Technology Report

Don’t Count Out Growth Equity Investors

This class of tech investors has been battered by the market downturn, but their approach has permanently changed the financing of fast-growth innovation.

By Christian Buecker, Greg Fiore, Dunigan O'Keeffe, and Sean Tanaka

First published on setembro 19, 2022
min read


Executive Summary In recent years, tech innovators backed by growth equity investors have grown rapidly to valuations of $1 billion or more. The underlying technological and business model innovation that made this possible remain sound. But the market shock of 2022 has clear ramifications—and offers new opportunities—to stars, fallen angels, and savvy tech incumbents. This article is part of Bain's 2022 Technology Report. Explore the report A version of this article appeared on Fortune.com. In the last decade, technology companies like Airbnb, Snowflake, Stripe, and Crowdstrike led a wave of disruption that reordered established industries and invented whole new ones. Along the way, they created astonishing value. In June, the number of private billion-dollar start-ups exceeded 1,100, according to data from CB Insights, a more than tripling in five years of these once-rare unicorns. As a group, they reached a value of roughly $4 trillion to $5 trillion before the recent market correction, according to CB Insights and Crunchbase. This explosion has been backed by a new wave of growth equity investors. While many traditional venture capitalists narrowed their focus to early-stage companies that have not yet achieved product market fit, the funding of a new class of investors pioneering a different model of investment grew significantly (see Figure 1). These growth equity investors deploy large amounts of capital—often exceeding $100 million in a single funding round—to help relatively mature companies pursue breakthrough innovation and scale at an unprecedented pace. They often double down in later fund-raising rounds, positioning themselves as long-term investors by holding their stakes through the initial public offering (IPO) and beyond. As a result, newly minted growth specialist funds, hedge funds, refocused VC firms, and other growth equity investors have become the financial partner of choice for many fast-growth companies. Figure 1 In technology, growth equity has increased faster than all other investment segments Thanks to this new model, in recent years capital ceased to be a limiting factor for a private company’s quick scaling. Some 30% of companies that went public in 2020 had raised more than $100 million before their IPO, compared with 7% in 2015. This made it possible for Space X (valued at approximately $125 billion) and Shein (at approximately $100 billion) to grow to huge valuations while still private and helped Uber’s IPO reach $70 billion-plus and Kuaishou Technology’s debut in the range of $150 billion to $160 billion. Once public, growth-backed software companies continued to perform. Among software companies, growth equity-backed tech companies account for only 8% of revenue, but 19% of growth, 14% of sales and marketing spending, and 13% of research and development spending. Growth equity’s first big test came in 2022. By May, as interest rates hit high-growth stocks and the IPO markets, the cumulative market capitalization of the fastest-growing software-as-a-service (SaaS) stocks had fallen almost 70%, according to Meritech. Tech IPO volume in the first half of 2022 fell 80% from the same period a year earlier. The number of late-stage financing rounds collapsed. High-profile investors began to speak of black swans and tough times ahead. Companies that once couldn’t hire fast enough started letting people go. Today, both Kuaishou and Uber trade well below their offering price. Was this the growth equity bubble bursting? That’s an understandable question given the 2022 crash in valuations for high-growth assets, but growth equity has fundamentally altered tech investing over the last decade, and there is a strong argument that the underlying changes that led to the creation of the asset class remain sound—as technical innovation will continue to create opportunities for fast-scaling companies. Technological innovation Innovative technology will continue to help build and scale disruptive businesses. Cloud computing puts highly scalable data centers and advanced capabilities at the fingertips of fledgling companies. Cloud-native companies like Snowflake, Databricks, and GitLab catapulted to success with tools for cloud data analytics, artificial intelligence, and DevOps. Their technology’s modularity, the way applications communicate via API-based architectures, has built an ecosystem of complementary solutions that collectively compete against the monoliths. And the next generation is waiting in the wings—nascent technologies like the Internet of Things, quantum computing, artificial intelligence, virtual reality, autonomy, new space, and web3. Not all will succeed, but the ones that do will become the next generation of growth equity-backed leaders. Business model innovation Business model innovation has changed how technology is bought and sold. SaaS customers no longer have to install and operate technology purchases themselves. Thanks to open-source, freemium, and product-led growth models, today’s frontline users can both try and buy technology. Other business model innovations have lowered the barriers to entry in industries previously considered immune to tech disruption, including financial services, healthcare, and even space, in the process creating a well-understood playbook and an ecosystem of executives and investors experienced in running and investing based on it. This flywheel of disruption is accelerating as innovations combine to create more innovation, a concept called recombinatory innovation. Think of how GPS, cell phones, and digital maps together created real-time navigation. Even in a world where geopolitical tensions increasingly affect the technology industry, innovation today remains a global market, nurturing a rich worldwide competition of ideas. Steps to take now While the new model of innovation has already spread strong roots, the market shock of 2022 will have ramifications. Once-rising stars will have to focus sooner on unit economics and a path to profitability. Fallen angels that haven’t lived up to expectations would benefit from thinking like a private equity investor: What costs, products, or customer segments would they cut? What assets would they sell in order to concentrate on the core? Incumbent tech leaders have a unique opportunity to fundamentally rethink corporate innovation patterns, and, after doing their homework, aggressively pursue mergers and acquisitions (M&A), partnerships with innovators, and talent acquisition. Three steps are paramount. Develop the skills to sense disruption. No industry or company is safe from disruption. Invest in customer relationships and deeply understand their needs. Ensure your customer and competitive intelligence is up to the task of monitoring the landscape and informing your strategy. Assess where you can partner and integrate with the next generation of companies, including the use of corporate venture capital as a means to better understand, partner with, and cultivate the ecosystem. Commit to major investments. Most companies will need to become tech-native. That may require new organizational structures, talent, culture, and budgeting. Rationalize your innovation bets by focusing resources where you can win and cutting subscale, half-hearted efforts. Reevaluate your M&A strategy for an environment in which buying the winners will remain difficult due to growth equity-backed valuations and founders who see selling to a big corporation as less attractive. Get good at scaling. An incumbent may never be as innovative as a founder able to raise $100 million, but it does have valuable assets a disrupter may lack: business ecosystems, customers, and often a strong core business. Established companies that figure out how to unlock untapped potential in those assets and scale them can borrow a page from the unicorns and set themselves on a whole new growth trajectory. Savvy incumbents can compete with growth equity-backed success stories. Google Cloud’s sustained investment and innovation in analytics has enabled BigQuery to go toe-to-toe with Snowflake, for example. And Dynatrace incubated Ruxit, a cloud-native observability tool under the Compuware banner that is now its core product, helping it compete with growth equity-backed Datadog. Whether as direct competitors, complementary partners, or acquirers, companies are smart to operate on the principle that growth equity-backed business innovation is here to stay. Read the Next Chapter How to Compete and Win in the Multicloud World Value Evolution The Rise of Growth Equity Investors A Multicloud World Welcome to Web3 The US-China Decoupling Competitive Battlegrounds Defending against Disruption The Engine 2 Imperative AI’s Next Frontier The Industrial IoT Operational Advantage Beyond the Rule of 40 Sales Productivity Consumption-Based Pricing Software R&D Efficiencies The Chip Shortage The Circular Economy Read our 2022 Technology Report Explore the report Download PDF

Executive Summary

In recent years, tech innovators backed by growth equity investors have grown rapidly to valuations of $1 billion or more.
The underlying technological and business model innovation that made this possible remain sound.
But the market shock of 2022 has clear ramifications—and offers new opportunities—to stars, fallen angels, and savvy tech incumbents.

A version of this article appeared on Fortune.com.

In the last decade, technology companies like Airbnb, Snowflake, Stripe, and Crowdstrike led a wave of disruption that reordered established industries and invented whole new ones. Along the way, they created astonishing value. In June, the number of private billion-dollar start-ups exceeded 1,100, according to data from CB Insights, a more than tripling in five years of these once-rare unicorns. As a group, they reached a value of roughly $4 trillion to $5 trillion before the recent market correction, according to CB Insights and Crunchbase.

This explosion has been backed by a new wave of growth equity investors. While many traditional venture capitalists narrowed their focus to early-stage companies that have not yet achieved product market fit, the funding of a new class of investors pioneering a different model of investment grew significantly (see Figure 1). These growth equity investors deploy large amounts of capital—often exceeding $100 million in a single funding round—to help relatively mature companies pursue breakthrough innovation and scale at an unprecedented pace. They often double down in later fund-raising rounds, positioning themselves as long-term investors by holding their stakes through the initial public offering (IPO) and beyond. As a result, newly minted growth specialist funds, hedge funds, refocused VC firms, and other growth equity investors have become the financial partner of choice for many fast-growth companies.

In technology, growth equity has increased faster than all other investment segments

Thanks to this new model, in recent years capital ceased to be a limiting factor for a private company’s quick scaling. Some 30% of companies that went public in 2020 had raised more than $100 million before their IPO, compared with 7% in 2015. This made it possible for Space X (valued at approximately $125 billion) and Shein (at approximately $100 billion) to grow to huge valuations while still private and helped Uber’s IPO reach $70 billion-plus and Kuaishou Technology’s debut in the range of $150 billion to $160 billion. Once public, growth-backed software companies continued to perform. Among software companies, growth equity-backed tech companies account for only 8% of revenue, but 19% of growth, 14% of sales and marketing spending, and 13% of research and development spending.

Growth equity’s first big test came in 2022. By May, as interest rates hit high-growth stocks and the IPO markets, the cumulative market capitalization of the fastest-growing software-as-a-service (SaaS) stocks had fallen almost 70%, according to Meritech. Tech IPO volume in the first half of 2022 fell 80% from the same period a year earlier. The number of late-stage financing rounds collapsed. High-profile investors began to speak of black swans and tough times ahead. Companies that once couldn’t hire fast enough started letting people go. Today, both Kuaishou and Uber trade well below their offering price.

Was this the growth equity bubble bursting?

That’s an understandable question given the 2022 crash in valuations for high-growth assets, but growth equity has fundamentally altered tech investing over the last decade, and there is a strong argument that the underlying changes that led to the creation of the asset class remain sound—as technical innovation will continue to create opportunities for fast-scaling companies.

Technological innovation

Innovative technology will continue to help build and scale disruptive businesses. Cloud computing puts highly scalable data centers and advanced capabilities at the fingertips of fledgling companies. Cloud-native companies like Snowflake, Databricks, and GitLab catapulted to success with tools for cloud data analytics, artificial intelligence, and DevOps. Their technology’s modularity, the way applications communicate via API-based architectures, has built an ecosystem of complementary solutions that collectively compete against the monoliths. And the next generation is waiting in the wings—nascent technologies like the Internet of Things, quantum computing, artificial intelligence, virtual reality, autonomy, new space, and web3. Not all will succeed, but the ones that do will become the next generation of growth equity-backed leaders.

Business model innovation

Business model innovation has changed how technology is bought and sold. SaaS customers no longer have to install and operate technology purchases themselves. Thanks to open-source, freemium, and product-led growth models, today’s frontline users can both try and buy technology. Other business model innovations have lowered the barriers to entry in industries previously considered immune to tech disruption, including financial services, healthcare, and even space, in the process creating a well-understood playbook and an ecosystem of executives and investors experienced in running and investing based on it.

This flywheel of disruption is accelerating as innovations combine to create more innovation, a concept called recombinatory innovation. Think of how GPS, cell phones, and digital maps together created real-time navigation. Even in a world where geopolitical tensions increasingly affect the technology industry, innovation today remains a global market, nurturing a rich worldwide competition of ideas.

Steps to take now

While the new model of innovation has already spread strong roots, the market shock of 2022 will have ramifications. Once-rising stars will have to focus sooner on unit economics and a path to profitability. Fallen angels that haven’t lived up to expectations would benefit from thinking like a private equity investor: What costs, products, or customer segments would they cut? What assets would they sell in order to concentrate on the core?

Incumbent tech leaders have a unique opportunity to fundamentally rethink corporate innovation patterns, and, after doing their homework, aggressively pursue mergers and acquisitions (M&A), partnerships with innovators, and talent acquisition. Three steps are paramount.

Develop the skills to sense disruption. No industry or company is safe from disruption. Invest in customer relationships and deeply understand their needs. Ensure your customer and competitive intelligence is up to the task of monitoring the landscape and informing your strategy. Assess where you can partner and integrate with the next generation of companies, including the use of corporate venture capital as a means to better understand, partner with, and cultivate the ecosystem.
Commit to major investments. Most companies will need to become tech-native. That may require new organizational structures, talent, culture, and budgeting. Rationalize your innovation bets by focusing resources where you can win and cutting subscale, half-hearted efforts. Reevaluate your M&A strategy for an environment in which buying the winners will remain difficult due to growth equity-backed valuations and founders who see selling to a big corporation as less attractive.
Get good at scaling. An incumbent may never be as innovative as a founder able to raise $100 million, but it does have valuable assets a disrupter may lack: business ecosystems, customers, and often a strong core business. Established companies that figure out how to unlock untapped potential in those assets and scale them can borrow a page from the unicorns and set themselves on a whole new growth trajectory.

Savvy incumbents can compete with growth equity-backed success stories. Google Cloud’s sustained investment and innovation in analytics has enabled BigQuery to go toe-to-toe with Snowflake, for example. And Dynatrace incubated Ruxit, a cloud-native observability tool under the Compuware banner that is now its core product, helping it compete with growth equity-backed Datadog.

Whether as direct competitors, complementary partners, or acquirers, companies are smart to operate on the principle that growth equity-backed business innovation is here to stay.

Read the Next Chapter

How to Compete and Win in the Multicloud World

Value Evolution

Competitive Battlegrounds

Operational Advantage

Authors

Christian Buecker

Partner, San Francisco
Greg Fiore

Partner, San Francisco
Dunigan O'Keeffe

Partner, San Francisco
Sean Tanaka

Alumni, San Francisco

Don’t Count Out Growth Equity Investors

Don’t Count Out Growth Equity Investors