When looking at private equity vs. venture capital, there are noteworthy differences to consider. Both invest in companies to earn a return on their money, but the deal size, company type, acquisition percentage, and much more are distinct.
Here we’ll discuss what private equity and venture capital are, why they’re different, and which one is right for your business.
What is Private Equity?
Overview
Private equity firms invest in companies that are deteriorating due to operational inefficiencies with the understanding that correcting these issues should grow the company and generate profit.
Private equity involves investments in companies that are not public, hence the term “private” equity. In some cases, PE firms take companies private.
Private equity (PE) is a source of investment capital coming from high-net-worth individuals and firms. These entities purchase control of public companies to take them private, or they buy stakes in already private companies.
Partners at PE firms manage investors’ capital with the intent of producing a positive return on investment, typically over four to seven years.
Who can invest in private equity?
To gain control over a company, investors must provide significant funds, and so only extremely wealthy entities partake in private equity. This can include institutional investors or large PE firms whose capital comes from accredited investors.
Not everyone can become a PE investor, as most firms have a minimum investment amount of $250,000 upwards into the millions.
Additionally, to invest in PE, you must be an accredited investor. Accredited investors are perceived to have advanced understandings of money to the point where authorities don’t deem it unnecessarily risky or ignorant for these individuals to invest hundreds of thousands if not millions of dollars.
To qualify as an accredited investor and invest in PE, one must earn over $200,000 annually ($300,000 joint), including over the last two years, with the expectation that earnings will not decrease in the coming years. Otherwise, an accredited investor must have a net worth of over $1 million, either individually or jointly.
Working in private equity
Private equity comprises some of the highest achieving people in corporate America, including the best and brightest at Fortune 500 companies, management consulting firms, and law firms. Strong experience with finances is a must.
Compensation for private equity is lucrative, consisting of a 2% management fee and a 20% cut of gross profits upon sale of a portfolio company. At the smaller level, this can yield six-figure salaries up to millions per year for principals. At larger firms, compensation can pay tens of millions per year.
Those who work in PE work hard. They work 60-70 hours per week, sometimes on weekends when deals require it.
What’s the benefit of private equity?
Private equity creates value in two ways:
- Deal origination
- Portfolio management
Deal origination involves generating large quantities of high-quality deal flow. Deal flow is defined as the rate at which businesses receive investment pitches. To ensure regular investment pitches, private equity works to create and maintain relationships with mergers and acquisitions parties, investment banks, and other entities that can provide investment.
Portfolio management and oversight involve guidance with financial management, accounting, and procurement systems to boost the value of a company. Essentially, any way that a PE firm can increase the value of their investment, typically by boosting earnings, is considered favorable portfolio management.
Top PE-Funded Companies
As of 2022, here are the top PE-funded companies.
Voltron Data: Latest funding round of $110 million
Cider Security: Latest funding round of $38 million
FreeWill: Latest funding round of $30 million
Lendai: Latest funding round of $35 million
Top Private Equity Firms
Curious which PE firms are the best in the world? Here are the top few.
- The Blackstone Group: This private equity firm has a total of $881 billion AUM and invests across a variety of sectors. Their interests extend to technology, energy, and retail. The Blackstone Group invests in more than just private equity, although that’s its largest investment category. They also take an interest in hedge fund, real estate, and credit solutions.
- KKR & Co. Inc.: KKR & Co’s total AUM is $459 billion and was one of the first firms to partake in large-scale leveraged buyouts.
- CVC Capital Partners: CVC’s private equity platform amassed $92 billion in AUM for a total of $122 billion across all holdings. Their private equity portfolio boasts 114 global companies.
- The Carlyle Group Inc.: Founded in 1987, this firm has $293 billion AUM. Its private equity holdings include Orion, Supreme, and Workforce Logiq.
- Thoma Bravo: With $91 billion AUM, Thoma Bravo is one of the top PE firms out there. Its portfolio includes Conga, Anchorage, and McAfee.
What is Venture Capital?
Overview
Venture capital (VC) is a sub-classification of private equity. VC invests in startups and small businesses specifically, hedging a bet that these early-stage businesses will have long-term success.
A venture capitalist prefers to see companies with exceptional potential for growth, whether due to early success, a previously successful founding team, or a particularly innovative concept.
What is the structure of venture capital?
There are a few prominent players involved in venture capital.
- Venture fund. VC firms raise money to create venture funds with lifetimes of 7-10 years. They then invest this raised capital into companies they deem most likely to return a profit. At the end of the fund’s lifetime, investors receive returns known as carried interest, or 20% of returns.
- Limited Partners (LPs). These are the entities that give money to venture funds. LPs are typically institutional investors, including foundations, endowments, insurance companies, pension funds, and high net worth individuals.
- General Partners (GPs). These are the people working at VC firms managing funds. They make investment decisions to generate returns on venture funds, so LPs turn a profit on their original investment.
- Portfolio companies. VCs focus on startups, or early-stage companies, where capital tends to be tight. These portfolio companies grant VC firms equity in exchange for their investment. VC funds realize gains when a liquidity event occurs, and these shares can be sold. Liquidity events include IPOs or acquisitions.
Working as a venture capitalist
The majority of VCs have one or all of these traits:
- Successful startup founder in the past, sometimes more than once, indicating that this individual knows what it takes to build a company successfully. Their expertise is precious to current founders, who will face many roadblocks.
- Prior industry experience, making them a subject matter expert and better equipped to make industry-related investment decisions.
- Master in Business Administration (MBA) degrees from top universities such as Stanford or Harvard.
VCs spend a lot of their time in meetings with portfolio companies, entrepreneurs seeking investment, or other firm members. A large majority of VCs’ time is spent networking and cultivating relationships.
How does a venture capitalist create value?
Since VC firms invest in early-stage companies that lack substantial capital, they provide the money these startups need to grow and expand. In addition to this, VCs offer expertise to startup founders and help guide them towards success.
Since 75% of venture-backed startups fail, VCs are enabling entrepreneurship by strategically accepting high risk.
Top VC-Backed Companies
According to PitchBook, here are some of the most valuable VC-backed companies as of 2021.
Stripe: $95 billion valuation
SpaceX: $74 billion valuation
Instacart: $39 billion valuation
Databricks: $28 billion valuation
Top VC Firms
Here are some of the top VC firms in the world.
- Sequoia Capital: This VC firm was created in 1972 and has companies such as Apple, Google, and Oracle in its portfolio. It’s best for high-growth and tech startups.
- Kleiner Perkins: Kleiner Perkins is best for hardtech, consumer product, and healthcare startups. They have a portfolio that includes Spotify, DocuSign, and Amazon.
- Bessemer Venture Partners: Bessemer works closely with healthcare, enterprise, and consumer product startups. Their portfolio includes LinkedIn, Shopify, and Pinterest.
- Andreesen Horowitz: Nicknamed a16z, this venture fund is known for powering late-stage startups that use technology to innovate modern life and the future. They’ve recently amassed a large cryptocurrency fund, too. Their portfolio includes Instacart, Lyft, Asana, and Stripe.
- Accel: This VC firm is known for funding startups across all stages. They have various noteworthy investments including Slack, Facebook, and Dropbox. Accel works closely with growth- and early-stage tech startups.
Private Equity vs. Venture Capital: Key Differences
While venture capital is a subset of private equity and both provide capital with the intent of receiving a return on investment, there are many differences between the two.
Stage
Private equity firms prefer larger companies that are well-established. They look for mature companies with a track record but that are suffering some sort of downturn due to managerial inefficiency. As such, PE firms acquire control of the company and streamline management to increase revenue and the subsequent value of the business.
Venture capital firms invest in early-stage startups and small businesses that typically have no established track record. The tradeoff here is that the upside is significantly more considerable, so although most startups fail, the ones that succeed pay out enough to generate large portfolio returns.
One famous example of VCs’ potential for upside is Sequoia Capital’s investment in WhatsApp. They gave WhatsApp a whopping $60 million, but that turned into $3 billion when Facebook purchased the company.
Deal Size
According to PitchBook, one-fourth of private equity deals in the United States are between $25 – $100 million.
Venture capital deals tend to be significantly smaller, although this depends on the stage:
- Angel or seed rounds were an average of $1.2 million in 2020. (Note: angel rounds tend to be smaller than seed rounds.)
- Early VC rounds (such as Series A) were an average of $4.5 million in 2020.
- Later VC rounds (such as Series B, C, and onward) were an average of $9.9 million in 2020.
Since private equity firms invest in larger companies, they need to provide significantly more capital to acquire control of these businesses. Private equity firms are backed by far more money than most venture capitalists as a result.
Additionally, VCs face significantly more risk, so they want to put in as little capital as necessary. They’re anticipating that a large percentage of their portfolio companies won’t succeed, and thus that money will be lost. (However, all investments will be recouped and then some of the companies that do succeed!)
Type of Company
In terms of private equity vs. venture capital, the type of company is a significant differentiator.
Private equity firms have portfolios that span an extensive range of industries, from healthcare to transportation to construction, and they aren’t looking for the next big “disruptor.”
Venture capital tends to be more focused on big tech disruptors that are changing industries. Disruptors include the likes of Uber, Slack, Facebook, Instacart, and more. Try imagining a world without Facebook or Uber!
However, venture capital firms can also focus on specific industries within tech, such as healthcare, clean energy, sustainable food, and more. These are often categorized by business types, such as consumer, crypto, enterprise, and more.
Level of Risk
A venture capitalist anticipates that most of her investments will fail and lose money within that deal. However, this is offset by the immense potential upside of startups, where one success produces enough returns to recoup any lost investments and turn a profit on the larger fund.
Private equity firms invest large sums of money. These sums are so significant that they cannot fail; one failure means the fund suffers an unrecoverable loss. As such, private equity firms’ risk appetite is near-zero. Private equity firms target large, established companies with a near-guarantee of profitability if the PE firm takes the right managerial steps.
Acquisition Percentage
When it comes to private equity vs. venture capital, acquisition percentage varies considerably.
Private equity firms often purchase an entire company, where a venture capitalist obtains a small stake in a startup. Even if a PE firm doesn’t acquire the whole company, it will purchase a majority stake to have control.
VCs split ownership with other VCs, angel investors, founders, and employees.
How Do Private Equity and Venture Capital Work Together?
When Limited Partners commit funds to private equity or venture capital firms, these get invested in different types of companies.
As established, venture capitalists invest in early-stage companies. A small but mighty percentage of these eventually become publicly traded. Should these now publicly traded companies begin suffering some hardship, private equity firms can step in and change the trajectory.
Since VC and PE firms both invest in private companies (in PE, they often take the company private themselves), investors sell shares once their time with the company is done and it goes public. Returns then go back to Limited Partners, who invested initially, thus regenerating the investment cycle for new companies.
Which Is Right For You?
Private equity vs. venture capital is a critical decision, and which is right for you depends on the current stage of your business. Ask yourself:
- What is my current business size?
- Is my business well-established?
- Do I want to grow this company alongside my investors, or would I rather my investors take the wheel?
- Am I comfortable giving up a majority stake in my business?
If you operate an early-stage company or one that isn’t established, venture capital or angel investing will be the way to go. Private equity firms likely won’t be interested in you. Additionally, a venture capitalist will take a minority stake and work with you to provide insight and expertise. You won’t cede control.
If you’ve already received VC funding and are now a mature company, it’s possible to receive further VC funding. However, if you’re suffering operational problems and are worried about the business failing, it may be time to look for PE funding. PE funding may also be more appropriate if you’re ready to sell your company and look to your next venture.
Conclusion
When it comes to private equity vs. venture capital, there are many differentiating factors, although their intention is the same.
In a nutshell, private equity invests in well-established companies facing problems due to operational inefficiencies, and their risk appetite is near-zero. Venture capitalists invest in early-stage startups, expecting that most will fail, but the ones that succeed will pay out huge sums.
Both private equity and venture capital are excellent sources of funds for different companies, and both can transform your business. Which you ultimately choose depends on the stage of your company.
