May 15, 2024

5 Ways Venture Capital and Private Equity Are Not the Same

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If you're looking for investors for your company, it might be helpful to understand which investor category to invest your resources and energy in. While most tend to use the terms interchangeably, there's a distinctly vast difference between venture capital and private equity firms.

Venture capital and private equity are both significant players in the investment landscape, but they operate in unique spheres with different objectives, strategies, and target companies. It's important to note that while all venture capital is private equity, the reverse is not always true.

Confused a little? This article aims to dive deeper into the difference between venture capital and private equity and how to best position yourself to be more attractive to your potential investors.

Five key differences between private equity  and venture capital funds to keep in mind

1) Investment Stage and Company Focus:

The key difference between a private equity firm and a venture capital firm lies in the stage of investment and the types of companies they typically invest in.

For private equity firms to take an interest:

Your company must be established with stable cash flows and a proven business model. They typically don't invest in or target private companies still going through the startup phase because their intention is to buy the majority of the business from the owner. That means the business needs to have reached maturity in its operations.

In addition, your company needs to have a track record of generating revenue and profits. Private equity funds seek opportunities to enhance operational efficiency, expand market reach, or pursue strategic acquisitions that drive growth for an already profitable business.

According to research from Prequin, a leading source of data and intelligence for the alternative assets industry, the majority of PE investments are made in established companies in industries such as healthcare, technology, consumer goods, and manufacturing.

For venture capital firms to take an interest:

Your startup simply needs to demonstrate you've got high growth potential and that you've got some disruptive technologies or innovative business models. Early-stage companies are extremely desirable to venture capital funds, where investors typically look to see what kind of people are behind the strong vision and bold promises.

VC investors typically work with companies that are still developing their products and those looking to establish market traction or build and scale their teams. The goal here is to provide capital injection and post-investment support to help these startups grow and scale. That means you can get VC investors to fund your business even if you have little to no revenue or profit as long as you can demonstrate their investment will potentially generate huge returns.

Research from the National Venture Capital Association (NVCA) highlights that VC investments predominantly target technology-driven sectors such as software, biotechnology, artificial intelligence, and fintech.

2) Risk and Return Profile:

What PE firms are looking for:

PE investors are generally considered to have lower risk tolerance and usually seek to invest in low-risk investments. This is because PE firms tend to target more mature companies with a proven track record of generating revenue and profits, reducing the risk associated with early-stage ventures.

PE investments typically generate returns through steady cash flow streams, operational improvements, and eventual exits through initial public offerings (IPOs) or sales to other companies. However, the returns from PE investments may be more moderate compared to the potentially exponential returns associated with successful VC investments.

What VC firms are looking for:

While both private equity firms and venture funds are subject to risk, venture capitalists tend to have a higher appetite and tolerance, which is why early-stage companies are exciting for them. They understand the uncertainty and nature of early-stage startups. Although as many as 90% of startups fail to achieve profitability or market viability, leading to a higher risk of capital loss for investors, VCs are willing to take a chance because the rewards of those who do make it are well worth it. Think of brands like Uber, Air BnB, and Facebook to name a few of the many that have exceeded expectations for both the investors and the marketplace.

With great risks comes great rewards for VCs. Investments typically yield exponential returns, often far exceeding the initial investment. Research from Cambridge Associates, a global investment firm, highlights the potential for outsized returns from successful VC investments, with top-performing funds generating multiples of invested capital.

3) Investment Size and Structure

Private equity firms typically invest in larger-sized companies and institutions with high valuation metrics, a strong and scalable business model, and a business with tangible assets. This is because PE deals are typically financed through a combination of debt financing(leverage) and equity. According to data from PitchBook, a leading financial data and research company, the median deal size for PE transactions is significantly higher than that for VC deals. PE transactions often involve multimillion or multibillion-dollar investments to acquire controlling stakes in target companies.

Conversely, venture capital investments tend to be much smaller in size, especially because their VCs deal with early-stage startups that usually don't have a strongly defined positioning in the marketplace and no cashflow stability.

A venture capital investor would also not take a controlling share of the deal, unlike a PE investor, ensuring their stake in the game (should the startup fail) doesn't ruin the firm. Startups at the seed or Series A stages typically require relatively modest amounts of capital to fund product development, market validation, and initial growth.

Research from Crunchbase indicates that the average VC deal size for early-stage investments is substantially lower than that for PE transactions. VC investments at the seed or Series A stages may range from hundreds of thousands to a few million dollars.

4) Investment Horizon

Both private equity and venture firms work with clear exit strategies and limited time horizons, though it may differ from fund to fund depending on their vision, the markets they work in, and the size of their firm. Private equity firms tend to buy controlling shares, immediately roll out strategic changes to drive performance and growth, release inefficiencies, optimize for profit, and then exit.

The rule of thumb for most private equity firms is to more than double the value of the investment within three to five years.

More often than not, private equity firms will target brands with strong positioning in the marketplace that are perhaps underperforming or struggling in some way, shape, or form that prohibits their ability to maximize profits. Consequently, many private equity companies have experienced tremendous growth within a relatively short time period once acquired by a PE firm.

A great example of this was when Dunkin Brands was acquired by the Carlyle Group back in 2006. The Carlyle Group, partnered with Bain Capital and Lee Partners, acquired 33% of the Dunkin Brands Group, a quick-service restaurant that offers coffee and baked goods. It already had a strong position in the US marketplace, but it was mostly regional.

During the holding period, Carlyle's value creation strategies enabled the brand to enter new US markets and expand into Asia and Middle East markets. But it wasn't just the global reach they got. Dunkin Brands was able to increase operational efficiencies, decreasing store build-out costs by 24%. They were able to generate more repeat customers through menu and coffee/beverage innovations that also increased sales. By 2013, Dunkin Brands Group had 11,000 Dunkin Donuts and 7,300 Baskin Robbins.

The typical holding period for most PE firms ranges from five to ten years or more, allowing sufficient time for the management team to execute the value-creation strategies that will optimize performance and help prepare for eventual existence. In recent years, we've seen a shift that focuses more on prioritizing sustainable growth and operational excellence to maximize returns over the investment lifecycle.

What about venture capital?

The typical time horizon a VC firm works with is much shorter, ranging from three to seven years, although there can be significant variation depending on the specific circumstances of each investment and market conditions.

According to data from the NVCA, successful VC exits through IPOs or acquisitions typically occur within five to seven years of the initial investment, highlighting the relatively shorter time horizon for VC investments compared to PE investments. A great example of this is when Andreeseen Horowitz invested $ 10 million in cloud company Okta while leading its Series A Round. The startup soon grew into a unicorn and, by 2017, had a $75 million funding round.

5) Exit Strategies

The ultimate goal in private equity and venture capital is to achieve a successful exit. This means that if you intend to raise capital or sell your company to investors, it is crucial to have a clear plan in place that enables your investors to reap their rewards.

Private equity investors tend to invest with the intention of exiting via one of three ways: an initial public offering (IPO), a sale to strategic buyers, or a secondary buyout. The choice of exit strategy depends on various factors, including the firm's vision, market conditions, and company performance.

An IPO can be a viable exit strategy if a company has a strong market position and is expected to continue to grow in the future. On the other hand, a sale to strategic buyers may be a better option if a company has a niche market position and would benefit from the resources and capabilities of an established player. Finally, a secondary buyout may be a good option if a company is not yet ready for an IPO or strategic sale but has the potential for future growth.

Conversely, VCs invest with the intention of reaching the holy grail of venture capital investing, an IPO. For a VC firm, an IPO is one of the best ways to realize significant returns on their initial investments and build a strong track record. While this isn't always the case (there are many small and thriving VC investors who opt for acquisitions by larger companies) all venture capitalists want to know how their equity stake will generate profitable returns at the end of their investing cycle and the best founders figure out a way of outlining this path during the pitch process.


Now that you understand these nuanced differences in how the game is played between private equity and venture capital firms, it's time to do your research and identify the opportunities that will drive significant results for your business and investors.

Whether you're going after PE investors, venture capitalists, or even angel investors, all private equity professionals with the resources and desire to fund your business development, always keep in mind the ultimate objective.

You might also enjoy reading: Navigating the Digital Landscape - How Startups Can Thrive

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