The potential of growth equity for family businesses

The private equity (PE) landscape has evolved significantly in recent years, offering family businesses new opportunities for growth without compromising their core values.

Family firms have historically been wary of PE, which often conjures images of aggressive cost-cutting, loss of control and a focus on short-term financial gains.

This perception is not without merit: in both popular culture and academic literature, the impact of PE buyouts is often associated with workforce reductions, wage cuts or other measures aimed at boosting profitability.

But as we found in our recent study, not all private equity is created equal. A rapidly expanding segment of the PE industry–growth equity (GE)–provides a compelling alternative for family businesses looking to achieve both financial and non-financial goals.

What exactly is growth equity?

Growth equity sits between venture capital and traditional buyouts. GE investors typically acquire minority stakes in mature companies to fuel growth. Unlike buyout investors, who take full control and often overhaul operations, GE investors partner with existing owners to achieve shared goals.

This distinction in ownership structure is key. In a traditional buyout, previous owners often exit the business entirely, leaving new owners with free rein to implement changes–including workforce restructurings.

In contrast, GE investors work alongside incumbent owners, who retain a majority stake. This shared governance means that decisions on human capital issues like wages, job security and employee development are made collaboratively with a long-term view.

The rapid growth of GE assets

The growth equity asset class has seen remarkable growth in recent years. Global GE fundraising totaled $132 billion in 2021, representing a 56% increase over 2020 (Edlich, Hayes, and Miele, 2023). In 2022, total assets under management reached $1.218 trillion globally, accounting for 10% of all private market assets under management and 37% of assets under management in buyout funds (McKinsey, 2023).

These figures highlight GE’s rising prominence within the broader PE landscape. As more investors recognize the potential of GE to deliver sustainable growth, it’s becoming an attractive option for family businesses in search of external capital without the downsides associated with traditional buyouts.

Why family businesses should care about growth equity

Family firms are known for their deep commitment to their employees and communities, viewing the business not only as a profit-generating entity but as a legacy to be preserved for future generations. This long-term perspective can clash with the short-term focus of some traditional PE investors.

Yet our research provides a nuanced view when it comes to the impact of PE on employees. In our analysis of 176 private companies that received PE investments, we found GE investors to be more likely to support human capital investments–by expanding the talent pool, increasing wages and improving job security, for instance–compared to traditional buyouts. These practices align closely with the values of many family firms and their efforts to foster employee well-being and stability.

GE-enhanced employment conditions were also found to positively correlate with important employee outcomes: higher productivity and reduced employee turnover. By comparison, firms subject to traditional buyouts often faced wage reductions and lower job security, even if overall employment levels grew.

Interestingly, wage reductions did not appear to adversely affect employee turnover or productivity, possibly reflecting a more selective approach to reconfiguring employment practices.

Addressing family firms’ concerns about opening capital

For family businesses considering outside investment, one of their biggest fears is a loss of control. Compared to PE buyouts, GE offer a different proposition.

Since GE investors typically acquire minority stakes, family-business owners retain decision-making power. In the ideal case, owners can leverage the capital and expertise that GE brings to fuel growth while safeguarding the firm’s culture and mission.

As our study shows, this shared control structure reduces the likelihood of breaching the implicit social contracts that family owners and managers have with their employees.

Growth equity as a win-win for family firms

For family business owners contemplating how to ensure their companies thrive for future generations, GE offers a promising path. It provides access to capital and expertise while allowing families to retain control and stay true to their values.

Our findings suggest that GE investors are associated with significant investments in human capital–the lifeblood of any organization–suggesting that GE might help family firms achieve growth in a way that aligns with their long-term vision.

 

Homepage image: Scott Graham on Unsplash