Interview - What makes a good growth equity investment?

My take is the following:

Key answer is you need an "engine" that is reasonably clean i.e. you know that every $ invested into growth gets you $*n revenue increase in X years. This together with the conviction that there is room for an asset of Xm revenue / size in the space and an exit environment supporting this, is at the core.

How do you know whether this is one of these assets that can become of the size you need it to be? In order to be able to do this you need to understand exactly the economics. Is this headcount driven? If so ramp up times, quotas and all of that needs to be assessed. If it is SaaS, the key drivers to assess for slightly change (churn, CAC, LTV etc.). The asset shouldn't be too hairy (non-core parts and other distractions). Unit economics and "fixed costs" need to be understood.

Obviously, what needs to be a given is an understanding of and a sizeable end-market (not just 10% of 10bn is our opportunity but a proper ASP x customer segments, ideally lists of customers etc). You will be surprised how detailed growth players audit customer lists (how much and on what do they spend their money exactly? What do they really use it for? What other solutions did they look at? What is your price / functionality compared to competition?)

What needs to be achieved but by back solving is an entry valuation that allows you to make enough returns and an equity ticket that gets you to the exit (or factor in further rounds and at what valuation these need to be done...). Don't get the cash needs wrong because if you all of a sudden need 3x the assumed equity ticket to get to the target company size - you're returns have just disappeared. Yes you can throw in more money into the tank if you see great growth coming out of it and thus can get you faster to your target position (Accretive and return enhancing) but you cannot put in more money because your unit economics calculation is wrong and more $'s are required for the same outcome.

In a perfect world, you quantify exactly where this company can go over 3-5 years in terms of revenue, the funding required to get there and backsolve for what you can pay. You will see players like insight e.g. come in with valuations and ticket sizes that are extremely aggressive when looked at based on what stage the asset might be at. However if you have a high conviction that a e.g. 300-500m player can be created in this space, there is need for such a player, and you know exactly what you get for each $ invested, you can make great returns.

I sit in Europe so my example is European but if you look at insight investing $165m into tricentis this is a good case study. This business - when looked at in isolation (and i don't know it personally at all but for that I missed spotting it) - probably doesn't support this ticket or valuation but when your conviction is that there is room next to an IBM / HPE for a global automated testing business of scale (lets assume for the sake of the exercise 1bn revenue target) and you know exactly how the unit economics work and how the sales ramp up will work (adjust for SaaS metrics where required) then you have a great trade by selling / listing this with rev(1bn) @ a multiple of e.g. 5-10x. However, if you get the assumptions wrong and need more money to get there or don't get there at all because of slower roll out or less attractive market (exit, competition, size) you're screwed. Identify the market need, find the engine, add fuel, make money. Scale controlled into a market need (space might be empty or you offer feature parity at lower price etc. whatever your justification for the need of your player is).

Another point to add - which supplements - your answer above beyond the "growth engine part": ideally the asset is slightly overlooked in the market. There is a reason all growth shops prefer buying from management teams, outside of auctions and have cold calling teams to spot these assets. It is of course price but often it is also that these assets still have significantly more levers to pull in terms of growth vs. buying from another sponsor that has scaled this already. Growth can sell to LBO but growth buying from growth is difficult (unless fund time issues) because other people have already been investing behind the roll out and probably taking the returns and each $ you invest has not the same unit economics.

What needs to be in place is a governance / shareholder structure that allows you to execute on your trade even as minority but this is true for all investments hence not core to my answer. The structure needs to support the thesis in any investment unless your thesis itself is changing the structure e.g. forced sellers (funds at end of lifetime etc.), succession, de-listings etc.

If you look at the teams at the leading growth players you will find that even the junior team members can speak very smartly about what end market and why and understand exactly the KPIs in this space and what to look for when calling companies / meeting companies at conferences.