Venture Capital vs Private Equity vs Angel Investing

Key Takeaways

• A venture capitalist is a private equity investor who, in exchange for an equity stake, provides capital to companies believed to have high-growth prospects.   

• Because banks and other lending institutions provide a substantial amount of venture capital, regulations adhered to by banks also apply to venture capitalists.

• Angel investors are typically high-net-worth individuals who, in exchange for equity, use their own money as seed funds to finance small business ventures or startups.

Understanding the nuances of top funding and investment options is key for novice investors as well as seasoned ones. After all, when opportunities in startup funding arise, it is best to be prepared – and with the proper funding type. To that end, here is venture capital vs private equity vs angel investing.

What is Venture Capital?

A form of private equity, venture capital (VC) is a type of investor financing provided to startup companies and small businesses. 

A venture capitalist is a private equity investor who, in exchange for an equity stake, provides capital to companies believed to have high-growth prospects. 

Venture capital firms include those such as Sequoia Capital, Andreessen Horowitz, and Benchmark.   

Pros and Cons of Venture Capital

As with any other vehicle in the investment space, there are pros and cons for this type of startup funding that should first be considered. 

Advantages of employing venture capital include:

• A significant amount of capital can be raised
• No monthly payments required
• The venture capitalist typically helps manage risk
• No pledge of personal assets
• Networking opportunities
• Can benefit from experienced leadership and advice
• Possible collaboration opportunities with other startups and industry experts
• Help with hiring and team building
• Potential increased exposure and publicity
• Possible help with future funding rounds

There are possible drawbacks, including:

• Reduction in founder ownership stake
• Relatively scarce funding
• Seeks investors can distract from core business
• Financing costs can be expensive
• Mandatory official reporting structure and board
• Required due diligence
• Expected swift business growth
• Underperformers can lose their business
• Release of funds timed to performance schedule
• Rare negotiations leverage

Note that the U.S. Securities and Exchange Commission regulates venture capitalists and private equity firms. Because banks and other lending institutions provide a substantial amount of venture capital, regulations adhered to by banks also apply to venture capitalists.

Also, in exchange for funds, venture capital organizations typically require between 25 percent to 55 percent of equity ownership of the company, some strategic planning control, and payment of various fees.    

What is Private Equity?

Private equity (PE) involves interest or ownership in an entity that is not publicly traded or listed. In general, these firms seek opportunities for better returns than what can be gained through public equity markets.

Private equity can come from high-net-worth individuals or from firms that buy stakes in private companies or gain control of public companies with intent to take them private.

The PE industry is made up of institutional investors – pension funds, for instance – and major private equity firms funded by accredited investors. Such firms include Kohlberg Kravis Roberts, Audax Group, and HarbourVest Partners.

Pros and Cons of Private Equity

As with venture capital, there are advantages and disadvantages in PE as well. As for advantages, those include:

• Access to expertise and opportunities for improvement
• Potential for high returns compared to public market investments
• Active involvement in management decisions
• Exposure to different companies
• Risks spread across multiple markets

Possible drawbacks to private equity include:

• Relinquishing control over the business
• The possibility of major company changes
• The possibility of selling the company
• Lack of liquidity
• Management fees and other fees
• Longer holding periods compared to stocks and bonds, rendering less flexibility
• Potential conflict between making decisions that benefit customers or employees and maximizing shareholder value

What are Angel Investors?

Angel investors are typically high-net-worth individuals who, in exchange for ownership equity, use their own net worth as seed money to finance small business ventures or startups.

These investors may be the entrepreneur’s family member or friend, or a professional whose responsibility it is to fund projects. The funds may be in the form of a one-time lump sum, or in installments to get the product to market.

Note that angel investors do not lend money. Rather, they invest in a concept they like, and expect a reward only if and when the company profits.

Some investors, many of whom are themselves entrepreneurs, are hands off in the company in which they are invested, while others take a more participatory role.

Pros and Cons of Angel Investing

For those pursuing getting involved in angel investing, there are potential upsides and downsides here, too.

On the plus side:

• The entrepreneur benefits from having a management team with expert knowledge and personal connections 
• The potential for quick funding
• The money is not a loan
• Increases odds for success

Limitations with angel funding can include:

• Relatively smaller investment sizes 
• Limited ability for follow-on funding
• Must give away a portion of net earnings
• Usually must relinquish full control

Similarities and Differences Between Venture Investing and Private Equity

There are similarities and differences between venture investing and private equity. Both venture capital and private equity are part of what are called private markets, for example. They both raise capital from investors who seek to invest in privately owned companies. Both types of firms also seek to make the businesses they invest in more valuable, and will subsequently seek to sell them, or their equity stake, for a profit.

The differences, though, lie in the types of companies invested in, the capital levels usually invested, the amount of equity garnered through the investments, and the time at which investors get involved. There are other factors such as sector focus, use of debt, acquisition percentage, deal size, risk reward, and the investment target’s stage.

PE firms frequently take a 50 percent or more stake in mature companies that operate in traditional sectors. Such companies are typically stagnant or possibly experiencing some difficulty, with the expectation that they will become profitable. 

Meanwhile, VCs typically fund, and serve as mentors, to startup companies, many of which are tech-focused, in exchange for less than 50 percent ownership in those companies.

How Do PE and VC Work Together?

Flowing through a series of financial transactions, capital moves from entity to entity through private markets.

Whenever there is a private-market capital transaction, it is either advised upon or executed. For the company involved, such transactions trigger a transition or growth phase.

For example, say capital is committed to a PE or VC fund. The VC fund uses the capital to invest in startups. The PE firm puts the capital in private companies. The companies either then become public or eventually be purchased by another company, generating returns for the investors (limited partners).

Why Should Investors Understand the Three Types of Startup Funding?

While seed money is obviously beneficial for those raising it, investors also can benefit by using their capital to produce social as well as economic value. Before investing their capital, though, investors should fully understand the difference between the three types of startup funding.

Deciding when and where to place capital can depend on the varying stages of investment, including:

• Seed capital. This is the funding amount used to start a business.
• Early-stage capital. This is financing that is usually provided to startups and small businesses by venture capitalists.
• Late-stage capital. This kind of investment supports companies that have shifted from start-up to rapidly growing sales.

For its part, the alternative investment platform Yieldstreet, which seeks to generate passive income streams through accessible investments, offers a venture capital program that exposes retail investors to private companies that are disrupting existing sectors or creating whole new ones. During this stage, companies typically experience swift growth as commercialization ramps up and allows for scale.

Generating returns outside of public markets also gives investors an opportunity to diversify their portfolio – create holdings that contain a variety of asset types – which can mitigate risk and the effects of inflation. In fact, diversification is crucial to successful investing over the long term.

Portfolio Diversification and Alternative Investments

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

Understanding the ins and outs of venture capital, private equity, and angel investing – and the similarities and differences among them – is crucial for those who seek rewards from startup funding.

Potential investors should also pay attention to how funds are raised and what that means for the business in which they are investing.