Review, while private equity firms as well as venture capitalists provide funds needed to run the business, there are some key differences. Comprehending these differences would help you understand the realm of business finance better.
Anyone associated with business finance comes across terms as Private Equity (PE) and Venture Capital (VC) which are often used interchangeably. At a level, both the terms can certainly be used to describe the investment - putting in cash to purchase equity in business entities and realise returns. However, in fact, there are several key differences between the two. Understanding these differences would help you comprehend how venture capitalists and private equity firms differ.
PE vs VC: Definitions
Private Equity
Private equity is an asset class consisting of equity securities in business entities that are not publicly traded on a stock exchange. Some examples of private equity investment strategies are Leveraged Buyouts (LBOs), Mezzanine Capital and Growth Capital. Even Venture Capital (VC) is a subset of private equity as per business school professors.
Venture Capital
Venture capital (VC) is finance provided to start ups, early stage, high potential businesses. Venture capital funds usually invest in firms having novel technology or business model in high technology industries like biotechnology, IT etc. Venture capitalists prefer high risk high fund companies.
PE vs VC: How They Differ
PEs and VCs, both invest with the objective of making substantial returns on their investments. However, they have different ways for attaining the objective.
Stage of Investment
PE firms invest in mature, well-established public companies where any chance of losses for a long term investment is close to none. On the other hand, VCs invest mostly in start up businesses where the risk of losing the investment is considerable. And, in case of success, returns are big too. VCs can even provide the seed money to fructify an idea which a PE firm would never do.
Ownership Acquired
PE firms tend to buy large stakes in a company which can be even 100%, whereas VCs usually buy minority stakes which is less than 50%. VCs are content in making profits with their investment rather than getting involved in running a business. If they are satisfied with the business plan, they will invest and reap profits, and let the entrepreneur be at the driving seat.
Size of Investment
PE firms put in large investments which run into hundreds of millions dollars. VC investments are much smaller, often below $10 million for start up or early stage business ventures. The size of investment is quite dependent on the stage of investment. For a firm which has already begun making profits and needs funds for expansion, venture capitalists could provide larger funds.
Structure of Investment
PE firms' investment usually combines equity as well as debt. However, VC firms use only equity mode of investing. Venture funds usually make initial investment for three to five years and thereafter make follow-on investments in an existing portfolio. Investment strategy of PE firms is much more sophisticated.
Risk Factor
VCs know that their business is risky. Hence they diversify their investment, hoping that even if a few of these fail, there will be some generating enough returns to make the fund as a whole profitable. As they invest small amount of money in dozens of firms, this model works for them. As for the PEs, number of their investments is smaller while the size is larger. This means that they have to play a safe game. They ensure their investments are safe by putting in their money in large stable companies.
Private equity firms as well as venture capitalists have a critical role in pushing the business wheel. They provide businesses with funds they require to keep moving or expanding themselves without any need to go the banks for expensive loans or to raise money at stock exchanges. Venture capital funds provide the start ups and early stage businesses with crucial financial support.
The article has been written by Robert Bachmann, who is currently associated with Investment Intelligence, which offers private equity funds a professional way to make portfolio companies visible to relevant investors and caters to their individual needs.