Private equity and venture capital are two big concepts in the world of investing. There is a lot of competition between startups and mature companies alike to secure the level of funding that firms in one of these two categories provide. When looking at venture capital vs. private equity, there is a lot to consider.
A common question that arises when considering these two concepts is: “Which one should my company target?” In order to answer that question, we must first understand the major differences between these two terms. We must also match the growth stage of the company with its ideal type of investment firm. The following information will discuss these points in greater detail.
What is Private Equity?
In simple terms, private equity is a type of investment capital. It refers to ownership or interest shares in a business entity that are not publicly listed or traded.
Private equity is sourced from either individuals with a high net worth, or firms that consolidate and leverage investment capital from such individuals. The primary goal of private equity firms is to directly invest in a company, meaning that a sizable amount of capital is needed. Private equity firms may buy out private companies or take over public companies with the objective of taking them private.
What is Venture Capital?
Venture capital is often considered a form of private equity. It is a type of investment capital specifically oriented towards startups and small companies that investors believe have significant long-term growth potential. Interestingly, venture capital does not always have to be financial in nature, but may also involve the leveraging of technical or managerial expertise in return for equity in the company.
In a sense, venture capitalists are “gambling” that the startups they invest in won’t fail. However, since the failure rate for new businesses and ventures is so high, the vast majority of venture capital firms aim to achieve a wide diversity in their portfolio (i.e., they invest in several companies to mitigate their risk).
Venture Capital vs. Private Equity: What are the Main Differences?
While there is some measure of overlap between private equity and venture capital firms, there is also a world of difference between these two markets in terms of intent, scope, and other factors. Here are some key differences between these two categories:
In simple terms, private equity firms are focused on optimizing an acquired business and then turning around and selling it for a profit. These firms are generally not interested in owning assets for an extended period of time, but almost always have an exit strategy in place that will, after a few years, ensure that they realize a hefty return on investment (if everything goes well).
Venture capital firms are focused on investing in a company during its earlier stages of operation. They want to see the company achieve long-term profitability. However, they usually are not interested in a long-term (or even permanent) ownership share in the business. In fact, venture capital often pushes for quick results followed by a speedy exit, since they may have deadlines on their funds.
Private equity firms mostly invest in well-established, financially mature companies. Perhaps such companies are struggling to make a profit because of inefficient processes or ineffectual leadership. Whatever the case may be, a private equity firm wants to come in, streamline and optimize the business’ operations, and turn it into a very attractive prospect for other potential buyers and investors. This typically means that private equity firms operate within a “play it safe” mindset; they are usually not interested in infusing an unknown company with fresh capital.
However, venture capital firms primarily deal with high-risk, high-reward startups. They may have a greater portfolio diversification compared to private equity firms because they are looking for that “diamond in the rough” — the startup that yields a ten-fold ROI, if not more — and are willing to suffer through a certain number of failures in order to get there.
Amount & Nature of Investment
It’s not unheard of for private equity firms to invest well over $100 million in a single company. They also tend to acquire 100% of their target businesses; in other words, they “buy out” these assets. The reason why private equity investors are unafraid of such deep commitments to single companies is the relative stability that such assets have demonstrated over a period of time prior to their buyout.
In contrast, venture capital firms often invest between $1-5 million per asset, and typically acquire 50% or less of each company’s equity. Venture capitalists are investing at a much riskier business stage than private equity firms, and therefore want to mitigate their risk to a reasonable degree.
Numbers vs. People
One side of the ‘venture capital vs. private equity’ question where this is little to no conflict is this: both are ultimately results-driven businesses. Nevertheless, there is a significant difference between how each type of firm approaches the decision-making process.
Since private equity firms are concerned with companies that are already mature, their analysts want to see the numbers more than anything else: financial records, trends, past performance, profit projections, etc. The objective of a typical private equity investment is to optimize a known quantity — and a known quantity should have a backlog of data to analyze.
On the other hand, venture capital firms deal with startup companies that, by their very nature, don’t have a wealth of data from which to form predictive models. For that reason, venture capitalists tend to be much more interested in the “human side” of a potential asset. For instance, a VC analyst may ask: “Does this startup’s ownership group have the necessary technical, administrative, and marketing skills to succeed? How big of an investment would it take to effectively assist them? Do the company’s executives demonstrate the characteristics required for sustainable growth?”
In summary, ‘private equity vs venture capital’ isn’t always the right question — both types of firms have their place in the world of investment. If you’d like to learn more about how to grow your business by attracting either private equity or venture capital investors, reach out to our experienced consultants at Ascent for further information.