In the expansive realm of private capital, private equity and venture capital have long been the focal points of extensive research. However, a lesser-explored territory, growth equity, has recently garnered attention for its unique position between the two. A recent study, examining over 1,500 private UK companies from 2000 to 2021, sheds light on the impact of growth equity on these businesses. The findings are intriguing, revealing both the positive contributions and potential pitfalls associated with this form of investment.

The Upside: A Catalyst for Remarkable Growth

The study unequivocally indicates that growth equity investment has a transformative effect on the UK economy. The research employs a difference-in-differences approach, showcasing a robust pattern of substantial growth in companies that received growth equity funding. These firms outperform their non-growth equity-backed counterparts in key metrics, including sales, assets, employment, and earnings.

Growth equity emerges as an appealing option for companies that have outgrown traditional venture capital but are not yet ready to succumb to the full spectrum of private equity or go public. This investment serves as a financial catalyst, injecting capital into well-established companies eager to fuel further growth. It’s essentially a late-stage venture capital or a minority mid-market private equity infusion.

The Downside: Navigating the Perils of Increased Leverage

However, the study doesn’t shy away from acknowledging the darker side of growth equity financing. The remarkable growth observed in these companies is accompanied by increased access to credit and a substantial rise in firm leverage. Growth equity-backed firms exhibit a significant surge in leverage compared to their non-growth equity-backed counterparts, heightening the risk of financial distress.

Companies leveraging growth equity are more susceptible to bankruptcy if the anticipated growth fails to materialize. The study underscores the inherent risk, cautioning that when running with the wolves, companies might indeed get bitten.

Investor Dynamics: Exit Strategies and the Risk-Return Balance

The study unveils an interesting facet of growth equity investment—investors exit over 70% of their investments during the study period. However, a notable revelation is that almost 20% of exited growth equity-backed companies file for some form of insolvency. This intriguing statistic hints at the delicate balance that growth equity investors must navigate, showcasing the fine line between aggressive growth and financial stability.

Despite the elevated risk of insolvency, troubled growth equity-backed companies are more likely to opt for insolvency rather than outright liquidation when facing financial distress. This nuanced approach suggests that, even in challenging times, growth equity investors are willing to explore alternative strategies to salvage value and mitigate losses.

As the study by Paul Lavery, William Megginson, and Alina Munteanu highlights, growth equity is a double-edged sword. While it propels companies to new heights of growth and economic contribution, the associated risks, particularly in terms of increased leverage and the potential for insolvency, cannot be ignored.

For both companies and investors, navigating the growth equity landscape demands a delicate balance between ambition and prudence. As growth equity continues to evolve and gain prominence in the private capital arena, further research and insights will be crucial to unravelling the full spectrum of opportunities and challenges inherent in this dynamic financial landscape.

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