What is growth equity? Minority deals, structure and risk

A founder has built something that works. Customers keep coming back and the business needs money to grow faster, but selling the company is not the plan. Growth equity is the investor’s answer to that situation: put money in, take a minority share, and leave the founder in the chair.

What is growth equity?

Growth equity is capital investment in an established, growing company⁴. It comes later in a company’s life than venture capital, once the business is established but needs more funding to grow⁴. The usual payment is a share of the company’s equity, typically a minority share⁴.

Three definitions agree on the shape. Growth capital targets companies beyond the startup stage that need capital to scale operations, enter new markets or accelerate growth⁵. In KKR’s classification, growth equity means minority stakes in scaling businesses with proven product-market fit that are growing quickly and are short of buyout maturity⁶. And the stake is a minority one: the usual holding is often 20 to 40% of the company, not a majority and not 100 percent².

The strategy name varies, but the labels are stable. IOSCO groups strategies as early stage or venture capital, growth capital and late stage or leveraged buyouts⁷. Growth equity is the middle label. It is a distinct investment class with its own return and risk profile, which can appeal to limited partners looking to diversify¹.

Growth equity has grown into a segment of its own. PE firms increasingly acquire noncontrolling stakes in targets where existing shareholders retain control¹. One estimate from Preqin puts growth equity as a segment of private capital at almost US$920 billion at the end of March 2021, more than double its 2016 size¹.

What kinds of company get growth equity investments?

The target is neither a startup nor a mature cash cow. The money goes to companies with proven business models that need capital to fund a specified expansion strategy outlined in their business plan¹⁰. A fund looks for a company that has already proven its business model, not one still searching for it².

A peer-reviewed study of 1512 UK private companies over 2000 to 2021 gives the best data on the profile. Targets are younger, smaller, more intangible-asset intensive and more rapidly growing than the general pool of UK private companies³. They also differ significantly from venture capital and buyout targets, and the transaction structure differs too³. The study covers UK companies, so it is context for other markets, not a rule for them.

Ownership tells you something as well. Businesses targeted by growth equity funds tend to be founder-controlled¹. For those owners, an investment brings growth capital and expertise while they keep control, perhaps ahead of an eventual sale or listing¹. It can also let them realise part of their own stake¹.

Sectors cluster. Capital tends to skew towards software, and to consumer discretionary and healthcare to a lesser degree¹⁰. Technology holds the highest share of private equity deal value across Asia-Pacific⁸.

A typical profile has several features at once:

• A proven product and a repeatable way to win customers, rather than an idea¹⁰.
• A specific use for the cash, such as new markets, product development or sales capacity¹⁰.
• Existing owners who want to stay in control¹.
• A business that may be far from cash flow positive, because growth comes first¹⁰.

The last point matters. At this stage the company is likely far from being net cash flow positive¹⁰, and growth capital proceeds are used for expansion: entry to new markets to reach new customers and demographics, and internal development of existing product or service offerings¹⁰. That is why debt is a poor fit for the same company. A business burning cash to grow has little spare cash to pay interest.

Growth equity vs private equity

Growth equity is one strategy inside private equity, and the comparison that matters is with the buyout, the strategy that the plain term usually means. The two differ on control, debt and where the return comes from.

Control is the first difference. A buyout fund seeks a controlling equity stake in a mature company⁷. Growth equity investors usually take a minority and leave day-to-day operations with the founders and management². A buyout buyer acquires a majority stake and a thesis that does not necessarily include rapid growth, whereas the growth fund is paying for growth¹⁰.

Debt is the second. Growth equity deals typically involve neither full control nor a lot of debt². Growth equity firms rarely use debt¹⁰. In a buyout, by contrast, it is not unusual for 50 to 70 percent of the financing to come from debt², which is the subject of how a leveraged buyout works. A growth deal is often smaller too. Because the amounts at stake are lower than in a buyout, the deals often involve no debt financing at all, which means they can proceed even when debt markets are shut¹.

Returns are the third. The returns from a growth equity investment come predominantly from the growth of the equity itself¹⁰. A buyout’s returns depend more on the financial structure and paydown of debt¹⁰. No control premium is paid, because growth equity does not normally involve an auction¹.

For the full side-by-side, see buyout versus growth equity. The broader map of the asset class is in what is private equity.

Growth equity vs venture capital

Growth equity and venture capital both take minority stakes, so people blur them. The stage and the thesis differ.

Venture comes first. In most cases venture capital is the first institutional money into early-stage companies, for market research and product development¹⁰. Growth equity investors, unlike venture capitalists, can examine the company’s financial track record and speak to its clients⁴. A venture fund expects most of its portfolio to fail, with the return from a home run offsetting all those losses¹⁰. A growth investor has less room for failure, because it pays for a company that already works.

The growth profiles show the difference. Early-stage companies usually see growth rates near or far above 30%, while growth-stage companies grow around 10% and 20%¹⁰. Growth does not stop at the later stage; it slows. Growth equity funds also invest predominantly in late-stage venture-backed companies, whose founders have already given up some of their equity and governance rights in earlier funding rounds¹⁰.

Risk and return follow from that. Returns from growth deals tend not to be as high as successful venture investments, relative to the amounts invested¹. The risk is lower, as these companies are often mature but still fast growing¹. On the risk and return scale, growth equity sits right between venture capital and buyouts¹⁰.

VC investors also behave differently on exits. Venture firms do not typically ask for formal exit mechanisms, because their thesis assumes a larger number of failed investments with a few home runs generating the returns¹. A growth investor with a minority stake cannot rely on that, which is why the contract matters so much (next section).

How growth equity investments are structured

Minority stakes need contracts. A fund that does not control the company cannot decide the exit, the budget or the next share issue on its own, so the rights are written down. Negotiations focus on the return on capital, mechanisms to control the exit and the minority protections¹. Whether the investor wins those depends on the size of the stake and the expertise it brings¹.

Preferred equity

Growth equity investments are often made through voting preferred equity¹. Preferred shares are generally entitled to dividends accruing at a fixed annual rate on a compounding basis, paid to the investor before dividends reach other shareholders¹. On an exit or a winding up, preferred shares rank junior to debt but senior to other classes of shares¹. As a minimum, the preference amount is the investment itself¹.

The preferred shares are also convertible into ordinary shares, at the investor’s election, on a pre-agreed conversion ratio¹. That gives the investor a floor from the preference and a share of the upside from conversion. Companies and controlling shareholders often push for automatic conversion on events such as a listing or a control sale, to make those events easier¹.

Exit rights

A control investor can determine the timing and manner of its own exit. A minority investor cannot, so it wants clearly defined contractual mechanisms for its exit¹. Four appear repeatedly:

• Tag rights. At a minimum, the investor can sell its shares alongside controlling shareholders who sell¹.
• Put rights. The right to require the company to redeem or buy back, or the controlling shareholders to acquire, its shares after a period, normally five to 10 years after the investment¹.
• Exit obligations. A general obligation on the shareholders to start an exit such as a sale or listing, usually after three to five years from investment¹.
• Minimum return. The investor often asks for a minimum return on a put or a drag sale, calculated from a minimum internal rate of return or a multiple of invested capital, as downside protection¹.

The other side holds drag rights. The controlling shareholders, and not the minority investor, can require the minority to sell its shares¹. Existing shareholders also ask for a lock-up period during which the investor cannot transfer its shares other than to affiliates¹.

Board seats and reserved matters

A seat at the table matters. The right to appoint at least one director or an observer to the board is crucial, because it is a source of information on how the investment is performing and what lies ahead¹. A minority investor typically appoints one director when it holds above 5 percent of the share capital¹. For larger stakes of between 25 and 49 percent, the investor normally gets directors in proportion to its holding¹. Growth equity investors will often pursue protective provisions and sit on the company’s board to keep some influence over decisions².

Because minority investors often cannot pass shareholder resolutions on their own, they negotiate veto rights over reserved matters¹. A distinction is normally drawn between fundamental matters, which affect the value or structure of the investment, and operational matters¹. Fundamental matters include changes to the company’s constitutional documents, variation of share rights, issuing shares, changing the nature of the business and winding up the group¹. Operational matters include increases in capital expenditure and taking on debt, usually subject to a leverage ratio threshold¹. Investors have vetoes over the fundamental matters, and the larger the stake, the more operational matters they can block¹.

Finally, anti-dilution. Investors want protection against dilution, often through pre-emption rights to join new share issues pro rata or a veto over them¹.

Worked example (our arithmetic): a minority stake

The numbers below are invented to show how stake, preference and dilution interact. They are not a real deal and not a forecast. The structure follows the features above: a minority stake, a preference whose minimum is the investment itself, and protection against dilution¹.

A fund invests 30 in a company, and the post-money value is 120, so the fund owns 30 divided by 120, or 25% (our arithmetic²). It exits five years later. Interest and fees are ignored.

In case D, a plain 25% share would be 20, but the preference amount, at a minimum the investment itself, puts the fund first in line for 30 (our arithmetic¹). That is the point of preferred equity. Case B shows what anti-dilution protection is for: without it, a later round would cut the same 300 exit from 75 to 60. Not every company is worth enough to pay the preference, and the preference is only as good as the exit.

How do growth equity managers add value?

Money is not the only product. A growth investor can be more than a capital provider along for the ride¹⁰. Common areas of expertise include capital structure, M&A, listings, relationships with lenders and investors, go-to-market planning and the professionalisation of internal processes¹⁰.

Three channels stand out.

Capital for the growth plan. Growth equity provides the cash to accelerate expansion, new products, acquisitions and scaling⁶. The proceeds are for expansion and often go to the company’s balance sheet, not to buying out earlier shareholders².

Knowledge and access. A founder expanding into a new jurisdiction may want funding from an investor that can share its contacts there¹. PE expertise and credibility help a company prepare for the next stage, perhaps an eventual sale or listing¹. Some firms track promising companies for as long as 10 or 15 years, so they can approach them when funding is needed⁴.

Governance without control. The weight of an investor’s advice in board discussions rises with the value it contributes¹⁰. Without a majority stake, growth equity investors hold less influence over strategy and operations¹⁰, and cannot take matters into their own hands. Trust with management is the prime hurdle¹⁰.

The contrast with a buyout is sharp. With control, a buyout owner can install its own management or significantly influence company strategy². A growth investor is more of a partner providing capital and guidance, not an owner overhauling the business².

Growth equity firms and funds

PE firms are launching more and more dedicated growth equity funds¹. Why? In a busy M&A market with auctions as the default way to sell a company, opportunities for PE firms to invest are limited and often expensive¹. Growth equity offers a different path for deploying committed but uninvested capital, known as dry powder¹. A minority investment can also position a firm for a later opportunity to take control¹.

A growth equity fund is built like any other private equity fund. The firm acts as the adviser that pools investors’ money in a fund, and the fund is typically open only to accredited investors and qualified clients in the United States⁹. The legal form, life and fee structure follow the pattern described in how a private equity fund works, with the manager paid a fee and a share of the profits.

The firm’s deal approach differs from a buyout shop’s. Growth equity investors can examine the company’s financial track record and speak to its clients before investing⁴. They typically require a growth strategy from the company in order to estimate the return⁴. And it must align with management on market share, pace of growth, the capital needed and the exit strategy before it invests¹⁰.

A firm can also run several strategies at once. IOSCO’s three common categories, early stage or venture, growth capital and late stage or buyouts, are strategies of funds as much as labels for firms⁷.

Risks and returns of growth equity investing

Growth equity is not a safe cousin of the buyout. It carries its own risks.

Influence risk. Without a majority stake, an investor holds less influence over the company’s direction¹⁰. Contract rights partly make up for that, but a veto is a brake, not a steering wheel.

Exit risk. A minority investor cannot decide when to sell. That is why put rights, tag rights and exit obligations exist¹. They only help when the company or its owners can honour them, and the owners may resist, as lock-ups and drag rights work against the investor¹.

Growth risk. The return comes predominantly from growth of the equity itself¹⁰, so a company that stops growing delivers little. Case C in the worked example shows a flat company returning only its cost.

Leverage risk, indirectly. A peer-reviewed UK study finds that much of the extra expansion of growth equity investees was financed by significantly faster growth in leverage than at non-backed firms³. The same study finds that these firms dramatically outperform a matched sample on sales and asset growth, employment and earnings growth³. Faster growth with more borrowing is a package, and the data cover one country.

Liquidity risk for the fund investor. A fund interest is often illiquid, and several years can pass before any return is realised⁹.

On returns, the sources used here are descriptive. Returns tend not to be as high as successful venture investments, and the risk is lower¹. That is a different return profile, not a better one, and nothing on this page is a forecast.

Growth equity in Asia

The latest regional data show a shift towards buyouts. In Asia-Pacific the share of buyout deals grew to more than 50% of deal value in 2024, while the share of growth deals shrank⁸. That figure comes from AVCJ and Bain data compiled in a King & Wood Mallesons paper, covering Asia-Pacific for 2024, so it is context and not a rule.

Hong Kong is a hub for the funds themselves. By AVCJ Research data in the SFC’s 2024 survey, Hong Kong ranked second in Asia after Mainland China in 2024 by capital under management by private equity funds (excluding real estate funds), at US$229 billion, up from US$221 billion in 2023¹¹. For the market in full, see private equity in Asia.

Read next

Buyout versus growth equity compares the two strategies point by point, and how a leveraged buyout works explains the debt that growth equity mostly avoids. The strategies hub lists the rest. The regulator’s own investor page on private equity funds, IOSCO’s report on conflicts of interest and the SFC’s survey of Hong Kong asset management are the primary starting points. This page is education only and does not recommend any fund, manager or investment.