A view of San Francisco’s skyline
A view of San Francisco’s skyline. Some hedge funds have jumped into growth equity after being attracted by the returns offered by technology, in particular © John G. Mabanglo/EPA-EFE

Growth equity has become one of the hottest corners of the private capital industry, as ever-larger companies eschew public markets and find strong demand among investors desperate for higher-returning bets.

The investment strategy has long existed as a vibrant yet ill-defined halfway house between traditional venture capital firms that acquire small stakes in nascent companies, and private equity funds that usually buy more mature ones outright.

But torrential inflows into private markets from investors seeking alternatives to mainstream stocks and bonds have helped buoy dedicated growth equity funds — which typically finance well-established but still younger, fast-growing private companies in return for minority stakes — and transform them into a larger and more distinct asset class.

“The category has existed for a very long time, but it’s being separated out in investor minds, and has definitely seen a lot more capital coming in,” said Jeff Diehl, head of investments at Adams Street, a private capital firm. “It’s an area that’s generated very interesting returns.”

TPG, one of the biggest private equity groups, highlighted growth equity as one of its leading areas of focus in its pre-Christmas filing to go public in 2022, while Permira, a large UK-based buyout firm, recently raised $4bn for its second growth equity fund, more than twice the size of its predecessor fund and almost twice the initial target of $2.5bn.

Chart showing assets under management in 'growth equity' investing

Specialist information provider Preqin estimates that growth equity has more than doubled in size since the end of 2016, to almost $920bn at the end of March 2021. Morgan Stanley has estimated that growth equity is the fastest-expanding slice of the private capital world, with a compound annual growth rate of about 21 per cent in the past decade, compared with 10 per cent for private equity and 16 per cent for venture capital.

More money is likely to enter the booming industry. A survey of 200 institutional investors by Numis Securities found that 73 per cent planned to increase their asset allocation to growth equity — and 20 per cent expect a “dramatic increase”.

The boom is being driven by the fact that many blue-chip private equity and venture capital firms have limited capacity and have amassed big war chests of committed but still-undeployed money from earlier fundraising drives. Money is, therefore, spilling over into growth equity, where it is easier to write bigger cheques than in venture capital, as the companies invested in are generally larger and more well-established.

“By its nature, [growth equity] does not have the same return profile as early stage venture capital investing, as you’re investing at a much later stage, but an upside return scenario remains and the risks are lower as the companies have already proven that their business model works,” said Marc Brown, a partner and head of growth investing at EQT, the Swedish buyout firm.

But there are still signs that some are being stirred by hype to buy into the growth equity space, without extensive knowledge of what they are adding to their portfolios.

“The game has changed phenomenally,” said Michael Turner, a partner at Latham & Watkins, the law firm. “There’s quite a lot of FOMO (fear of missing out) investing going on, a lot of investors coming into the market who don’t fully understand the companies and the opportunities they are investing in.” 

Private capital industry has exploded in size

Growth equity is also increasingly becoming a battleground between private equity groups, venture capital, hedge funds and even some mutual funds.

Private equity groups are launching more growth funds that accept minority stakes to get in earlier in a company’s life, while some venture capital firms have established growth funds that can hold on to investments longer and inject bigger slugs of money than they normally would.

At the same time, hedge funds such as Tiger Global have jumped into growth equity — attracted by the returns offered by technology in particular — while some traditional asset managers are also making more early investments in private companies that might end up going public anyway, so that they are not stuck with more mature, slower-growing businesses.

“It’s a sign of froth, but we just have to accept that the market is attracting new sources of capital, and you can’t complain too much about that, whether it’s hedge funds or mutual funds,” said Michael Wand, a managing director at Carlyle. “It’s not going to go away unless we have a massive fallout from a bursting bubble.”

Hedge funds and mutual funds are partly jumping into growth equity to address the fact that many companies are staying private for far longer than they have historically. But the scale of the money gushing into growth equity is exacerbating the phenomenon, by allowing even more and bigger companies to shun stock markets for longer, some industry insiders say.

Brown at EQT stressed that this was not purely a result of the explosion of growth equity funds. “More capital at every stage of investing is allowing companies to stay private longer,” he said. “The venture capital community is also doing larger and later rounds, and investors like BlackRock are also doing more late stage investments on the private side.”

He argued that listing on a major bourse remained a long-term target for many entrepreneurs. “I think going public is still a big goal for a lot of founders. If someone offers to take you off that path then you’ll listen to them, but going public is still seen as a prize.”

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