Difference Between Private Equity and Venture Capital

25-June-2019 by Virtue Ventures

Private Equity and Venture Capital are a type of financial assistance provided to the companies at various stages. Due to the similarity in their concept, they are taken as one and the same thing. However, there is a considerable overlap amidst the two terms which is not known to people. Private Equity capital involves larger investments in the matured companies. Unlike, Venture Capital in which relatively small sized investments is made, in the companies passing through initial stages of their development.

Private Equity capital fund refers to an unregistered investment vehicle, wherein the investors combine their money for investment purposes. On the contrary, venture capital financing implies funding to those ventures which possess high risk and promoted by new entrepreneurs, who need money to give shape to their ideas.

Definition of Private Equity capital:

The term private equity capital refers to the capital investment made by the investors or companies in the private companies that are not quoted on the stock exchange. The funds may also be invested in a public company to conduct buyout, through, which the public company will be delisted. The investments are made at the maturity level of the company, having a substantial operating history.

Private Equity capital firms buy an already existing company and restructure it to develop further, expand and make it better than before.

If you look at the private equity capital graph, you will observe that it has become an important part of the financial services across the world in last 20 years. It is one of the attractive funding options.

Definition of Venture Capital

Venture Capital is described as the capital contributed by the investors or individuals to small enterprises or startup firms which are having a fresh concept and promising prospects. The new private company is not able to raise funds from the public, may go for venture capital.

This kind of financing may involve a high degree of risk and whose promoters are young & qualified entrepreneurs. They need capital assistance for shaping their ideas. Venture Capital firms support the growing companies in their early stages before they make a public offer. The financier is known as Venture Capitalist, and the capital is provided as equity capital.

Venture Capital funding is related to huge initial capital investment business or sunrise sectors like information technology. The risk and return factor in this type of funding are relatively higher.

 

Key Difference between Private Equity and Venture Capital:

 

Parameters

Private Equity

Venture Capital

Stage

Later stage

Initial stage

Investment Made

All companies

Startup companies

Focus on

Corporate Governance

Management Capability

Provide Service

All industries

Mainly in Energy conservation, high technology

Risk

Less

High

Fund requirement

Growth and expansion of business

Scaling up operations

Ownership

100% Investor Ownership

Does not exceed 49%

Structure

Combination of equity + debt

Use only equity

Liquidity Horizon

Mostly 6 to 10 Years

Mostly 4 to 7 Years

 

How private equity works?


Private equity capital firms pool their money from Limited Partners (LPs) who tend to be pension funds, insurance companies, high net worth individuals, and endowments. The LPs invest in a private equity capital fund in order to employ a management group to seek out high yield investments on their behalf.

 

Unlike venture capital firms that make big early stage bets that they hope will have an enormous return when the company explodes with growth, a private equity capital firm bets a little less on speculative growth and a little more on demonstrated growth or opportunity.

 

The focus of the group is to purchase a company that they can either take to IPO, sell, or generate cash returns on. The private equity group is essentially betting on the fact that the asset it worth more in the future than it’s presently worth.

 

In order to help that company, get there, a private equity firm may provide more operating cash, provide the owners with liquidity (buying the business from them) or potentially orchestrate a merger or acquisition that will generate more value.


How venture capital works?

A venture capital firm is usually run by a handful of partners who have raised a large sum of money from a group of limited partners (LPs) to invest on their behalf. The LPs are typically large institutions, VC to help generate big returns on their money.

 

The partners have a window of 7 to 10 years with which to make investments, and more importantly, generate a big return. Creating a big return in such a short span of time means that VCs must invest in deals that have a giant outcome. These big outcomes not only provide great returns to the fund, they also help cover the losses of the high number of failures that high risk investing attracts.

 

Although venture capital firms have large sums of money, they typically invest that capital in a relatively small number of deals. The reason for this is that once each investment is made, the partners must personally manage that investment for up to 10 years. While money is often plentiful, the VC’s time is very limited.

 

With such a small number of investments to make, VCs tend to be very selective in the type of deals they do, typically placing just a few bets each year. Regardless, they still may see thousands of entrepreneurs in a given year, making the probability that an entrepreneur will be the lucky recipient of a big check pretty small.

 

Venture capitalists also tend to migrate toward certain industries or trends that are more likely to yield a big return. That’s why it’s common see so much venture capital and angel investment activity around technology companies: They have the potential to be a huge win. A win for a VC is either one of two outcomes – the company they invested in goes public or is sold for a large amount.

VCs need these big returns because they make may be a total loss.

 

Conversely, other types of industries may yield great businesses, but not giant returns. A landscaping business, may be wildly successful and profitable, but it’s not likely to generate the massive return on investment that a VC needs to make its fund work.