Private Equity vs. Venture Capital: What’s the Difference?

Availability

It’s easy to confuse private equity and venture capital since people often use them interchangeably, but they’re actually very different types of capital growth. Both terms refer to firms that invest in a company and exit through selling their investments, but there are some major differences that set them apart.

The age of the business is essential in telling a private equity from venture capital. Private equity focuses on purchasing underperforming or undervalued, distressed companies that have had time to mature. They have established financial records that private equity firms can use to improve and manage profits to later sell for capital.

Alternatively, venture capitalists seek out new, start-up companies that have high growth potential. Most of the companies are pre-revenue, which can make it tough for a venture capitalist to determine if the startup could be a loss or a sound investment.

Private equity is often considered risky, but of the two, it’s much more stable. Firms do a lot of research to determine what companies will yield a profit for investors. A loss means that the management team will be required to return money to any investors that provided leverage to purchase the distressed business. Venture capitalists don’t have much research to work with, which results in a high failure rate. Some returns on investments offer solid returns, but there are few spectacular successes.

Private equity firms can purchase a part of the company, but most buy 100% of the business so they can receive maximum returns on investments and allow for a clean exit strategy. Following the buyout, companies are in total control of the firm so that significant changes can take place to improve the financial status of the business.

Venture capitalists do not purchase the majority of the company. Most invest 50% or less in the equity of companies, which allows them to spread out their risk and invest in several different opportunities at once. If one startup fails, then there are others which keep the firm from being impacted substantially.

It isn’t rare for a private equity firm to invest hundreds of millions into a single company. All of the efforts are put into one business to improve the financial status and to receive significant profits later once the exit strategy is completed.

Venture capitalists avoid spending large chunks of money on one company. It isn’t rare for a firm to pay around $10 million or less per business. It’s tough to determine whether the company will succeed, so it’s smarter to spread the funds among several different groups. Additionally, start-up companies usually don’t require large amounts of money to perform better for a venture capitalist firm.

Private equity firms can purchase companies from any industry, which allows for the chance of high diversification for potential investor’s portfolios. Many groups choose to invest in a broad range of sectors to avoid experiencing too much loss if one is impacted negatively. Venture capital is limited to only purchasing start-ups from technology, biotechnology, and clean technology.

X