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Initially seed funding, later growth capital: to power their growth, companies need capital to grow. Yet, its availability depends on the industry and phase. What do companies need to know?
Imagine a startup that has successfully closed its pre-seed and seed financing rounds. It has developed a product, achieved product-market fit, and built a team across various departments. Now, it's time to take the next step: scaling the business, entering new markets or verticals, and increasing traction. This phase is capital-intensive, making growth capital crucial for success.
What is growth capital?
Growth capital is a financial strategy utilized by companies to foster their expansion. Other terms for this include growth financing or expansion capital. It encompasses internal and external measures of corporate finance, such as:
- Expansion into new markets
- Development and introduction of new products and services
- Expansion of marketing and sales activities
- Scaling of the business model
- Hiring of new employees
- Execution of strategic acquisitions (M&A)
The use of growth capital can be planned for the long or short term. Long-term strategies may involve expanding into new markets, while short-term strategies may entail expanding targeted marketing campaigns.
First seed funding, then capital for growth
First, startups receive seed funding to establish their business. After successfully establishing their business, they typically pursue expansion and further growth. This is where growth capital comes into play. Unlike other forms of financing, it is not intended to cover ongoing operating expenses but rather to boost revenue.
To increase revenue, companies must invest. Depending on the phase, business model, and industry, they may refinance investments using either equity or debt funding.
Growth capital comes into play for projects with high-risk profiles and less predictable returns on investment (ROI), such as product development. For investments with more predictable ROI – like M&A – companies can use debt capital.
How growth capital works
Growth capital is typically not the first funding a company receives. However, there can be overlaps between seed and growth capital. Access to growth capital can offer diverse opportunities for firms. It is typically provided by investors who believe in a business's potential and are willing to support its expansion. Here's how growth capital works:
- Expansion into new markets: through investments in marketing, sales, and infrastructure, companies can expand into new geographical markets and broaden their customer base.
- Product development: growth capital can support companies in developing new products and services, improving existing offerings, and driving innovation.
- Scaling business operations: to grow rapidly, companies often need additional resources for personnel, technology, and operating expenses. Growth capital can enable this scaling by providing financial flexibility to invest in growth.
- M&A: with growth capital, companies can also make acquisitions to expand their product offerings, integrate new technologies, or enhance their market position.
- New employees: companies can hire new employees to increase their capacities.
Types of growth capital
Financing with growth capital can take various forms. It depends on the needs and goals of the company. Common types include:
- Venture Capital: VC funds invest in startups with high growth potential, typically in the early stages. Financing amounts can range up to several hundred million euros. In return, companies sell shares to investors.
- Private Equity: private equity firms invest in established companies to accelerate their growth, increase efficiency, or make strategic changes. PE investments can occur at various stages of the business lifecycle and often involve active management participation.
- Business Angels: angel investors provide growth capital, expertise, and networks for startups and high-growth companies.
- Venture Debt: venture debt lenders provide growth loans (and thus debt capital) to companies. Venture debt follows venture capital.
- Alternative Financing: This involves tailored debt capital solutions for companies and startups with regular revenues, allowing them to invest in further growth initiatives.
Advantages and disadvantages of growth capital
Advantages
Accelerated growth
- Provides the necessary funds for expansion, product development, or market entry.
- Helps companies scale faster than they could through organic growth alone.
Non-dilutive control
- Typically, investors take a minority stake, allowing founders and existing management to retain control.
- Ideal for entrepreneurs who don’t want to sell their business entirely.
Strategic support
- Growth capital investors often bring industry expertise, strategic guidance, and valuable networks.
- Can lead to mentorship opportunities and enhanced governance.
Financial stability
- Unlike debt, growth capital doesn’t burden the company with repayment obligations.
- Enhances the balance sheet and can make the company more attractive to future investors.
Credibility and validation
- Attracting reputable investors signals confidence in the company’s potential, boosting its reputation
Disadvantages
Equity dilution
- Even if investors take a minority stake, founders lose a portion of ownership and future profits.
- Potential for disagreements over strategic decisions.
Pressure for high returns
- Growth capital investors who provide equity typically expect substantial returns within a set period (often 3–7 years).
- This pressure may lead to more aggressive growth strategies that aren’t always sustainable.
Governance and influence
- Investors may demand board seats or significant decision-making power, reducing entrepreneurial autonomy.
- Potential conflicts between founders’ vision and investors’ priorities.
Exit expectations
- Investors generally expect a liquidity event (IPO, sale, or merger) within a few years.
- This can push the company towards an exit strategy that may not align with the founders’ long-term vision.
Potential misalignment of goals
- Investors often focus on profitability and quick scaling, while founders may prioritize innovation or sustainable growth.
- Can lead to strategic friction, especially if market conditions change.
Who is growth capital relevant to?
It’s as simple as it sounds: growth capital is relevant for companies aiming to expand and grow their business. This applies to both young and established firms.
Growth capital for startups
Startups in the early phase
Startup funding consists of multiple phases. First, they need access to capital. That’s why the early phase is primarily determined by access to funding, which can come from their own pockets, internal funds, or external sources.
Typically, venture capital, business angels, or government-backed startup loans are available at this stage. Startups develop their product, invest in new hires, and build their business. Growth capital and financing plays a relatively minor role during this time.
Startups in the growth phase
This changes during the growth phase. The startup has already established its basic structures. It has won its first customers and build a stable revenue stream. Typically, it now aims to further expand – entering the growth phase. The focus shifts to scaling up and driving growth. This phase is often very capital-intensive. For the first time, growth capital plays a significant role.
At this point, growth capital can be funded through equity or debt capital.
Growth financing with equity
For growth financing with equity or venture capital, startups must demonstrate appropriate growth rates now – and even better ones for the future. Venture capital funds bet that their investment will pay off in the future due those high growth rates.
Growth financing with debt
Besides the traditional route with VCs, debt can also for the first time play a major role at this stage. Especially companies with stable revenues are able to incorporate debt into their capital stack. By entering the world of debt funding, startups have a variety of alternative financing options at their disposal – and this is much needed.
Because especially for startups in the growth phase, there is a lack of capital in Europe. According to a recent study by the German Private Equity and Venture Capital Association, American companies raised an average of €13.7m in venture capital during the growth phase, while European companies received only around €5.8m. Although VC financing constitutes the majority of startup financing, young companies still need to explore alternatives.
Growth capital for established companies
For established companies, the situation is different. They have already penetrated their market and built a broad and stable customer base. For them, growth capital means investing in new markets, expanding their product range, or their market power.
Established companies have different options for growth capital. This is mainly because they are already established in the market, have a robust and proven business model, record stable and regular revenues, and there is generally more trust from external capital providers in their business model.
More freedom in choosing between equity and debt
All these factors affect access to capital. While startups face more restrictions in choosing between equity and debt, established companies have more flexibility. They have a variety of equity and debt options with which they can diversify their capital structure.
Whether a young or established company, both should show growth potential if they seek growth financing. For investors, this is relevant due to the prospect of attractive returns. The risk profile and objectives determine which type of capital can be used for growth financing and which capital providers are suitable.
The differences between growth capital and venture capital
The main differences between growth capital and venture capital lie in the stage of company development, risk profile, investment size, and return expectations. Here are the key distinctions:
Key Differences
Stage of company development
- Venture capital: typically invests in early-stage startups, often at or near inception, with unproven business models and high growth potential.
- Growth Capital: focuses on established, profitable companies that have proven their business models and are looking to scale operations.
Risk profile
- Venture capital: involves higher risks due to market and product uncertainties, with potential for significant returns but also higher failure rates34.
- Growth capital: offers a lower risk profile as it targets companies with established customer bases and positive unit economics, aiming for more predictable growth48.
Investment size and valuation
- Venture capital: typically invests smaller amounts at lower valuations, diversifying across multiple startups to mitigate risk.
- Growth capital: involves larger investments at higher valuations, focusing on fewer, more established companies.
Return expectations
- Venture capital: seeks exponential returns, often aiming for 50-100x returns from a few successful investments.
- Growth capital: targets more moderate returns, typically 3-5x, with a focus on sustainable growth.
Holding period
- Venture capital: investors often hold their investments for longer periods, typically over 10 years.
- Growth capital: investors usually aim for a shorter holding period, around 5 years.
Operational involvement
- Venture capital: investors are often actively involved in strategy and operations to help young companies grow rapidly.
- Growth capital: investors focus on optimizing existing structures and processes for sustainable growth, with less direct operational involvement
Growth capital to expand business
Revenue growth is one of the most important goals for companies. Whether to use debt or equity capital for growth financing depends on the investment project. It also raises the question of access to capital, which depends on the phase of the company. As with any funding, companies should also consider the cost of capital and the expected ROI (as far as it can be planned).
For established companies, there is usually a greater range of financial instruments available for growth financing. In contrast, startups are often limited to venture capital or business angel investments.
Summary: growth capital
Growth capital, or expansion capital, helps companies accelerate growth, enter new markets, develop products, and scale operations. It follows seed funding and typically comes from venture capital, private equity, business angels, or venture debt. Startups use it during the scaling phase, while established companies leverage it to expand or strengthen their market position.
Unlike venture capital, growth capital targets mature companies with proven business models, involving larger investments and moderate returns within a shorter period. While it provides financial stability and strategic support, it can lead to equity dilution and governance challenges.
Q&A: growth capital
What is the meaning of growth capital?
Growth capital, or expansion capital, is funding provided to mature companies to accelerate growth, expand into new markets, develop products, or make acquisitions.
What is an example of growth capital?
An established tech company raising funds from private equity to launch a new product line or enter a new geographical market.
What is the difference between venture capital and growth capital?
Venture capital targets early-stage startups with high growth potential, while growth capital is for established companies looking to scale.
Is growth capital the same as growth equity?
Yes, growth capital and growth equity are often used interchangeably, both referring to minority investments in expanding companies.
How dies growth capital differ from LBO?
Growth capital involves minority investments to fund expansion, while a leveraged buyout (LBO) involves acquiring a company, often using significant debt.
