On any website talking about investment and investors, the terms Private Equity and Venture Capital get thrown around quite a bit. In some cases, these terms get muddled – which is somewhat understandable. Both Private Equity and Venture Capital firms are, essentially, mechanisms by which the money of investors known as limited partners (LPs) can make it to companies who need it.

Both VC and PE are big businesses, particularly in the US. Despite the pandemic, VC companies raised nearly $148 billion as of December 14th, 2020, a decade high, albeit a drop from 2019. PE deals in the US were also impressive, totaling $326.7 billion in the first half of 2020 – and that number is a 20% decrease from the same time last year.

However, if you’re doing any reading or research about investment, it’s key that you first understand the differences inherent in private equity vs venture capital. This is especially important if you intend to become one of the portfolio companies for an investment firm – you need to know who you should be approaching! So, hopefully, this article will help you better understand the difference between private equity and venture capital.

The Similarities Between PE and VC

Before we talk about the difference between private equity and venture capital, it’s worth it to go over the similarities. This will help explain why portfolio companies might sometimes conflate the two, and the confusion among those outside of the investment industry.

  • Both firms invest in private companies or companies that they intend to make private. The difference is that venture capitalists are interested in a private company as a starting point, hoping to help it grow. Private Equity tends to be interested in private operation as a process – a place to work on a company before organizing a sale.

  • Both firms raise capital from outside investors, the LPs. The form LPs take can vary, including pension funds, endowments, insurance firms, and wealthy individuals. Whatever the method, both Private Equity and Venture Capital firms are involved in raising capital.

  • Both Private Equity and Venture Capital firms charge their LP’s a management fee, traditionally 1.5-2.0% of assets under management, at least initially. Assuming that a minimum return is achieved, both types of firms normally take part of the interest on profits as well.

How Does a Private Equity Firm Operate?

Private Equity firms are investment groups that manage shares representing ownership, or interest in, private companies. Private Equity firms are those that buy the shares in these private companies or purchase shares in public companies with the intention of taking them private.

  • Because Private Equity firms are directly investing in a company to the point of gaining control of it, substantial capital is required. Private Equity firms thus tend to be larger and deal with larger sums of capital. However, Private Equity firms tend to also have all their eggs in one basket, focusing their efforts on a single project.

  • Usually, Private Equity firms purchase 100% ownership of the company in which they’re investing. This is so that they can have total control of that company after the buyout.

  • Private Equity Firms have a few options to make a profit off of their investments. The hope is that the company will grow so that its assets are worth more. However, since they are the owner, they can also follow a strategy of selling the company at a price higher than they acquired it.

  • Traditionally, Private Equity firms can buy companies from any kind of industry.

How Does a Venture Capital Firm Operate?

Venture Capital firms are investment groups that provide funding to startups or other young private businesses that are believed to have the potential for growth. Venture Capital firms specialize in this kind of investment.

  • Venture Capital firms often work with smaller amounts of capital, tending to invest in companies that are just getting started. There is no guarantee that any one startup is going to make it big – not every startup can be a Facebook, after all. Venture capital firms normally have an array of portfolio companies to help mitigate this risk.

  • The goal of a Venture Capital firm is to find a younger company and provide it with the investment, and sometimes expertise, to help it grow. Their hope is to find a company that will have future success.

  • Venture Capital firms tend to take on a minority stake, investing less than 50% of the equity in a company. This helps them mitigate risk, and mentioned earlier, by spreading out smaller investments across multiple startups.

  • This growth is vital to Venture Capital firms – they make a profit by ensuring that the company they put money in becomes more profitable and that the shares they purchased go up in value.

  • Venture Capital firms tend to be mostly associated with companies that are involved in the startup space, with an over-representation of technology and biotechnology companies. Businesses, where a good deal of the product is in software, don’t need large manufacturing bases.

In Summation

While both Private Equity and Venture Capital are useful ways for companies to promote their own growth, they have different purposes and methods of operation. Understanding where they generally operate, and how, is important whether you’re interested in becoming an investor, or seeking an investor out.