Private Equity vs. Venture Capital: Understanding the Difference


What are the differences between private equity and venture capital?

Private equity is sometimes confused with venture capital because both refer to companies that invest in companies and come out selling their equity financing investments, for example by holding initial public offerings (IPOs). However, there are significant differences in the way that the companies involved in the two types of financing conduct business.

Private equity and venture capital buy different types and sizes of companies, invest different amounts of money, and claim different percentages of capital in the companies in which they invest.

Key takeaways:

  • Private equity is capital invested in a company or other entity that is not listed or listed on the stock market.
  • Venture capital is financing given to startups or other young companies that show long-term growth potential.
  • Private equity and venture capital buy different types of companies, invest different amounts of money, and claim different amounts of capital in the companies in which they invest.

Understand private equity and venture capital

Private equity, in its most basic form, is equity capital (shares that represent ownership or an interest in an entity) that is neither listed nor publicly traded. Private equity is a source of investment capital for high-net-worth individuals and businesses. These investors buy shares in private companies, or acquire control of public companies with the intention of turning them into private companies and, ultimately, delisting them from public stock exchanges. Large institutional investors dominate the world of private equity, including pension funds and large private equity firms financed by a group of accredited investors.

Because the goal is direct investment in a business, substantial capital is required, which is why high net worth individuals and deep-pocketed businesses participate.

Venture capital is financing given to startups and small businesses that is considered to have exploding potential, when the asset price moves above a resistance area or below a support area. Funding for this financing generally comes from wealthy investors, investment banks, and any other financial institution. The investment does not have to be financial, but it can also be offered through technical or managerial knowledge.

Investors contributing funds are betting that the new company will comply and not deteriorate. However, the trade-off is potentially above-average returns if the company lives up to its potential. For newer companies or those with a short operating history (two years or less), venture capital financing is popular and sometimes necessary to raise capital. This is particularly the case if the company does not have access to capital markets, bank loans or other debt instruments. One downside to the startup is that investors often get shares in the company and therefore a voice in company decisions.

Key differences between equity capital and venture capital

Private equity companies mainly buy mature companies that are already established. Businesses may be deteriorating or not making the profits they should because of inefficiency. Private equity firms buy these companies and streamline operations to increase revenue. Venture capital firms, on the other hand, invest primarily in startups with high growth potential.

Private equity firms primarily buy 100% ownership of the companies in which they invest. As a result, the company has full control of the companies after the purchase. Venture capital firms invest in 50% or less of the companies’ equity capital. Most venture capital firms prefer to spread their risk and invest in many different companies. If a startup fails, the entire fund of the venture capital firm is not substantially affected.

Private equity firms generally invest $ 100 million or more in a single company. These firms prefer to concentrate all their efforts in 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 venture, mostly dealing with startups with unpredictable chances of failure or success.

Special Considerations

Private equity firms can buy companies from any industry, while venture capital firms are limited to tech, biotech, and cleantech startups. Private equity firms also use both cash and debt in their investments, while venture capital firms deal only with stocks. These observations are common cases. However, there are exceptions to all the rules; a company can act out of the norm compared to its competitors.

Advisor Insight

Rebecca dawson
Silber Bennett Financial, Los Angeles, CA

With private equity, the assets of several investors are combined and these combined resources are used to acquire parts of a company, or even an entire company. Private equity firms do not hold ownership for the long term, but rather prepare an exit strategy after several years. Basically, they are looking to improve an acquired business and then sell it for a profit.

A venture capital firm, on the other hand, invests in a company during its early stages of operation. You take the risk of providing financing for startups so they can start producing and making a profit. Often times, it is the seed money provided by venture capitalists that gives startups the means to become attractive to buyers of private equity or eligible for investment banking services.

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Mark Holland

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