VC Growth Funds Encroaching on Private Equity's Turf

VC Growth Funds Encroaching on Private Equity's Turf

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VC Growth Funds Encroaching on Private Equity's Turf

Venture capital’s trend towards growth funds and what it means for private equity

The core of the private equity industry comprises middle-market and lower-middle-market firms, those with approximately $150M to as high as a few billion dollars in funds to put to work. They have invested in the core of the economy, and while the mega firms take most of the credit for getting the splashy, media-loving deals, it’s the two aforementioned divisions that really shape the industry.

The problem, as I touched on last time, is that private equity firms are still stuck with dry powder (unused cash for deals) due to expensive price tags on companies. While I have advised many of my PE contacts to start looking at investing in startups around the Series B rounds and beyond, it looks like many of the venture capital firms are taking notice. Hunter Walk, a partner at Homebrew, has touched on this “barbelling” of venture capital funds, where more capital is concentrated in the middle area (between $250M and over $1B funds) and encroaching on PE turf as a result.

In the past few months, we’ve seen a trend towards venture capital firms raising money for “growth funds,” which are focused on much-later-stage deals. In other words, they’re going into private equity’s turf. From Spark Capital raising $375M and Greycroft (with private equity ties, specifically Apax Partners) raising $200M, to Google starting a middle-market private equity shop in Google Capital, what was a ripe opportunity for PE to get into (using VC firms as a “farm system” for deal flow, a strategy we’re using at Brand Foundry) is starting to look bleak.

So what exactly does this mean for private equity? Three things:

1. The playing field is getting crowded

With strategic buyers already crowding the field in terms of developed companies, there was an opportunity for specialist private equity firms to develop relationships with younger companies and startups. As these startups focused on their roadmap to scale the businesses up to profitability, they could then reach the investment criteria where PE could make a formal investment. That opportunity was going to be with VC firms as a conduit. But with venture firms building their own private equity-sized funds, it’s going to crowd up the field of investors, making that opportunity for building up the “farm system” relationship less feasible. Cambridge Associates believes so much in this trend that it created a “growth equity” category, so it’s an area that PE needs to take notice.

2. Relationships between PE and VC could strain more

Many venture capital firms still unfortunately don’t take too kindly to the private equity industry, so these new growth funds give early-stage venture capital firms an opportunity to keep startup investing within their sector. There have been some exceptions, with PE firms getting into startup investments due to friendly relationships (TPG and Stripes Group come to mind), but as of now, that’s still a small exception.

3. All that said, it’s still not too late

In my recent conversations with consumer-focused PE shops, many execs believe in the future of startups and building those relationships. I know one PE shop has been looking hard into the area and another that has built its own “shell company” to invest $100k-200k in startups, with the partial aim to have them grow into the main fund’s investment criteria. Many early-stage venture capital firms have private equity backgrounds so it’s hard for me to actually understand why the relationships haven’t flourished more these days.

So what happens next? Most private equity firms can use their Deal Origination teams to build those relationships with VC firms, but there could also be an opportunity for intermediary organizations (such as the Association for Corporate Growth) to foster potential relationships. The window to build strong partnerships is closing and, thanks to these new growth funds by more and more VC firms, it’s closing a lot faster than anyone expected.