Private equity and venture capital are two major subsets of a much larger, complex part of the private markets. Private equity and venture capital are sometimes used interchangeably and confused by people because both terms refer to firms that invest in private companies in exchange for equity. However, private equity and venture capital have several key differences. Here we will simplify private equity vs venture capital dualism and tell which option you should pursue.
What is private equity?
Private equity is an alternative funding where a group of investors makes direct investments in a company with a goal to enhance the company’s financial health and generate a return on their investment.
Private equity firms typically invest in mature companies that have passed the growth stage. A business that is in distress often gets funds from private equity investors. Sometimes they buy out a business with an intention of improving its operations and selling it for profit.
You can find the top private equity firms in India.
How does private equity firm bring value
Typically, a private equity firm acquires companies experiencing financial stress and poor management. The PE firm will usually take a major stake in the company and restructure company debt and can hire a new management to improve operational efficiency.
Pros and cons of private equity
The key advantage of inviting a private equity investor is that not only will they provide access to cash, but also professional expertise. If investors have experience within your industry, they can help you find room for improvement.
However, if a private equity investor takes a majority stake in the company, they will have power to make decisions on how the business is run. They can fire management or make major changes to the business.
PE firms enjoy the power to sell the company – or their equity stake in the company – for a profit. Investors are on board to earn profit, hence if the right opportunity arrives, selling is a real possibility.
What is venture capital
Technically, venture capital (VC) funding is a form of private equity. The main difference is that VC investors usually invest during the startup phase and private equity investors prefer stable companies.
Venture capital is financial investment provided to small companies with incredible growth potential. While this type of investment tends to be riskier, VC investors identify promising startups or emerging high-growth companies that have the potential for very high returns.
Usually, venture capitalists pool funds from a limited partnership and buy an equity stake in the company.
How does venture capital firm bring value
A venture capital firm plays an active role in a company’s growth. They conduct many board meetings to keep tabs on their investments. They can also help in sales and fundraising campaigns. In addition, venture capitalists have powerful connections to industry experts, which can help startups to grow exponentially.
Pros and cons of venture capital
VC funding can help startups in the initial phase of growth. VC investors can offer their knowledge and expertise to the process. It will help a startup minimize the risk and not to make common mistakes in the beginning.
New businesses have a high rate of failure. Venture capitalists have an experienced team and are usually well-connected and can help new businesses find new opportunities.
While VC funding provides money to a new company, the company dilutes its equity and issues shares to venture capitalists. Later if you need to raise additional rounds of funding, your ownership and control over the company will be reduced further.
Private equity vs venture capital: what is the difference
While there are many similarities between private equity and VC funding, they are different from each other in many ways.
| Particulars | Private Equity | Venture Capital |
|---|---|---|
| Beneficiary | Private equity firms invest in companies which have not been listed on any public stock exchange | Venture capitalists typically fund startups or new companies in their primary stage |
| Investment stage | Later stage | Initial stage |
| Number of companies funded | Only a few companies are funded | Large number of companies are funded |
| Industries | All industries | Typically, tech startups, energy conservation, etc. that need initial funding |
| Focus on | Corporate governance | Management skill |
| Risk involved | Low | High |
| Ticket size | Large | Medium |
| Capital requirement | For business expansion and growth | For operation growth |
Key difference between private equity and venture capital
Here is a point by point VC vs PE comparison to discover the real difference between private equity and venture capital.
Stage of funding
Private equity investors buy established businesses, whereas venture capitalists typically invest in new companies in the early stage of growth, and startups.
Private equity firms typically look for companies that have already grown but are struggling due to inefficient management or poor process. PE investors intervene to make significant improvements, streamline operations, and sell business for profit.
Venture capitalists invest in promising new startups with massive growth potential. Many Indian tech startups are the best examples of this.
Company types
Types of companies invested in by private equity and VC are major differentiators for comparison between PE vs VC investment.
Private equity investors often have diverse portfolios and cover industries across spectrums, from healthcare to technology, construction, transportation to energy.
Contrary to this, venture capital firms usually focus on tech startups. Uber, Lyft, etc. are some of the latest examples of companies funded by venture capitalists.
Deal size
Typically private equity acquisitions dwarf deals done by VCs. As per a report by PitchBook, 25% of private equity deals range between $25M and $100M. While many venture capital deals are less than $10M in Servies A round in the US.
With some exceptions, private equity firms own vast wealth, even when compared to wealthiest venture capitalists.
Percentage of acquisitions
This is one of the key differences between private equity and venture capital. Private equity firms usually buy out the entire company, whereas venture capitalists only acquire a portion. If not the entire company, PE will secure the majority share.
In most cases, shares are split among founders, venture capitalists, angel investors, and/or private partners involved in the startup.
Risk appetite
Venture capitalists take higher risk because they invest in startup companies, the majority of which are bound to fail. However, they invest small amounts in lots of companies, considering that at least one will be a hit, and the return on investment (ROI) from it will offset the losses.
On the other hand, private equity firms invest large amounts and even if one company fails, the entire fund is doomed. Therefore, private equity firms acquire mature companies, because the probability of failure is virtually zero.
Structure
Private equity investors use a combination of cash and debt to take over a company, while venture capital funds are simply cold cash.
Since private equity firms can spend many years to transform the company to work off the debt and recover their initial investment, usually they acquire the entire company. Venture capital investors make smaller investments to get quicker returns.
Return on investment
Which generates the higher return between private equity and venture capital?
Both of them target about 20% internal rate of return (IRR), but usually they fall short. Private equity firms can generate returns from all sorts of companies. By comparison, the ROI for venture capitalists depends on the success of the companies in their portfolio.
The Indian Venture Capital and Private equity market has become a hot investment destination. Investors made 25-30% annual returns in the last 5-6 years by investing in Pre-IPOs. However, it may be risky to invest your hard-earned money without market research and investment guidelines. SBNRI is an online platform exclusively designed to cater investment and transactional needs of NRIs living around the world. The investment experts at SBNRI guide NRIs throughout the investment process.
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