The high interest rate environment that prevailed between 2022 and 2024 led investors to a rapid search for asset classes that could provide above-average returns. As the cost of capital increased, the returns had to follow suit.
Growth equity was one of those asset classes that became attractive. In 2023, growth equity’s share of total private equity (PE) deals increased to 12.7%, from 9.9% in 2022, according to Debevoise & Plimpton LLP, a New York-based law firm. Similarly, it represented 21.5% of all sponsor deals, from a 5-year average of 18.7%.
Things will even become more exciting in 2024.
In the first half of 2024, private equity growth investments accounted for 23% of all private equity deals in the US, a higher share than leveraged buyouts (19%), according to PitchBook, a private market software company.
To put this in historical context, this was the first time since 2007 that growth equity will outweigh leveraged buyouts (LBOs) as a portion of total PE deals.
Private equity growth and leveraged buyouts as a percentage of all private equity deals
Source: PitchBook
As interest in growth equity investments surges, asset owners need to understand where the opportunities lie before venturing into the space (or increasing their allocation to it). One way to do this is by analysing current growth equity trends (in relation to overall private equity trends) and using them to forecast what the future will likely hold.
In this article, we will consider the dominant growth equity trends and explain how each trend should affect your strategy for investing in this market in 2025.
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1. Lower market valuations provide an opportunity for long-term outperformance
The valuations of growth equity companies peaked in 2021. There was a 63% drop in median valuations between 2021 and 2023, according to J.P. Morgan, the global financial services company. Though valuations surged in the first quarter of 2024, they were still far away from the 2021 peak, as seen in the chart below:
Median valuations of venture capital growth equity companies between 2014 and Q1, 2024
Source: J.P. Morgan
J.P. Morgan attributed this downturn in valuations to the inability of many growth equity companies that emerged during the pandemic to live up to their potential. Remote communications, delivery, and at-home exercise companies experienced higher growth rates during the pandemic but they couldn’t sustain that rate after the pandemic, with growth rates returning to pre-pandemic levels.
A second reason is the intense competition for funding. While demand for funding increased, supply somewhat dried up in both private equity and venture capital markets, as shown below.
Funding availability for venture and early-stage firms between 2014 and Q1, 2024
Consequently, many growth equity companies had to lower their valuations to raise much-needed capital (down rounds). “This, too, means that some companies are open to investment at valuations that may not reflect their present levels of growth, or their underlying potential,” they noted.
As we saw, valuations began to improve in the first quarter of 2024. AI companies have been the most important contributor to this trend reversal, according to J.P. Morgan. “Their valuations surged 61% in the first quarter of 2024 compared to the previous year. Indeed, multiples for companies in the AI space are at all-time highs.”
What this trend mean for you
J.P. Morgan believes that the plunge in valuations seen in 2021 can be the springboard for the improved performance of growth equity companies. “We see this valuation decline as a healthy correction that can help set the stage for potential outperformance over the longer run.”
Their optimism seems to be justified given that AI companies have started leading this charge towards improved performance (more on that below) and if lower interest rates pave the way for improved funding, more growth equity companies will be well-positioned for higher valuations.
In essence, you should not be discouraged by the valuation plunge but see it as an opportunity to pick up quality growth equity companies for cheap and earn higher returns when valuations pick up.
2. Greater emphasis on capital efficiency and value creation
The potential for high growth has always been the appeal of growth equity companies. Since they are in an earlier stage of their life cycle, compared to public companies, they have more growth potential and can provide higher returns to investors.
However, increased competition for limited funding has also led growth equity companies to prioritise value creation and capital efficiency.
“Strategic and operational improvements will continue to be the largest sources of PE returns,” according to Ernst and Young (E&Y), the global consulting firm. “With opportunities for exits currently slower than historical averages, firms will zero in on efforts to create value in portfolio companies on the operations side. The focus will be on finding the sweet spot between cost-cutting and fueling future growth to prepare for anticipated improvements in the exit market.”
In essence, there was a decoupling of growth and value with investors realising that growth at all costs and growth for growth’s sake does not necessarily translate into a value metric. The high interest rate environments exposed companies that expanded rapidly but did not build any resilience, leading to high volatility.
“During 2023, we saw a significant shift toward capital efficiency,” said Jeff Klemens, partner at Sageview Capital, a company that helps founders build transformative technologies, writing for Forbes. “A company’s financial resiliency is paramount, with a renewed emphasis on liquidity and the Rule of 40. This means that investors’ value-add for portfolio companies has also changed, creating new terms of engagement for growth equity investing.”
While this emphasis on value creation is crucial for future competitiveness, it is also needed to meet the IRRs (internal rate of return) and justify the high cost of capital from pandemic-era deals, according to Escalon, an HR, accounting, and tax outsourcing company.
What this trend means for you
Capital efficiency and sustainable growth rather than mere above-average revenue growth rates or higher returns than what is available in public markets are the new competitive advantages that investors are seeking.
As an asset owner, that should also be your priority. Instead of focusing solely on growth data, you need to also consider financial resilience via capital and operational efficiency and growth resilience via sustainable growth.
3. Growing secondaries market
In its 2024 outlook published in December 2023, Cambridge Associates, a global investment firm, anticipated a resurgence in private investment secondaries as one of the key private equity industry trends. With large fundraisings in the secondary markets in 2022 and 2023, they expected this “dry powder” to be deployed in 2024.
They were right after all. In H1, 2024, $72 billion worth of transactions were conducted globally in the secondary market, according to Evercore, a private capital advisory firm.
As seen in the chart below, deal activity increased in H1, 2024 for both limited-partner led (LP-led) and general-partner led (GP-led) deals.
Deal volume in the secondary market, H1 2021 to H1, 2024
Source: Secondaries Investor
Venture capital and growth contributed 14% of all GP-led deals and 8% of LP-led deals.
Furthermore, Evercore noted that the dry powder available in this market has increased to $189 billion at the end of H1, 2024, a 14% increase from the beginning of the year. It was also the highest amount of dry powder available since 2013.
Source: Secondaries Investor
What this trend means for you
The availability of the secondary market means you can exit your positions earlier than planned and without waiting for traditional exit routes like IPOs and mergers and acquisitions (M&As). It also provides more liquidity, enabling you to pursue a diversification strategy by buying from existing shareholders instead of waiting for a fresh funding round.
Also, pricing in secondary markets can provide information about the “true value” of growth equity companies. A knowledge of this “true value” can help you evaluate the desirability of your current growth equity holdings – to keep holding or to sell off.
4. Investment opportunities in artificial intelligence
AI was the leading category for capital raises in the US in the first half of 2024, according to Rothschild and Co., a private banking company. During this period, there were three $1bn raises and a large number of smaller raises.
At the end of the year, they noted that US AI deals for the whole of 2024 were worth $34.5 billion, led by Open AI ($6.6 billion), xAI (two $6 billion deals), and Anthropic ($4 billion).
Top US AI deals in 2024
Source: Rothschild and Co.
This was not limited to the US, however. European AI deals in 2024 were worth $3.5 billion. Also, the largest raise in 2024 in Europe was for Wayve, an AI-powered autonomous vehicle software company in the UK, and the second-largest was for Mistral, a LLM provider in France.
Top VC deals in Europe in 2024
Source: Rothschild and Co.
Funds have also been allocated to data centres, the powerhouse of the AI revolution (the largest deal in the US in 2024 was a $9.2 billion equity investment in Vantage Data Centers). More importantly, private equity firms have gone beyond LLM (large language models) providers to also fund smaller AI companies.
Top 15 US VC Deals
Source: Rothschild and Co.
“LLM providers have attracted the largest deals (xAI in the US, Mistral in Europe ) but with a widening of funding to pick up smaller AI apps-based businesses - the likes of RobinAI, Photoroom and Luminance in Europe and Alphasense, Hebbia and Suni in the US,” they noted.
The percentage of PE funds deployed to the technology sector (led by cloud computing, AI, and IoT) increased from 34% in Q1, 2024 to 40% in Q3, 2024, according to E&Y.
In addition, growth equity companies are also deploying generative AI to improve their operations and help them gain a competitive advantage, according to Ernest and Young.
What this trend means for you
First, you should consider looking for investing opportunities in the AI space.
One thing we have learnt in 2024 is that the AI revolution is just beginning. If the stock performance of NVIDIA was thought to be extraordinary, Palantir Technologies and Applovin showed that it was just the scratch of the surface.
More importantly, the focus is not only on the big companies involved in AI development; those who are deploying it to create solutions and products for small, medium, and large businesses and those who are using it to disrupt existing business models are also benefiting.
A significant 70% of GPs surveyed by E&Y in Q3, 2024 believe that the technology sector – driven by cloud computing, AI, and IoT – will experience increased deployment of PE funding in the years to come.
Source: Ernst and Young
Second, you should explore ways that the operations of your portfolio companies can be enhanced with AI. “By working with a variety of portfolio companies, investors can help identify differentiated opportunities for each to implement GenAI,” according to Klemens. “Investors can help entrepreneurs identify the best places to capture and share data across systems, generating additional efficiencies and creating additional value.”
5. Investment opportunities in healthcare and life sciences
Whether in public or private markets, the healthcare sector has always been a top destination for growth investors. It is no surprise then that growth equity investors have beamed the light of their attention on the sector.
“The last few years have witnessed exponential growth in healthcare investment, particularly within tech-enabled healthcare services and outsourced services to pharmaceutical companies (supporting R&D innovation), “ according to Tech Bullion, a fintech news website. “According to industry reports, venture capital and private equity funding in healthcare have reached record levels, with investors drawn to the sector’s potential for sustained, long-term growth.”
A report by Silicon Valley Bank found that more than 55 biopharma companies in the US raised $100 million or more during H1,2024. With this performance, the biopharma industry is set for a record year in terms of mega deals.
Number of mega-deals in the healthcare sector between 2020 and H1, 2024
Source: Silicon Valley Bank
Similarly, 17 deals worth $5.7 billion were completed in the US biotechnology industry in 2024, according to Rothschild and Co. Xaira Therapeutics, a company using AI for drug discovery, was the highest beneficiary, raising $1 billion.
Source: Rothschild and Co.
Tech Bullion notes that healthcare investments have focused on solutions that improve patient experience and enhance personalised care, R&D innovation (especially pharmaceuticals and medical devices), as well as tech-enabled services and delivery transformation (remote patient monitoring, telemedicine, digital health platforms, etc).
Similarly, healthcare investors recognise that the value-creation process in healthcare takes time, which implies that they must embrace a long-term horizon.
What this trend means for you
This trend shows that the healthcare sector remains a viable option for growth equity investors.
In the E&Y survey quoted above, 63% of GPs expect more deployment of PE capital into the healthcare sector.
However, as we have seen, investors in this sector may need to embrace a long-term approach if they want to truly create value.
Furthermore, regulatory uncertainty continues to be a concern for healthcare PE investment given that many healthcare stakeholders are worried about the impact of PE investment on the cost, quality, and utilization of healthcare, as reported by the National Institute of Health Care Management (NIHCM).
6. Focus on corporate governance
The last on our list of growth equity trends is the growing interest on corporate governance.
Why this renewed focus?
Events in recent years have shown that there is more corporate governance fragility in private and public markets than many investors realise.
“2022 saw the collapse of FTX and 2023 saw Binance fined $4.3bn with its founder stepping down,” noted Rothschild and Co. “2023 also saw the demise of Silicon Valley Bank and the issues over control and corporate governance structures at Open AI.”
PE and growth equity firms are now becoming more active in the due diligence process which leads to them being selective in the investment opportunities they pursue, according to Capstone Partners, a middle-market investment bank.
This concern over corporate governance has also led to a reduction in the speed of funding rounds. “The ‘hot’ market conditions of 2020-22 saw a pressured environment and rapid decision making,” according to Rothschild and Co. “Outside of AI, where competitive tension to invest remains high, the environment appears much less pressured. For companies, it means funding rounds are more onerous and take longer than they did in the recent past.”
The delay in funding rounds is understandable since a robust due diligence process will cover legal, financial, environmental, tax, commercial, and insurance issues.
Increased interest in due diligence was also necessitated by the economic environment, according to EisnerAmper, an audit, tax, and advisory firm. “A multitude of vectors are hitting at the same time: cash flow implications of higher interest rates and leverage levels, the extent to which companies can pass on inflation to their customers, labour market implications, and the ability to obtain portfolio company talent to execute a growth strategy all must be succinctly analyzed together with some understanding of the sensitivity of how they interplay.”
The pursuit of value creation and the focus on corporate governance shows that growth equity investors are prioritising quality over quantity, an all-important strategy in a market where demand still exceeds supply.
What this trend means for you
Quantity and speed can no longer be priorities. Instead, you should focus on implementing (and working with firms that implement) a robust due diligence process for weeding out the bad eggs and focusing on quality growth equity companies.
One way to improve your due diligence process is to sound off your investment ideas to other asset owners and asset managers. For example, they might know something about a company of interest that might constitute a due diligence red flag.
On the other hand, they might point you to investment opportunities that may not have been on your radar.
At cio investment club, we provide you with a community of asset owners and asset managers from across the globe, with which you can exchange investing ideas and evaluate investment opportunities.
We also organise exclusive roundtables and investment breakfasts where you can have face-to-face interactions and networking sessions with other finance and investment professionals.
Do you want to be part of an investment community where you can discover and evaluate investment opportunities like growth equity companies? Register today to become a part of the cio investment club.
Takeaways
- The significant drop in median valuations of growth equity companies from 2021 to 2023 represents a healthy market correction. While valuations began to rebound in early 2024, they remain below their peak levels, offering investors the chance to acquire quality growth companies at attractive prices.
- Growth equity companies are prioritizing operational and financial efficiency in response to increased competition for limited funding. Investors are shifting focus from pure revenue growth to sustainable growth models and resilience.
- The resurgence of the private equity secondary market provides investors with greater liquidity, alternative exit options, and an opportunity to build diversified portfolios.
- AI and healthcare sectors dominate growth equity investments in 2024. AI companies, both large and small, are attracting significant capital, while healthcare investments focus on innovation, patient experience, and long-term value creation.
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