Growth Equity vs. Venture Capital: Understanding Key Differences (2024)

While both growth equity and venture capital investors target growing businesses, they differ in several important respects. In this article, I’ll outline the key similarities and differences.

Differences between growth equity and venture capital

The major distinction between growth equity and venture capital is the stage of company development.

While venture capital firms invest as early as possible in the company’s lifetime (usually, at or near the very beginning), growth investment rounds typically occur after several years of development once the company has proven its business models, established positive unit economics, and has a significant customer base.

In this way, growth equity investment tends to follow venture capital investment. While there is no exact dividing line in terms of when a company’s “early venture stage” ends and its “growth stage” begins, many point to the following as key factors in telling the difference:

• Customer traction or “product-market fit” – while early stage venture firms invest in companies who are still attracting their first customers, growth equity firms invest in companies that have found initial traction and are now “scaling” their customer acquisition
• Positive unit economics – Early venture stage companies have often not yet proven positive “unit economics,” while this is often a key criteria for growth stage investors as they seek to help the business scale
• Type of primary investment risk – Related to above, venture capital firms take “market” and “product” risk (will this work at all?), while growth investment firms take “management” or “execution” risk (can we scale what’s working?)
• Size of investment – Growth equity firms tend to invest much larger amounts of capital (and at higher valuations), while venture capital firms invest smaller amounts commensurate with the company’s earlier stage of development
• Holding period – Venture investors tend to “hold” their investments for much longer periods (e.g. 10+ years), given the fact they invest so early in a company’s life, whereas most growth investors are more accustomed to hold their investments for a more standard 5-year period

Similarities between growth equity and venture capital

While there are key differences between growth equity and venture capital, it’s worth mentioning there are many similarities as well:

• Private companies – Both venture capital and growth equity firms target privately-held companies that are not yet publicly-traded
• Debt is rarely used – Most early stage and growth stage investments do not have significant debt burdens and financial engineering is not a key driver of returns
• High growth companies – Given growth is the primary driver of returns, both venture capital and growth equity firms target fast growth enterprises; however, due to the law of large numbers, it’s usually the case that growth equity investments will be growing somewhat slower than early stage venture investments (which are literally starting from zero)
• Minority ownership stake – Both investment strategies usually seek to acquire a significant non-controlling minority ownership stake (sub-50%)
• Deal structure – Both kinds of investors are likely to request “preferred equity” shares (as opposed to “common equity” typically held by employees) with special rights pertaining to dilution, information-sharing, etc.

Asset class risk-return profile

The return expectations and risk profile differ significantly between growth equity and venture capital investing.

While venture investors seek investments that could potentially “return their fund” (e.g. 50-100x return), growth stage investors target a more normal return of 3-5x. Of course, the key distinction is that venture investors accept a much higher “loss rate” for their investments. Each individual venture capital investment must have really high potential because the most likely outcome for each is to “fail” or go to “zero.”

In this way, the expected “loss rate” for growth investors is much lower than venture investors and is akin to that of private equity, where the standard expectation is that each investment will perform reasonably well. It would be quite a (negative) surprise for any growth or private equity investor if one of their portfolio companies failed. While venture investors do not enjoy this outcome, it is expected to occur with high frequency.

This dynamic drives the difference in compensation structure between growth equity firms and venture capital firms.

Growth equity vs. venture capital exit strategies

Understanding the various exit strategies is crucial for both growth equity and venture capital investors. Each type of investment has distinct exit strategies that align with their respective investment horizons and risk profiles.

Initial Public Offerings (IPOs)

Both growth equity and venture capital investors aim for IPOs as a primary exit strategy. For venture capital, an IPO is often the ultimate goal, turning early-stage investments into substantial returns. Growth equity investors, with their focus on more mature companies, also pursue IPOs to capitalize on the established market position and growth potential.

Acquisitions

Acquisitions are another common exit strategy. Venture capital-backed startups are often acquired by larger companies looking to integrate innovative technologies or business models. Growth equity investments, in contrast, target established businesses that can attract strategic buyers seeking to enhance their market presence or capabilities.

Secondary Sales

Secondary sales involve selling shares to other investors. Venture capitalists might sell their stakes to later-stage investors or growth equity firms as the company matures. Growth equity investors might use secondary sales to provide liquidity to founders and early investors, aligning incentives and ensuring business continuity.

Comparison and Implications

• Venture Capital: IPOs and acquisitions are high-reward exits but come with significant risks. Secondary sales offer interim liquidity and risk mitigation.
• Growth Equity: Emphasizes stable, lower-risk exits like acquisitions and secondary sales. IPOs are pursued for high-potential returns, leveraging the company’s established market position.

Financing methods in growth equity and venture capital

The use of debt versus equity is a critical consideration in both growth equity and venture capital investments. Each approach reflects different risk profiles and investment strategies.

Use of Debt in Growth Equity

Growth equity investments often involve some level of debt financing. These companies are more mature, with established cash flows and a proven business model, making them suitable for leveraging debt to finance further growth.

The use of debt allows growth equity investors to enhance returns while maintaining a non-controlling equity stake. For example, a profitable fintech company might use growth equity investment combined with debt to scale operations and enter new markets.

Use of Equity in Venture Capital

In contrast, venture capital investments are predominantly equity-based. Early-stage startups typically lack the stable cash flows necessary to support debt financing. By taking equity stakes, venture capitalists share in the high risk and high reward potential of startups. This equity investment provides the capital needed for product development, market entry, and scaling operations.

For instance, a tech startup developing a new AI solution would rely on venture capital equity investment to fund its research and development efforts.

Comparison and Implications

• Growth Equity: Utilizes a mix of equity and debt, leveraging the stable cash flows and lower risk profile of mature companies to enhance returns.
• Venture Capital: Relies heavily on equity investments, sharing in the significant risk and reward potential of early-stage startups, with the aim of achieving substantial growth.

Founder liquidity and secondary shares

Understanding founder liquidity and secondary share purchases is crucial when comparing growth equity and venture capital. These aspects directly influence investment decisions and the trajectory of a company’s growth.

Founder Liquidity

In growth equity, investors often provide liquidity to founders by purchasing their shares. This allows founders to realize some financial gains without exiting the company entirely. It helps align interests and motivates founders to continue driving the company’s growth.

For example, a founder might sell a portion of their shares to a growth equity firm, securing personal financial stability while retaining a significant stake in the business.

Secondary Share Purchases

Secondary share purchases are more common in growth equity than in venture capital. These transactions involve buying shares from existing investors or employees, providing them with liquidity. This approach reduces the need for new equity issuance, minimizing dilution for current shareholders.

In venture capital, secondary purchases are less frequent, as the focus is on primary investments to fund growth and development.

Growth equity vs. late-stage venture capital

Whereas the difference between growth equity and traditional venture capital is relatively easy to define, the difference between growth equity and venture capital is more subtle and less obvious.

Indeed, the two types of investments seemingly have lots in common. They both involve taking minority stakes in high growth, relatively young private companies. Both investment styles aim to generate their returns from growth.

In practice, “growth equity” and “late-stage venture” are used somewhat interchangeably, making any discussion of the distinction between them somewhat academic. Many growth equity firms have even marketed themselves as “late-stage venture capital.” Interview candidates interested in growth investing should certainly target both growth equity firms and late-stage venture firms (Series B/C or later).

That said, if one HAD TO draw distinctions between the growth equity and late-stage venture, it’d likely be along the following vectors:

• Degree of profitability – while both late-stage venture and growth equity focus on positive unit economics, some might distinguish the two by the fact that companies receiving a growth equity investment may be more likely to be profitable overall, whereas late-stage venture capital companies may still be operating with large losses
• Expectation of future dilution – since growth equity investments are at or near profitability, there is an expectation that they will not require additional fundraisings in the future and therefore investors will avoid future dilution
• Use of proceeds – venture capital investors tend to focus on primary transactions and have traditionally had a strong aversion to providing founder liquidity via secondary share purchases; meanwhile, growth equity investors are usually less averse to deal structures involving secondary purchases, in part because the trajectory of the business is more secure so a potential loss in motivation among founders is less of a concern (note, this is situation dependent)

Industry-specific examples: growth equity vs. venture capital

Consumer Services

• Growth Equity: Growth equity invests in established consumer service companies with a strong market presence and positive cash flow. These companies use the investment to expand their operations and improve their services. For example, a successful online retailer might use growth equity to fund their plans for improving logistics and customer experience.
• Venture Capital: Venture capital focuses on early-stage consumer service startups with innovative ideas but no proven market fit. These investments help develop products and attract initial customers. An example is a new subscription service aiming to change how people access daily necessities.

Financial Services

• Growth Equity: In financial services, growth equity targets mature fintech companies with a significant user base and positive economics. These investments help scale technology and enter new markets. For instance, a digital banking platform might seek growth equity to upgrade its infrastructure.
• Venture Capital: Venture capital in financial services supports early-stage fintech startups developing new financial products. These companies need funds for product development and market testing. An example is a startup creating a blockchain-based payment system.

Healthcare

• Growth Equity: Growth equity in healthcare invests in companies with approved medical products and established market traction. The funds are used to scale production and enhance distribution. An example is a biotech firm with an approved drug looking to expand manufacturing.
• Venture Capital: Venture capital in healthcare backs early-stage companies working on new medical technologies. These investments fund research and clinical trials. An example is a startup developing a new gene therapy needing funds for trials and regulatory approval.

Impact of market trends and changes on growth equity and venture capital

Technological trends in venture capital

Venture capital investments are often driven by the latest technological advancements and innovations. Key trends include artificial intelligence, blockchain technology, and biotech. These areas attract significant venture capital due to their potential for high returns and market disruption.

For instance, AI startups developing machine learning algorithms for various applications, from healthcare to finance, are prime targets for venture capital.

Market disruptions in growth equity

Growth equity investments are influenced by broader market trends and disruptions. These include shifts in consumer behavior, regulatory changes, and economic cycles.

For example, the rise of e-commerce and digital payments has led to increased growth equity investments in established fintech companies. Similarly, regulatory changes in healthcare can create opportunities for growth equity investors to support companies that navigate these shifts successfully.

Impact on investment strategies

Technological and market trends shape the strategies of both growth equity and venture capital investors. Venture capitalists focus on emerging technologies with the potential for exponential growth, while growth equity investors look for mature companies that can capitalize on market disruptions to achieve sustained growth.

Understanding these trends helps investors make informed decisions, aligning their strategies with current and future market opportunities.

Conclusion

To learn more, read myprimer on the growth equity industry. Also, if you’d like to learn how to get into the growth equity industry, read my guide onhow to prepare for growth equity interviews.