Private Equity vs. Venture Capital: An Overview
Private equity is sometimes confused with venture capital because both refer to firms that invest in companies and exit by selling their investments in equity financing, for example, by holding initial public offerings (IPOs). However, there are significant differences in the way firms involved in the two types of funding conduct business.
Private equity and venture capital (VC) invest in different types and sizes of companies, commit different amounts of money, and claim different percentages of equity in the companies in which they invest.
Key Takeaways:
- Private equity is capital invested in a company or other entity that is not publicly listed or traded.
- Venture capital is funding given to startups or other young businesses that show potential for long-term growth.
- Private equity and venture capital buy different types of companies, invest different amounts of money, and claim different amounts of equity in the companies in which they invest.
Private Equity
Private equity, at its most basic, is equity—shares representing ownership of, or an interest in, an entity—that is not publicly listed or traded. Private equity is a source of investment capital from high-net-worth individualsand firms. These investors buy shares of private companies—or gain control of public companies with the intention of taking them private and ultimately delisting them from public stock exchanges.
Large institutional investors dominate the private equity world, including pension funds and large private equity firms funded by a group ofaccredited investors.
Because the goal is a direct investment in a company, substantial capital is needed, which is why high net worth individuals and firms with deep pockets are involved.
Venture Capital
Venture capital is financing given to startupcompanies and small businesses that are seen as having the potential to generate high rates of growth and above-average returns, often fueled by innovation or by carving out a new industry niche.The funding for this type of financing usually comes from wealthy investors, investment banks, and specialized VC funds. The investment does not have to be financial, but can also be offered via technical or managerial expertise.
Investors providing funds are gambling that the newer company will deliver and will not deteriorate. However, the tradeoff is potentially above-average returns if the company delivers on its potential.
For newer companies or those with a short operating history—two years or less—venture capital funding is both popular and sometimes necessary for raising capital. This is particularly the case if the company does not have access tocapital markets, bank loans, or other debt instruments. A downside for the fledgling company is that the investors often obtain equityin the company and, therefore, a voice in company decisions.
Key Differences
A private equity firm's strategy is to buy mostly buy mature companies that are already established. The companies may be deteriorating or failing to make the profits they should due to inefficiency. Private equity firms buy these companies and streamline operations to increase revenues. Venture capital firms, on the other hand, mostly invest in startups with high growth potential.
Private equity firms mostly buy 100% ownership of the companies in which they invest. As a result, the firm is in total control of the companies after the buyout. Venture capital firms invest in 50% or less of the equity of the companies. Most venture capital firms prefer to spread out their risk and invest in many different companies. If one startup fails, the entire fund in the venture capital firm is not affected substantially.
Private equity firms usually invest $100 million and up in a single company. These firms prefer to concentrate all their efforts on a single company since they invest in already established and mature companies. The chances of absolute losses from such an investment are minimal. Venture capitalists typically spend $10 million or less on each company since they mostly deal with startups with unpredictable chances of failure or success.
Special Considerations
Private equity firms can buy companies from any industry while venture capital firms tend to focus on startups in technology, biotechnology, and clean technology—although not necessarily. Private equity firms also use both cash and debt in their investment, whereas venture capital firms deal with equity only. These observations are common cases. However, there are exceptions to every rule; a firm may act out of the norm compared to its competitors.
Advisor Insight
Rebecca Dawson
President, Dawson Financial, Los Angeles, CA
With private equity, multiple investors’ assets are combined, and these pooled resources are used to acquire parts of a company, or even an entire company. Private equity firms do not maintain ownership for the long term, but rather prepare an exit strategy after several years. Basically, they seek to improve upon an acquired business and then sell it for a profit.
A venture capital firm, on the other hand, invests in a company during its earliest stages of operation. It takes on the risk of providing new businesses with funding so that they can begin producing and earning profits. It is often the startup money provided by venture capitalists that gives new businesses the means to become attractive to private equity buyers or eligible for investment banking services.
Correction—Dec. 2, 2022: A previous version of this article wrongly stated that venture capital firms are limited to startups in technology, biotechnology, and clean technology. In fact, VC firms can work with a broader range of companies and sectors.
FAQs
Private equity firms do not maintain ownership for the long term, but rather prepare an exit strategy after several years. Basically, they seek to improve upon an acquired business and then sell it for a profit. A venture capital firm, on the other hand, invests in a company during its earliest stages of operation.
What is the difference between private equity and venture capital? ›
Private equity involves making controlling investments in distressed companies, with the hopes of making them more profitable. VC, often considered a subset of private equity, refers to making early investments in promising companies (or even ideas) with significant growth potential.
Is Shark Tank VC or PE? ›
The sharks are venture capitalists, meaning they are “self-made” millionaires and billionaires seeking lucrative business investment opportunities. While they are paid cast members of the show, they do rely on their own wealth in order to invest in the entrepreneurs' products and services.
Is it harder to get into venture capital or private equity? ›
It is quite a bit easier to break into the venture capital industry. You won't need specific experience in investment banking either.
Is venture capital riskier than private equity? ›
Which is riskier, Private Equity or Venture Capital? VC investments are generally considered riskier due to the early-stage nature of the startups they back. However, they also offer the potential for much higher returns if the startup becomes successful.
Do you make more money in VC or PE? ›
Compensation: You'll earn significantly more in private equity at all levels because fund sizes are bigger, meaning the management fees are higher. The Founders of huge PE firms like Blackstone and KKR might earn in the hundreds of millions USD each year, but that would be unheard of at any venture capital firm.
Why choose VC over PE? ›
Private equity is suitable for those envisioning transformative roles, focusing on established firms' expansion and restructuring. Venture capital, on the other hand, caters to the fervor of individuals keen on fostering early-stage growth for high-potential startups.
Is PE the same as VC? ›
What is venture capital? Technically, venture capital (VC) is a form of private equity. The main difference is that while private equity investors prefer stable companies, VC investors usually come in during the startup phase. Venture capital is usually given to small companies with incredible growth potential.
Is Growth Equity VC or PE? ›
Growth equity, a form of venture capital, aims to temper that risk by investing in a private start-up company's last stretch before it goes public or sells itself. The lower risk entails lower profit. Often the same private equity firms do both traditional venture-capital and growth-equity investing.
Who are the Tier 1 VCs? ›
Tier-1 VC
- Andreesen Horowitz.
- Khosla Ventures.
- SV Angel.
- Accel Partners.
- NEA.
- Sequoia.
- Venrock.
- First Round Capital.
Berkshire Hathaway was founded in the mid-1980s and is a source of investment capital from wealthy individuals and institutions for investing in and acquiring equity ownership in companies. Therefore, it can be concluded that Berkshire Hathaway is a private equity firm.
How do I break into VC or private equity? ›
Tips for Aspiring VC or Angel Investors
- Develop Your Investment Point of View. ...
- Identify and Evaluate Quality Deal Flow. ...
- Avoid Common Investment Mistakes. ...
- Education and Continuous Learning. ...
- Build a Strong Personal Brand and Network. ...
- Embrace Diversity and Inclusion in Investment Decisions.
Firstly , venture capital funding often comes with strings attached , such as giving up a portion of ownership in the company or having to meet certain growth targets . This can limit the entrepreneur 's control over their own business and may not align with their long - term goals .
What is a disadvantage of venture capital? ›
Approaching a venture capitalist can be tedious. Venture capitalists usually take a long time to make a decision. Finding investors can distract a business owner from their business. The founder's ownership stake is reduced.
What is better than venture capital? ›
In most cases, angel investors put in lower amounts than venture capitalists, and they do expect an equity stake in the firm. It is important to arrive at a clear understanding and delineation of roles, as a lack of clarity may lead to conflicts between startup founders and the angel investors who have come on board.
Which is an uncommon feature of private equity and venture capital? ›
From these points, the most uncommon feature for both PE and VC refers to the second point: "Their investment is used for financial or operating restructuring of the investee companies." Additional Information Here are some additional points about Private Equity (PE) and Venture Capital (VC):
What is the difference between a private investor and a VC? ›
Private equity investors tend to invest in older, more established companies that have the potential to increase profitability with the help of investors. On the other hand, venture capitalists tend to invest in young, growing startups with unproven, yet promising, value.
What is the difference between private equity hedge funds and venture capital firms? ›
Private equity firms invest in mature companies with stable cash flows, while venture capital firms invest in new or emerging companies with high growth potential. Hedge funds invest in various financial instruments and use different strategies to generate returns for their clients.
What is an LP in venture capital? ›
In venture capital, limited partners or LPs are entities or individuals who contribute capital to VC funds. LPs invest in the fund's corpus with the expectation of generating returns from the fund's investments in various startups and high-growth companies.
