Crashing valuations and a dearth of initial public stock offerings (IPOs) in the technology industry this year have many wondering if the bubble has burst for a key enabler of the sector’s rapid growth over the past decade: growth equity investors.
In recent years, a new wave of growth equity investors backed an explosion of private billion-dollar startups that have reordered established industries and invented whole new ones, creating astonishing value along the way.
While many traditional venture capitalists narrowed their focus to early-stage companies that haven’t yet achieved product-market fit, the funding from a new class of investors pioneering a different model of investment grew significantly. From 2017 to 2021, growth equity’s share of technology sector investments grew from 19% to 27%, the largest increase of any investment segment, according to Bain & Company analysis of data from S&P Capital IQ, Pitchbook, and Dealogic.
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 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.
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.
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.
Was this the growth equity bubble bursting?
That’s an understandable question, but growth equity has fundamentally altered tech investing over the last decade. There’s 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.
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.
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 business?
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. In our work with companies worldwide, we’ve found that 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.
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.
Christian Buecker, Greg Fiore, Dunigan O’Keeffe, and Sean Tanaka are partners in Bain & Company’s technology & cloud services and private equity practices. They’re based in San Francisco.
The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.
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