A record year for growth equity investments

While global M&A may have seen some turbulence this year, a record number of growth equity investments into late-stage private companies has been underway.[1] Currently, 2020 is on track to set records for the largest number of late-stage deals completed (more than 3,000) as well as the largest amount ever raised (over $100 billion, for the first time).[2]

In addition, over 30% of these late stage VC deals are valued at greater than $25 million.[3] This is seemingly driven by record amounts of excess available capital in the market and a shift in investors who have flocked towards lower risk, more mature companies.

We believe that much of this growth is thanks to companies pursuing private capital raises in lieu of full exit strategies planned before the pandemic. In addition, transactions that include a portion of the capital raised used for liquidity for existing shareholders (secondary capital), have continued to grow.

We believe most institutional investors are comfortable partially cashing out existing owners under the right circumstances, which was considered a red flag several years ago.  For entrepreneurs and owners of private companies, selling a minority stake today may arguably be the best tactic to increase valuation and return capital over a 3-4 year period, without a full exit. Any dilution resulting from selling equity today is often offset by growing value in the medium term, increasing proceeds to original owners.

Another key factor contributing to the unprecedented sums of capital currently being injected into late stage companies, is the growing number of non-traditional investors participating in the process. Non-traditional investor activity is at an all-time high. LPs, PE firms, sovereign wealth funds, hedge funds and corporate VCs have participated in over 25% of 2020’s US transactions through September 30.[4]  We believe founder-backed and sponsor-owned companies who have made the shift from capital raising independently to working with an advisor are now better accessing non-traditional investors and benefitting most from the current climate.

A shift in investor demands

While the market is flush with excess capital, founder-backed and sponsor-owned companies looking for outside capital should be mindful that current investments are not like other years when the macro economic climate has been strong. A few noticeable changes in the market for 2020’s growth equity investments are becoming more evident in our view:

    • We’re seeing non-traditional investors take a closer look at their current portfolios and assessing whether now is the time to shift to new areas of opportunity, or participate in growth equity investments. Regardless of strategy, investors are seeking more favorable terms, namely more downside protection, in the form of structured equity and debt investments

    • Structured debt and equity raises— often comprised of hybrid equity & debt components — have been an increasing alternative approach to growth capital raising, particularly with smaller companies that have a harder time accessing traditional growth equity. Structured debt capital consists of a debt or a redeemable preferred security with warrants for equity upside to the investor.  The investor base for structured debt deals consists of credit funds and special situation funds.  Many larger asset managers, hedge funds and PE firms also have separate funds dedicated to structured debt investing[5]

    • Structured equity — which in a sense is a form of traditional growth equity — can include participating preferred stock, in which case the investor receives the face amount of their investment amount at exit, in addition to proceeds based on equity ownership.  This “double-dip” feature is in contrast to a traditional convertible preferred security where an investor is entitled to receive their original investment amount, or their equity ownership at an exit

    • Alternative structured equity features can come in the form of traditional convertible preferred stock with a liquidation preference greater than 1x, or either security with a tranche mechanism that allows for additional capital to be invested if certain financial milestones are achieved.  Another common feature is a financial performance measurement that can potentially adjust valuation

  • Some investors are more interested in seeing that proceeds from their infusion be used for working capital, rather than providing liquidity for existing stockholders. The effect of the pandemic on the global market is pushing investors to demand these extra protections, which is another ripple effect for companies hoping to raise capital

Conclusion

We anticipate that there will be a continued increase in fund raising in the coming months, particularly in areas that have been active during the Covid-19 pandemic (i.e., healthcare IT, supply chain, e-commerce etc.). We believe that non-traditional investors are looking for mature companies to partner with in a late-stage or structured equity transaction. With a significant amount of dry powder available in the market, companies who hope to improve valuation before they sell are well-positioned to do so by taking advantage of the current investment climate.

 

References

[1] Pitchbook-NVCA Q3 Venture Monitor, October 2020

[2] Pitchbook-NVCA Q3 Venture Monitor, October 2020

[3] Pitchbook-NVCA Q3 Venture Monitor, October 2020

[4] Venture Capital Fundraising and Investment Dollars Remained Healthy Through 1H 2020 Amid Slowdown in Exits and Deal Count Due to Impacts of COVID-19, Pitchbook, July 14 2020

[5] Private equity firms are becoming lenders. Here’s why., Mergers & Acquisitions, September 20 2019