Private equity growth funds attract record first-half inflows as sector rebounds

US private equity funds that invest in fast-growing companies without taking a controlling stake raised a record amount of capital in the first half of this year, in a sign of their strong recovery from a 2023 fundraising slump.

Growth funds attracted $33.2bn in the first six months of this year, the highest first-half total on record and a 36 per cent jump from a year earlier, according to data from Preqin. Fundraising across other private equity strategies grew 20 per cent over the same period.

The surge comes even as the number of growth funds raising capital dipped to 87 in the first half from 96 a year earlier.

Large, established managers and smaller specialist funds are among the beneficiaries of the inflows, helped by surging interest in AI-related companies and valuations that in some cases are still below the highs hit in the industry’s 2021 boom during the coronavirus pandemic.

“I think the recovery is definitely real,” said Jeff Machlin, managing partner of Connecticut-based Wingman Growth Partners, which closed a $215mn growth fund in June, “but it’s selective in nature”.

Fundraising for US private equity growth funds peaked in 2021, when $67bn was raised for the year, as monetary and fiscal stimulus during the pandemic helped drive a technology investment rush that pushed valuations sharply higher and often prioritised revenue growth over profitability.

But as doubts grew over whether rapidly expanding companies could ultimately deliver the profits implied by their valuations, investors raced to pull back from growth equity, with fundraising tumbling to just $29bn in 2023.

“The whole asset class got penalised,” said Hugh MacArthur, chair of Bain & Company’s global private equity practice. “Investors basically said: ‘Stop — I don’t know what anybody’s doing, so I’m not investing.’”

A drop-off in initial public offerings and dealmaking meant there were fewer exits available for private investments, which limited the payouts back to investors and reduced their ability to put money to work again in new funds.

However, growth equity fundraising has risen in both of the past two years and is on track to grow again this year. A survey by consultancy McKinsey & Co of 296 institutional investors in January found 46 per cent of respondents planned to increase their allocation to growth private equity in the coming three years. That compared with 35 per cent for buyout funds and 41 per cent for venture capital.

Private company valuations had “come down pretty materially” compared with 2021, said Chris Cavanagh, general partner at Boston-based Guidepost Growth Equity, which raised $521mn for its latest fund in January, adding that investors could now “enter at more attractive multiples”.

The huge success of AI start-ups has also helped make growth equity more attractive, say investors, as pension plans and endowments seek exposure to what they think could be the next technology winner.

“There is more demand from allocators to make sure that they have access within their portfolios to the next OpenAI, Anthropic or SpaceX, to ensure that they’re not kind of missing the boat,” said Luke Riela, who advises institutional investors on private market investments at consultancy Meketa.

However, investors have also been selective in the funds they back, with much of the money flowing into a handful of big funds, which are often more able to absorb large inflows from institutional investors. Three growth funds — including the $10bn Thrive X fund, run by Joshua Kushner’s Thrive Capital — accounted for more than half of the capital raised in the first six months of this year.

“This is not where the best returns are,” said an executive at a state pension plan that had invested in large growth funds this year, speaking about large funds in general. “This is ‘I think I can safely put $500mn to work.’”

Smaller, specialised growth funds have also found success. Sheldon Lewis, managing partner at San Diego-based Blueprint Equity, said he was able to raise $333mn for a fund focused on early-stage AI-driven software companies, helped by strong returns from its previous funds.

“When you come back to your investors to raise your next fund and you’ve already paid them quite a lot of money, they are obviously a lot more inclined to give you money down,” said Lewis.

Despite the momentum, many growth funds are still struggling to raise capital as exits remain challenging and traditional software, once a major focus for growth equity investment, faces the threat posed by rapid developments in AI.

Sarah Sandstrom, head of North America private equity placement at Campbell Lutyens, a financial advisory, said growth funds launched in 2022 had so far returned virtually no cash to investors, while those launched in 2021 had returned about 60 cents for every dollar invested — low levels by industry standards.

“The last wave of growth investing has yet to really give people confidence that it’s bearing fruit by and large,” she said.

Bruce MacDonald, chief investment officer of the $2.5bn Virginia Commonwealth University Investment Management Company, said he has stayed away from traditional growth funds.

They are “so dependent on software, which is a very risky place to be investing”, he said.