If you’re looking for investors, you’ve probably heard of private equity and venture capital. But what’s the difference, and which option should you pursue? Technically speaking, venture capital is just a subset of private equity. Both make money from making investments. However, if you take a closer look, you will see the difference. Private equity investors typically focus on mature companies that are past the growth stage. On the other hand, venture capital investors focus on the companies in their early stages of working.
Private equity refers to an alternative form of private financing away from public markets. Likewise, we use the term for firms that buy companies through leveraged buyouts (LBOs) in the finance industry.
- Private equity is, shortly speaking, an investment by a private equity firm in a specific company. Investors make partial or complete investments as they hope to gain higher returns.
- Generally speaking, there are various changes that the private equity firm can make in a specific company. Those include expenses reduction, management, strategies, etc., to make the company profitable.
- After a few years, the private equity sells the company generating a profit and high returns through the entire transaction.
What is the difference?
Venture capital funding can be beneficial for new companies in the early stages of growth. Like private equity investors, venture capital investors can lend their knowledge and expertise to the process. As shown in the image below, private equity firms invest in big companies that they predict could gain high profitability in the following years. At the same time, venture capitalist set their eyes on companies at an early stage that have long-term growth potentials.
Venture capital investments are generally divided into several rounds of financing, in which various co-investors usually contribute equity to the company as part of a capital increase in return for the subscription of new shares. The participation of a private equity company often takes place as part of a single transaction. That said, the existing shares of a selling shareholder are taken over by the private equity investor with the intermediary of an acquisition vehicle so that a shareholder change occurs. In contrast, to venture capital investors, private equity companies usually try to increase the company’s value by restructuring the target company.
Private markets are becoming more beneficial
Drawn in by the potential of high returns, more and more investors have entered the space, creating an influx of available capital. According to Pitchbook, With companies now taking longer to go public, many PE firms have turned their sights to crossover investments. As a result, more investors put their money into the private markets. It’s now easier than ever for new private companies to get the funding they need to grow.
They have demonstrated their ability to offer further diversification in a portfolio by lowering volatility while generating superior returns. Therefore, private markets can provide investors with attractive recurring returns and capital gains. This is not just Europe centric trend. The development of private market investing has experienced global growth. That said, we will see more of the PE-backed companies and VC-backed startups in the coming years.
Similarities between venture capital and private equity
Both venture capital and private equity investors are primarily so-called financial investors who are structured as funds and invest their capital. That means that the investment decision is made solely from a financial point of view, without any particular interest in the product or the synergetic use of know-how or economies of scale or scope. In both cases, the aim of the investment is an exit trade sale of an investment. Therefore, these are not long-term investments but in expected high returns.
The approach of venture capital investors and private equity investors is often similar. Both perform due diligence on a potential target company when the opportunity arises. Then, if they decide to invest, the participation agreements often provide for management or employee participation to incentivise the company’s management. Usually, venture capital and private equity investors also secure their investment by demanding certain guarantees regarding the financial position and business figures of the target company.
To summarise, anytime you bring on investors, you’ll give up a certain amount of control over your business. Private equity investors require a majority stake in the company, whereas VC investors only ask for a minority stake. However, the forms of investment venture capital and private equity have many points of contact. We’ve seen some significant differences. In venture capital, different investors usually invest pure equity in several financing rounds in early-stage, growth-oriented startups and accept a particularly high risk of total loss. On the other hand, private equity investors aim for a partially leveraged majority stake in mature companies where they can take control of the company’s assets and create value through structural changes.
