Finance Seminar Series

Anderson School Of Management

University of New Mexico

April 14, 2023

Bill Megginson

Capitalizing Entrepreneurship: The Rise Of Growth Equity

Professor & Price Chair In Finance

University of Oklahoma

Visiting Professor

University of International Business & Economics (Beijing)

Finance Area Editor, Journal of International Business Studies

Short-Term Consultant, World Bank Group

Lubomir Litov

Gabriele Lattanzio

Assistant Professor in Finance

Nazarbayev University

Visiting Assistant Professor

Duke University

Co-Authored With Gabriele Lattanzio, Lubomir Litov, And Alina Munteanu

David M. Moffett Professor of Corporate Finance

Associate Professor of Law

University Of Oklahoma

Alina Munteanu

Doctoral Candidate in Finance

University Of Oklahoma

What Is Growth Equity Capital?

Source: Cambridge Associates LLC.

GROWTH EQUITY PORTFOLIO COMPANY LIFECYCLE

And What Role Has It Played In The Massive Growth Of Private Capital Since 2000?

Growth Equity Is Private Capital Funding Sharing Similarities With Both VC & B/O

• Private Equity Funds Organized as Limited Partnerships
• With same 10-yr life, capital acquisition, investment, management, distribution and compensation policies
• Invests Directly In Rapidly Growing Private Companies
• Allows companies to delay IPO, remain private longer
• Experienced Similar Spectacular Growth Since 2000
• GE has grown as fast as VC, faster than B/O funds
• Now Has AUM > $1.1 Trn; Dry Powder ~ $350 Bn
• Raises up to $100 Bn new funds recent years
• Investment Returns Far Exceed Public Market Returns
• Comparable to VC; higher than B/O funds

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Growth Equity First Defined By Auerbach (Cambridge Associates, 2013)

• Identified Type Company GE Funds Invest In, And How
• Founder (or heirs) owned and managed company
• With no prior institutional equity investment
• With a proven business model, preferably in tech
• Substantial revenue growth, organic or acquired
• EBITDA positive, or expected to be soon
• With little or no leverage at firm-level
• Almost always take minority stakes (not control)
• Structure investment as preferred equity, with ratchets and other protective provisions for investors
• Presume no further external equity funding until exit

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The Global Growth in Private Capital Since 2000

Source: Akila Quinio and Robin Wigglesworth, “Growth equity booms as investors embrace private markets,” Financial Times (January 5, 2022).

• Growth Equity Grew the Fastest of All, 21% CAGR

• Private Capital Grew from $500 Bn to $7.2 Trn

World Stock Market Capitalization, 1983-Jan 2023 ($US Bn)

Source: Author’s calculation using World Federation of Exchanges data

• Global stock market capitalization grew from $3.34 Trn in 1983 to $121 Trn YE 2021

• Market Cap increased ~2.5X from 2010 to YE 2021, from ~$50 trn to $121 Trn

• Publicly Listed Stock Still Far More Valuable Than Private Equity, But The Total Value of External Equity Raised from PE Many Times Greater Than (Net) IPOs and SEOs

Global Corporate Security Issues 1990-2022 ($Billion)

Global debt & equity

U.S. Issuers worldwide

Source: Refinitiv (formerly Thompson Reuters), Global Capital Markets Review, Annual editions 1990-2021

Record $11.47 trillion debt & equity offerings in 2021, 23X Record 1990 Total

Fundamental Point #1: For Large Global Companies Today, Corporate Finance Is Capital Market Finance

Global Corporate Security Issues, $Bn, 1990-2022

Source: Investment Dealers’ Digest, January editions, 1990-2008; Refinitiv (formerly Thomson Reuters), 2009-2022

Fundamental Point #2: Capital Market Finance Today Is Debt (Bond) Finance

Number & Value Global IPOs, 2012-2022

• Asia-Pacific (China) has led IPO totals every year since early 2000s

• Even during extreme years (2021), IPOs raise small fraction of equity

• Net equity issuance several hundred billion $ negative every year

Source: Global Equity Markets Review-Full Year 2021, Refinitiv

2021 Global IPO total:

$413 Bn; ~2,300 offers

How Is Growth Equity Capital Presented In Professional Literature?

Has Come To Prominence Only Since 2014, Especially Since 2019

GE Only Separately Identified Recently

• First Mention In Practitioner Media In 1997 (Williams, Pensions & Investments)
• First mention in WSJ in 1998 (Shapiro); first WSJ mention of GE fund forming in 2001 (Burns)
• First Economist mention 2007; First FT mention in 2008 (Bill Ford interview); Only common from 2020
• First Mentioned In Bain & Company Global Private Equity Report in 2010; First Separated In Charts 2014
• McKinsey Global Private Markets Review first mentioned in 2017; PitchBook in 2019
• First academic mention 2001 (Bolin, JACF); only began common, separate coverage 2016 (Gompers, et al JFE)

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Growth Equity AUM Now About $1.2 Trn. Has Increased >50X Since 2000; 7X Since 2010

Source: Akila Quinio and Robin Wigglesworth, “Growth equity booms as investors embrace private markets,” Financial Times (January 6, 2022).

• PitchBook (2022): $130.3 Bn Invested in 1,599 GE Deals, FY 2021

AUM=$920 Bn

• PitchBook (2023): $102.9 Bn Invested in 1,479 GE Deals, FY 2022

Number & Value Of US Growth Equity Deals Fell In 2022; Still Second Largest Ever

Source: PitchBook, “Deals: PE Deal Activity,” US PE Breakdown 2022 Annual (January12, 2023).

Beginning With Bain GPER In 2014, Scale Of GE Fundraising, Asset Growth Became Apparent

Source: Preqin, Reported in Bain & Company, Global Private Equity Report 2023

• Private capital fundraising surged 2003-08, fell in GFC, surged again 2012-21

• In 2014 Bain retrofitted Growth to 2003, seemingly classed as VC before

Global Private Capital Raised, by Fund Type ($B)

Beginning With Bain GPER In 2014, Scale Of GE Dry Powder Growth Became Apparent

Source: Preqin, Reporte in Bain & Company, Global Private Equity Report 2023

• Dry powder is capital that has been called and collected, but not invested

• Growth and VC now almost equal to B/O dry powder, from <50% before

Global Private Capital Dry Powder, by Fund Type ($T)

Private Equity AUM Geographic Distribution

Source: Preqin, Reported As Figure 1.8 in Bain & Company, Global Private Equity Report 2022

• Over 60% of all private equity (VC, GE, B/O) AUM in North America

• And over half of growth equity AUM in Asia, particularly China

• Across Asia, VC and GE account for >75% of PE AUM (McKinsey, 2022)

• Economist (2012): “VC & GE preferred in emerging markets like China, where control and highly leveraged deals are not welcome”

VC, Growth Equity, And Buyout Returns: �Net IRR For 3, 5, 10, and 15-Year Horizons

Source: Preqin, Reported As Figure 2.6 in Bain & Company, Global Private Equity Report 2022

• All types of private equity returns exceeded public market over 2007-2021

• Growth equity returns comparable to VC, higher than B/O funds all horizons

• In First WSJ Discussion of GE returns, Garland (2013) noted GE out-performed VC over 2003-2012 by nearly 6ppt, 12.7%/yr vs 6.9%/yr

Size & Geographic Distribution Of Private Capital, 1H 2022

• Total 1H2022 AUM of private market assets $11.7 Trn

• Private Equity (B/O, VC, GE, Other) total AUM totals $7.08 Trn

• Growth Equity total AUM $1.22 Trn

• 43% of GE AUM in Asia; 41% in North America

What Characteristics Of GE Have We Found Empirically?

Have Downloaded Large Sample OF VC, GE, B/O Deals And Funds From Preqin; What Do We Find?

Our First Empirical Analysis Compares To VC And B/O Funds And Investments?

• How Large Is the Average/Median GE Investment?
• Bain & Co. (GPER 2022): Avg GE investment in 2021 was $125 Mn vs $56 Mn late-stage VC; B/O much larger
• How Big A Stake (% Of Equity) Do GE Investors Purchase?
• Auerbach (2013) and others assert GE usually purchase minority stakes, like VC but unlike B/O.
• Also predict GE will insist on ratchets, redemption rights, other investor protections: like VC, unlike B/O
• Is Initial GE First (And Last) External Equity Investment?
• Likely very different from late-stage VC (Series F round)
• Also predict GE will invest in much older firms than VC

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Our First Empirical Analysis Compares GE To VC And B/O Funds And Investments

• Do GE Investors Really Focus Only On EBITDA Positive Firms With Established Businesses—And Likely In Tech?
• If so, would be very different from VC, similar to B/O
• Do GE Investors Really Prefer Unlevered (Or Low-Debt) Investee Firms, Which Forego Leverage Afterwards?
• If so, would be very different from B/O, similar to VC
• Are GE investors truly looking for returns from revenue and profit growth, not financial engineering?
• Do GE Investors Only Purchase Preferred Stock (likely CPS), Like VCs, Or Also Purchase Common Stock?
• 95%+ US VCs invest as CPS primarily or exclusively

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Number Of VC, GE, Buyout (B/O) Funds Has Grown Sharply Recent Decades, Especially VC

Source: Authors’ calculation, from Preqin.

Capital Committed by Strategy and Vintage

• This is capital actually invested in target firms, so lower than capital raised

Source: Authors’ calculation, from Preqin.

Committed capital peaks for VC in vintage year 2017 ($162 Bn)

Committed capital peaks for GE ($122 Bn) and B/O ($389 Bn) in 2018

Industry Distribution of Committed Capital by VC, GE, and B/O Funds Globally, 1980-2021

VC and GE funds in invest in similar industries, mostly tech. Buyout targets much more industrially dispersed

Software the top industry target for all three types of funds

Biotech

Internet

Financial

Services

Deals And Target Firms Characteristics

• Test whether median deal values differ between B/O, GE, and VC investments

• Find three fund targets usually, but not always, have different characteristics

• GE fund targets are more similar to B/O fund than VC fund targets wrt EBITDA, Revenues, Profitability (% and >0?), and Firm Age

• GE fund targets are more similar to VC fund targets wrt Deal Size and % Stake Acquired

Distribution of Investment by Round for VC, GE, and B/O Funds Globally, 1980-2021

• Test whether B/O, GE and VC funds make investments at similar firm stages

• Unsurprisingly, 100% of B/O investments classified as Buyout (majority control)

• Far more GE investments at Seed stage than for VC; More later stage VC deals

Seed stage investment means first external equity investment for Growth Equity

Syndicate Size For GE And VC Investments

• Do VC and GE funds syndicate their investments to the same degree?

• GE funds much less likely to syndicate their initial investment (seed stage) than are VC, 1.29 vs 1.93 avg funds involved.

• After Seed stage, syndication propensity becomes more similar, but always less with GE than VC funds.

Likelihood of Investing in Following Round

• Do VC and GE funds participate in follow-on investment rounds for target firms at the same rate?

• GE funds are much less likely to participate in all A-E rounds than are VC funds.

• Untabulated results show that there is a shorter time between investment rounds for GE (607 days) than for VC (650 days).

• Overall, show both VC and GE funds tend to syndicate investment rounds, do so with similar frequency, and GE deals involve fewer investing partners and are less likely to repeat.

The Geography of Growth Equity Investing:�Top 10 Countries by Number of Deals

• US leads in number of B/O and VC deals, is second in number of GE deals

• China leads in number of GE deals, is second in number of VC deals

• France, UK, and India in top 5 for multiple deal types, by number

The Geography of Growth Equity Investing:�Top 10 Countries by Deal Value

• US leads in value of B/O and VC deals, is second in value of GE deals

• UK second in value of B/O deals, 4^th in value of GE and VC deals

• India ranks 3^rd in value of both GE and VC deals

• US and India have grown fastest in overall PE investment last 5 years

• China leads in value of GE deals, is second in value of VC deals

The Geography of Growth Equity Investing:�Top 10 Countries by Deal Value

• Key takeaway here is that Asia largest GE market, second largest VC market

• China, India, Hong Kong, South Korea, and Singapore collectively account for almost half (47.1%) of global GE investment

Deal & Target Characteristics: Investment Holding Periods & Returns By Fund Type

• VC funds hold their investment longest (1,783 days median), GE funds the shortest (1,183 days), B/Os in the middle (1,546 days)

• VC funds have the highest return to full exit (Exit IRR=273%) and highest Exit Multiple (9.2X). GE highest Partial Exit IRR (47%).

• Full Exit IRRs and Exit Multiples very similar for Buyout (40%, 3.4X) and GE funds (38%, 3.2). Partial exits far more common for all fund types.

Exit Strategy By Fund Type

• Most common “exit strategy” for all three fund types is Write Off

• Second most common exit is Sale to GP for all three fund types

• Third most common exit: IPO for B/O funds, Merger for GE

Graphic: Exit Strategy By Fund Type

• Only a small fraction of PE fund investments are exited in “preferred ways, by IPO (5-16%) or Merger (6-13%)

30% of Buyout Fund Investments are Written Off, as are 42% of VC Fund Investments

Is Growth Equity A Distinct New Form Of Private Capital?

If So, Would Be Hugely Important. How Many New Types Of Corporate Finance Have You Seen Created?

Source: Venero Capital Advisor (18 January 2018)

Both Practitioners & Academics Struggled With Whether GE A Separate Asset Class

• Multiple Commentators Classified GE As Late-Stage VC
• Metrick & Yasuda (EurFM 2011): “mezzanine category comprises both GE (that overlaps with late-stage VC) and subordinated debt layer of B/O transactions”
• Brown (RFS 2022): Group with VC rather than B/O
• Many More Classified GE As Buyout Funding
• Jensen, et al (JACF 2006): Warburg Pincus, “though we call some transactions ‘buyouts’ really provide GE”
• WSJ Deals & Dealmakers (2017): Report B/O funds with excess cash “trying growth equity”

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Both Practitioners & Academics Struggled With Whether GE A Separate Asset Class

• Many More Classified GE As Buyout Funding (Continued)
• Gompers, Kaplan, Mukharlyamov (JFE 2016): “classify PE as buyout and GE investments in mature companies”. First academic study to use GE as proper noun.
• Fleming (AusEconHist 2018): First academic mention of GE in Asia; implicitly groups as extension of B/Os
• Kaplan & Mortensen (JF 2021): Mention GE nine times; If not separate, group with PE, not VC and “others”
• Cesare, Previtero, Sheen (JF 2022): PE firms with a “GE style” produce highest growth of B/Os in their sample

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Both Practitioners & Academics Struggled With Whether GE A Separate Asset Class

• Others Classified GE As a Separate Category Of Private Equity, “Between VC And Buyout Funding”
• Bill Ford founded General Atlantic in 1980; first fund to invest in mid-market growth firms. FT interview 2008
• Economist (2012): B/O funds re-inventing themselves as “alternative asset managers,” investing in GE deals
• PitchBook (2021): Discuss GE and assert “companies remaining private longer & unicorns a new asset class”
• Wigglesworth (FT 2021): “Fastest growing corner of PE is so called GE; too big for VC but unwilling to go public or sell to PE”.

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Both Practitioners & Academics Struggled With Whether GE A Separate Asset Class

• Most Recent Commentators Categorize GE As A Separate Asset Class And Form Of Private Equity Financing
• Hellmann, Chure, Vo (JFE 2021): Show that VC & Angel capital are distinct financing forms, not complements
• Quinio & Wigglesworth (FT 2022): Ever larger firms “eschew public markets, find strong demand with yield-hungry investors”… GE halfway between VC and B/O
• Economist (2022): PE firms now actively chasing non-buyout private capital. GE between VC and B/O

• Current consensus in both practitioner & academic literature that GE is a separate asset/financing class

What Is The Growth Equity Research Agenda?

And What Are Our Immediate Research Goals Vs Long-Term Research Possibilities?

Connect To Research Documenting Rise Of Private Equity Capital In Corporate Finance

• Shift To Private Equity Market Financing Due To Increased Private Capital Supply, Changing Nature Of Firms
• Several authors, summarized in Stulz (OxREP 2020)
• Technological Change Favors Organizational Capital, Intangible Assets Over Hard Assets In Production
• Gao, Ritter, Zhu (JFQA 2013), Agarwal, et al (ROF 2022), Crouzet, et al (JEP 2022), Davydova, et al (WP 2022)
• Increased Capital Comes From VC and B/O Funds, Plus Mutual Funds, SWFs, Hedge Funds, GE Funds
• Chernenko, Lerner, Zeng (RFS 2021); Kwon, Lowry, and Qian (JFE 2020)], Lopez, Malik, Megginson (ARFE 2021)

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Possible Research Extensions Based On Recent VC, PE Published Research

• Ewens & Rhodes-Kropf (JF 2015): VC Partners’ Human Capital 2X-5X More Important Than Organization Capital
• Predict a similar directional result, but lower X for GE
• Antoni, Maug, Obernberger (JFE 2019): German Buyouts Followed By Reduced Employment, Lower Wages
• Fracassi, Previtero, Sheen (JF 2022) find opposite for US
• Also predict opposite will be found for GE, as for VC
• Doidge, Karolyi, Stulz (JFE 2017): Document US Listing Gap; Caused Mostly By Mergers, Cost of Being Listed
• Test whether rise of GE an alternative to IPO

Source: Craig Doidge, G. Andrew Karolyi, and René M. Stulz, “The U.S. Listing Gap,” Journal of Financial Economics 123 (2017), 464-487.

US Listed Firms

Non-US Listed Firms

The U.S. Listing Gap�“Is The American Public Corporation In Trouble?”

Possible Research Extensions Based On Recent VC, PE Published Research

• Cavagnaro, et al (JF 2019): Skilled PE Investors Out-Perform, Leads To Consistently Higher Returns of 1-2 ppt
• Predict a similar, perhaps even greater, result for GE
• Nanda, Samila, Sorenson (JF 2020): Each Early VC Success (One Additional IPO of 10 Deals) Predicts Later Success
• Result due to improved later deal flow
• Predict a similar, perhaps more muted, effect for GE
• Ewens, Gorbenko, Korteweg (JFE 2022): Find VCs Use Bargaining Power To Extract Better Terms in Contracting
• Predict effect in GE will be muted or non-existent
• Power balance more favorable to founder in GE deals

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Possible Research Extensions Based On Recent VC, PE Published Research

• Chernenko, Lerner, Zeng (RFS 2021): When MFs Invest In Private Firms, Rounds Have Stronger Investor Protection
• Predict similarly strong terms in GE investment rounds but perhaps not as focused on near-term exit
• Aggarwal, et al (JFE 2022): Find Dual-Class Firms Have Different Controlling SH Types (Founders) And Wedges
• Directly analogous test for GE investments, since most are into founder-controlled firms

• In Sum, Many Research Possibilities Open Up If Growth Equity Documented As A New Form Of Corporate Finance

Thank You

William L. Megginson

wmegginson@ou.edu

http://www.ou.edu/content/price/finance/faculty/billmegginson.html

https://www.linkedin.com/in/megginson-william-4b672222/