Private Equity vs Venture Capital – Key Differences

There are several key differences between private equity vs venture capital. These are two completely different investment approaches and are some of the ways companies are able to raise capital. Both the types of businesses and investment strategies are different in private equity vs venture capital.

There are several important private equity books and venture capital books that can help you to learn more about each type of investment.

What is Private Equity?

Private equity (PE) is the ownership or representation of ownership in an entity that is not publicly traded. It refers to a large pool of investment funds that invests in private companies.

Wealthy individuals and private firms pool their funds to form a limited liability partnership (LLP). The LLP aims to invest in private businesses in order to generate a return.

The PE firm seeks at least 50% stakes in private businesses. In some cases, the PE firm may purchase stocks of a publicly listed company. However, the PE firm would target to acquire majority shares and delist the company to convert it into a privately held business.

Although PE firms require substantial investment as they aim to buy majority stakes in a company, they can use leverage to their advantage as well. Many PE firms usually invest around 25% of the total value of the target company. The remaining amount is funded through leveraged finance. 

Thus, the PE firm would target to generate sufficient funds that repay its initial investment as well as the borrowed capital. PE firms usually expect around 20% of internal rate of return (IRR) through their investments. However, the actual returns would vary by industry or the nature of the business. 

What is Venture Capital?

Venture capital (VC) is a type of financing that investors provide to startups and growing companies. However, venture capital is one form of private equity.

Venture capital funds invest in startups with an aim to exit the plan with an initial public offering (IPO) or a merger. VC funds aim to invest in companies that offer growth potential in the long run.

VC funding comes in the form of cash and non-cash assets. The investment is riskier when compared to private equity. Thus, VC funds would expect a higher return on investment. Venture capital becomes a necessity for many young and aspiring companies. 

Startups often struggle to obtain financing from the capital market or commercial banks beyond certain limits. Venture capital funding may come in more than one investment round. VC funds would usually invest a small amount initially.  However, the subsequent investment or funding series are often substantial when the target company shows significant growth potential.

Private Equity vs Venture Capital – Key Differences

Both private equity and venture capital seem similar. However, there are some key differences in how both these types of financing work.

Ownership Stakes

PE firms look to gain control over their target companies. They often buy 100% stakes in the privately held business. If the target company is publicly listed, the PE firm will acquire major stakes that give them control over the company.

Most VC funds gain less than 50% of the ownership stakes of the target company. VC funds prefer to invest small in a number of startups rather than investing large investments in a single company.

Company Stage

Private equity firms look to invest in established and settled businesses. They target private businesses with growth potential and that require private equity financing in exchange for high returns.

Contrarily, venture capital funds aim to invest in startups usually. They invest in young and growing firms with the potential to succeed.

Investment Size

Although both types of financing can arrange large investments, the typical investment size varies. The PE firms invest large investments as they usually invest in established businesses. Also, PE firms look to obtain majority control or 100% ownership.

VC funds invest small amounts in several private businesses that are in the initial stages. This makes them have minority stakes in the invested companies.

Active Participation

VC funds would look to have a representation on the board of the target company. However, their participation level is inferior to PE firms.

PE firms establish an authoritative representation in the target company’s board. They also provide active participation in the decision-making and work closely with the management.

Preferred Industry

Private equity firms invest in many industries. Their pool of investment is often diversified. Contrarily, the VC funds have shown a keen interest in the technology sector only.

Exit Strategies

Private equity firms look to turn a private business profitable. They aim to sell it after a specific period.

When comparing exit strategies of venture capital vs private equity, venture capital funds hold their investments for longer periods. Their typical exit routes result in an IPO, merger, or acquisition.

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