The growth revival

Growth equity is big business. Last year, according to data from the European Venture Capital Association (EVCA), 10 growth capital funds raised €3bn, one fund and €1bn more than 2007. Investment almost doubled to more than €7bn, with €5bn of this coming from buyout funds alone, which is more than the total amount invested in 2007 in growth capital deals by venture, growth and buyout funds (€4.3bn). Buyout funds contributed an extraordinary 70% of total growth capital investment in 2008.

At first glance, the turn towards growth capital by buyout funds seems staggering, and a startling indication of how barren life is in their traditional investment space. A move into growth was the subject of much speculation following the banking crisis last year – the argument went that following the huge funds raised by both the mid and mega deal firms in 2006-2007 and the collapse of the debt markets, they would be forced to move down the food chain in search of smaller companies and make smaller investments.

The problem with this is no-one operating in the growth capital space has seen any buyout houses making growth capital investments. The issue would appear to be down to the definition of growth capital, and EVCA’s appears broader than that adopted by most growth firms, as it includes buyout funds investing in venture deals and sometimes taking majority stakes in companies, which specialists tend to avoid.

Buyout challenge

The reconciliation of the discrepancy between the data and the observation is the size of the deals classed as growth equity. Many of the growth players don’t go beyond €100m per investment. 3i’s sweet spot is around €80m, Kennet looks to invest between €10m and €15m, Index Growth Fund between €20m and €30m, and Summit Partners doesn’t go beyond €100m. Some of the cheques that have been written by the buyout houses have been well beyond this.

LBO France paid €300m for a one-third stake of Converteam, the French power company, for example, whilst Candover paid €250m for a 40% interest in Italian fitness equipment supplier Technogym, and Carlyle bought a 48% stake in sportswear maker Moncler for €150m. However, these examples are not seen as part of a trend, more as opportunistic moves in the absence of leverage.

Scott Collins, managing director at the London office of Summit Partners, refers to the differences between venture, growth and buyouts as “overlapping circles”. He says: “Buyout houses invest in more mature businesses, ones that aren’t growing all that fast, so they generate their returns through financial engineering and that’s associated with high amounts of debt, and it’s a control transaction. With growth capital it’s more about partnering with entrepreneurs. They are companies that are growing, and in our case, always profitable. They want to grow rapidly, from £20m of sales to £100m for example, and they have a strong momentum.”

Summit is behind one of the most successful technology deals in European history through its investment in Jamba!, German-based mobile phone content provider. Summit took a 56% stake in September 2003 for US$40m and sold it nine months later to VeriSign, realising a 3.8x return and an IRR of more than 300%.

A more recent, and current investment is Vente-Privee, a French business which runs Internet-based, members-only events for consumers interested in purchasing high-end designer brands at substantial discounts to retail prices. A customer signs up to and receives a handful of emails a week inviting them to online sales for luxury and upper-end high street brands. Recent examples include Calvin Klein, Diesel, Guess and Alberta Ferretti. The company’s turnover is over €500m a year and growing at 40% a year, with operations now in Spain, Germany, Italy and the UK.

Summit acquired a 20% stake in 2004 and three of the Summit team joined the Vente-Privee board and helped with the international expansion as well as modernising its financial reporting and helping appoint a CFO.

“The mentality of a growth investor is different to a buyouts one because you are not in control. With growth investing you have to have a mentality that is about building relationships with entrepreneurs and being a quality partner,” says Collins.

The partnering issue is key. “The challenge for buyout firms is the entrepreneurs and what they want,” says David Whileman, who leads the UK growth capital team at British private equity house 3i. “Buyout firms are a financial purchaser, typically through an auction process and you pay the best price based on how good you are at financial engineering and how much debt you can raise. With growth deals, you are not a buyer. With growth, it’s much more about the people you are backing. Once you’re invested, you can’t change the management team like a buyout house can. The person you’re backing is often the founder who is not looking to sell the business. He or she is looking for a partner, not a buyer, and they very much want it to still be their business. As a result, they will do a lot of research into their potential investors, and this will include talking to as many CEOs who we have backed in the past as possible because they want to know what we can do to help him or her grow their business, which you don’t have with the LBO firms, which are much more about professionalising management by bringing new people in. Growth capital is more about what you as an investor, as a partner, are going to bring to the table.”

Whileman cites the case of Hyperion Insurance Group, a UK company specialising in providing liability insurance cover. 3i paid £30m for a 27% stake in April 2008. It was founded by David Howden 15 years ago, and by the time of 3i’s investment, the company had reached a point where if they wanted to accelerate the business, they needed additional funding to expand its product range, move into new geographies and professionalise the business. 3i helped by finding a new chairman – John van Kuffeler, also chairman at Provident Financial – and a new group finance director – Eric Fady – from insurance giant Marsh. The company also wanted to restructure the shareholding base – its entrepreneurial model meant it had a lot of minority shareholders and the company wanted to “suck these up” to the top company, as Howden puts it, and align their interests, and the needed money to do this.

“For a lot of the people we saw, one of their first questions was, ‘what was my exit strategy’, and that wasn’t really a very interesting question to me. I wanted to know how they were going to help me grow the business, not how they were going to exit the business. Whereas 3i’s first question to me was ‘what is your growth strategy, how are you going to grow the business, what are you about’, and that was important,” says Howden.

Changing tack

This goes to the core of the argument surrounding why buyout houses will struggle in the growth capital space – it’s a different way of investing, it takes a different skill-set, a different mentality to work in growth than in buyouts.

More simply, it’s also a different investment strategy. Michael Elias, managing director and founder of UK VC house turned technology growth investor Kennet, says: “We haven’t seen buyout firms at this end of the market. Growth capital companies are not often cash positive or are only slightly cash positive and at the beginning are in a position to service debt, and many of them, especially in a sector like software, are unpredictable. This is unattractive to buyout houses.”

“The buyout guys have been more conscious of growing their own businesses rather than making new investments,” says Mike Reid, former 3i director and now managing partner of Frog Capital, the renamed Foursome Investments. “The old model of leveraging a company up to the hilt and then selling it on at a profit doesn’t work anymore. If they have a buyout deal now they aren’t going to get returns from leverage, so they are focusing on growing their companies.”

“From a buyouts perspective, you are generally a minority shareholder, and that is a very different relationship to the management and other shareholders than you would have in a buyout situation,” he continues. “There’s no ‘I’m the boss’ attitude – growth investors have to be more diplomatic and constructive.”

One such constructive relationship is currently taking place at SiC Processing, a German cleantech company that services the makers of silicon wafers for the solar industry, which raised €53.4m in October 2007 from a number of investors including Frog. Reid explains: “It was a profitable company which had seen its international model become successful and it was in a growing market and they had reached a point where they could have hunkered down and settled for what they had, and run the risk of jeopardising their market position, or they could accelerate their growth.”

Investor alignment

The lack of control over companies is what is likely to put off most buyout houses from making new investments in the growth space. It is the primary risk associated with taking minority stakes. 3i’s Whileman says it’s the most crucial issue in growth equity investing. “Do you know who you are backing and have they got skin in the game? We don’t know how the investment is going to go but if you know that all your eggs are in the same basket and are fighting for a common goal then it’s so much easier.”

For Summit’s Scott Collins, it’s about communication. “Once you have identified your partner, you have to build your relationship over time and get to know each other. There are some things you can do with legal documentation, like veto rights, but these instruments can only go so far.”

Reid says it is more likely that venture capital firms will come into the market rather than buyouts because the former are much more comfortable with taking minority stakes.

One recent example of a venture firm who has taken the plunge is Index Ventures. It closed a €400m growth fund, its first, in January last year. “It was just a very natural path,” says Dominique Vidal, a partner at Index Ventures. “There were many companies we had met once or twice in the past but didn’t invest in who now needed some extra financing. Most of these companies had founders who had reached a point where they either wanted to sell up or continue, and if they wanted to continue, they wanted to grow the business, be this by acquiring companies themselves, or growing internationally, and they needed capital.”

Index identified a gap in the European market. “In the US you have a lot of funds providing growth capital, whereas in Europe there were very few,” says Vidal. “I was running a business, Kelkoo, back in 2002 and 2003 and there were only about two or three firms providing growth capital, like General Atlantic and TA Associates, at the €20m to €30m space. Since then, they’ve raised bigger funds and moved out of this space, and we saw a gap.”

This is an opinion shared by Mike Chalfen, a GP at Advent Venture Partners and formerly of Apax Partners. “There is no leader in European growth equity. I was talking to an intermediary and they were saying that if they have a company looking for venture backing, there’s about 70 VCs to call. With companies looking for growth, there’s about seven or eight.”

This idea of an historical lack of growth capital isn’t shared by all. Anne Glover, CEO of Amadeus Capital Partners, argues it’s always been there, the difference now is that companies articulate their investment strategies better.

For Glover, renewed interest in growth capital is as much about the lack of leverage and the disillusionment with venture capital on the part of LPs as it is repackaging an old idea. “It’s really a terminology thing. You can talk about the rebranding but in terms of activity it’s always been there.”

However, she does admit there is something of a growth capital revival underway at the moment: “I put it down to the macroeconomic environment. A renewed interest in growth capital by private equity firms is a natural response to the reduction of leverage. From the other end, there is a population of around 4,000 VC-backed companies still in private hands in Europe. About a quarter of these are profitable and they need expansion capital and that is a very healthy market to be in. For us, it’s a very attractive place to invest.”

Like Index, Amadeus has its roots in venture, but the latter has always maintained a balanced approach to its investment, willing to invest at all stages of a company’s life-cycle, from early stage, to late stage to growth capital, although question marks surround whether the last two are in fact the same thing.

Venture versus growth

“LPs are very excited about growth equity but not venture. Well what’s the difference?” asks Simon Cook, CEO of UK VC DFJ Esprit. “They talk about growing companies – that’s our business as well.”

The difference between venture capital, especially late stage venture, is either non-existent or massive, depending on who you speak to. “It’s very similar to venture in many ways,” says 3i’s David Whileman. “I see growth being in the middle of venture and buyouts, it’s about the lifecycle of the business. Growth tends to be at the later stage in the company’s development. Venture capital invests in businesses which are usually not yet generating a profit. It is still in the phase of developing its products and services. Growth companies are generally profitable. The money is to be used to grow the business internationally, find new customer channels, new markets or new synergies, or to give them more firepower to make bolder acquisitions.”

“The purist definition of growth capital is that it funds businesses that are in the growth phase of its development. It’s got products that work, it has good revenues, has a good management team and is unlikely to go bust and wants to accelerate its growth” explains Frog Capital’s Mike Reid. “When it comes to looking at the difference between venture and growth, you have to look at the different types of VCs. Early stage VCs have moved to late stage, Balderton for example, and some of those deals could be classed as growth deals.”

For Index’s Dominque Vidal, it’s a question of stage. “In venture, you invest in companies where the model isn’t proven. The risk/reward factor is higher than in growth capital. In venture, you could make 10x your money, but the risks involved mean that few companies will do so. In growth capital, because the business is more mature and the revenue stream is there, the entry price is higher and the chance of making a very high return is unlikely, but there is a greater chance that more companies will make a return, typically between 3x and 5x.”

Kennet’s Elias hinges his definition on money: “They are business that are typically generating revenues of between €10m to €15m a year and have not taken material outside capital. They have been boot-strapped.

“There’s a profound difference between growth and venture-backed companies. Growth companies tend to grow more slowly. If you are starting a company with no capital you have to make sure your products and services meet customer needs from day one, and you have to make sure they are generating really high margins.”

For Glover, the difference between the two is more subtle: “VCs grow companies through all stages and that means you have to look at the whole evolution. You don’t simply stop backing a company because it’s making £50m of revenue. You are there to support them. It is only because venture has got such a bad name that growth capital is being used as a term. I understand that reasoning but I don’t think the two are that different.

“Late stage venture and growth are the same. The term ‘late stage’ venture was an invention by the venture capital industry to explain why they were doing series C and D rounds. It used to be called ‘expansion capital’.”


Despite the differences over definition, there is no denying the fact that growth capital is experiencing a comeback of sorts. The absence of leverage is a cause of consternation for investors in buyout funds, but it goes deeper than that. Frog Capital’s Reid explains: “There are more European business now that are getting to that phase where they have this growth ambition, and rather than sell out early, the owners want to stay on and compete in the market place.

“What investors are looking for today is a more balanced risk/reward profile. They are too nervous to go into venture capital but can’t get the leverage now. They want a growth profile but don’t want the risk of venture.”

Elias agrees: “Late stage venture is not very interesting right now. Being in a G round of a company that is raising €80m is a scary place to be, whereas returns from growth investments have been compelling for LPs.”

Consequently, competition is set to grow. “There are more players going after growth capital today because of the lack of leverage available,” says Vidal. “This means you are going to see more competition in coming years. The pipeline of growth companies won’t change, but the competition for them will increase.”

Ultimately, the growth revival is one of timing. The ability to deliver between 3x to 5x investment is very attractive in the current economic environment. “It’s a cyclical point,” argues Advent Venture Partners’ Chalfen. “It’s a good time in the cycle to be focusing on growth. Leverage has been destructive and above all remains extremely hard to get. Growth capital is the best place to be.”