Table of Contents
What is venture capital and how does it work?
What is private equity?
Two similarities between venture capital and private equity
7 differences between venture capital and private equity
The bottom line
Aug 8, 2022
7 min read
VC firms invest in tech startups in the early stages, while PE firms invest in all sectors, typically in well-established companies they seek to improve and then sell.
Nearly all private business owners need capital, whether launching a new app for professional dog walkers, opening a new restaurant, or scaling an already thriving business. Founders often choose between two options for funding: take on debt with a bank loan or secure private investment.
The umbrella term for private investment is private equity, which technically includes venture capital. However, most founders today think of private equity and venture capital as two separate categories of private investment.
(VC) is a type of private financing geared for young startups, even pre-startups, typically in the tech sector—from biotech to fintech. VC also stands for venture capitalist, a person who invests in startups, usually part of a team in a venture capital firm—although some fly solo. Sequoia Capital, Accel, and Kleiner Perkins are all examples of VC firms, and they’re all located in California’s Silicon Valley. They made investments in once budding tech companies like Alphabet Inc. (formerly Google) and Meta (formerly Facebook), which are increasingly household names.
VC investment is typically made in exchange for equity or an ownership stake, with each deal having its own terms and conditions. When a startup fails, these investors can face major losses or zero returns on their investments. But wildly successful companies, like Apple and Amazon, have generated tens of millions of dollars for their early investors.
Venture capital includes different rounds of funding—pre-seed, seed to Series A, then Series B, and so on—that are contingent on a startup’s maturity stage. For instance, pre-seed investors, often called “angel investors,” invest in very early stage startups that are considered risky but could have higher returns than traditional investments. In 2021, approximately $329.9 billion of VC capital was invested in more than 17,000 deals in the US, according to the National Venture Capital Association (NVCA).
This type of financing has multiple players with different responsibilities. A venture capital firm’s general partners, who typically make final decisions on potential investments, might have previously founded their own startups or have expertise in finance, business development, or tech, among other sectors. Principals, associates, and staff vet founders and startups as potential investments. VC culture is more informal and non-conformist than many other industries in the financial sector like investment banking, asset management, or a bank associate.
Each VC firm has its own fund, possibly several. Each fund, or a firm's combined funds, could range from millions to billions of dollars. A mix of high-net-worth individuals and institutional investors, called limited partners (LPs), invest in these funds. While it varies, an average LP investment in a VC fund is $1 to $2 million.
(PE) invests in private—or public, soon to be taken private— businesses spanning all sectors, from consumer brands and media to energy and real estate. Private equity firms traditionally invest in more established companies than venture capital firms.
PE firms are perhaps best known for leveraged buyouts, investing in formerly successful companies on a downward trajectory and selling them after restructuring. But PE firms are involved in a variety of investment types beyond buyouts, including growth equity, which is investing in established companies in good financial standing as a minority stakeholder.
Blackstone Group, KKR & Co, and The Carlyle Group are well-known, global PE giants. Managing directors oversee teams involved with not only private equity funds, but also hedge funds, as well as investments in real estate, life science, energy, financial services, among other sectors. Still, there are plenty of smaller PE firms with a couple of managing directors and significantly less staff focusing on several growth equity investments.
Depending on the size of the PE firm, it might have one or hundreds of active portfolio companies. Investments can range from multiple millions or billions of dollars. High-net-worth individuals and institutional investors, considered LPs, invest in private equity funds. The average dollar amount to invest in a PE fund varies, but it’s typically in the multiple millions. The culture at PE firms is on the more formal side, similar to investment banking.
There are more differences than similarities between VC and PE firms’ investment types and strategies, but there is some overlap.
Both VC and PE firms invest in companies hoping to make high returns for their LPs, which are a mix of high-net-worth individuals and institutional investors.
It’s standard practice for VC firms—and to a lesser degree, PE firms—to help business owners they’ve invested in with mentorship, access to professional networks, legal advice, as well as help with management, sales, and marketing.
The differences between venture capital and private equity investments can be profound and subtle.
VC investments sizes vary due to the type of startup and funding round—pre-seed or Series D, for example. Firms generally invest $5 to $20 million in a Series A round, which is usually a startup’s first official round of financing. Global PE firms often invest more than $100 million in one company; smaller PE firms might invest $10 to $40 million.
VC firms invest in startups, early stages, or even before an official launch. PE firms, however, may invest in well-established (including once profitable) companies. If the business is restructured successfully, some PE firms sell the companies for a profit.
Since VC firms invest in young startups and no one can predict the future, these investments are considered extremely risky. VC firms typically invest smaller dollar amounts spread out in more portfolio companies than PE firms. Private equity investments are considered less risky because the companies are established and the PE firms are confident they can make a profit by improving, then selling, the company.
Startups taking VC funding maintain control over their companies as VC firms are a minority stake holder. Equity is given to VC investors at each round of funding, so founders will gradually own less of the startups, but that’s ideally counterbalanced by a startup’s higher valuation. PE firms, on the other hand, usually take a majority stake. They have the power to make significant changes to the business that could include day-to-day operations, replacing executives if they see fit, and selling the company.
VCs earn returns when a startup is acquired or goes public, making money when the company grows. That is not necessarily the case for PE firms, which can see their returns by selling their equity stake or through leveraged buyouts, where they make money on the debt, sometimes selling off portions of the company in the process.
The exit timeline between VC and PE firms is vastly different. VC firms are known to invest for the long haul while PE firms typically embrace a more short-term investment strategy. VCs earn returns when a startup is acquired by another company or files for an IPO, which might materialize over 6 to 10 years. PE firms typically see their return when a buyout is completed or they sell their equity stake, usually in 4 to 7 years.
While PE firms have the reputation of solely valuing profit above all else, there are scores of VC firms that specifically invest in female, Black, or immigrant founders—those who have historically not had easy access to capital. There are also VC impact firms that invest in social good startups focusing on the environment or issues around human rights.
While founders can bootstrap their businesses, many simply can’t launch or expand without the help of private investment. Private equity and venture capital are two ways to do that, but there are clear perimeters for both. VC firms invest in tech startups in the early stages, while PE firms invest in all sectors, typically in well-established companies they seek to improve and then sell at a profit. Since investing in early stage startups that have a higher probability of failure, VC is considered a riskier type of investment than PE. However, should a startup become successful, there’s a higher rate of return for VC investors.
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