While the lines between private equity and venture capital do blur, these kinds of private investments tend to vary in company type, investment scope and exit strategy.
Though private equity and venture capital both fall under the rubric of private investment, there can be significant differences between the two—and getting the details right often matters a great deal for business owners pursuing that next round of funding.
Broadly speaking, venture capital firms focus on early-stage companies and target high-multiple returns. In exchange for equity, venture capitalists offer company founders industry connections and strategic guidance, but rarely seek full control.
Whereas venture capitalists typically help growing companies get to the next level in their development, private equity firms tend to focus on established companies that they can increase the value on — such as by making improvement to sales, operations or capital structure — for an eventual initial public offering or strategic sale.
An apt analogy for the difference between venture capital and private equity is to think about it in terms of real estate: Venture capitalists help companies develop new property in up-and-coming neighborhoods. Meanwhile, private equity buyers will hunt for companies with good bones (products) or ideal locations (market share) and buy with the intention of doing an extensive remodel, refinancing the debt, or sitting on the investment until the time is right to put it back on the market.
Of course, venture capital and private equity firms run the gamut in terms of the kinds of companies they back or buy, the returns they aim to achieve and their level of involvement. Here are some key differences to keep in mind.
Venture capital firms seek early-stage companies with big upside growth potential and typically work with original founders who may not have the complete business background or industry contacts to take the company to the next level. Venture capitalists can serve as conduits to industry expertise and more sources of capital.
Because these investments are high-risk and high return, venture capital firms often manage portfolios of dozens of companies.
General partners in private equity, on the other hand, seek mature companies across a broad spectrum of industries. From sporting goods to shipping and manufacturing, private equity investors look for public or private companies that have a familiar and fixable problem, whether it’s injecting much-needed capital, rectifying inefficiencies, bringing in new management, and/or revamping strategy.
Investment Size and Scope
Every firm and deal is different, but venture capital thrives in the $500,000 to $10 million range. Typically venture capital firms are not looking for complete ownership of companies but, rather, stakes of up to 50 percent. This usually comes with a seat or seats on the executive board to provide input and strategy related to the company’s growth and funding trajectory.
For companies considering taking on VC funding, it’s important to look beyond the dollars and consider what value a firm and its partners bring to the table: Specific expertise in product development, sales, marketing and capital markets, among other areas, is, after all, potentially worth as much as the checks they write. Venture capitalists often have a light touch when it comes to making management changes. Nevertheless, their involvement often paves the way for other investors to follow on with additional funding.
In contrast, it’s not uncommon for private equity deals to start around $100 million and rise into the billions. Private equity firms generally seek a majority stake in underperforming companies within specific industries, often replacing top managers with their own trusted people or fresh hires.
Venture capital firms and private equity firms also have different expectations of investment periods and exit strategies.
Venture capital typically cycles toward a one- to five-year exit, either through next round investors, an IPO, or through a strategic merger or acquisition.
Because of the size of the deals and often significant changes within the company, private equity firms take a longer view. It’s not uncommon for a PE owner to hold on to an investment for a decade, with an exit coming in the form of an initial public offering or an outright sale to a strategic buyer.
It’s All About the Details
When thinking about venture capital and private equity, they generally fall along these lines:
Venture capitalists typically:
- Focus on early-stage companies with significant growth potential
- Take an equity position alongside other investors
- Advise founders on ways to improve strategy and potential for growth
Private Equity firms typically:
- Focus on mature companies that have untapped potential or are in distress
- Seek a majority stake in the company
- Often revamp or replace management teams
While understanding some of these similarities and differences between venture capital and private equity is important, remember that these labels are merely a starting point. Which is to say, some venture capital deals resemble private equity—and vice versa. With that in mind, always strive to fully understand the nuances of the proposal before you. Leverage your legal and financial partners to help you see the big picture and the details along the way. That will help you locate an investment that works on your terms.