Growth capital woos unhappy buyout investors

Date: Friday, March 26, 2010
Author: Reuters

Private equity firms which aim to take minority stakes in companies, rather than debt-laden controlling stakes, are taking advantage of investors' dissatisfaction with recent low returns from buyouts to land more funding and make more deals with entrepreneurs.

Investors have thrown ever larger sums of money at the buyout industry in the last decade as the industry boomed and returns mushroomed, but suffered a painful last two years.

The fundraising market remains tough, said John Bernstein, managing director at General Atlantic. But the growth capital, or growth equity, sector will take a larger slice of the overall private equity pie.

"The voice of growth is louder than it used to be. I do think there's more investor focus," Bernstein said.

There are 130 growth capital funds seeking to raise $27 billion, according to data from consultancy firm Preqin. That's more than doubled from 51 growth capital funds raising $11.6 billion at the height of the fundraising boom in 2007.

The fact that 3i Group (III.L) has chosen now to launch its first ever dedicated growth fund indicates a belief in investor appetite in the subsector. Investors are seen looking for a less risky investment and are prepared to take lower returns. [ID: nLDE62O06S]

"Growth equity has got a lot more attention because of the problems on the leveraged buyout side," said Scott Collins, managing director at Summit Partners.

Firms such as General Atlantic, 3i and TA Associates, take minority and majority positions in fast-growing companies, using little or no debt.

While their returns are lower in peak times than buyouts, they typically outperform through downturns, drawing investors to their less volatile model.

3i's new standalone 1.2 billion euro ($1.6 billion) fund continues the firm's shift back to its roots as a minority investor.

The 400 million euros raised from external investors is below some analysts' expectations, but it raised the cash in just nine months since it first broached the topic, far more quickly than the year or 18 months frequently taken to raise a buyout fund.

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The voice of growth capital also resonates with entrepreneurs who want funding to help their businesses grow, the growth capital experts claim.

"They've seen what's happened to the management teams of private equity companies buried under debt -- it's not a pleasant life," said Bernstein.

"You can't focus on building the business because you have to focus on the capital structure."

One gripe is that growth investments take longer to realise: firms regularly hold their companies for over five years, compared with buyout funds' average of three or four years, which pushes down annualised returns (IRRs).

The best year for 3i's growth capital portfolio in the last decade was 2005, although its average growth return of 27 percent lagged well behind the 62 percent for buyout deals in the same year.

But they fare better in downturns: in 2008 3i's growth returns were down 16 percent, compared to a 30 percent drop for buyouts.

General Atlantic claims to have generated 9 percent returns in 2009 and 20 percent in 2008, compared to an industry whose returns fell 9.2 percent in the 12 months to the end of September, according to Preqin.

The growth industry still sees most of its deals in North America and Europe, although emerging markets -- particularly China, India and Brazil -- are taking a bigger portion of activity.

"We are really keen to be present in Asia because, by definition, it's just a fast-growing region," said Guy Zarzavatdjian, global head for growth capital at 3i.

Two thirds of 3i's fund will be invested in Europe, while the remainder will go to Asia and the North America, he said.