Private Equity vs. Venture Capital: What’s the Difference?
The terms private equity and venture capital are sometimes used interchangeably but they vary in principle in their investment philosophy. Venture capital investors usually invest in a company at an early stage whereas private equity investors invest as a part of growth capital.
Private equity investors usually do not invest into ideas or at an early stage. They require a significant and proven history of the company before they consider investing i.e. 3-10 years of operations. Venture capital investors on the other hand may invest as a seed capital in an idea or into 1-3 year old companies for them to grow.
KEY TAKEAWAYS
- Venture capital and private equity funds are financial intermediaries between sources of funds and high-growth and high-tech entrepreneurial firms.
- Venture capital funds invest in start-up entrepreneurial firms. Private equity funds invest in more established firms.
Private Equity vs. Venture Capital – Key Differences
The terms venture capital and private equity differ primarily with respect to the stage of development of the entrepreneurial firm in which they invest.
Venture capital refers to investments in earlier-stage firms (seed or start-up firms), whereas private equity is a broader term that also encompasses later stage investments as well as buyouts and turnaround investments.
Private equity investors generally seek out mature, established companies and acquire a majority, controlling interest. Venture capital is the sub branch of private equity and is mainly concerned with entrepreneurship rather than developed companies.
The goal for private equity investors tends to be more focused on maximizing the value of the company in the short-term with the intent to sell the company once it has done so.
The main goal for venture capital investors is to identify promising startups with high growth potential and help them grow by providing financial, administrative, marketing, and strategic advice, as well as facilitate a network of support for startups.
Financing Stages
Although private equity and venture capital finances different stages of investment, they have the same idea in the end.
Private equity and venture capital investments are consists of various financing stages are defined as follows:
Seed: Financing provided to research, assess, and develop an initial concept before a business has reached the start-up phase.
Start-up: Financing provided to firms for product development and initial marketing. Firms may be in the process of being set up or may have been in business for a short time but have not sold their product commercially.
Other early stage: Financing to firms that have completed the product development stage and require further funds to initiate commercial manufacturing and sales. They will not yet be generating a profit.
Expansion: Financing provided for the growth and expansion of a firm that is breaking even or trading profitably. Capital may be used to finance increased production capacity or market or product development and/or to provide additional working capital.
Bridge financing: Financing made available to a firm in the period of transition from being privately owned to being publicly quoted.
Secondary purchase/replacement capital: Purchase of existing shares in a firm from another private equity investment organization or from another shareholder or shareholders.
Rescue/turnaround: Financing made available to an existing firm that has experienced trading difficulties —for example, the firm is not earning its weighted average cost of capital (WACC) — with a view to reestablishing prosperity.
Management buyout: Financing provided to enable current operating management and investors to acquire an existing product line or business.
Management buy in: Financing provided to enable a manager or group of managers from outside the firm to buy in to the firm with the support of private equity investors.
Venture purchase of quoted shares: Purchase of quoted shares with the purpose of delisting the firm.
Other purchase of quoted shares: Purchase of shares on a public stock market.
SEE ALSO: Business Risk vs Financial Risk
The Bottom Line
Sometimes, venture capital and private equity are mixed up. Venture capital is the sub branch of private equity and is mainly concerned with entrepreneurship rather than developed companies. Private equity not only includes the financial support in company’s early stage but also includes the financing in the expansion stages of the enterprise following the financing stages. Although private equity and venture capital finances different stages of investment, they have the same idea in the end.
This has been a guide to what is the key differences between private equity and venture capital. Here we explain their meanings, key differences, and financing stages. You may also check out these additional resources from Money and Financial Literacy: