European Growth PE is a booming segment in Europe’s private equity market. With scale comes specialization and the emergence of different investment strategies
European Growth PE is maturing and a segmentation has emerged
European Growth PE exists at the intersection of venture capital and traditional private equity. It combines organic value appreciation and fast growth as typically seen in venture capital with a degree of scale and stability more common in traditional private equity. Today, European Growth PE funds account for 17% of overall annual European private equity fundraising, compared to 5% only five years ago. European Growth PE is clearly emerging as a third, strong private equity investment strategy between the venture capital and the buyout business.
The scale of the growth market allows players to find ample opportunity even in its subsegments. Actors in the market have different preferences, resources and capabilities. This reflects their particular positioning in the overall market. Two vectors are most important:
The first vector is the preference for control vs. non-control investments. Some investors are philosophically control investors and want to own at least 51% of a company in order to call the shots. Other investors prefer syndicated transactions, work collaboratively with entrepreneurs and prefer minority positions in their portfolio companies.
The second vector is the valuation range at which investors tend to get involved. Given respective fund sizes and target ownership stakes, investors target broad ranges of valuation that suit their investment strategy. €100 million seems to be a frontier that divides the market.
Tech Buyout
The tech buyout strategy is relatively close to traditional buyout strategies as investors are seeking a control position in the target company. Target companies in this segment tend to be mature businesses that are sizeable, profitable and moderately growing.
Investors in this category are often technology specialists, but many traditional buyout firms allocate a certain percentage of their capital to these transactions.
Some investors (Thoma Bravo, Vista Equity,..) in this category are targeting late-growth transactions, with enterprise values above €100 million, with very sizeable funds, typically of €1 billion or more, while others (Marlin Equity, Main Capital,..) target early-growth businesses, with enterprise values below €100 million, investing from smaller funds.
Value creation in this market relies on the traditional buyout playbooks: Target companies often have recurring revenues and strong cash-flows. Leverage, multiple expansion, operational improvements and buy-and-built are all strategies that work well.
Large Growth
This strategy differs fundamentally as investors are not seeking control positions. Target companies are the most prominent and most highly valued private technology companies. Generally, they are not profitable, often consuming large amounts of cash to grow rapidly even at substantial scale. Casually, these companies are referred to as unicorns or future unicorns. There are very few targets, all well-known and visible, which makes the market highly competitive and very pricey.
Investors (General Atlantic, Insight Partners,…) operating in this segment have very large funds of at least €1 billion in commitments. They acquire significant minorities for investments that amount to €30 million and more.
Value creation in this segment is almost entirely driven by the underlying growth of the target companies. Leverage is not used in a big way and multiple expansion is not a substantial lever if at all. Some transaction structuring, e.g. dividend preferences, is commonly used to reduce down-side risk.
Growth and Minority Buyout
This strategy is similar to the large growth segment, albeit with some important differences.
Target companies are less prominent and don’t pretend to hold or strive for unicorn status. They are in the early-growth segment, have less scale, possibly slower growth and much less cash burn. In return, they also have lower valuations not only in absolute terms, but also in terms of multiples. There are many, many more potential investment opportunities, but they are less visible making the market fairly untransparent. Also, transactions are at least as complex as in the large growth segment for much less capital at stake.
Some investors (Summit Partners, Accel-KKR,..) in this category target transactions well above €15–20 million with quite sizeable funds, while others (Verdane, Cipio Partners,..) target transactions below the €15–20 million threshold investing from smaller funds of €500 million or less.
Value creation in this segment is driven partially by the underlying growth of the target companies and to partially by transaction levers such as multiple arbitrage and discounts on minority buyouts. Leverage is not used in a big way if at all.
Conclusion
The scale of the European Growth PE market is expanding rapidly and a segmentation by transaction types is emerging. We can clearly distinguish control vs. non-control and early-growth vs. late-growth transactions. This enables European Growth PE actors to pursue three different strategies: 1) Tech Buyouts, 2) Large Growth, “unicorn hunting” and 3) Growth and Minority Buyouts. Players in this buoyant market align their strategy to their fund size, investment philosophy and operational capabilities.
