We think growth capital is an attractive source of capital and merits another article which goes into more background.
Growth capital is a segment of the capital market between venture capital and conventional private equity.
Growth companies can raise capital on attractive terms and, typically, rapidly.
Growth Versus Venture Stage
So, what is a growth company? A growth company’s products or services are developed and have garnered customer sales. In our view, this is the feature that distinguishes growth companies from venture stage companies.
Think about this from the investor’s perspective.
Investment in a growth company involves less risk, customers have shown demand and the growth company has delivered its product or service.
Growth Versus Conventional Private Equity
How are growth investors different from conventional private equity investors?
Growth capital investors are willing to invest before a company’s potential is fully established.
Growth investors want their investment to drive faster sales growth, to enable the growth company to “step on the gas”.
The growth investor takes risk that the growth company, with capital and capable management, will achieve its potential.
Valuation for a growth investment involves projecting the future “potential” value.
In contrast, conventional private equity investors value companies based on historical performance, often referred to as “looking through the rear-view mirror”.
While this is a generalization, it defines the difference between growth capital and conventional private equity.
Types of Growth Capital
My colleagues and I have been pleased by the increasing number and variety of growth investors.
So, let’s discuss types of growth capital investors, growth equity and growth debt.
Growth Equity
Growth equity investors buy equity, maybe a preferred stock. These growth equity investors take risk side by side with entrepreneurs. Their return depends on future value. They expect rapid value appreciation to generate a very healthy return.
Given that growth companies often experience some variability in performance, deviating from their projections, having a growth equity investor riding in the co-pilot seat with the entrepreneur can be valuable. Both entrepreneur and growth equity investor ride through performance turbulence together.
As a side note, I’ve worked with many growth companies and can’t recall an instance when there wasn’t deviation from the projection. Growth companies are simply in a dynamic period of change. Growth equity investors know this and expect it.
On the issue of investor control, I’ve posted an article just on that topic and link to it here.
In short, however, in the growth capital sector, investor control is not a given, especially in cases of growth debt.
Growth Debt
There is another type of growth capital, growth debt, sometimes called venture debt.
Growth debt investors invest in growth company’s debt. This is not the type of debt that banks offer. This is more like equity but on a company’s balance sheet as debt.
Growth debt investors get their return in two forms, a periodic cash interest payment and equity which has some future value.
Recently, my colleagues and I arranged a growth debt deal for a client. This client had some customer traction but was not yet profitable.
Under its growth debt arrangement, our client drew capital as needed based on contracts signed. After a deferral period, our client was required to make periodic cash interest payments.
The interest rate was low so not a major cash burden.
Our client’s equity give-up on this deal was very small. The value of the equity, presuming the company’s future success, plus the periodic cash return from the interest payments will give the growth debt investor a healthy return.
Conclusion
Growth capital, whether debt or equity, is an attractive source of capital to fund growth.
We recommend that you consider it when raising capital.
Please contact us to discuss your capital market goals.