Private equity and venture capital both have the goal to purchase stakes in private companies. However, they tend to focus on distinctly different types of enterprises, and at a different stage of development.
Private equity investors and venture capitalists also differ in the amounts of money they invest, the degree of control they require, and the percentage of ownership they expect in exchange for the invested capital.
Private equity deals entail purchasing shares of a business entity that is not listed or traded on a stock exchange. It could also be a buyout — a previously public firm that is delisted as it is acquired by an investment entity or a wealthy individual.
The ultimate goal of private equity investments is to acquire a controlling interest, run the company and sell it — all of which require significant amounts of capital.
Venture capital is a form of private equity investment that is used to provide funding to early stage companies with high growth potential. A typical venture capital deal provides funding to a company that is innovative or disruptive, seeking outsized returns and potentially an exit at a later stage of the company’s development.
Venture capital funds normally invest in a basket of companies, as there is a high probability that some of them may not provide any return at all. The ones that will succeed, however, are likely to provide outsized returns that will more than offset the losses. Needless to say, the higher the number of successful companies in a venture capital fund’s basket, the higher the overall returns.
Private equity investors tend to favor established companies, with proven track records and business models. In some cases, they may also buy into firms with solid fundamentals that are struggling for one reason or another. Often, these are firms that have hit a ceiling and stalled for whatever reason or need capital to access new markets for further growth. Some late stage venture capital deals can resemble a more traditional private equity investment, with firms attempting to use the additional capital to consolidate before attempting an Initial Public Offering.
A private equity investment house will buy a stake in the company, providing a fresh infusion of capital — sometimes in exchange for a controlling interest in the company. Private equity firms also tend to take a hands-on approach in managing the companies they take over. Their goal is to achieve more efficiency in the way the company conducts its business, to minimize its use of capital, maximize its cash flow and expand its profitability.
The minimum private equity investment is typically around $100M and can be structured as a combination of debt and equity. Private equity tends to be cash intensive because a lot of money is required to gain control of a company and keep it running until it can be sold at a profit.
Venture capital firms are focused on the search for the “next big thing.” Companies they consider can either be in the startup phase, or already up and running, but in need of scaling up.
Where private equity deals typically involve a controlling stake, venture capital funds tend to buy smaller, non-controlling interests, at least at early stages. Further down the road, as more investors are involved in future rounds of funding, the actual founder may end up losing control.
Venture capital deals are less concentrated – as we mentioned above – as funds tend to make multiple investments of which only a limited number of them are likely to be successful, potentially providing enough returns to offset losing bets. Overall returns are typically a function of a manager’s skills, which makes it all the more important to allocate money to venture capital funds with deep industry and a proven track record.
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