Venture capital and Private Equity are both methods of providing capital to businesses at different stages in their life cycle. Often, people confuse these two to be the same. Even though, there are some overlaps between these two, they are fundamentally two different forms of financing.
In this post, we will discuss the key points on how Venture Capital is different from Private Equity.
Stage of Investment
Venture Capital is financing that is provided to startups and young companies that are still early and small in size. A lot of times, these companies have not even started generating revenue and are still in the product development stage.
These investors have faith that the companies in which they invest have extremely high growth potential and would result in a high return on their investment. Some examples of recent successful venture capital investments are Sequoia Capital’s investment in WhatsApp and Accel partner’s investment in Facebook.
Private Equity firms; in contrast, usually invest in mature companies that are already well established. Some examples of this are, Blackstone’s investment in Hilton Hotels and Silver Lake’s investment in Dell.
Venture Capital firms tend to invest in companies for a stake of less than 50%. They also spread out their investments into a large number of startups to diversify their risk. These investors focus on improving the management of the startup and advising them to help develop a product that is widely adopted by customers.
Private Equity firms usually always buy 100% of the companies that they invest in. This is called a buyout and gives them complete control of the company that they invest in.
Even though the companies that they invest in are mature companies, a lot of times they have poor efficiency and deteriorating profits. Private equity firms make a return on their investment by helping these companies in improving the efficiency of their operations and increase their profitability.
Risk and Return
Venture Capital firms face high risk on their capital due to the investments being made in startups with no track records of performance. There is a high level of uncertainty involved because historically, a high percentage of startups are destined for failure.
This high risk also means that there is potential for high returns. The investments are made in early stage companies many of which have almost unlimited potential for growth. If these companies face wild success like WhatsApp and Facebook, the venture capital firms realize extremely high returns.
Private Equity firms face lesser risk and more stability when compared to venture capital. Since the investment is made in matured companies, there is a track record of previous performance. This reduces uncertainty and therefore risk.
This reduced risk also means more stable and lesser returns. The growth potential is limited because these companies are matured. Even though the returns are still attractive when compared to traditional investment instruments, they are lower than successful venture capital investments.
We hope that this post helped clear up the basic differences between both these types of funding. As an investor, you could use this as a simple guideline on which form of investment is better suited to your requirements. And as a founder, this could be a basic guideline to help you decide which form of investment is best suited to your business.