Growth capital woos unhappy buyout investors

Private equity firms that aim to take minority stakes in companies, rather than debt-laden controlling stakes, are taking advantage of investors’ dissatisfaction with recent low returns from buyouts to land more funding and make more deals with entrepreneurs.

The fund-raising market remains tough, says John Bernstein, managing director at General Atlantic. But the growth capital, or growth equity, sector will take a larger slice of the overall private equity pie.

“The voice of growth is louder than it used to be. I do think there’s more investor focus,” Bernstein says.

There are 130 growth capital funds seeking to raise $27 billion, according to data from consultancy firm Preqin. That’s more than doubled from 51 growth capital funds raising $11.6 billion at the height of the fund-raising boom in 2007.

The fact that 3i Group has chosen now to launch its first ever dedicated growth fund indicates a belief in investor appetite in the subsector (see new brief, page TK). Investors are seen looking for a less risky investment and are prepared to take lower returns.

“Growth equity has got a lot more attention because of the problems on the leveraged buyout side,” says Scott Collins, managing director at Summit Partners.

Firms such as General Atlantic, 3i and TA Associates, take minority and majority positions in fast-growing companies, using little or no debt.

While their returns are lower in peak times than buyouts, they typically outperform through downturns, drawing investors to their less volatile model.

Growth capital also resonates with entrepreneurs who want funding to help their businesses grow, the growth capital investors claim.

“They’ve seen what’s happened to the management teams of private equity companies buried under debt. It’s not a pleasant life,” Bernstein says. “You can’t focus on building the business because you have to focus on the capital structure.”

One gripe is that growth investments take longer to realize. Firms regularly hold their companies for more than five years, compared to a buyout funds’ average of three or four years, which pushes down annualized returns.

The growth industry still sees most of its deals in North America and Europe, although emerging markets, particularly China, India and Brazil, are taking a bigger portion of activity.

“We are really keen to be present in Asia because, by definition, it’s just a fast-growing region,” says Guy Zarzavatdjian, global head for growth capital at 3i.

Two thirds of 3i’s fund will be invested in Europe, while the remainder will go to Asia and the North America, he says. —Simon Meads