Is The Pandemic-Era Surge In Growth Equity Investing Sustainable?

Growth equity investments in digital-centric companies have further accelerated during Covid-19, following the brief initial freeze in global M&A and growth financing activity in early 2020. Even when measured against what was then a high-water mark for private markets in the pre-pandemic period, the last two years have been remarkable.

The widespread availability of liquidity driven by central banks setting historically low interest rates has pushed even more investor capital into higher-risk and higher-return asset classes like growth equity and venture capital, in a search for higher returns. Only in late 2021 did a tightening of monetary policy re-emerge as an imminent prospect.

At the same time, homeworking and lockdowns during the pandemic led to certain digital business models like e-commerce marketplaces and online education platforms experience an upward swing in demand for their services. These in turn have become key targets and beneficiaries of well-capitalized and deal-hungry PE and VC investors. In addition, government support packages sustained consumers’ purchasing power throughout the sharp economic downturn.

While these businesses thrived, registering rapid growth in user volumes and revenues, the number of growth equity investors competing to back them reached new highs. Data from Preqin showed that the number of specialist growth equity funds increased from 544 to 604 in 2020, seeking to raise in excess of $200bn. A 2021 UBS Global Family Office Report highlighted how private equity is now the preferred asset class for over half of the world’s 191 largest family offices, with over three quarters of these making growth equity investments. This ‘non-traditional’ investor type is now very firmly established in the asset class, alongside ‘traditional’ fund managers.

This combination of factors has inevitably pushed the valuations of those earlier-stage companies that raise growth equity funding rounds to unprecedented highs. That, in turn, creates compelling economic incentives for those businesses eligible to raise growth equity to come to market. Doing a deal now means getting access to historically cheap capital and raising more money on less dilutive terms than was previously possible. The result: a huge increase in the volume of transactions, both globally and in Europe specifically.

Another symptom of these market dynamics is the increasing frequency of sizeable ‘mega-deal’ funding rounds, particularly for companies that have benefited from changes to lifestyles and habits during the pandemic. Wolt, a Helsinki-based food delivery service with operations in 23 countries and 129 cities, serving food from over 30,000 restaurants to homes, raised $530 million in growth capital in January 2021. Alongside Delivery Hero’s purchase of a $235 million minority stake in Gorillas, the Berlin-based grocery delivery company, this epitomized the inflow of capital into the food delivery and online retail sectors.      

Yet, whilst acknowledging the considerable growth achieved in recent times, we must also analyze the factors which have the potential to stall the momentum of growth equity investing. As ever, there is a bear case and a bull case.

The former focuses on the short-term cyclical trend of increased inflation leading to central bank rate hikes. This could pull the plug on the liquidity in the market, requiring companies to raise their next funding rounds at lower valuations and forcing investors to write down the value of their holdings. There is also the notionally existential threat to the growth equity asset class posed by the rise of special purpose acquisition companies (SPACs) as an alternative to private funding rounds – albeit the inaugural SPAC boom of later 2020 and early 2021 appears to have subsided for now.

The bull case focuses on the secular trend of more and more commercial activity migrating to more efficient digital platforms driven by the inexorable rise in automation through software and AI. This transition, accelerated by the pandemic, is a tailwind for digital-centric businesses. It is the rising tide that continues to lift all boats, even as the uniquely amenable financing conditions of 2020-21 abate.

There are also regional variations to consider in this debate. In Europe, venture capital funding has historically been low relative to GDP across the continent when compared to key markets in North America, specifically, the USA. More recently established European VCs are therefore more likely to bet on the secular trend persisting. By comparison, we are seeing US growth and private equity investors trending towards a more cautious outlook, having typically had more exposure to volatile private tech company valuations through the dotcom bubble and the financial crisis.

Clearly some synthesis of the bull and bear cases is in order. On balance, we believe that there are strong grounds to regard growth equity as an asset class in Europe that is poised for further growth fueled by secular trends. This should be considered alongside the unpredictable 12 months ahead, with further economic volatility expected. Additionally, it is difficult to predict the impact that emergent new technologies like quantum computing or the metaverse will have on existing industries, or indeed on the previous generation of digital disrupters. However, the ability of growth equity and venture funds to navigate the complex environment will ensure that we can be cautiously optimistic, with those players who have survived previous economic cycles undoubtedly best placed.

What is certain is that investors will continue to chase high-growth opportunities, and currently growth equity remains the asset class in pole position to offer exactly that.