Stage Expertise is as Important at Sector Expertise
The Workhorse Capital team believes that successful investors differentiate themselves by contributing to the value creation process at each portfolio company. In order to do so, we keep close to our roots – focusing our investments in technology-enabled service businesses which leverage recurring revenue business models. We believe in sector expertise. Likewise, we believe in stage expertise. We’ve chosen to become growth stage experts. We believe that growth equity offers investors an asymmetric risk-return profile; the opportunity to derive venturesome return potential with much lower loss rates than venture. In our view Growth Equity investments exhibit the following return characteristics:
Proven Product-Market Fit and Economic Model
Candidates for Growth Equity investment typically operate in a quantifiably large market with a proven value proposition and economic model. These businesses know how to sell their product/service, how to identify their target customer and understand the economics of customer acquisition. With this foundation in place, growth-stage businesses can deploy investment capital at the use(s) of proceeds that generate the highest return on investment.
This cannot always be said of venture investments, which often wander in the woods and often must “pivot” before discovering a market, or leveraged buyouts, which must focus on repayment of debt to create equity value.
Attractive Risk-Adjusted Upside Potential
Growth and value are concepts that are inextricably linked in the financial markets. It is a well-known axiom that – all else equal – the faster a company is growing, the higher the multiple it commands, and vice versa. It is obvious but worth emphasizing that growth-stage businesses create incremental value by growing revenue and profitability. In a sufficiently large market segment, growth stage investments have the opportunity to drive meaningful growth and profitability.
The same can be said of venture investments, although the failure rate of venture-financed companies remains very high. While it is easy to recall high-profile acquisitions of venture-backed companies with unproven economic models, these exits are very much the exception to the rule. Growth Equity returns are more predictable because base exit value is tied explicitly to growth and financial performance, with the added upside potential of strategic value. Buyouts on the other hand often create value through cost-cutting and by reducing debt. As a result, traditional buyout returns are often bounded, as there is only so much cost cutting and debt repayment available to a given company.
Limited Risk of Capital Loss
We make Growth Equity investments in companies that have created a baseline of value and are typically un-levered, so that the preferred equity is not subordinate to debt. If the investment is priced right, the investment need only maintain its value in order to return capital to preferred shareholders.
This is distinct from both the venture capital asset class and the buyout asset class. In buyouts, the equity is typically subordinate to debt, creating a default risk that could wipe out equity. One need look no further than the 2007/’08 business cycle to see how leverage cuts both ways. In venture, the company must typically grow into its valuation by hitting development and/or performance milestones, which if not achieved can render the equity worthless. Venture is about harnessing home-run potential, but with that upside comes higher loss rates.
Being a stage expert (as well as a sector expert) enables us to better understand the challenges faced by growth stage businesses and to design our business around helping the entrepreneurs we partner with to stay ahead of those challenges. With a combination of sector and stage expertise, we are purpose built to execute on the promise of growth equity.