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Venture capital vs. private equity could be one of the most challenging questions you’ll face as an entrepreneur. Both VC/PE firms raise money for these opportunities from pools of interested investors, including institutional capital (pension funds, insurance companies, etc.) as well as high net worth individuals. When it comes time to support substantial growth, your company will likely rely on one of these funding sources to ascend to the next level of operations. A profound understanding of the benefits and drawbacks of both PE and VC is essential as you map the future of your endeavor.
It’s no surprise that private equity and venture capital are often confused with one another. As the U.S. Chamber of Commerce notes, venture capitalists are actually a subtype of private equity investors. Both purchase shares in private companies, as opposed to public companies that trade on exchanges, such as the New York Stock Exchange. Here are a few of the most important factors that distinguish VC vs. PE.
Private equity firms tend to purchase majority ownership of established companies in a transaction. They see an opportunity to increase enterprise value by implementing operational efficiencies or innovating new products or services. PE companies make these household-name businesses even better, then sell them for a profit down the road with a clear exit strategy from day one.
Rather than seeking mature businesses, venture capital firms target new start-ups with the potential for exponential growth. They usually purchase smaller stakes (less than 50%) to alleviate the risk of putting all their proverbial eggs in one basket. Unlike private equity firms, which can cast a wide net in terms of business sectors, most venture capitalists specialize in tech-based opportunities.
Private equity firms range dramatically in the sizes of companies they target and how much money they invest in each business. While the mainstream media typically covers larger PE firms that invest billions of dollars, a substantial number of PE firms make investments in smaller businesses poised for growth and expansion. Unlike VC’s, PE firms tend to invest in established companies with sustainable cash flows and more moderate growth opportunities, and therefore have a lower risk profile.
VCs, on the other hand, take a greater risk by investing in promising but unproven start-up companies. They usually put no more than $10 million into a single idea and try to spread around their available funds to mitigate the risk of loss if a company doesn’t pan out as planned. While private equity firms may offer a combination of equity and debt, VCs typically fund opportunities with equity only.
PE provides access to more than just money. If you choose an investment firm with expertise in your area, you can take advantage of their accumulated knowledge and wisdom as you move into your next phase of growth.
Because private equity investors have a significant ownership stake, they often influence the company’s direction and operations. While some business owners have concerns about giving up their independent status, many welcome the chance to partner with a team seasoned in growing companies in their sector. If you are interested in growth and a new vision for the future of your business, guidance from the right PE partner can accelerate expansion and innovation.
As a start-up poised for rapid expansion, you may attract the attention of venture capitalists who fund companies like yours in their early-to-mid growth stages. Blockchain platform Ripple Labs, self-driving innovation firm Waymo, and online payment processor Stripe all used venture capital to scale their products and services.
Venture capitalist and private equity companies both help guide the direction of burgeoning businesses. VCs have targeted expertise in tech innovation and bring connections to the table that can build your professional network. With a smaller stake in the process, however, they tend to be more hands-off than PE firms.
When your company needs financing to facilitate growth, a strong pitch will help attract VC or PE funding, depending on your intended audience. Both types of investors look for businesses that can produce future profits with strong offerings, leadership, and vision. Understanding the similarities and differences between both types of investors can ensure your business receives the growth capital it deserves.