Venture capital and private equity are forms of financing that collect funds from limited partners and invest them in private companies to make a return. Below is a list of the differences between private equity and venture capital.
Private Equity (PE) Definition
A PE focuses on businesses that want to increase their value with time before owners sell the company at a higher price. A PE raises capital from limited partners and invests in a company that promises returns. PE investors may also invest in a potentially distressed or stagnant company with signs of potential growth. Investment structure varies, but a leveraged buyout (LBO) is the most common deal. An investor who invests in a leveraged buyout will purchase a controlling stake in a potential company using significant equity and debt, which the company then repays. The investor will then work to improve profitability to settle the debt, which lessens the company’s financial burden. Once the PE firm sells its portfolio, the profit gets distributed to the limited partners who invested in the funds.
What Is Venture Capital (VC)?
A VC mentors and funds startups that are often tech-focused in exchange for a given percentage of equity in the startup. As startups grow, they go via various venture capital stages, and investors or firms can focus on specific steps that impact how they invest. Below is a list of VCs’ different stages.
Seed Stage
A seed round is a relatively small fund provided to fund a startup. The capital can is used for market research, product development, or business plan development. A seed round is the company’s first round of funding that is official. Seed round investors are provided with equity, convertible notes, or preferred stock options once they invest.
Early Stage
The stage of venture capital funding is crucial for companies currently going through the development phase. The financing sum is often more significant than that in the seed stage as new businesses require additional capital to enhance their operations once they develop a viable service or product. Venture capital is given in Series A, Series B, Series C, and so on.
Late Stage
The late stage is for mature companies with proven growth and revenue. Like the early stage funding, each round of funds is designated by a letter. If a VC firm invests in a company that goes public or gets acquired, the firm makes a profit which gets distributed to the limited partners. The firm may also sell some of the shares to various investors to make a profit.
The Main Differences
Private equity is an ownership or investment in private companies. It is also a term that refers to the PE investing strategy. Venture capital investments focus on startups during their early stage. The two differ in the levels of invested capital, the types of companies they fund, when they get involved in the company’s lifecycle, and the equity they earn through their investments.
According to Brad Kern, PE firms take over 50% ownership upon investing in companies, whereas VC firms get a minority stake. Both funding options can have ownership in multiple companies, which forms part of their portfolio. VC firms invest in young companies and tech-focused startups in their seed. Investing in startups can be highly risky, but the risk presents the opportunity for higher returns. In exchange for an ownership stake or equity, PE investments are directed into mature businesses.
Venture capitalists invest in startups with the potential for aggressive growth. A private equity investor finances more established companies.