L3 - Growth Equity

Question 1

What is growth equity?

Answer 1

Growth equity refers to minority investments in relatively mature, rapidly growing, privately-held companies.
It is distinguished from VC by the maturity of the business and the size of the financing.
It is distinguished from private equity since the transactions do not involve a change of control to the investor

Question 2

Do growth equity companies have a clear path to positive EBITDA and profitability?

Answer 2

Yes.

Question 3

Who is in the investor base?

Answer 3

Institutional investors from prior financing rounds (including VC)
- but the company may also still be closely held by the founders

Question 4

Investment amounts in growth equity

Answer 4

• larger than in VC rounds

- span the entirety of the landscape from the first non-VC equity financing of 15-20M to pre-IPO financing of 500M plus.

Question 5

Investment returns are a function of

Answer 5

growth, not leverage or other financial engineering or cost cutting

Question 6

Is the loss ratio higher than in VC?

Answer 6

No it is smaller.

Question 7

Control in minority transactions

Answer 7

• seek participation in, and limits on control of majority owners through board representation and negative controls.

Question 8

negative control meaning

Answer 8

The negative control provision is designed to provide veto right to the investors for protecting their investments.

Question 9

exit in minority investments

Answer 9

Absence of control means investor needs a contractual right to enable it to monetize its investment; sale of minority stake to a third party is not desirable.

Question 10

Type of security held by minority investors

Answer 10

preferred stock

Question 11

Timing in minority investments

Answer 11

Timeline my be quicker; depends on investment size which drives regulatory approval analysis; rarely third party consents.

Question 12

Due Diligence

Answer 12

typically more tailored due diligence focused on material risks

Question 13

Indemnification clauses

Answer 13

Indemnification clauses are clauses in contracts that set out to protect one party from liability if a third-party or third entity is harmed in any way

Question 14

Are transactions relationship based?

Answer 14

Yes

Question 15

What can the board (not) do in growth equity?

Answer 15

No affirmative right to fire management, change strategy or inject additional capital, even when the business is not performing
- only negative covenants

Question 16

Main transaction documents in growth equity

Answer 16

• Equity Purchasing Agreement
• Investor Rights Agreement
• Certificate of Incorporation
• ROFR/ Co-Sale Agreement
• Voting Agreement
• Side Letter (VCOC)

Question 17

What is the equity purchasing agreement?

Answer 17

The agreement pursuant to which the investor funds cash in exchange for equity. Includes purchase mechanics, reps and warranties, and covenants

Question 18

Investor Rights Agreement

Answer 18

Sets forth the information rights, preemptive rights, and registration rights

Question 19

preemptive rights

Answer 19

Preemptive rights give a shareholder the opportunity to buy additional shares in any future issue of a company’s common stock before the shares are made available to the general public.

Question 20

Registration right

Answer 20

A registration right is a right entitling an investor who owns restricted stock to require that a company list the shares publicly so that the investor can sell them.

Question 21

Certificate of Incorporation

Answer 21

Publicly filed document that sets forth the rights and privileges associated with the company’s stock, including liquidation preference, dividends, anti-dilution provisions, and approval rights.

Question 22

ROFR

Answer 22

Right of first refusal (ROFR) is a contractual right to enter into a business transaction with a person or company before anyone else can.
In this context it means that stockholders must first offer their shares to the company and or the preferred stockholders before selling to a third party.

Question 23

Co-Sale Agreement

Answer 23

the right to tag along in a sale to a third party.

“co-sale rights,” are contractual obligations used to protect a minority shareholder, usually in a venture capital deal. If a majority shareholder sells his stake, it gives the minority shareholder the right to join the transaction and sell their minority stake in the company.

Question 24

Voting Agreement

Answer 24

Sets forth the composition of the board of directors and the drag-along rights

Question 25

Side Letter

Answer 25

Sets forth other contractural rights, such as the right to designate board observers.

Question 26

Growth Equity Deal Term Drivers

Answer 26

• current capital structure
• use of proceeds
• round size and ownership percentage being sold
• pre-IPO round