Growth Capital Investing
A safe harbour in rough seas. Financial markets have been thoroughly roiled in 2022, caught between inflation running above 8%, substantial 75 bps rate hikes, and a seemingly unresolvable conflict on the European continent. Against such volatility, even the most astute investors have been shaken by uncertainty; stocks have degenerated into numerical counters that move with the winds of macroeconomic change, devoid of the fundamentals of their underlying businesses. We believe that these are times to go back to basics, recognising that investors are ultimately partial business owners – as legendary investor Warren Buffett has reminded of time and again – and allocate capital towards the most promising avenues of future growth. This is a discipline that the private equity (PE) market – especially that of Growth Capital – excels at.
Nonetheless, Growth Capital investments require more than just mere capital allocation. Their true value comes from their ability to unlock value in their investments through their extensive network and platforms. Such non-monetary resources equip growth-stage companies with an added edge to amplify their businesses and generate quality earnings. This ultimately benefits investors when these higher earnings are realised in the form of higher company valuations.
Growth Capital lives up to its name. To illustrate the attractive growth prospects of Growth and Venture-backed companies, we analysed Growth and Venture-backed companies in their first five years post-IPO. Our findings suggest that these companies exhibited significantly higher earnings growth during compared to a wider index of listed growth public equities in general. While such growth outperformance appears attractive, it requires astute professionals familiar with this realm of investing to identify such opportunities in the private markets. Growth Capital funds provide investors access to such promising companies enjoying rapid organic growth. This presents a particularly appealing strategy for investors faced with the prospect of a low-growth environment.
Phases in Growth Capital investing. While the promise of returns exceeding that of listed equity investments is enticing, investors must be prepared for the long investment horizon necessary to realise these attractive returns. This is because of the nature in which capital is deployed and how investment returns are generated. Time is required for each of the stages necessary in realising the potential of an investment (Figure 2):
- Investment phase – The fund manager sources for target companies, evaluates the opportunities, and bids for stakes in the companies. During this phase, a fund may make calls for investors to provide more capital to deploy into new investment opportunities.
- Value creation phase – Fund managers focus on helping portfolio companies grow by working hand-in-hand with company management to scale the businesses, penetrate new markets, and grow earnings.
- Harvesting phase – After the fund has finished making its initial investments, the managers focus on further enhancing its existing investments, and exiting. This is the phase that generates cash for investors, as portfolio companies hold their IPOs, or the fund sells its ownership stake to other investors.
Good things come to those who wait. Unlike the liquid public markets, the nature of private market investing makes it a long-term commitment – those who wait would find themselves rewarded for their patience. One means of mitigating the impact of capital calls is to invest across funds of multiple vintages, where distributions from more mature Growth Capital funds would aid in funding the capital calls of the newer vintage funds, resulting in smoother cash flows for the long-term PE investor (Figure 3). The notion of long-term investing may have lost its appeal of late, but when investors come back to thinking more like business owners, they would find that it pays to be composed in deploying capital for the long haul.
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