The following article was published by Fundwise on July 20, 2021.
Edison Partners, which was founded in 1986, is currently raising its 10th fund, targeting $425 million, according to regulatory filings. The Princeton, N.J.-based firm was an early pioneer to growth equity when it evolved its strategy with Edison VII. For more than 20 years prior to that, its sweet spot was venture capital.
Fundwise recently spoke to Christopher Sugden, a managing partner at Edison Partners, about the evolution of growth equity and why the firm wants to keep its funds under $500 million.
How has growth equity evolved in the past decade or so?
If you go back to 2006, 2007, and 2008, we were actually using the term expansion capital, and we were educating the market. LPs really only had allocations for VC and buyout strategies, there was nothing between these strategies. Today, you probably have 50% or two thirds of LPs who have a specific growth equity allocation, so we are no longer educating the market.
Still, everyone in our world has their own definition of growth equity. What you see today is a lot of the buyout/control-oriented firms saying they do growth equity, but they're really doing control growth or buyout growth, and that is a very different animal because an entrepreneur doesn't necessarily want to sell control at $10 million or $20 million of revenue. The tail is wagging the dog with fund size driving firms to write $50 million plus checks and raising valuation to convince the entrepreneurs to take more capital than they need—which is crazy.
Our fund size is a key differentiator because we can write $10 million to 20 million checks. The level of investment matches the entrepreneur’s and the company's needs.
Why is it important for Edison to keep its fund size under a certain level despite this infatuation for growth equity and despite higher valuations?
Fund VIII was $275 million, and Fund IX in 2018 was $365 million. With a future fund, we might make it a little bigger, but one of our differentiators is to keep fund size consistent with our strategy. Sub $500 million fund allows us to stay consistent. We think fund size is so important because we can write $10 million to $25 million initial checks, and then we reserve two to three times that, we can go up to $50 million in a given deal. The whole idea is to have a fairly concentrated but not overly concentrated portfolio. So we typically invest in 15, plus or minus, companies per fund. And our top half will end up in that $20 million to $50 million range. And the bottom half of companies will end up in the $10 million to $20 million invested capital range.
A lot of firms are raising bigger funds, because they can, not necessarily because they should. This is a hot LP topic. How big is too big of a strategy drift?
Since the definition of growth equity still varies greatly in the market, how does Edison define growth specifically?
Edison has been pretty consistent with our definition, which is businesses with $5 million to $20 million in revenue. Edison VI and VII focused on the lower end of this range. As we raised Fund VIII, and subsequently Fund IX, we’ve been focused on $10 million plus revenue run rate companies.
There’s always a question of whether growth investors are really doing late-stage venture. But the attributes Edison focuses on are not only revenue run rate, but growing, capital efficient businesses. If companies are growing less than 30%, they are not growth businesses in our mind, and in the current environment, we’ve probably seen average growth rates more in the 50% to 100% range. Beside the revenue and the growth rate, having been capital efficient prior to our investing is a critical attribute. We think companies that have not raised institutional capital are the true definition of growth equity businesses. But we would also say companies that have raised less than $10 million and have revenue run rates of $10 million or more are also growth equity companies.
Larger fund sizes for growth equity have also pushed valuations higher, do you think that’s going to be a problem going forward?
I do think we're in a slippery slope time where fund sizes have gotten ahead of themselves, and growth has become defined by both being a unicorn and having raised a nine-figure round. But that’s not really the measure of success so I'm a little nervous about that dynamic.
The scary part is with the amount of capital being raised. The opportunity fund concept from early-stage VCs pricing/investing in their own deals gives me pause. It’s good for management to know they have a funding partner for the long-term, but too much capital chasing too few quality opportunities is a growing concern for me. I know LPs are also thinking about that.
How does Edison differentiate itself from other growth-focused firms?
Growth equity has grown dramatically over the last decade and there are a lot of growth-focused funds these days. Mega funds have raised growth equity funds. Venture funds have raised opportunity funds. So all this growth is a converging area that's gathering high interest. But our perspective is that as an investor, you better be bringing something more than dollars to the table.
The Edison Edge team is a group of internal people and operating partners (who are exclusive to Edison, but not full time on our team). The people who lead the Edison Edge in our team are also deal partners. They don’t sit in a separate silo waiting for deals to get done, or even diligence to begin. We integrate the Edison Edge from end-to-end in our evaluation of an opportunity through deal closing and then from company building through exit.
About the Author
A veteran financial reporter, Marine Cole has written for the New York Times, The Wall Street Journal, Barron's, and The Dow Jones newswire. Formerly Americas Editor at PEI's Private Equity Group, Cole specializes in coverage of firms' LP relationships, but has written on regulatory issues and the secondaries market.