What is the difference between private equity & venture capital?

What is the difference between private equity & venture capital?

The difference between private equity and venture capital is relatively simple - while both entities function to invest in and fund promising companies, private equity will purchase all or a portion of a company and  look to reduce cost and use leverage to create value. Whereas, venture capital will take heavily dilutive stakes in early stage companies, to fund growth around tight milestones and topline metrics.

The three key factors that differentiate these two investment types are:

1. The maturity of the companies the firms choose to invest in

2. Which industries those companies typically operate in

3. How much ownership the firm takes in the company

What You Need to Know

Private equity investment firms typically provide funding to more mature companies operating in traditional industries, in exchange for a majority stake (50% ownership or more) of equity.

Venture capital investment firms typically provide funding to young companies or startups, often in the tech industry,  in exchange for minority stake (less than 50% ownership) of equity.

This article will give you a comprehensive understanding of private equity vs venture capital - the differences, similarities, use cases, and other related terms you should know about.

What Is Private Equity?

Private equity (PE) is capital investment made by high profile investors into both public and  private companies .Private equity will use leverage and cost cutting to drive a return on investment.

Companies seek out private equity as a means to finance and help grow or turn around their business. Investors seek out private equity funds to earn a positive return on investment that is better than what can be gained in public equity markets. As long as the business grows and is able to pay back its investors, both sides benefit - often handsomely.

Private equity firms are financial institutions that specialize in investment management and providing capital to the companies mentioned above. Some of the top private equity firms include: The Blackstone Group, The Carlyle Group, and CVC Capital partners which are all themselves publicly traded.

Why Private Equity?

Private equity offers a number of advantages to business owners who are looking for a way to fund and grow their businesses:

Can procure large amounts of funding for your business with an established firm.

Since private equity firms have greater share of ownership, that means more firm involvement, which can mean more mentorship, business advice, and hands-on support from a larger team.

Can point out and specialize in turning around underperforming aspects of a business

Private equity firms also tend to be highly risk-averse, so if your business is nascent but promising, private equity is less likely to offer funding than venture capital.

What Is Venture Capital?

As we’ve discussed, venture capital (VC) is another way of funding businesses that typically skews toward up-and-coming businesses in the tech and biotech industries. The key factor here is potential: Does the company in question show enough promise and potential that a VC investor is willing to take the leap to invest in them with belief in significant return?

In many cases, the goal of the partnership is for the invested business to become acquired or successfully go public. If and when that happens, “the firm makes a profit and distributes returns to the limited partners that invested in its fund” (Pitchbook).

According to Entrepreneur Magazine, some of the top venture capital firms as of 2020 are Khosla Ventures, Sequoia Capital, Accel, New Enterprise Associates, and Kleiner Perkins.

Why Venture Capital?

There are many advantages to pursuing venture capital as a source of investment in your business:

VC firms are willing to take a chance on smaller, newer companies - if they show enough promise

Can provide a young business with a source of experienced consultation and guidance to assist with key business decisions.

High reward potential that typically accompanies higher-risk opportunities

Proven results - many tech companies that are now household names were initially backed by VC (e.g. Stripe, Airbnb)

The biggest drawback to partnering with a venture capital firm is similar to partnering with a private equity firm - being okay with giving up control. Even though the ownership threshold is lower with venture capital firms (less than 50%), this still means that the firm will likely want to be involved in the business and making decisions that impact the future of the company.

Private Equity vs Venture Capital - Choosing Your Solution

By now you should have a stronger understanding of venture capital vs private equity, and which one may be a better choice for your own funding needs.  But, like many financial topics (and especially ones that may play a key role in the potential growth of your own business), there is always more to learn.

If you want to learn more about private equity, venture capital, and other funding solutions for growing businesses, then we encourage you to join our Assembled Brands Partner Community. In joining our Community, you can network with other business owners, learn, and share experiences - including experiences with funding. Set yourself up for new business and gain useful insight from other consumer brands businesses as a partner in the Assembled Brands community - apply today.