Pretty much every fast-growing online business you know has been fuelled by some form of growth capital.
Traditionally, there are three different types of funding for any company that's looking to scale:
- Private equity (PE) growth capital for established companies. This is the traditional definition of growth capital.
- Early-to-mid stage capital, such as venture capital.
- Seed capital, such as angel investments
All these funding types have a lot in common – in all cases, you give up some of the shares in your company for funding and expertise.
But it’s best to think of them as stepping stones because each of them works best at different stages of your growth.
We’ll look at all three different types of growth investment, along with alternatives to growth capital that entrepreneurs use to finance their business without giving away equity.
What is growth capital?
Growth capital, sometimes called growth equity, is a form of financing which gives late-stage companies the funding they need to grow their business. Growth capital could be used to:
- grow customer acquisition
- launch into new markets
- invest in growing your team or in upskilling your existing team with new skills such as management or team leader training
- invest in your technology
- fund acquisitions
- offer liquidity to shareholders
It's usually taken on by more mature companies that have already established themselves in their market, demonstrated profitability (or a clear route to profitability), and have spotted that there's an even bigger opportunity for them out there.
Who is growth capital for?
Late-stage businesses might need an injection of capital to enter a new market or take on a larger, better-resourced competitor. That's where growth capital comes in.
Growth capital funds usually offer between $5-50m of capital to be spent on major projects to drive growth such as product development, customer acquisition or to acquire competitors.
Once a business has met its growth targets, that’s when growth equity funds look for their exit. The two most popular forms of exit are an IPO or via sale to another business.
How growth capital works
Businesses that take on growth equity are usually already profitable, but struggle to build up the cash that they need in order to:
- fund expansion,
- invest in technology
- develop new products
- buy other companies
They could take on debt to do this but the cost of repayments would put too much pressure on their cash flow. Instead, these entrepreneurs sacrifice shareholding in their company to a growth equity fund in exchange for funding.
Entrepreneurs approach organizations like PE firms, mezzanine funds, hedge funds, sovereign wealth funds, startup advisors and family offices, among others for this capital.
With most growth capital deals, investors will want to take a majority shareholding in the business and play a big part in strategy.
Investors will probably want one or more seats on the board to help the company quickly grow revenue, profitability, and market share with the goal of floating on the stock market or selling the company in 5 years.
Growth capital in action: Deliveroo
Deliveroo was relatively late to the food delivery market, so the high growth start-up was up against well-funded, well-established competitors like JustEat.
Having raised €275m in October 2016, its goal was to invest in technology, expand to new markets, buy out competitors (it bought Maple and Cultivate), and grow its UK market share.
By investing the capital quickly and effectively, Deliveroo delivered its growth equity investors a serious windfall when it floated on the London Stock Exchange.
In March 2021, shares in the company were worth €5.1bn, a big return for its backers who invested €1.2bn in the years leading up to its flotation.
Growth capital vs venture capital
While PE growth capital is for latter-stage companies, venture capital investors target younger businesses with high growth potential.
Unlike private equity firms, venture capitalists take a minority shareholding in your business even though they’re taking a much bigger risk.
It's riskier for them because, although they see the potential of your idea to generate revenue, there’s less certainty that:
- there's enough market demand
- whether demand within the market will last
- big players won’t copy what you’re doing and roll it out faster
- you'll ever reach profitability
At this point, you're gaining traction but you’re probably still working out your product's long-term value.
Your venture capitalists are impressed by your team and they think there’s a huge amount of potential in your young organization. They'll give you the advice you need to help you deliver your product to a wider market and achieve high growth.
But unlike PE investors, they prefer to see a strong team and an established board already, because they don’t have time to closely support you throughout.
So what’s in it for the VCs making these capital investments?
Big risks can bring big rewards. When it goes right, VC's stand to make a large return on their investment.
Growth capital vs angel investments
Many of today’s biggest online companies got their first funding from an angel investor. Angels come in handy when your product is little more than an idea or an early prototype.
You won’t have many customers and your revenue is likely to be patchy in these beginning stages. Although angels are taking a risk by investing in your business, this risk is often offset by government tax rebates.
However, angels often expect you to invest your own money in your business before they do as a show of faith in your product.
Angel investors add a lot of value in the early days because:
- they can introduce you to their more valuable connections, including potential customers or suppliers
- their involvement can help attract a team to develop your product or service quickly
- they are often successful entrepreneurs in their own right with plenty of great advice up their sleeve
- they hold you and other senior people into business to account for achieving or missing targets
In the context of your business' growth capital journey, an angel’s job is to help you grow your business, usually in preparation for a Series A round.
Advantages and disadvantages of growth capital
With angel investments, venture capital investments, and private equity investments, you receive the money you need to make key investments you probably wouldn't be able to otherwise. You'll be able to better absorb risks, so you can push out to new markets, develop new products or acquire businesses.
Growth capital investors will also lend you their expertise and introduce you to their professional network. Suddenly you'll be plugged in to experts who can help you grow. It's no wonder that growth is in the name.
The more money you're looking for, the more dilution you'll be looking at.
At mature companies, PE investors will want to install their own people onto the board. That means you will have less control on decisions around hiring, budgets, business plans, M&A activity, equity and debt transactions.
Of course, when these investors bring useful advice, their role on the board will be a very good thing.
This is especially true of private equity firms and VCs (on average 44% of VCs take a seat on the board), while angels are less likely to want a seat.
Most deals are costly
Finding investors can take months, sometimes years.
Plus, you'll need to prepare a huge amount of documentation before investors will consider investing in your company, particularly for venture capital and PE investments.
Legal fees and closing fees are just part of the agreement, and depending on the deal type, you'll often pay out for warrants when your company is listed or is bought by another.
And, at the private equity stage, your investors can sell the company whenever they want - whether you feel the price is fair or not – if they insist on majority ownership and ‘drag-along rights’.
Alternatives to growth capital
No entrepreneur likes giving away equity, so what are your other options?
You could look to the bank or other traditional lenders. However, the process for getting a traditional loan can be painful too.
You'll need to produce a business plan that gives financial projections for the next 3-5 years, an indication of how you’re going to achieve your targets, and exactly where money will be spent to make that happen.
If the bank wants to lend to you, you’ll pay back the loan - with fees and interest - over a certain period. You may also have to pay the lender warrants that allow them to buy shares back at a specific price further down the line.
Debt financing advantages
With commercial loans, you don’t have to give up your equity or shareholding. You’re in control too, so when the deal is agreed, it's up to you how cash is spent.
And there are no surprises either. The cost of the loan is fixed, which means that you always know what you’ve got to pay back.
Debt financing disadvantages
But it isn’t all plain sailing. If you’re looking to grow quickly, any periods of rapid growth will increase the fixed and variable costs of your business.
You’ve also got a limited window to grow revenues, and if you don’t meet repayments you’ll be slapped with additional monthly fines.
The toughest requirement is that lenders will require you to sign a personal guarantee. That makes you and other shareholders responsible for repayments if your business fails.
Lenders could repossess your property or any other assets you’ve given as security, which could be enough to put you off becoming a founder altogether.
Revenue based financing
Now to the newcomer. Revenue-based financing is growing in popularity as a quicker, more flexible way to take on growth capital. It works a bit like a merchant cash advance (which you might already be familiar with), but focuses on providing quick capital to online businesses.
With revenue-based financing, there’s often no need to give up equity or make personal guarantees. Instead the lender will take a cut of your future revenue as a monthly fee. It’s usually between 6% and 12%.
This works well for early and mid-stage companies - particularly online businesses - where they've got bags of potential to grow.
Revenue based finance advantages
Unlike with growth and venture capital investments, revenue-based finance providers don't ask for any shareholding in your business, and decisions about whether to invest can be made within five days.
Why not? Well, for starters, the lenders are using different tools.
Instead of poring through your records and creating their own models, they just connect to your existing business tools. Data from platforms like Stripe and Shopify give them all they need to know to perform their due diligence.
They have to be pretty confident in your business’s potential to grow revenues, but that confidence also means they don’t ask for personal guarantees.
Flexible investment capital providers charge between 6% and 12% on the funding they advance you. So if you borrow $500,000 and you're given a rate of 6%, you can expect to pay back $30,000 over the next few months.
Revenue based finance disadvantages
Revenue-based finance providers take a greater risk with the businesses they lend to because most do not ask for:
- Personal guarantees
- Their say on how you run your company
- Shareholding or equity
- Business plans, cap tables, or pitch decks
Although the amount you repay increases and decreases with your company's monthly revenues, providers want to collect between 6% and 12% of all revenues until the capital and cost of the loan is paid off.
There’s a good reason for this - they want to be paid back faster so that they can recover funds quickly to reinvest elsewhere. If you don’t grow as fast as you expect, some revenue-based finance providers will take action to recover the funds within the loan period.
And just like longer-term debt funding, you may not get access to a network of advisors to help your business make the right decisions.
Should you take growth capital?
There have never been so many options open to entrepreneurs who want to fund their business.
But as with all deals, what works for others might not work for you. You should carefully consider whether your business is at the right stage to take on growth capital, or whether you need capital at all.
To make the right decision, you’ll want to consider:
- The level of control you want over your business now and in the future
- The cost to your organization and potentially to you personally
- Whether you'll be able to afford the payments growth capital investments come with
- Whether you need the capital right now
- Whether you’re looking for capital with advice or just the capital
In reality, you're likely to use a range of growth capital sources. Maybe you'll use every one in this blog. Each will come at a different stage of your company's growth to help you push on to that next step.
At Uncapped, we offer investment capital with offers ranging from €100k to €10m through a revenue share agreement similar to a merchant cash advance. See if you qualify!