Last Updated on April 10, 2023 by George
Private equity and venture capital (VC) are not the same, although they frequently overlap. Private equity and venture capital are undoubtedly two sorts of financial investments motivated to make money by purchasing at a discount and selling the asset at a higher price. Yet, they use an entirely different strategy to achieve this goal.
We have prepared this overview of private equity and venture capital to get you up to speed on the distinctions between the two forms of funding.
An Introduction Private equity (PE) and venture capital (VC) raise funds to invest in businesses with solid growth potential. With over $4 trillion in assets under management and another $500 billion in total capital raised, PE and VC investment companies collectively account for a sizable portion of the global private markets.
A company is said to be “VC-backed” if venture capitalists have contributed money to its funding. Contrarily, businesses supported by private equity are frequently wholly or majority owned by a PE firm like the Carlyle Group or the Blackstone Group.
You could consider PE and VC firms to be rivals. On the one side, PE investors purchase an already profitable firm, restructure it to increase performance, and sell it. Yet, VC firms help promising management teams run smaller, frequently unprofitable businesses by giving them working capital and guidance.
List of Largest VC and PE Firms by Capital Raised
Private Equity Firms
- The Blackstone Group ($58 billion)
- Kohlberg Kravis Roberts ($41 billion)
- The Carlyle Group ($40 billion)
- TPG Capital ($36 billion)
- Warburg Pincus ($30 billion)
Venture Capital Firms
- New Enterprise Associates ($17 billion)
- Intel Capital ($9.8 billion)
- Oak Investment Partners ($8.4 billion)
- Insight Venture Partners ($7.6 billion)
- IDG Ventures ($6.8 billion)
The relative dominance of private equity firms over venture capital firms reflects that PE firms typically acquire and reorganize privately held businesses. Leveraged buyouts of private corporations are a common practice among private equity firms, and it explains why PE firms have far more assets under management than VCs.
The Mentor Factor
To acquire a minority share, venture capital firms look for young, early-stage development companies primarily focused on technology and tech subcategories (such as fintech and biotech). VC firms actively train the company’s higher management and share their skills with them because they frequently invest in smaller, less established businesses.
Its mentality contrasts sharply with PE firms, which adopt a far more paternalistic approach. Unlike venture investors, PEs typically acquire a controlling interest in a company and make significant structural modifications to guarantee it is operating at peak efficiency and producing the highest possible profits.
In What Ways Do VCs Differ From PE Firms?
We’ve outlined the main distinctions between venture capital and private equity below to help you understand the difference between the two.
Between PEs and VCs, the proportion of the company acquired varies greatly. On the one hand, PEs almost invariably buy the entire acquired firm. Contrarily, venture capitalists only own a small portion of the company they invest in. Instead of taking complete control of day-to-day operations, VCs mentor an existing management team.
Rarely does venture finance reach $10 million. On the other hand, private equity can be as high as 10 figures, or $10 billion and above. The size disparity indicates that VCs frequently invest in startups and early-stage tech companies with more minor, non-controlling stakes.
Private equity investing is frequently described as another term for “leveraged buy-out.” Private equity firms are in charge of this kind of business deal, which entails buying privately held businesses with a combination of loans and equity. So, the purchase is “leveraged” since the acquiring company borrowed money to fund the deal and used the acquired company’s cash flow as security for the loan.
On the other hand, venture capital firms never buy businesses. Thus, they don’t borrow money or use assets as leverage; instead, they only employ stock to invest in firms.
Private equity firms typically take longer to sell a company after acquiring it than VCs. Before seeking a sale, the typical private equity firm stays on its acquisition for five to ten years. Venture capital firms typically quit their investments after four to six years as part of their shorter-term investing strategy.
The Difference In A Nutshell
The first significant distinction between PE and VC firms is the stage at which they invest in businesses. Private equity firms purchase mature companies, while venture capital firms invest in early-stage businesses and startups.
The second and most crucial difference between PE and VC firms is that the former invests in companies in all industries and sectors, while VCs favor technology and biotech. Finally, PE investors always look to buy companies outright, whereas VCs only acquire minority company holdings. Finally, unlike venture capitalists, PE firms typically exit their investments after a longer time horizon and use a combination of loan and equity funding.
Private equity investors play the numbers game; they examine a company’s operational efficiency and restructure it to maximize its financial potential, unlike venture capitalists who invest in a company’s human leadership potential.
Pros & Cons
- PE investors are typically more experienced than VCs and can provide expert advice and guidance.
- Private equity firms often have access to more significant amounts of capital, allowing them to invest more in businesses.
- PE-backed companies may have a longer time horizon for their investments when compared to ventures backed by venture capitalists. PE-backed businesses may have more time to realize their potential.
- Private equity investors typically take a more hands-on approach than venture capitalists, which can be intrusive for the founders and management of the company.
- Private equity firms often require companies to accept specific terms (such as board control) that venture capitalists may not.
- Private equity investments require more paperwork and due diligence than venture capital investments, which can be time-consuming and expensive.
- Private equity firms usually have a longer time horizon for their investments, making them less flexible when the market or industry conditions change.
- PE-backed companies often face higher scrutiny from the public and investors, which can add pressure to perform.
- Private equity investments are typically more expensive than venture capital investments due to higher fees and longer terms. It can limit a company’s access to capital and decrease its potential returns.
- PE-backed companies may need help going public since they must meet specific standards that are often more stringent than those of venture-backed companies.
- Private equity investments can be a good source of capital for certain types of businesses, but assessing the risks and rewards is essential before making any decision. It’s best to consult an experienced advisor who can guide you.
- Private equity investments also significantly change ownership as the private equity firm takes control of the company. It can result in changes to management, board composition, and operational direction that may be unwelcome or unsettling for existing employees. Companies must understand the implications of such a shift before taking on a PE investment.
- Finally, it’s important to note that PE investments are often a long-term commitment. Companies should be prepared for the potential upside and downsides of such a relationship before taking the plunge. Making an informed decision about private equity investments can help ensure success on both sides.
Final Thought – Difference Between PE and VC
While PE firms focus on the optimization potential of a company’s unused assets, VCs are more focused on the people. Although private equity firms purchase out established businesses, venture capitalists seek out teams leading startups with a promising chance of success.
VCs are the more appealing option for entrepreneurs and business owners trying to secure startup cash between the first and fourth rounds of funding in the early stages of a company’s growth. PE firms offer a workable exit option for business owners wishing to profit from their initiative as the company matures.