Growth capital is raised by established, growing companies that utilise it to accelerate their growth. These companies issue new equity to private investment funds, which may be alongside or instead of other forms of financing such as bank loans.

Unlike the traditional venture model, in which multiple rounds of financing are raised, growth capital may be the first external equity injection into a business, and may also be the last, depending on the cash needs of the business.
It is also common for existing shareholders to realise a return on their own investment to date and sell a portion of their shares to the new investor, depending on how established the business is. This is sometimes referred to as “cash out”.

It is usual, but not always the case, that the new investor holds a minority equity stake, in contrast to the more traditional private equity model in which the investor holds a majority stake and controls the business. As a result, the investment represents the formation of a partnership between the old and new shareholders, and the management team.

Who provides growth capital?

Institutional investment funds are the primary source of growth capital for businesses. These funds may be structured in a variety of ways, for example:

• Venture Capital Trusts (VCTs), that offer certain tax advantages to their investors
• Dedicated growth capital funds, that are specifically set up solely for the purpose of offering minority growth capital investments
• Growth capital arms of private equity funds
• Corporate funds, that usually follow a mandate that aligns with the parent corporate company
• Government backed funds, that usually provide a combination of private and public funds, for example, Enterprise Capital Funds (ECFs)

Co-investment is less common for growth-stage businesses, as the entire round can usually be sourced from a single fund; however, occasionally funds do invest alongside one another. It is relatively rare for more than two funds to participate.

How large is a typical growth round?

Typically, between £1m and £20m depending on the specifics of the business and opportunity.

How are growth capital investments structured?

In its simplest form, growth capital is structured as equity, i.e. new shares, in the company. The equity will ordinarily be structured as a new class of share to allow for the fact that investors often require certain “special” rights that other shareholders do not.

In practise, growth capital investments can be structured across a spectrum of instruments that vary in their level of commercial risk and return:

• Ordinary equity: delivering the highest expected return to the new investor but with the highest risk profile.
• Preferred equity: an element of fixed or preferred return mitigates some of the risk and thus is priced to deliver a lower return than ordinary equity
• Loan notes: a debt-like instrument but without the protections that lenders require, these deliver the lowest return to investors but also represent the lowest risk.

Each investment can be structured as one or a combination of the above, to provide the right balance of risk and return to the new shareholders and existing shareholders.

What does the process entail?

Initial preparation of investor materials is important to ensure the investment opportunity is adequately represented. Initial meetings will be held with institutional funds and investors where they will assess the opportunity. If these discussions progress, then you will normally be issued a term sheet setting out the terms on which the investor is willing to invest.

Around this time, the investor will prepare and present a paper to their internal investment committee. There may be one or multiple sittings of investment committee throughout the transaction.

Once a term sheet is agreed, due diligence will commence and the legal documentation will be negotiated and agreed. Provided that due diligence is satisfactory and agreement has been reached on the legal documentation, the transaction will then complete.

How long does it take?

This can vary considerably based on how long it takes for the business to prepare investor materials, how initial discussions with investors go and whether any issues arise during due diligence. Assuming no significant roadblocks in the above, a process typically takes 6 months from start to finish.

Each investment fund is set up with a set of broad principles that govern the types of investments it will do, for example, to invest in a certain sector or a certain size of business. Working within these specific principles, there are a number of core themes that almost all investors seek to fulfil when selecting their investee companies. It is not necessary to meet every single one, and not all will be applicable to every business, but if your business can achieve and communicate the items detailed below, then it will be more likely to succeed in raising capital.

A team that has deep experience in their respective business and sector

An experienced and motivated team is more likely to have the skills required to deliver the business plan, respond to external shocks and work collaboratively with their investors. Minority equity investors place a lot of importance on the quality of the people and team that they are investing in relative to other metrics.

How this can be demonstrated:

• A history of having built and / or sold a similar business
• A track record of strong performance within the current business
• Deep and broad sector experience
• Experience at a larger or blue-chip competitor or industry player
• A well-balanced team with diverse but relevant skills and experience
• Spending sufficient time with potential investors to build the relationship

Relevant, industry advisors can also add to the credibility of the company, provided they are genuinely involved and available to lend their experience as the business grows.

High barriers to entry

Barriers to entry make it difficult for others to enter the market and compete with you. This makes the business less to susceptible to commoditisation and price erosion, and more likely to achieve or retain its status as a market leader.

How this can be demonstrated:

• Intellectual property and IP protection
• Complex technology or processes
• Specialist knowledge
• Capital investment to date
• Brand profile and reputation
• Strong customer feedback and relationships
• Customer “stickiness”, i.e. complexity for customers to switch providers
• Established distribution networks
• Exclusive trading arrangements
• An established footprint of sites or locations
• A highly skilled team that would be difficult to recruit from scratch

Operating within an attractive, growing market

A sufficiently sizeable market ensures that there is capacity for further growth, and one that is growing demonstrates rising demand. A new market may also be addressed provided there is a clear rationale for demand to emerge and develop.

How this can be demonstrated:

• Market statistics including recent and forecast growth
• Positive pricing trends
• Demographic changes that are driving demand
• Recent fundraising activity in the industry

An attractive customer proposition that generates a competitive gross profit

A product or service that has demonstrated success with customers, while also being commercially viable with an attractive margin.

How this can be demonstrated:

• A clear and simple explanation or illustration of the product or service that you offer
• Customer feedback and testimonials
• Case studies
• Customer uptake and churn statistics
• Social media and press commentary
• Pipeline of customers or contracts
• Positive gross profit
• A downward trend in the cost of customer acquisition

Differentiation from the competition

Investors are looking for companies that can generate above average returns and thus must be differentiated in order to do so. Remember that you are highlighting how the investment opportunity, i.e. the company, is differentiated, which is often linked, but not necessarily the same as, the product or service - those points of differentiation matter more to customer than investors. A typical investment fund sees hundreds of investment opportunities each year, and therefore it is important to communicate this clearly – it may be best to focus on the one or two most salient points of differentiation in place of an extensive list.

How this can be demonstrated:

• Specific features and benefits associated with your product or service
• A different approach to others that is difficult to replicate
• Intellectual property and IP protection
• A highly skilled team / specialist knowledge
• A strong network
• Superior traction
• Specific process efficiencies
• Pricing power

Recurring, contracted or predictable income

This depends to some extent on the industry in which you operate; however, recurring, contracted and predictable income is considered attractive as it brings greater certainty of trading and often represents an attractive return on capital invested.

How this can be demonstrated:

• Illustration of how the fee structure works
• Monthly or annual recurring revenue
• Customer pipeline
• Contracted revenue

Short customer payback period and high lifetime value

This is the average time it takes for the cost of customer acquisition to be repaid through income from the customer. For example, if it costs £50 in marketing spend to acquire a customer, who then pays £10 a month for a subscription, then the payback period is 5 months. Business models with a short payback period (some are instantaneous), are particularly attractive.

Lifetime value is also important – if the same customer only requires the product for 5 months, then although the cost to acquire has been repaid, there is no further value generation. If the customer uses the product for 2 years, then the lifetime value of the customer is higher.

How this can be demonstrated:

• Calculate the average cost of customer acquisition for your business
• Calculate the average lifetime value of a customer (this may require some forecast assumptions)
• Calculate the payback period of a typical customer
  Demonstrate low customer churn / customer stickiness.

Low customer (and supplier) concentration

Dependency on one or a small number of customers can be a concern to investors, who look for companies that have a long term, diversified customer base. This also applies to the supplier base – how dependent is the business on a single supplier or a small group of suppliers and how easily could they be replaced.

How this can be demonstrated:

• A table illustrating the top ten (or number as appropriate) customers of the business and the percentage of turnover that they represent.
• To demonstrate long term relationships, include the date on which they first became a customer of the business.

A clear use of funds

New funding into a business must be deployed effectively to generate a return on investment. Investors look for businesses with a clear use of funds and demonstrable return on capital from those uses.

How this can be demonstrated:

• A breakdown of the use of funds.
• An explanation for the anticipated return on each use.

A high-growth but credible business plan

The company’s business plan (financial forecasts) should demonstrate growth in turnover and profitability that is sufficiently strong to deliver an attractive return to investors, while also being deliverable and credible.

Exceptionally over-optimistic business plans are sometimes to blame for an investor declining the opportunity.

How this can be demonstrated:

• A clear and simple forecast financial model
• Forecast assumptions that align with historic performance while taking into account the expected use of funds and associated acceleration.

The potential for an attractive exit

Equity investors require a form of exit or liquidity event in order to deliver a return to the investors in their fund. They will be looking for companies that have the potential to deliver a successful exit for their investment, such as through the sale of the company to a strategic acquirer, the sale to a private equity firm or a listing on the public markets.

How this can be demonstrated:

• Highlight value drivers that would be attractive to certain acquirers, for example, profitability, data, lease premiums, customer relationships, IP
• Provide indicative views on exit routes, such as a strategic sale, private equity sale or IPO
• Data on comparable exits in the market
• Data on industry consolidation and/or an active M&A market
• Any prior approaches to the business from potential acquirers.

VCT eligibility

If you are raising from a VCT fund, then your business will need to meet the criteria for this scheme.