related to geographic expansion, acquisitions, new products or services, or sales force expansion. Whereas with initial stage VC investments, investors financing enterprise-wide initiatives, such as operations, R&D, and compensation.
Similarities between Venture Capital and Growth Equity
Though there are many differences between both investments, there are a few similarities too that are worth mentioning:
· Enterprises with High Growth
Growth is the driver of returns for both because it essentially targets quick-growth enterprises due to the existence of huge numbers. The growth equity investments grow slower than early-stage venture investments because they begin starting from zero.
· Structure of Deal
Both types of investors mainly request “preferred equity” shares (as opposed to “common equity” that employees hold) with special rights about dilution, information-sharing, and many more.
· Rare Usage of Debt
In the initial and growth stage investments, there is no burden related to debt because financials are not a given focus for returns.
· Private Enterprises
Both targets privately held enterprises that are not yet publicly traded. Examples include TA Associates, TPG Inc., General Atlantic, and many more.
· Ownership Stake
Both investment strategies usually find ways to acquire a crucial non-controlling minority ownership stake.
Conclusion
An in-depth understanding of these investments is necessary for investors and business owners. They share many differences with some commonalities, which are helpful for the private equity industry. It will help investors and business owners align their objectives, navigate the risks inherent in every approach, and determine the path suitable for the investment journey.
| Read More: Private Equity vs Venture Capital
