Venture capital vs. private equity: what are the key differences and similarities? In this article, we look at the key differences between VCs and Pes, as many still confuse these two terms given that they both refer to businesses that tend to invest in companies and make profits by exiting these investments.
2021 was a record year in many aspects. For instance, stocks and cryptocurrencies hit record highs while the largest number of private companies went public. The last year was also a record-breaking year for both venture capital (VC) and private equity (PE) as a sharp increase in the Fed’s balance sheet yielded a significant amount of dry powder to invest in high-growth startups and private companies. Here is what you should know about venture capital vs. private equity.
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Venture capital refers to a type of financing where investors provide funds to smaller businesses and startups. These investments are typically made to fund the startup’s expected rapid growth or a small business that has already grown but needs fresh capital to continue to scale.
Venture capital firms raise funds from financial institutions (e.g., private investors, hedge funds, pension funds, etc.) to invest in startups with high-growth potential. In return, these investors expect above-average returns.
For many young startups, venture capital represents the sole option for raising external funds as they may lack experience accessing bank loans or institutional funds. It could be said that venture capital is created to fill the void between sources of funds for startups.
For instance, a young tech startup is looking for funding to keep growing and maturing. The equity is created, and a portion of the company is sold to venture capital firms in exchange for funding.
Venture capital firms usually come with a long-term investing horizon. The basic idea is to invest in a startup until it reaches a sufficient size and can operate on its own or gain access to larger capital markets. This process can take years.
“According to Crunchbase, venture capital funding shattered all records in 2021, with global investments totaling $643 billion, up nearly twice compared to $335 billion in 2020.”
Some of the biggest venture capital firms in the world include Sequoia Capital, Andreessen Horowitz, Accel, TCV, Kleiner Perkins, etc.
Private equity is focused on equity (total assets minus total liabilities); otherwise, the “value” within a company is not publicly traded. Generally, Private Equity firms raise specific funds from high-net-worth individuals and institutional investors. They then source deals, represent investors, and manage the funds that invest in a certain business, usually but not always distressed businesses.
Private equity firms buy shares/equity positions of companies that are not publicly listed. The reason for investing in private companies could be to gain control of the company to take it public. This type of investment is usually focused on underperforming businesses that could attract investor attention by going public later once the PE firm helps them become more stable or profitable.
However, PE firms also acquire public companies in the so-called “take-private” deals. Once acquired, these companies are then delisted from public stock exchanges – like NYSE or NASDAQ- before they become private-owned businesses.
“The goal of take-private deals is to stabilize these companies, which is a process that is much easier if the company is not public before making them public again in a few years or selling them to another investor for a profit.”
Today’s biggest private equity firms include Thoma Bravo, which is focused on investing in software companies, Apollo, Bain Capital, TPG Growth, KKR, Blackstone, Vista Equity Partners, CVC, etc.
In essence, venture capital is a subset of private equity. Besides venture capital, private equity includes large buyout deals, private placements, and take-private deals. Here, we discuss the key differences between venture capital and private equity.
Private equity firms tend to have a much larger scope for investing, while venture capital funds are mostly focused on startups and smaller businesses. VCs typically invest in a high-growth startup that is looking for funds to keep scaling.
On the other hand, a typical private equity deal is focused on larger, established companies that are looking for an injection of funds for different reasons. Moreover, venture capital firms are mostly focused on tech startups, while a private equity fund can invest in different industries, from Energy to Health Care.
Venture capital usually has long-term plans for startups that it invests in. VCs could opt to stay if needed to make sure they receive a substantial payout. Although this is not always the case, private equity firms usually set their goals on making quick profits.
For instance, Sequoia invested in the messaging service WhatsApp at an early stage before making an exit after Facebook acquired the company for $19 billion in 2014. The initial $60 million investment turned into a $3 billion exit.
Another key difference between venture capital and private equity lies in the size of deals. The former generally involves smaller deals with many pre-seed, seed, and Series A funding rounds measured in millions of dollars. This is the opposite of private equity deals that could involve tens of billions of dollars.
Take Thoma Bravo as an example. The PE firm Thoma Bravo agreed to a deal for the U.S. enterprise software firm Anaplan in a take-private deal valued at $10.4 billion. In this case, Thoma Bravo acts as a private equity firm with a huge investment in the publicly-listed company.
Just a couple of weeks later, Thoma Bravo announced it took part in the $90 million Series D funding round for startup Aisera, an AI-driven service experience platform. Here, the company likely invested a couple of million dollars to help the startup sustain its 300%+ revenue year-over-year growth.
Acquiring control differed between venture capital vs. private equity firms. While venture capital firms focus on acquiring a stake in emerging startups, private equity firms tend to acquire businesses. In case they cannot secure 100% of voting powers, PE firms will then at least seek a majority stake in the company that will see them control how the business moves forward.
Don’t forget VC is a subset of private equity. As it is focused on the high-reward, high-risk type of investment, VCs are also very exposed to the overall macro environment. For instance, the NVCA data showed that VC activity slowed down significantly in 2022 amid market uncertainty.
While the PE activity also tends to slow down in market turmoil, private equity firms are much larger, stable businesses, making them more immune to macro headwinds.
Net-net venture capital is a subdivision of private equity. As such, its focus is much narrower and more placed on acquiring a minority stake in young startups that need funding to scale. This is the opposite of private equity firms that usually ask for full/majority control over the business.
While there is a certain overlap between venture capital and private equity, the key differences between these two include what type of business is targeted for investing, control over the business, size of the deal, time horizon, etc.
About The Author
Jonathan Hung is one of the most active angel investors in Southern California; his mission is to drive value creation within each portfolio company. In support of this mission, he serves as Co-Managing Partner at – Unicorn Venture Partners.
He and his team target investments in US companies with global market potential, focusing on long-term growth expansion to East Asian markets.
As a Managing Member for his family office fund, J Heart Ventures, Jonathan developed his investing prowess, making investments in startup companies such as Gyft, ChowNow, Miso Robotics, Clover Health, and Bitmain, to name a few startups he funded.
Jonathan has various degrees from the University of Southern California, the London School of Economics, the Massachusetts Institute of Technology, and The Wharton School at the University of Pennsylvania.