Initially seed, later growth capital: to propel their growth, companies need growth capital. 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, then growth capital
First, companies receive seed capital to establish their business. After succesfuly 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 generate increased revenue, companies make various investments. Depending on the phase, business model, and industry, they may refinance investments using either equity or debt capital.
Growth capital comes into play for projects with high-risk profiles and less predictable returns on investment (ROI), such as product development. Conversely, for investments with more predictable ROI, companies utilize debt capital, such as for M&A.
Types of growth capital
Financing with growth capital can take various forms, depending 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.
Implementing growth capital
Growth capital is typically not the first financing a company receives. However, there can be overlaps between seed and growth capital. Access to growth capital can offer diverse opportunities for firms.
- 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.
- Mergers & Acquisitions (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.
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 and foremost, they need access to capital. That’s why the early phase is primarily determined by access to risk or seed capital, which can come from their own pockets, internal funds, or from external sources.
Typically, venture capital, business angels, or government-backed startup loans are available at this stage. Startups invest in their product, new hires, and build their business. Growth capital and financing plays a relatively minor role during this time.
Startups in the growth phase
Naturally, this changes during the growth phase. First, the startup has established its basic structures, won their first customers, and secured 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, and 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 financing, 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 €13.7 million in venture capital during the growth phase, while European companies received only around €5.8 million. 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.
Conclusion: 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.
