Growth Capital Investment: What is it and How Does it Work?

Growth Capital (also referred to as expansion capital & growth capital) is a type of private equity investment used by mature companies seeking funds for expansion & restructuring operations without changing control.

Growth Capital Investment: What is it and How Does it Work?

Stocks and real estate are two of the most common investments used for capital growth. While these asset classes can have income components: stocks through dividends and real estate through rental income, investors with an investment objective of capital growth tend to seek price appreciation.

Growth capital

(also referred to as expansion capital and growth capital) is a type of private equity investment, usually with a minority interest, in relatively mature companies seeking capital to expand or restructure their operations, enter new markets, or finance a major acquisition without changing control of the company. Companies seeking growth capital often do so to finance a transformative event in their life cycle. These companies are likely to be more mature than venture-funded companies, capable of generating revenues and profits, but unable to generate enough cash to finance large expansions, acquisitions, or other investments.

Because of this lack of scale, these companies often find few alternative ways to obtain capital to grow, so access to capital to grow can be essential to carry out the expansion of facilities, sales and marketing initiatives, the purchase of equipment and the development of new products as necessary. Growth capital can also be used to restructure a company's balance sheet, in particular to reduce the amount of leverage (or debt) the company has on its balance sheet. Growth capital is usually structured as preferred shares, although some investors will use a variety of hybrid securities that include contractual returns (e.g.Often, companies seeking growth capital investments are not good candidates to ask for additional debt, either because of the stability of the company's profits or because of their current debt levels. Growth capital lies at the intersection of private equity and venture capital, and as such, growth capital comes from a variety of sources.

The types of investors that provide growth capital to companies encompass a variety of sources of capital and debt, including late-stage private equity and venture capital funds, family offices, sovereign wealth funds, hedge funds, business development companies (BDCs), and intermediate funds. Growth capital investments are also made by more traditional purchasing firms. Especially in markets where debt is less available to finance leveraged purchases or where competition to finance startups is intense, growth capital becomes an attractive alternative. A company may meet the size and growth requirements of a fund, but it's still not an attractive investment candidate. A common reason for this is that a company is considered vulnerable to “exogenous” forces.

Examples of this are companies that operate, for example, in mining, agriculture or real estate development. A fall in commodity prices, a prolonged drought, or a radical change in interest rates—forces beyond management's control—can inexorably destroy shareholder value. However, it is not true that private capital requires that a company be exempt from capital requirements and that the investor's investment goes to outgoing shareholders as it would in a traditional purchase. From funding to finance acquisitions and expansions to expert advice and networking, equity for growth can be a big help for companies. Investors usually try to leave once the company they have invested in reaches a set of predetermined growth objectives. Many companies invested in growth capital simply won't be as prepared for the requirements of an institutional investor compared to more mature buying candidates.

In many cases, investors in growth capital are the same: they focus on acquiring companies of a comparable scale, since the challenges faced by growth companies at that level are similar, regardless of the type of investment they make. Growth capital funds will also have pre-established minimum and maximum investment amounts to be determined based on their mandate. The two most important moments in the life of a rapidly growing company are when the company receives its initial funding, often from venture capital (“VC”), and when it manages to exit through an initial public offering or commercial sale. Related to this, there is the importance for the founder of long-term liquidity and that his interest does not lose value as a result of the company's future capital needs or that there is no way out in sight. These may be important from a quantitative point of view, but will generally have to be limited and specific, and the uses of such capital will almost always focus on generating substantial EBITDA growth during the investment period.

In practice, the precise distinction between a growth capital operation and, for example, a venture capital investment at a later stage or a majority purchase that leaves the founders with a substantial equity stake and continuing executive functions, can be somewhat blurred in practice. At the same time, investors in growth capital can reap significant benefits by working in partnership with established companies that have proven to be profitable and have great potential for success in the future. Assuming that an opportunity meets the size requirements of a fund, the immediate concern of a growth capital fund is probably to establish that the target company is, in fact, growing rapidly, at least compared to its peers.