Growth Equity - Questions
What is Growth Equity?
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Investment characteristics
○ Typically minority interests investments made in late-stage companies
○ Little/no debt used in these growth transactions
○ Minority interest and preferred equity
Type of risks
○ Moderate risks
○ Execution and management risks are high
○ Miss the growth projections because the valuation multiple will be lower
○ Limited ownership and operational control
Holding period
○ On average 3-7 years vs. 5-10 years (VC)
Sources of returns
○ Scale operations
○ Revenue and profitability growth
Companies type
○ High growth to fund their continued expansion
○ Established business model and repeatable customer acquisition strategies
Growth equity funds
○ Target a MOIC of 3x-5x and an IRR of 30-40%
3 ways investors make money, and how do growth investors make money?
○ Growth
■ Buy and sell a company for 10x revenue and dramatic growth
○ Valuation
■ Buy a company for 10x revenue and sell it for 12x revenue
With the growth rate of company, we can estimate the returns
○ Revenue growth by X%
○ No change in entry vs. exit multiple
○ IRR = CAGR = X%
Company valuation multiple => Enterprise Value / Revenue, and Revenue Growth
What are the criteria for an ideal growth investment?
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Criterias for an ideal growth investment
○ Having a proven product and business model
○ Benefiting from significant organic revenue growth (x>30%)
○ Having sizeable portion of a defined market
○ Potential to upselling and customer retention
○ Scalable customer acquisition across geographies + verticals
○ Improvements in unit economics should be feasible
Ideal firm target
○ Does not require the growth capital to continue operating
○ No need for capital to survive
What are the main purposes of securing growth capital?
Growth Equity - Questions
Establish Scalable Business Model during Commercialisation Stage
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Company Profiles
○ High tractions for Products/Services
○ Important increase of recurring revenues
○ Margins improvising with scale (better unit economics)
○ Far from being cash-flow positive
Growth Avenues
○ Expansion into new markets to reach new customers and demographics
○ Developing existing products/services (or adding on new features)
○ Hiring more sales representatives and related back-office functions
○ Spending more on marketing and advertising campaigns
What are the three components that are critical for the investor?
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Focus on partnership
○ Management team retains strategic and operational control
Value-add
○ Operational and human resources to scale efficiently
Aligned interests
○ Agreement about the firm’s growth potential and long-term strategy
For growth equity investors, why is it important to perform diligence on term sheets and
capitalization tables?
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Term sheet established the specific agreement between the start up and the investment fund.
Cap table is a numerical representation of the equity ownership
○ number, types of shares (common vs. preferred), investment timing, liquidations
preferences or protection clauses
○ employee stock options, convertible bonds.
Compare and contrast the advantages and disadvantages of being a “horizontal” versus
“vertical” software company?
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Horizontal Software
○ All-encompassing solutions which can be used across a broad range of
industries (CRM, Salesforces)
■ More potential revenue based on the Total Addressable Market (TAM)
■ More time to adjust the strategy and pivot
■ Focus on most profitable markets
■ Highly-competitive market “winner takes all”
■ Higher rate of churn (freemium model)
■ Higher Sales and marketing cost
Vertical Software
○ Solutions which targets specific niches segment and tailored for a given
industries
Growth Equity - Questions
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Add meaningful value
Lower rates of customer churn
Meet the need of underserved markets
Need of sufficient traction
Risk of technical hurdles, lack of market demand
Potential of revenue less important
TECHNICAL QUESTIONS
How do growth equity investors protect themselves against the downside risk?
● Conduct a strong and rigorous due diligence
● Minority stakes (ie. < 50%) and mainly in preferred equity (specific rights : priority for
dividends, no voting right, priority in case of bankruptcy)
● No (or minimal) Debt
● Using full-ratchet provision
2 companies traded at different multiple : 15x multiple and the other 10x multiple
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Quality and experience of the management team
Financial profile (e.g. pricing, expenses, margin structure, capital requirements, etc.)
Business model considerations (e.g. length of customer contracts, form of payment, supply
chain)
Tell me about the difference between an up round vs. a down round
● Up round: when the company valuation is higher than the previous round
● Down round: when the company valuation is lower than the previous round
Imagine that you are meeting with the management team of a potential growth investment.
Which questions would you want to be addressed?
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Does the management team have the right skill set to lead their company in reaching the next
stage of growth?
What are the long-term financial goals in terms of revenue and market share growth?
Which factors make the business model and customer acquisition strategy more repeatable to
facilitate increased scalability and become profitable someday?
How much value do the company’s products/services provide to their customers?
Where do the new untapped opportunities for growth lie?
Does management have a plan for how they intend to use the proceeds from the investment?
Growth Equity - Questions
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What has been driving recent revenue growth (e.g., pricing increases, volume growth,
upselling)?
Is there a viable exit strategy planned by existing investors and management?
Seed round
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Friends,family and BAs (Eurazeo, Partech, Elaia, ISAI, Kima Ventures,
Earlybird)
Some specialist VCs
Serie A
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First-time institutional investors (Bpifrance, Eurazeo, Partech, Elaia)
Optimize the product offering and business model
Serie B/C
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Growth VC, expansion stage (Blisce, Eurazeo, Bpifrance)
Focus to scale, strategic decision (international, M&A, diversification)
Serie D
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Late stage VC (Alliance X
Go to IPO or profitable exit (corporate, merger)
Growth equity : it differs from Private Equity
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Invest in fast growing sectors/markets
○ PE: slower growth industries
Make money/create value from growth, not debt
Exposure to operations and best-in-class managers
○ Strategic advisory, M&A support, international expansion
Spirit of collaboration with management teams
Growth equity: it differs from Venture Capital
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Different stage of go-to-market strategy
○ Proof-of-concept stage:
■ Build a prototype and validate the idea with a potential market
○ Commercialization stage:
■ Product-market fit validated, goal to capture more market share and growth
dramatic the revenue
Invest in proven product and business model (mature stage)
Different financial risk-reward profile
Different ways to add value with your dollars
○ VC: find a product market fit / Growth : scale the company
How to source investment for Growth Equity?
Active sourcing
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Making Cold-calling
Attending industry conferences
Growth Equity - Questions
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Browsing companies
Build strong relationships with more Seed fund
Passive sourcing
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Ask to be a call investor in a deal
Intermediary deals brought by investment bankers
Characteristics of preferred stock
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Seniority: Debt > Preferred Stock > Common Equity
Typically receives dividends, paid out in cash or in PIK
Preferred stock does not come with voting rights
Can sometimes be convertible into common equity
Liquidation preference
● Investors right, preferred shares
○ Represent the amount the owner must be paid at ext
○ Recovering 2 or 3x times capital invested
2 main types of preferred equity investments
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Participating Preferred: receive the preferred proceeds (dividends) amount plus a claim to the
common equity afterwards
Convertible Preferred / Non-participating Preferred: receives either the preferred proceeds or
the common equity conversion amount, whichever is of greater value
What is the pay-to-play provision? Why is it useful?
Incentivises investors to participate in future rounds of financing à requires existing preferred
investors to invest on a pro-rate basis in subsequent financing rounds
Growth Equity - Questions
If investors refuse, they subsequently lose some or all of their preferential rights, which most often
include liquidation preferences and anti-dilution protection à preferred shareholder is converted to
common stock in the case of a down round
Drag-along rights
● Protect the interests of the majority shareholder
● Right of majority shareholders to participate in a sale or change or control
○ Sell the company to a strategic, but a few minority investors refuse to follow along..
With drag-along rights, majority owners override their refusal and proceed onward
with the sale.
Tag-along right
● Protect the interest for minority shareholders
● Prohibition for majority shareholders to sell his shares unless the buyer also purchases the
minority shares
○ If a majority shareholder sells his stake, it gives the minority shareholder the right to
join the transaction and sell their minority stake in the company. It obliges the
majority shareholder to include the holdings of the minority holder in the negotiations
so that the tag-along right is exercised.
Right-of-First-Refusal (ROFR)
● Protect the interest for preferred shareholders
● Right of preferred shareholder to buy newly issued shares by the company first
Redemption rights
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Feature of preferred equity which protects investors
○ Force the company to repurchase its shares after a specified periodRarely exercised
because company often not in a position to purchase shares
Full-ratchet provision
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Protect investors from future down rounds
○ Applies the lowest sale price as the adjusted option price or conversion ratio for
existing shareholders for the next round.
Growth Equity - Questions
Growth Equity
Growth equity investments generally come with a lower holding period (on average, 3-7
years) compared to venture capital investments (average is 5-10 years). The rationale
behind it is that early-stage companies simply need more time to realize their potential
relative to more mature companies.
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Targets companies:
○ Operate in established and mature markets
○ Have a commercial viable product.
○ However, execution and management risks are still high.
○ Ideals targets
■ do not necessarily “require” the growth capital to continue
operating
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Source of returns
○ Ability to scale its operations, which results in significant revenue and
profitability growth
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Type of deals:
○ Mainly minority investments.
○ Commonly executed using preferred shares
○ Low leverage or no debt at all
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Growth capital use
○ Subsidize the expansion of their operations,
○ Entrance into new markets,
○ Acquisitions to boost the company’s revenues and profitability.
○ High growth potential and moderate risk of the investments