What is the difference between venture, growth and buyout?
Private equity is an umbrella term. Venture capital, growth capital and buyout invest in very different companies, each with its own risk.
Private equity is often discussed as if it were a single asset class. In reality, it is an umbrella term for several strategies that invest in very different companies. The 3 best known are venture capital, growth capital and buyout. They differ in the stage a company has reached, in the size of the stake the investor takes and in the way value is created. As a result, the risk differs too. In this article, we explain how the 3 strategies work and how they relate to each other.
The company as the starting point
The distinction does not start with the fund, but with the company. A business usually goes through several stages: from an idea to its first customers, from its first customers to rapid growth, and eventually to an established position with stable cash flows. Each strategy focuses on a different part of that development.
A simple, fictitious example makes this clear. A software company starts with a small team and a product that is still being tested. There is hardly any revenue. At that point, it is a candidate for venture capital. A few years later, it has a growing customer base and wants to expand abroad: a typical situation for growth capital. Later still, it is a profitable business with a strong market position, and the founder wants to sell a large part of his shares. That is when a buyout comes into view.
This does not mean that every company follows this route. Many businesses never need venture capital, and many young businesses never reach the growth stage. Above all, the example shows that the question of which strategy fits is closely linked to the question of what kind of company is involved.
- 1YoungVentureProving: developing product and market.
- 2Scaling upGrowthAccelerating: scaling up the organisation and revenue.
- 3EstablishedBuyoutSteady improvement: professionalising, improving margins and expanding strategically.
Venture: turning an idea into a business
Venture capital usually invests in young companies with a scalable concept, limited revenue, often no profit yet and a great deal of uncertainty. In effect, the investor is financing the question of whether a product and a market really exist on the scale the founders have in mind.
The emphasis is therefore on product, market and scalability. Value is created when the company shows that the product works, that customers are willing to pay for it and that the model can grow. In short, the main objective is to prove.
Venture investors usually take a minority stake and often invest over several financing rounds, together with other investors. Because there are few historical figures, the outcome for each company is hard to predict. In practice, some of the investments fail, while a small number of successful companies can account for a large part of a venture fund's result. Outcomes therefore vary widely.
Growth: helping a proven business grow faster
Growth capital focuses on companies that already have traction. There is a product that works, there are customers and revenue is growing. The question is no longer whether the model works, but how quickly it can be expanded. The capital usually goes into new markets, new products, additional capacity or further professionalisation of the organisation.
So the foundation is already in place; the next step needs to be accelerated. Value is created by scaling up the organisation and revenue.
A minority stake is also common in growth capital. The founders or existing shareholders often remain in charge, while the investor acts as a sounding board and, through agreements with the other shareholders, has influence over important decisions. The risk lies elsewhere than in venture. There is less uncertainty about the product, but the growth still has to be achieved. An expansion into new markets or an investment in additional capacity does not always work out as planned.
Buyout: active ownership of a mature business
Buyout funds usually invest in companies with proven revenue, existing cash flows, an established market position and room for further improvement. The difference from the other 2 strategies is fundamental: the investor often acquires a controlling stake.
With a majority stake, a buyout fund can steer strategy, the make-up of the management team and important investment decisions directly. Value is created by professionalising the company, improving margins and expanding strategically, for example through acquisitions. The main objective is steady improvement.
This strategy also has clear risks. In many cases, a buyout is partly financed with borrowed money. That debt can increase the return on the equity invested when things go well, but it also increases the risk when results disappoint. In addition, the outcome depends heavily on the price paid at acquisition and on the options for selling the company again later.
The 3 strategies side by side
If you put the 3 strategies side by side, a clear pattern emerges. Venture invests in young businesses that are often not yet profitable, growth in scaling businesses with proven traction, and buyout in established companies that are usually profitable. Venture and growth often take a minority stake; buyout often a majority stake. The main objective shifts from proving, through accelerating, to steady improvement.
| Venture | Growth | Buyout | |
|---|---|---|---|
| Company stage | Young | Scaling up | Established |
| Profitability | Often not yet | Proven traction | Usually profitable |
| Type of stake | Often minority | Often minority | Often majority |
| Main objective | Proving | Accelerating | Steady improvement |
| Spread of outcomes | Large | Medium | Smaller |
Simplified and indicative representation.
A comparison like this is useful, but it is also a simplification. In practice, the boundaries blur. There are growth investors who take a majority stake and buyouts of companies that are still growing fast. And fewer fluctuations do not mean that a strategy is free of risk. All 3 strategies are illiquid, have a long fund term and rely in the interim on valuations that have not yet been realised.
No strategy is better by default
It is natural to ask which strategy is best. That question cannot be answered in general terms. Each strategy has a different balance between risk, fund term, involvement in the company, capital requirement and potential outcome.
The right strategy depends on the company and on the investor's objective. An investor who deliberately accepts large differences in outcome in exchange for the chance of exceptional outliers makes a different trade-off from an investor who mainly values existing cash flows and an active role for the investor in improving the company.
On top of that, results within a single strategy can differ widely between fund managers. The choice of strategy therefore says little about the outcome; the choice of the fund manager who executes the strategy is at least as important.
What Two Rivers Capital focuses on
Two Rivers Capital focuses on European lower mid-market buyouts, as this segment is often called internationally. The focus is on fund managers who invest in established, profitable European lower mid-market companies.
Value is created from 4 sources, among others. The first is organic growth: more revenue from the existing business, for example through new customers, products or regions. The second is professionalisation: strengthening management, reporting and decision-making. The third is operational improvement: more efficient processes, purchasing and pricing. The fourth is buy-and-build: a company grows by acquiring smaller, complementary businesses and integrating them, creating a larger and more broadly positioned group.
- 1Organic growth
- 2Professionalisation
- 3Operational improvement
- 4Buy-and-build
That last source does require careful execution. Acquisitions must be made at a sensible price and then genuinely integrated. Within this strategy too, outcomes differ by fund and by company.
