What’s the difference between Private Equity and Venture Capital?

Understanding the contrast between private equity (PE) and venture capital (VC) lies in their investment focus.

Distinctive Traits of Private Equity:

  • PE enterprises commonly engage with established businesses in traditional sectors.
  • Leveraging capital from LPs, PE investors commit to promising ventures, often securing a majority stake (>50%).
  • Upon selling a portfolio company, returns are divided, with investors receiving 20%, while LPs claim 80%.

Distinctive Traits of Venture Capital:

  • VC organizations typically support tech-oriented startups and fledgling businesses in their seed stage.
  • Utilizing committed capital, VC investors typically acquire a minority stake (<50%) in their invested companies.
  • These ventures, often unestablished and unprofitable, entail risks, yet the potential for substantial returns accompanies such risk.
  • Profit ensues for the firm through IPOs, acquisitions, or selling shares to another investor on the secondary market.

 

Common Ground Between PE and VC:

PE and VC enterprises both mobilize capital from accredited investors, termed limited partners (LPs), with the shared objective of investing in privately-owned businesses. Their mutual goal is to enhance business value and subsequently sell or profit from their equity stake.

Distinguishing PE from VC:

The principal contrasts between private equity and venture capital encompass:

  • The nature of companies they invest in
  • The levels of invested capital
  • The equity acquired through investments
  • The stage at which they engage in a company’s lifecycle

A Detailed Comparison of PE and VC: Private equity firms often secure a majority stake, over 50%, in mature businesses within traditional sectors. Typically targeting established companies facing operational challenges, the assumption is that correcting inefficiencies can render them profitable. However, this is evolving as PE firms increasingly acquire VC-backed tech companies.

In contrast, venture capital firms specialize in funding and mentoring startups, particularly tech-focused ones. Here, funding is exchanged for a minority equity stake, less than 50%, in these burgeoning businesses.

Venture Capital versus Private Equity explained