Posted on: May 22nd, 2014
When it comes to making an investment in an established business, growth capital and buyouts are two of the most common strategies employed by private equity firms.
However, there are several key distinctions between growth capital and control buyouts, both from the private equity investor’s perspective and from the target company’s perspective.
- Growth capital (or growth equity) is a private equity investment at the intersection of venture capital and control buyouts. Businesses seek growth capital investments when bank financing is unavailable either due to previously unpaid debt or when they are deemed unprofitable.
- Growth capital financing is usually designed to facilitate the target company’s accelerated growth through expanding operations, entering new markets, or consummating strategic acquisitions. Sometimes growth financing may be also used towards reducing the amount of debt on the company’s balance sheet thereby putting it in a better position to borrow from traditional sources.
- Returns from growth capital is generated by dividends (in some cases the deals involve preferred stock or hybrid securities with guaranteed dividends / interest payments) and from the eventual sale of the stake in the company.
- From the target company’s perspective, growth capital funding is often the preferred source of financing based on the company’s financial profile and operational characteristics. However, many private equity firms only use this kind of investment as part of a mixed portfolio.
- Buyouts encompass full acquisitions, in which a controlling ownership interest in the target company is obtained, along with non-control investments, recapitalizations and refinancing transactions.
- Private equity firms fund the purchase of the stake by borrowing between 60% and 90% of the money needed to complete the transaction. The company is then restructured in order to increase the value of the fund’s stake as quickly as possible. This is achieved through cost-cutting measures, disposal of loss-making parts of the business and the restructuring of the balance sheet in order to reduce interest payments.
- Although there may be some returns for the private equity fund from dividends, the ultimate goal is to sell the controlling stake in the company for a price that represents a sizeable profit. Usually the sale may involve taking the business public via an IPO or the shareholding being disposed of in a single transaction.
- Buyout funds have the potential to make healthy returns, but it comes with its own set of risks for even a slight change in economic or market conditions can result in private equity funds incurring huge losses on major buyouts.
This article only outlines an overview of certain characteristics of growth capital vs. buyouts. As is always in the case of private equity investing, is important to engage an experienced financial advisor early in the process.
Attract Capital, a reputed financial advisory firm with a 25-year old knowledge base of the private capital markets, provides a wide range of advisory and funding services, including Acquisition Funding Solutions and Growth Capital Financing Solutions.
Contact us with your concerns or set up a free consultation with our advisors.