Now and then, we come across private equity and venture capital. Often we use the two terms interchangeably, but the two differ widely. Private equity and venture capital firms are similar in the way that both invest in companies in equity financing and sell their investments but how the companies operate differs too.
Private equity and venture capital also differ in the way that they buy different types and sizes of companies, invest a different amount of money, and claim different percentages of equity in the companies they invest.
Here are a few characteristics of private equity and venture capital firms:
– Private equity is the capital invested in a company that is not publicly listed or traded.
– Venture capital is the funding given to start-ups and small businesses that show potential for sustainable and long –term growth.
– The types and sizes of companies in which private equity companies and venture capitals invest differ widely. They also claim different amounts of equity in the companies they invest in.
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Understanding private equity and venture capital
If we strip private equity to its bare minimum, it comes down to equity, which are shares that represent ownership and interest in a company that is not publicly listed. Private equity is a source of investment for companies that are looking for capital to expand their business or in times of financial needs. Typically, high –net worth individuals and private equity firms are investors for these companies. Sometimes firms can buy shares of private companies to gain control of public companies and take them privately after delisting them from stock exchange.
Institutional investors form a large part of the private equity world including pension funds and PE firms that are funded by accredited investors.
Venture Capital, on the other hand, is financing given to start-ups and small companies that show the potential to break out. This usually happens when the price of business moves above a resistance or below a support area. Venture capital comes from wealthy investors, investment banks, and other financial institutions. Venture capital doesn’t always come in the form of financial, but can also be technical or managerial expertise.
In the case of venture capital, investors are simply betting that the new company will deliver and will not deteriorate. The tradeoff is simple: Above average returns, if the company delivers on its potential.
Venture capital is popular among new companies with a short operating history (2 years or less). It is sometimes necessary for raising capital for them. This becomes particularly necessary if the company doesn’t have access to capital markets, bank loans, or other debt instruments. Often, investors get equity in the company and become a voice in the company decisions.
Key Differences Between Equity Capital and Venture Capital
PE firms mostly buy mature companies that are already established. The companies may be deteriorating or failing to make the profits they should due to inefficiency. PE companies buy these companies and streamline operations to increase revenues. Venture capital firms, on the other hand, mostly invest in startups with high growth potential.
One of the key differences in the operations of private equity companies and venture capital firms is – PE funds buy mature companies that have a substantial market share but are failing to make profits due to inefficiency.
The other major difference between private equity and venture capital is – PE firms buy 100% ownership of companies. This gives them total control of the company. Venture capital firms, however, buy 50% or less stake in a company. This minimizes risk for them. In case one start-up fails, the entire fund in the venture capital is not affected completely and VC firms can still make a profit on their investments.
Coming to the amount of investment, PE funds invest $100 million or more in a company. The idea is to concentrate all their efforts on a single company and bring it to profitability. The risk of absolute loss is minimal in such investments. VC firms invest less than $10 million or less on every company they invest in. Moreover, the chances of success for start-ups are far less than mature companies.
Another prominent difference between private equity firms and venture capital firms is – PE firms are typically open to buy companies from any industry sector, while venture capital firms restrict themselves to one particular sector – technology, energy, telecommunications, etc. Moreover, PE funds deal with cash and debt, but venture capital firms deal with equity only. These are general operating rules. A firm can operate out of the norm and take a completely different route.