What is Growth Capital?

Growth capital, or expansion capital, is the capital provided to relatively mature companies that require money to expand or restructure operations or explore and enter new markets. So basically, growth capital serves the purpose of facilitating target companies to accelerate growth. Growth capital is placed on the gamut of private equity investing at the crossroads of venture capital and control buyouts.

Growth capital firms provide a lesser-known investment than traditional venture capital and controlled. However, it represents a low-risk cost of capital for the investor compared to conventional private equity investments. In turn, target companies benefit from an attractive source of financing that helps them accelerate their revenue and profitability growth.

•  Growth capital is also known as expansion capital. The capital offered to comparatively mature companies needs money to expand or restructure operations or explore and enter new markets.
• The growth capital objective is to provide target companies to boost growth.
•  It focuses on investment in mature companies. In comparison, venture capital focuses on early-stage companies with an unproven business model.
• Compared to controlled buyouts and standard venture capital, growth capital is a less well-known form of investment.

Growth capital, often referred to as expansion capital, is a crucial component of corporate finance, providing companies with the financial resources required to foster growth and expansion. This form of financing primarily targets established businesses that have already passed the initial startup phase and are looking to take their operations to the next level.

One of the critical characteristics of growth capital is that it is typically invested in a company that is already profitable and has a proven track record. Unlike early-stage venture capital, which supports startups, growth capital is geared towards helping businesses scale up and reach new heights.

Growth capital can take several forms, such as equity investments, debt financing, or a combination of both. Equity investments involve selling a stake in the company to investors, which can include venture capital firms, private equity investors, or even individual investors. Debt financing, on the other hand, typically comes in the form of loans or bonds and requires the company to repay the borrowed capital over time with interest.

The usage of growth capital can vary widely among companies. It might be directed towards expanding operations, entering new markets, launching new product lines, acquiring other businesses, or investing in research and development. Ultimately, the aim is to accelerate growth and increase the company's value.

For businesses seeking growth capital partners, it's essential to carefully consider the terms of the investment, as it often involves giving up a portion of ownership or incurring interest payments on debt. However, when used strategically, growth capital can be a powerful tool for achieving expansion and securing a stronger position in the market.

These investments provide opportunities and challenges to private equity investors regarding growth capital. Not all private equity investors would be interested or active in this area. Few of them are not permitted to invest and provide growth capital based on their fund documentation.

Why so? Private equity funds would generally not be interested in opportunities that result in a cash burn rate in the foreseeable future. It is so as the investors would have little appetite to fund working capital or cash requirements as an ongoing responsibility or to invest where there is a risk of future dilution.

When a private equity fund wishes to make a growth capital investment, it would be looking out for a concrete, clear plan outlining the capital requirements. However, the conditions would be significantly huge but limited, such as generating substantial  EBITDA growth, international expansion, etc.

Now that we understand the basics of how growth capital firms operate let us apply the theoretical knowledge to practical application through the examples below. These examples are a culmination of the different aspects of this concept in the business world.

#1 - SoftBank investment in Uber Rival Grab - $750 mn

sources: Techcrunch.com

SoftBank investing in Uber's rival Grab in 2016 for $750 million was a growth capital investment. It was a Series F round of investment led by SoftBank and other investors. Currently, Grab operates in six countries in South Asia and has 400,000 drivers on its platform, with 21 million downloads for its app. The capital was required to compete efficiently with Uber and others, particularly in Indonesia, and focus on technology. Grab plans to refine its algorithms to help its drivers be more efficient, build mapping data and technology, and work on demand prediction and user targeting.

#2 - Airbnb raises $447.8mn in Series F round of funding

Airbnb could raise $447.8 million in a Series F round of funding. In the past, Airbnb has expanded in the travel sector by launching trips that offer customers tours and related activities. It plans to add flights and services in the future.

source: www.pymnts.com

#3 - Deliveroo raised $275 mn in round 5 funding

Food delivery service Deliveroo raised $275 million in round 5 funding. This London-based company is active in 12 countries in Europe, Asia, and the Middle East. This financing was led by experienced restaurant investor Bridgepoint and existing investor Greenoaks Capital. They procured the funds for geographic expansion in new and existing markets and further investments in projects such as RooBox, which would give restaurants access to off-site kitchen space that will cater to the takeaway demand that their restaurant kitchens cannot supply.

source: Bloomberg.com

#4 - InContext Solutions raises $15.2 mn from Beringea.

InContext Solutions successfully acquired $15.2 million through Beringea. Beringea is a private equity firm focused on providing growth capital. InContext Solutions is a global leader in Virtual Reality (VR) solutions for retailers and manufacturers. One would utilize this capital to accelerate sales and marketing efforts and expand its geographic footprint. It also focuses on improving the virtual reality product portfolio and also includes further development of solutions for head-mounted devices.

source: www.incontextsolutions.com

Of the total investment deals done in 2016, 2% were for growth capital/ expansion as per preqin.

source: preqin.com

Growth investments ideally take the form of significant minority interest. Compared to the traditional buyout or traditional VC investment, there is no single form of document that is used in such deals.

So, while some deals would be quite similar to late-stage VC investment, others would have similar characteristics to a typical buyout. It would depend on the negotiation among the parties. It would also depend on PE investors' earlier experience with growth capital partners and having a minority interest. Many investors are unaware of the dynamics of controlling interest so they would seek contractual rights. Else, they would rely on their relationship with the management and forego their protective rights.

If the investors go for control rights, then the investors would have these rights accompanied by the power to intervene when things go wrong or force an exit if the same does not occur in the agreed investment window. For example, three years from the initial investment. This scenario may cause friction, especially if the founder is successful and has developed the business early.

When an investor goes for growth capital, one must maintain clarity. One should maintain clarity on the steps to be taken if there is friction between investors and founders or when the founder ceases to be involved in the business on an active basis. The key area of the debate would be transferring shares that are the founder’s equity and ongoing shareholder protection and board rights of the founder when he decides to go into passive mode.

Sometimes there would be majority interest in the deal given to private equity investors. However, this happens rarely. If this happens, the contract and investment would resemble a traditional buyout. There would be few differences in the operational features and capabilities of the company.

Compared to a mature buyout, most target companies would not be ready for the requirements of private equity investors. It is pretty unlikely that they repaid shareholder debt during earlier years of investment. It would result in getting a loan note getting compounded. Also, these target companies wouldn't have the right infrastructure to provide the requisite financial reporting to PE investors. Failure to comply with provisions of providing requisite financial information can lead to operational and economic consequences. In such a scenario, one must draft the agreements, so that target companies have the time to develop the systems required for reporting.

Issues such as no HR policies, lack of health and safety compliance, and data protection policies need to be in place when a private equity investor steps in and invests. These issues would not break the deal between the two parties but require operational change.

Any investor is looking out for profitable investments. Private equity investors would be interested in growth capital investments if the business has the potential and the investment is made at the crucial point of the growth curve of a target company. Also, managing the finances is of utmost necessity for making the investments profitable.

Apart from financial performance, one must sort out the abovementioned issues to ensure that private equity investors make a successful exit. A successful business is easy to sell or attractive enough to be introduced to public markets.

Each deal would have specific terms. These terms would be decided based on key metrics such as past financial performance, operating history, market cap, etc. However, these terms would be similar to the traditional deal made for late-stage venture capital financing.

The key characteristics of growth capital firms are: -

1. Like a deal with a venture capitalist, investors would acquire preferred security in the target company, even in growth capital.
2. These would be a minority stake using little leverage.
3. The deal would give redemption rights to create liquidity on triggering events such as IPO.
4. The deal would be designed to give operational control over significant matters. These provisions give investors consent rights on the important transaction such as any debt or equity transactions, transactions relating to mergers and acquisitions, any change in tax/accounting policies, any deviations from budget/business plan, changes in key management personnel that are hiring/firing, and other significant operational activities.
5. The growth capital deal gives investor rights such as tag-along rights, drag-along rights, and registration. These rights are deemed appropriate for the transaction's size and scope and the issue's lifecycle.

From the private equity investor's perspective, there are several key distinctions between growth capital partners and venture capital. Let us understand them through the comparison below.

1. Growth capital focuses on investing in mature companies, whereas venture capital focuses on early-stage companies with an unproven business model.
2. In the case of venture capital, investments are made in multiple early-stage companies of a specific industry or sector. However, growth capital investment would be in a market leader or a perceived market leader within a particular industry or sector.
3. The investment theses in venture capital are underwritten on substantial growth projections of the target company's revenue. However, the investment logic is on the definite plan to achieve profitability potential for growth capital investment.
4. In venture capital investments, future capital requirements are undefined. However, this would not be the case in growth capital investments that target companies with no or minimum future capital requirements.

Also, look at the difference between Private Equity vs. Venture Capital.

When it comes to growth capital firms, it differs in several aspects. Let us understand the differences through the comparison below.

1. In control buyouts, the investment is a controlling equity position. Whereas, in growth capital, this is not the case.
2. Private equity investors invest in highly profitable operating companies in controlled buyouts. These are those companies that have free cash flow. However, growth capital investments are made in companies with limited or no free cash flow.
3. In controlled buyouts, debt financing is often employed to leverage the investment. However, the companies have no or minimum funded debt  in growth capital investments.
4. An investment in controlled buyouts is made at a point with growth stability; projections point towards stable revenue and profitability. However, as mentioned above, growth capital investments are made at a junction where the investment will boost the target company's revenue and profitability.

This article has been a guide to Growth Capital. Here we explain its characteristics, structure, examples and compare it with venture capital and controlled buyouts. You can learn more about venture capital through:

• Venture Capital Books
• Types of Alternative Investments
• Venture Capitalist Salary
• Clawback