Are Growth Equity Secondaries the New IPO?

The risk repricing in venture capital during 2022 significantly slowed the funding momentum, especially for startups considered long-shot investments. This domino effect ricocheted into the IPO market, nearly bringing it to a standstill. Many maturing companies now hesitate at the IPO doorsteps, awaiting more stable market conditions. But if we look closely, the pendulum had already started swinging away from public listings even before this financial hiccup. One of the powerful force driving this shift? Growth Equity investors.

Staying private longer has its benefits

Historically, there's been a discernible trend of companies staying private longer. The reasons are multifaceted. Being a privately held entity allows these organizations greater operational and strategic latitude. Without the relentless public scrutiny and quarterly reporting that public companies face, these firms can prioritize long-term strategies over short-term profit performance.

An asset class on its own: rapidly growing companies at the brink of profitability

Within this private markets universe, a segment has particularly drawn attention: Rapidly growing companies that have moved past their fledgling days but have yet to attain their full potential. They are typically characterized by rapid revenue growth and a need for capital to expand operations, enter new markets, or make strategic acquisitions. Their business models are more mature than early-stage startups, but they're still evolving, innovating, and expanding.

Source: Pitchbook via https://www.bain.com/insights/growth-investing-global-private-equity-report-2022/

Growth Equity used to occupy an ambiguous middle ground, caught between the realms of Venture Capital and Private Equity. It was a space where investors tread cautiously, wary of its undefined boundaries. But like all financial evolutions, the dynamics shifted. Growth Equity has emerged, shaking off its erstwhile ambiguities and presenting itself as a formidable asset class.

The evolution is both timely and apt. With traditional Venture Capital and Private Equity spaces becoming increasingly crowded, deal sourcing had often morphed into auctions, driving prices to inflated levels. The strategies that often revolved around leveraging also introduced heightened risks.

Capturing a sweet spot in investors' asset allocations

With its clearer focus, Growth Equity offers a refuge from these pitfalls. Companies that receive Growth Equity capital now have an even longer time horizon to achieve their growth objectives. They are mostly shielded from the pressure of quarterly earnings and shareholder expectations from being a public company.

Growth Equity provides companies with more flexibility in decision-making and operational strategies compared to a public company's regulatory requirements and reporting obligations.

The resulting value creation is particularly appealing to those investors who want to participate in the success of the leaders of tomorrow but without dealing with the tail risks (i.e. the risk of total loss) that earlier-stage venture capital investments pose.

Does it even need an IPO?

To assert that Growth Equity is the "new IPO" is not just a statement on its investment merits. Growth Equity investments generally have a lower risk profile compared to IPOs. This is because they are typically minority positions with low or no leverage, senior to management's equity ownership, and have protective shareholder and governance provisions, thus mitigating downside risk.

Contradictory at first, the holding periods of Growth Equity investments have been getting shorter despite the currently elusive (or undesired) exit option of an IPO. A healthy secondary market has developed, matching sellers, regardless of motivation, with buyers who seek to build exposure to this growing asset class.

Growth equity tends to outperform when markets rattle

It would be intellectually dishonest not to acknowledge that venture and growth capital funding has significantly diminished since its "free"-money fueled peak in the last quarter of 2021.

As a result, most of the deployed risk capital is concentrated in a few companies, leaving many peers with excellent prospects and skilful management in the dry.

This, in turn, has created pressure on prices in the secondary market, which is nothing short of a Growth Equity buyers' bonanza. While we do not advocate for market timing in private market investing, it would be imprudent not to take advantage of the current situation.

A win-win for both entrepreneurs and investors

In conclusion, while the current lull in the IPO market may or may not be a temporary response to 2022's risk repricing, the ascent of Growth Equity results from a more prolonged and profound shift in market dynamics and preferences. Companies and their founders continue to capitalize on their prolonged private status, and by doing longer what they love, they generate significant sustainable value for themselves and their investors. All it takes for investors is to take a closer look at the Growth Equity secondary market.