We speak with Chris Sugden, Managing Partner at Edison Partners, about what growth equity is and how investors should approach it given today’s uncertain environment. Sugden talks about how growth equity has evolved and what its current state looks like, along with how he is evaluating today’s down market.
What is growth equity and what makes it unique?
When investors take a minority stake in an established business and all the combined players collaborate to achieve rapid, sustainable growth, this is when the magic happens. That’s growth equity.
Growth equity is unique in that it is not necessarily companies chasing multiple rounds of venture funding or companies that are solely focused on hyper-growth.
We like to think of growth equity as boot-strapped businesses, or businesses that grow capital efficiently, and get to a scale of $10 million of revenue or more and are looking for a value-added partner to scale the business with them.
To put it in business terms, we might say a company has found product, market fit and significant traction with a large customer base, but now needs to institutionalize and scale.
What is the current state of growth equity?
What’s great about growth equity, given the volatile and uncertain environment where lots of talk of recession is looming, is that these are companies that not only know how to generate revenue but know how to make money.
They haven’t been built assuming multiple rounds of funding to reach a stage where they can be profitable. Therefore, we would say the current state of growth equity is quite healthy.
The one area of concern in the current market are those companies that are, in my opinion, not really growth equity companies but momentum players and hyper-growth companies. Those companies have valuations that are way off the current public comps, built on the assumption that multiple rounds of capital and burning hundreds of millions of dollars before reaching profitability is the norm.
We might say the current state of growth equity is a tale of two cities – those companies which are growing responsibly, or with a thought of not only unit economics but being profitable, and those companies taking advantage of a market of capital that was readily available at very high valuations. The latter is the one that’s more challenged right now and the former is very healthy from an advancing perspective and an exit perspective.
How has growth equity evolved?
Growth equity became momentum investing and hyper-growth investing for the last five to six years, which created some unhealthy capital structure and has caused some companies in the sector to be under stress.
The evolution 10-20 years ago is more the definition that we’ve applied — more capital efficiency, more bootstrapping and more focused on revenue and earnings.
I believe we are entering a “Back to the Future” era. Back to the days when growth equity was born 10-15 years ago. We are going back to the old days because evolution has not been that healthy.
Growth equity didn’t exist as an allocation between venture and private equity until about roughly 15-years ago (2007). When growth equity became its own allocation, we were not operating with a tremendous amount of history at the time.
What are you looking for now in entrepreneurs and management teams?
One thing I’m looking for specifically in a CEO’s leadership and decision-making at critical junctures is, “Are they being a maverick just to be a maverick, or is it strategic?” On the flipside, “When it’s time to be a maverick, do they have what it takes?”
I look for CEOs who are pragmatic visionaries because what that really says is, “I have a vision, but I’m not holding onto the vision at all costs, I’ve got to be able to pivot, I’ve got to be responsible to my capital partners, my management team, and the people I hire.” To me, a pragmatic visionary is especially appropriate in an environment of uncertainty and important in an environment like this one.
How are you evaluating the current market and economic conditions?
I’ve been doing this for more than 20-years on the investing side, and 15-years on the operating side before that, so it’s safe to say I have seen a balance like this before.
First, this doesn’t catch us by surprise, we’ve been thinking about a downturn for a long time. Things that go up always come down for operators and investors.
Because I’ve seen up and down markets as both an operator, going back to the dot com bubble, and an investor through the more recent global financial crisis, this isn’t new territory for me as an investor or for Edison as a firm. So, the way we’re evaluating it, in our opinion, is you can never time the market.
Great companies, especially private, high-growth companies and great entrepreneurs built businesses because in times like this, they might leave a job they no longer see the upside in. They might think it’s time to take a chance because of the market. Things get a little bit cheaper for talent.
It’s times like this where some of our best investments might’ve been created. Think about our approach as leaning in and looking to deploy capital, while at the same time being incredibly thoughtful about things like valuation. And finding pragmatic visionaries who don’t grow at all costs, but have a focus on the top and bottom line.
How are you looking at the fintech space, especially as we come out of the pandemic, and what do you see as the biggest themes shaping the industry?
Post-pandemic life is still in-flux as companies and employees maneuver office versus remote working, among other issues facing each industry. The result will be a change in how we live, work, travel and so on. Technologies that enable these shifts are sure to follow and we’re paying very close attention.
The public markets are currently taking a beating that always impacts the private markets. That said, I believe we’re still early in several innings for many sectors of fintech. I believe that payments and wealth tech may be on the verge of growing. Areas such as crypto or NFTs, need some of the same technologies that trading needed 10 to 20-years ago. To net it out, we think fintech remains in the early days, some areas are more mature than others, but a lot of runway to go.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
