Private Equity and Venture Capital are Increasingly Swimming in the Same Lane. Growth-stage CEOs Need to Engage Both Communities
“Because of the abundant capital on hand. VC-backed companies are staying private for longer before conducting an IPO or finding another path to exit. This has led to an overall increase in the number of companies seeking to raise late-stage fundings, deals that can often closely resemble the growth-stage financings with which many PE firms are already more familiar”
CEOs Always Need to Have an Eye on the ‘Next Stage’ of Investors
In today’s investing environment, the CEO of a Growth-stage company has to constantly keep an eye on the horizon, engaging and building relationships with the investor community for ‘the next stage’. In the past, if your company was backed by venture capital funds, keeping your eye on the horizon primarily meant knowing which venture funds could write larger checks for the next round as the company grew.
While that is certainly still true, the investing environment has gotten (much) more complex. A decade ago (and certainly two decades ago) Venture Capital investors had their domain, and Private Equity investors had their domain. Rarely did those two meet. Not so anymore.
In some sectors - notably tech - the distinction between Private Equity and Venture Capital has become murkier, and in some cases, no longer exists. Case in point, Pitchbook recently reported that “In 2020, PE firms have participated in more than 800 VC transactions worth a combined $48.3 billion in the US”. I do not have the full data set to review each transaction. However, I would not be surprised if in most of those transactions, the company was originally backed by traditional, early-stage Venture Capital funds. However, as the company grew, gained traction, and needed larger check sizes to fund the growth - Private Equity funds began to jump into the game.
Private vs. Public is More Important than Private Equity vs. Venture Capital
While on some level, the investment industry is conservative, in other ways, it is constantly changing and evolving. It is now more important than ever for growth-stage CEOs to understand these changes. Over the years, I have come to prefer the term ‘Private Markets’ over venture or private equity. Why is that you may ask? Because in this environment, the fact that a company is held by private shareholders (ie. not publicly-traded) is a far more important distinction than whether that partner is a Venture Capital or Private Equity fund.
Private Equity and Venture Capital have both always been a part of the investment landscape (in one form or another). They just resided at different ends of the spectrum. Venture Capital played in the startup and early-stage sandbox. While Private Equity limited its attention to more mature companies - primarily in the lower-middle market/middle market space. There were a few exceptions of course, but this simplistic distinction held true in most cases.
However, over the last two decades, both categories have experienced a generational ‘explosion’ in capital and activity. Private markets - be that Private Equity or Venture Capital - are the primary drivers of ‘growth-stage’ investing in the world today. Growth-stage is an ill-defined category, but often has come to mean that space just beyond early-stage (ie. Seed and Series A), and just before the ‘mature’ stage, often times just prior to IPO. Once again, this category is ill-defined, and a 100 people will have 100 different definitions - but you get the point.
PE and VC Meet Now at the Growth-Stage as Companies Opt to Stay Private Longer
So what changed? Well, a lot has changed in the past two decades. Gone are the days of growth-stage companies going public within three to five years of their founding. Companies now regularly remain in ‘private’ hands (ie. Private Equity and Venture Capital funds) for eight to ten years before they debut in the public markets (that is if they EVER go public at all). This may sound like a small distinction, but it has actually caused significant ripple effects in the capital markets - driving greater and greater amounts of capital out of the public markets (stock market) into private hands (PE/VC).
There are many reasons for this. However, to make it as simple as possible, think of it this way. Companies stay private because CEOs understand that is where the money is, and because that is where investors believe that they can generate the most alpha. As reported in Pitchbook, companies remain private longer “Because of the abundant capital on hand. VC-backed companies are staying private for longer before conducting an IPO or finding another path to exit. This has led to an overall increase in the number of companies seeking to raise late-stage fundings, deals that can often closely resemble the growth-stage financings with which many PE firms are already more familiar.”
Layman’s Translation: growth no longer has to be funded through public stock markets for many companies (particularly tech). Therefore, these companies get to stay private, pick and choose their cap table partners, avoid the tremendous added costs of being a publicly-traded company, and still get all the growth capital they need. With those benefits, don’t expect private companies to change behavior anytime soon.
Understanding the Capital Ecosystem is Now More Important Than Ever for CEOs
In the end, why is this important for growth-stage CEOs to understand? Because, if you are a growth-stage CEO, chances are that your company will remain private for nearly ten years (or more in some cases). In many industries - most notably (but not limited to) tech - your early round of funding came from the Venture Capital community. That probably means that you have spent the better part of five years getting to know the important players in your VC ecosystem. A decade or so ago, that probably would have been all you needed to do. Your company would have raised five years or so of VC capital, and then gone public. As the CEO, you might have run through the entire growth cycle without ever having to have met with or engaged in the private equity community.
That is no longer the case. The private markets funding cycle has lengthened. You may now need to plan for a decade or more of growth capital from the private markets. This will most likely mean that engaging with the private equity community will be more vital to the growth of your firm than ever before. The good news is that if your company is growing and meeting investor expectations, you should have little difficulty funding your entire growth cycle with a ‘smaller’ cap table consisting of private investors - thus avoiding all of the hassles that come with going public. The bad news is that the CEO and management team have to work a lot harder at engaging a broad set of potential investors. A set of investors that can span several categories and stages of Venture Capital AND Private Equity. It’s a brave new world.
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