Difference Between Private Equity and Venture Capital

Both of the private equity and the venture capital make their investments in the companies where in case of the private equity investment is generally made in the companies which are in their mature stage of working whereas in case of the venture capital, investment is made in the companies which are in their early stage of working.

Technically speaking, venture capital is just a subset of private equity. Both invest in companies, both recruit former Investment Bankers, and they both make money from investments rather than advisory fees. But if you take a closer look at them, you’ll see that they’re significantly different.

The term “private equity” generally refers to money invested in private companies. Such companies become private through investment. Most people in finance, though, use “private equity” to mean firms that buy companies through leveraged buyouts (LBOs) – so that’s how we’ll use it here.

So private equity, in a nutshell, is an investment by a private equity firm in a specific company. The investment can be partial or a complete one, with the hopes of earning high returns.

When we talk about the target company, there are various changes that can be done by the private equity firm. Changes can be made with respect to the strategies, management, expenses, etc. to make it profitable.

This change helps the target company to perform better and thus generate good returns for the private equity firm.

After a period of let’s say 5 years, the private equity sells the company generating profit and thus high returns through the entire transaction.

Many of you might be curious as to what exactly they do and what makes them different from one another. So let’s get started and find the answers. In this article, we discuss the following –

Private Equity vs Venture Capital Infographics

Who are they?

The image that you see below will help you understand what Private equity is.

Let’s consider that you are the one who is watering that big tree. Your vision has helped you to choose this one tree from the garden, which you think can bear more fruits once it is nourished with fertilizers and good care.

You have collected the money (for fertilizers) from your friends and family who also intend to eat the sweet fruits of the tree afterward. With the intention that the tree will bear more fruits, you are watering it regularly.

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Now connect this example with what happens in Private Equity.

You: Private Equity Firm Tree: Target Company (Either Potential Company or Company in need of Restructuring). Your friends and family who contributed funds for the fertilizers: Investors contributing Funds to Private Equity Firm. Sweets Fruit which is intended to be distributed amongst all: Returns from the Transaction which are distributed to Investors. You charging fee for taking care of the Tree on behalf of everyone: Private Equity Firm charging Management fe es for the Transaction .

Let’s take the same example to understand what is Venture Capital.

Assume that everything remains the same as the previous analogy that we saw with respect to the above image. The only difference is:

Now you have set your eye on a Small Sapling (instead of a large fully grown tree)

Your reason for selecting the sapling is its immune qualities like sturdiness, disease-resistant, shorter fruit-bearing period, etc.

So with respect to Venture Capital, the sapling depicts a startup company and you(watering the sapling) is the Venture Capital Firm

And this is how venture capital works. Venture Capitalists provide funds to the startup company or small businesses that have long term growth potentials. (Sapling having immune characteristics described above).

Here the risk can be high, but so are the expected returns.

Private Equity and Venture Capital Statistics (2014):

Assets under Management: $3.8 Trillion

Aggregate capital raised: $495 Billion

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Comparative Table

PE firms and VCs invest in companies and make money by exiting i.e. generally selling their investments. But the way they do it is different.

Private Equity Venture Capital Stage PE firms buy mature, public companies. VCs invest mostly in early-stage companies. Company Types PE firms buy companies across all industries. Venture Capital are focused on technology, biotech, and clean-tech companies. % Acquired It is seen that the PE firms almost always buy 100% of a company in an LBO Venture Capital only acquires a minority stake which is usually less than 50%. Size PE firms make large investments. ($100 Million to $10 billion) VC generally makes smaller investments which are often below $10 million for early-stage companies. Structure PE firms use a combination of equity and debt. VCs firms use only equity (Cash)

Risk Appetite

Venture Capitalists invest in start-up funds. But are they absolutely sure that all these companies will make it big someday? Chances here are very little for 100% shots.

Hence venture capitalists expect that many of the companies they invest in will fail. But the hope here is that at least 1 investment will generate huge returns and make the entire fund profitable.

Also, venture capitalists invest small amounts of money in dozens of companies, and that is why this model works for them.

But this model would prove a disaster if it is applied by private equity. In PE the number of investments is smaller and the investment size is much larger.

So even if a single company fails the entire fund would be doomed. And that is why PE funds are invested in mature companies where the chances of failure in the near future are 0%.

Return Differences

“So which model actually produces higher returns?” is the basic question that can arise in your mind.

Technically speaking each fund claim to target higher returns but there are a lot of controversies in this area.

But the actual scenario: Returns in both are much lower than what investors claim to achieve.

20% of returns are what is targeted by most venture capitals and private equity funds. But what is generally seen is that they are able to generate returns up to 10%( Except in some cases).

Venture Capital: Returns are mostly dependent on top firms. They believe in investing in one big winner and making money out of it.

Private Equity: One can earn great returns without investing in the largest and most well-known companies also.

Involvement in Target Company’s Operations

Private Equity:

Due to the LBO boom of the 1980s, there has been a bad picture of private equity firms. Due to those experiences people have always thought of a PE as a place where companies are simply bought, people are fired, then the company is burdened with debt and finally, it is sold off.

The general notion is that they finally sell the company without doing anything to improve operations. But this is the wrong notion in today’s scenario.

PE firms are now working hard towards improving the companies and findings ways to expand it. And this is absolutely true in case of recessions when there’s not much buying and selling of large companies.

Venture capital:

It is involved with a particular company or a project since its inception. Hence they should have a greater bond and involvement with the company.

As they’re working with early-stage companies, they should have a greater incentive to improve the company.

However, in practice, their involvement depends on the firm’s focus, the stage of its business life cycle, and how much the entrepreneur wants them to be involved. But note that there can always be exceptions to the above statements.

Most of the differences that we have seen are specifically dealing with the theory part of Private Equity and Venture Capital firms.

Now we are going to focus on specific differences between the two, which will help you to determine:

Interview processes involved if you want to get into any one of them.

Who are the people involved in Private Equity and Venture Capital?

Work involved

Salary Comparison

Culture

Exit opportunities

PE and VC Interview

The main point of similarities involved in the interview process is that “Both types of firms focus on your background and deal experience”. But that is it. This is the only similarity.

PE:

Do bear in mind that neither the Private equity interviews are for the light-hearted ones nor are they a piece of cake. The interview can have a complete a case study or modeling test.

This is because they want to test you since you are going to spend so much time doing analytical and financial modeling work.

VC:

Venture Capital interviews are more qualitative and fit-focused, especially for early-stage firms.

Since Venture Capitals work with companies that are smaller hence detailed financial models don’t make sense here. And that’s why they focus on relationships instead.

People Involved

Private Equity

Since the financial modeling and due diligence work you do in PE is very similar to the transactions in investment banking, private equity firms focus on recruiting former investment banking analysts.

Also, consultants and anyone with an operating background can get into PE, but then it’s an uphill battle.

Venture Capital

Whereas in VC’s you will see a mix of population including ex-bankers, consultants, business development people, and even former entrepreneurs.

PE and VC – Work

PE:

Especially at large PE firms, the work is not much different from Investment Banking. Although there is less work in comparison, you still spend a lot of time in Excel, valuing companies, looking at financial statements, and conducting due diligence.

However, the responsibility is more because you need to coordinate with accountants, lawyers, bankers, and other PE firms while you are working on a deal.

VC:

As you progress from “mega-PE fund” to “early-stage VC” the work gets less quantitative and more relationship-driven.

Some people actually dislike this because they hate cold-calling and constantly finding new companies. While some, on the other hand, prefer to talk to people rather than work in Excel.

So it’s hard to say what’s “more enjoyable” – it depends on whether you descend toward sales, analysis, or operations.

PE and VC – The Pay

You will almost always make more money in Private Equity than in Venture Capital.

The reason: In private equity, there is more money involved and fund sizes are much larger.

However, if you want to make big money in venture capital, all you have to do is to find a company to invest which can turn out to be the next Google. But this usually is very rare.

If you have a previous Investment Banking experience then, base salaries in both industries are around $100K with widely variable bonuses.

But on the whole, if you want to make the most amount of money in the shortest amount of time then Private equity is the option for you.

The Culture

The work atmosphere and the culture in Private equity are very similar to Investment banking and attract some of the more extreme and merciless bankers.

The culture in venture capital tends to be more relaxed. Also because people come from more varied backgrounds.

People in PE more often come from pure finance backgrounds, whereas those in VC tend to be technologists turned financiers.

Overall the work hours in higher PE firms tend to be longer as compared to the VC where the approach is a “normal” workweek.

PE and VC – Exit Opportunities

PE Exit Opportunities

Hedge funds: A lot of private equity professionals decide to move on to hedge funds, where returns and money can be earned more rapidly.

Private equity professionals get frustrated by the slow pace and tedious deal-making tasks. Also, it is difficult to become a millionaire overnight, it will at least take 5-10 years.

A lot of private equity professionals decide to move on to hedge funds, where returns and money can be earned more rapidly. Private equity professionals get frustrated by the slow pace and tedious deal-making tasks. Also, it is difficult to become a millionaire overnight, it will at least take 5-10 years. Venture Capitalist: Some private equity professionals may also find that doing large deals is not as exciting as investing in start-ups. Hence they switch to venture capitals.

Some private equity professionals may also find that doing large deals is not as exciting as investing in start-ups. Hence they switch to venture capitals. Joining a Corporate/Portfolio Company: A private equity job consists of working with portfolio companies to help them grow. It is therefore quite common for private equity professionals to decide to go to work for one of their portfolio companies in a senior position (CFO, CEO, Head of Business Development).

A private equity job consists of working with portfolio companies to help them grow. It is therefore quite common for private equity professionals to decide to go to work for one of their portfolio companies in a senior position (CFO, CEO, Head of Business Development). Other exit opportunities for private equity are: Launching your own fund Moving back to advisory roles Secondary funds, Fund of Funds Entrepreneurship



VC Exit Opportunities

IPO

Mergers & Acquisition(M&A)

Shares buyback

Sale to Other Strategic Investor/Venture Capital Fund

Which One Should You Choose?

So, private equity vs venture capital, what are you up for?

Your inclination towards one of them depends on your goal.

If you like to work in transaction deals or you’re trying to make money in the shortest amount of time possible, Private equity is a better option.

If you’re more interested in starting your own company one day and you prefer relationships for analysis, Venture Capital is better.

Hope the comparison made in this article helps you to know the differences and the similarities between Private Equity and Venture Capital.

Also, checkout Investment Banking vs Private Equity

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