Private equity vs venture capital: what’s the difference?

Capital investment (PE) and capital risk (VC) are two major subsets of a much larger and more complex part of the financial landscape known as private markets. Because private markets control more than a quarter of the US economy in terms of capital and 98% in number of companies, it is important that anyone, regardless of their business ability, from sales to operations, understands this. what they are and how they work.

In a previous article we discussed the key differences between public and private procurement. That is, public market companies sell stocks to the general population – who can then buy, sell or trade them on the stock exchange – while private market companies give equity to professional investors in exchange for a funding. Here we will focus on the two largest markets that make up the private market landscape: PE and VC.

Similarities Between PE and VC

Private equity and venture capital firms both raise capital from accredited investors called limited partners (LPs), and they both do so in order to invest in private companies. Their goals are the same: to increase the value of the companies they invest in, then sell them – or their stake (i.e. ownership) in them – at a profit.

How are PE and VC different?

In brief: the main differences between private equity and venture capital

PE and VC mainly differ from each other in the following points:

  • The types of companies they invest in
  • The levels of invested capital
  • The amount of equity they get from their investments
  • When they get involved in the lifecycle of a business

A closer look: PE vs VC

Private equity firms often take a controlling stake – 50% or more – in mature companies operating in traditional industries. Private equity firms typically invest in established businesses that deteriorate due to inefficiencies. The assumption is that once these inefficiencies are corrected, companies could become profitable. That is changing a bit as private equity firms increasingly buy out tech companies backed by venture capitalists.

In contrast, venture capital investment companies finance and supervise startups. These young, often technology-driven companies are growing rapidly and venture capitalists will provide funding in exchange for a minority stake (less than 50%) in these companies.

How does venture capital work?

To raise the funds needed to invest in businesses, venture capital firms open a fund and ask for commitments from limited partners. Through this process, they are able to tap into a reserve of money which they invest in promising private companies with high growth potential. As companies grow, they go through different stages of the venture capital ecosystem. Venture capital firms typically focus on one or two stages of venture capital funding, which affects how they invest.

If a company in which a venture capital firm has invested is successfully acquired or goes public by the IPO process, the company makes a profit and distributes the returns to the limited partners who have invested in its fund. The company could also make a profit by selling some of its shares to another investor in what is called the secondary market.

Examples of companies financed by venture capital

  • July: San Francisco-based manufacturer of electronic cigarettes and nicotine products
  • Bandaged: A San Francisco-based online payment processing platform
  • EspaceX: The Los Angeles County-based rocket and spacecraft designer and manufacturer
  • Waymo: A developer of autonomous driving technology in the Bay Area
  • Ripple labs: The developer of a blockchain platform headquartered in San Francisco

Examples of venture capital firms

How does private equity work?

Likewise, private equity investors also raise capital from limited partners to form a fund, also known as private equity funds, and invest that capital in promising private companies. However, the companies that private equity firms want to invest in are usually different from the startups that venture capital firms get involved with.

For starters, private equity investors can invest in a company that is stagnant or potentially struggling, but still has room for growth. Although the structure of private equity investments can vary, the most common type of transaction is an LBO.

What is an LBO?

In an LBO, an investor purchases a controlling stake in a company using a combination of equity and a significant amount of debt, which eventually has to be repaid by the company. In the meantime, the investor strives to improve profitability so that paying down the debt is less of a financial burden on the company.

When a private equity firm sells one of its holding companies to another firm or investor, the firm typically makes a profit and distributes the returns to the limited partners who have invested in its fund. Some companies financed by private capital can also go public.

Examples of companies supported by SEs

  • QE Office: An owner and operator of office buildings based in Chicago, United States
  • Panera bread: A St. Louis-based retail bakery and coffee shop owner, operator and franchisor
  • Refinitive: The developer of financial data and risk analysis tools headquartered in New York City
  • PetSmart: A Phoenix-based retailer of products and services for the lifelong needs of pets
  • Tom shoes: The shoe and shoe accessories manufacturer headquartered in Los Angeles

Examples of private equity firms

Why private markets are gaining in value

In the past, private companies often went public when their capital requirements exceeded what private investors could provide. With a public launch, a company could quickly raise a large sum of money from public shareholders and use it on a large scale. Over the past decade, this approach has become less common for two main reasons:

Investors flooded private markets

Attracted by the potential for high returns, more and more investors have entered the space, creating an influx of available capital. This, in turn, has changed the trajectory of private companies as they are no longer forced to raise capital in public markets.

More and more private companies are financed

As more investors pour more money into private markets, it is now easier than ever for new private businesses to get the financing they need to grow. As a result, we have seen a significant influx of VC-backed startups and PE-backed companies over the past few years. In other words, as more and more money flows into this space and more businesses stay or start up there, private markets will continue to grow in value and opportunity.

How PE and VC work together

As capital flows through private markets, it moves from entity to entity through a series of financial transactions. Whenever capital changes hands in the private markets, professionals advise or execute the transaction, which then initiates a phase of growth or transition for the company or companies concerned. The map below illustrates a simplified version of these exchanges.

Hover or click on the map to see where businesses and service providers can enter the process.

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