The New-Found Fashion for Growth

John Bernstein, General Atlantic

Published in Private Equity News, September 2009

In the boom years, private equity became synonymous with leveraged buyout investments. The growth part of the private equity market, including larger-scale growth investing, became lost in the noise.

As debt availability plummeted and costs increased, growth equity investing has started to attract more attention, including from LBO houses, which have found their business models challenged.

Many of the larger growth firms (here defined as investing $50m to $500m, as opposed to venture capital with investments up to $20m) have their roots in venture or expansion capital in the 1990s. General Atlantic, Advent International, Apax Partners, TA Associates, Permira and Warburg Pincus, for example, all started off investing in smaller growth deals, often with a technology bias. Fund sizes then were smaller than average deal sizes now. Furthermore, growth investing requires many different skill-sets to investing in LBOs including:

- Working alongside founder entrepreneurs - often strong characters who expect to have different relationships with their investors than professionally appointed management teams;

- Investing as minority shareholders rather than as majority owners in control positions;

- Deal structuring for minority positions and adapting structures to unforeseen circumstances;

- Making changes through persuasion and proving added value, rather than exerting change through ownership and control;

- Creating gains by growing revenues and profitability driven by a clear investment thesis;

- Understanding industries, technologies and growth drivers in order to help build businesses;

- Assisting companies by extending their contact networks;

- Understanding the issues associated with growth (both internal and external) and helping management teams to avoid "elephant traps";

- Helping with internationalisation and global expansion;

- Helping to bridge the gap between a great technology and a great company.

Exits for growth companies are also often different from exits for LBOs. Whereas the latter became dependent on recaps and on secondary and even tertiary sales to other buyout house, IPOs have played a larger role in assisting liquidity and exits for growth investors.

Venture investors tended to come from a broad range of backgrounds and many had significant industry experience before becoming VCs. Many of the people that have entered the industry over the past few years come from investment banking, and while these are some of the brightest around, the industry has homogenised.

Given the backgrounds of these industry entrants, their focus has often been on financial engineering rather than on business-building, and on processing books from investment banks rather than on hunting out proprietary opportunities.

Private equity houses are now facing strong pressures to change. A number of LBO firms are trying to adapt by bringing key industry experts on board, whether as "special advisors", "operating resources" or "operating partners", and this is helping to bring in a wider range of expertise to sit alongside the deal and financial skills of private equity professionals. However, it is hard to get a fund of $10bn to invest in $50m or $100m chunks, and most of the firms that started in VC and expansion capital have grown away from their roots, often so far that the original cores are hardly recognisable.

Whether the next crop of growth deals will be successful is as yet unproven, of course, but building the revenues, profits and strategic positions of great growth companies is not just valid, but essential, for the private equity industry and its investors, and for building the companies that will be the cornerstones of the economy in the future.