What is the difference between LMM and Growth Equity?

Making Gravy's picture
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What's the difference between LMM and Growth Equity? I understand LMM is typical buyout but the check sizes are smaller. Is Growth Equity like LMM but just even smaller check sizes? Or are there nuances to it that make it more like venture? Is Growth equity the same as late stage venture like NEA or IVP?

Comments (8)

Jun 1, 2018

LMM typically refers to buyout as you correctly stated - that means taking control and putting debt on the company's BS.

Growth equity is more about injecting primary capital (or secondary purchase from owner? - not too sure which is more common). It is a minority position alongside the owner of the business and there is usually little or no debt put on the BS. Key point is that you are not in full control of the business (i.e. less than 50% ownership)

I have not spent a lot of time in either of those so happy to be corrected by someone more knowledgeble.

Jun 1, 2018

I would add that the types of companies smaller growth equity firms are looking for are much different than what NEA and such are looking for. NEA is looking to fund massive checks into companies that could be billion dollar outcomes. They will often fund pre revenue businesses or companies with big cash burns. Growth equity is more focused on companies with proven models and usually closer to break even. They aren't looking for the next Uber, moreso the next solid small company that could grow into a solid market company.

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Jun 2, 2018

Secondary purchases are usually done when there is primary capital injected (ie increasing capital by 20M but with 30M brought by new investors and 10M of investors leaving). I have even seen such situations with Angels leaving projects in series B/C

Jun 1, 2018

Growth equity is more similar to venture than traditional PE in my experience. We're a very small shop and typically do minority investments around 20% in convertible debt or preferred equity. I'd say the vast majority of our portfolio companies aren't turning a profit yet. We'll be the first institutional money a lot of them see, but they at the stage they've already established their business model and need to expand sales and marketing.

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Jun 3, 2018

I will quote another comment I made:

APAE:

Growth equity has two definitions from two different sets of people.

One is 'growth capital for a proven business that wants to expand'. That is the private equity universe, and it tends to be capital for businesses that are targeting 15-30% annual growth. The hockeystick potential is either behind it or never existed because it wasn't that type of business to begin with.

The other is 'more fuel for a startup that is still early in its hockeystick'. That is the Series B, C, D for startups that have a massive addressable market and are starting to enjoy economies of scale (fixed development cost of the product, uncapped sales potential). That is the venture capital universe.

Lower middle market tends to refer to buyout. Growth equity refers to either of the two definitions above.

Lower middle market is a size definition. It refers to companies with $5-50m in annual revenue. Growth equity is a type of transaction definition. It refers to non-leverage transactions for businesses with a proven business model, regardless of profitability.

In summary, it's very often used interchangeably with 'late-stage venture'. One handy rule of thumb would be to look at the industry of the target company. If it's tech or tech-enabled (e-commerce, life sciences, etc.), it's venture-like. If it's not tech, it's private equity-like.

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Jun 3, 2018

I wrote a longer answer but it didn't let me post this so to save time I make it a bit shorter and break it into three parts - if my post shows up multiple times, I am sorry.

Based on broad market understanding: LMM mostly refers to buyouts, growth equity to (most of the time) minority positions created via primary capital intake.

If we look at this more theoretically: In a nutshell growth investing refers to allocating capital into growing the business vs. immediate cash yield. Most often this means primary capital intake and minority positions but it does not have to take that form exclusively. Lets take nomenclature and transaction structure aside for a minute.

On this page it is often mentioned that growth is closer to VC than it is to LBO and I think the answer is more complicated than that. I would look at it in terms of risk you are underwriting and think in terms of the classic "value creation" bridge.

In very simplistic terms and based on the "traditional" view:
VCs provide capital to a company for it to prove that a product works, a product market fit exists or a business model can disrupt existing operations. The returns are achieved if the business successfully proves that it has created a valuable business model. The risk is that no valuable business model is created.

Growth equity means providing capital to a company - post the product market fit stage - to permit it to scale operations. You want to be compensated for financing its expansion. Return stem from the achieved "growth" i.e. a more valuable business (sale of it, profits from it etc.). The risk you are underwriting is often operational and could mean that its more expensive to grow, there is no larger market after all, there is no exit etc.

In an LBO, you buy the Company and the returns are achieved by allocating capital towards paying down debt. In theory this could also be done without debt and just take the form of dividends but from the value bridge perspective, it's the cash allocation of the existing business you are betting on. If anything dislocates (exit environment, business not stable enough, financing markets etc.), you take a hit.

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Jun 4, 2018

The reason the risk / return thinking helps is because the transaction structure and nomenclature can mix: many buyouts have a growth element to it, i.e. the return bridge is quite growth oriented and primary capital is used to boost growth. So the returns and risks mentioned above mix. Another point to make things a bit more confusing, we also conduct growth deals without any primary capital but just permit the business to run EBIT breakeven and re-invest everything. Lastly, growth deals can happen as minority or majority. Ticket size does not really matter in that sense although we obviously expect to see growth investments much more in smaller companies where internal cash doesn't permit re-investment at the required amounts. If a company is break-even, for them to hire 30 new sales people would take x years. We can fast track this by providing that cash up front - think international expansion of something that works or adding new verticals.

Another point regarding the company size: If I buy a dental practice where I have visibility on the cash flow since 10 years, this is most likely an LBO structure. Although the thing is small. However, if we aim at generating returns from growing this by buying new equipment or capitalising it to open a second and third practice, we are back in the growth equity space.

The terms late stage venture and growth are also a bit tricky. Worse even, many VCs have growth vehicles, too. When I hear late stage venture - and this is very arbitrary and my own view - I think much more about the investments that doesn't fit the 5x VC target anymore but capital is still required to see it through. So for me that term is often much closer to momentum than it is to the "oldschool" growth nomenclature of taking something that was subscale before and has reached an inflection point / can accelerate with capital and expertise. Most growth deals as i think of them is first money in. Late stage venture is yet another round in a business model that has seen various funding rounds but needs some more capital (at a different risk / return profile though).

I copy an answer I wrote in response to a topic that was about giving the right answers in a growth interview below - not sure how helpful though.

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Jun 3, 2018
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