As already outlined, ‘private equity’ as a generic asset class term encompasses a multitude of different investment strategies, including venture capital. However, when used at the investment level there are key differences between private equity and venture capital investments; foremost of which is the maturity of the portfolio companies invested in. Venture capital investments are characterized by providing capital to young, start-up, or early stage businesses that are or have the potential to grow quickly.
VC investments are characterized by iterative rounds of financing with additional capital provided as growth/return on investment is achieved. Private equity investments are typically in larger, more mature businesses with proven financial record. Further differentiating traits include:
– VC investments are higher risk than PE, due to the unproven nature of the businesses invested in.
• Ownership stake
– VC firms typically acquire minority stakes whereas PE firms acquire controlling stakes.
– VC firms normally make pure equity investments whereas PE firms use equity and debt.
• Investment amount
– PE investments are typically larger than VC investments as they acquire greater ownership stakes and are in more mature businesses.
• Value creation
– VC investments rely on company growth and valuation of the business increasing, whereas PE investments rely on both growth and financial engineering including multiple expansion, debt settlement, cash generation, and so on.
As the industry has grown and firms have broadened their offerings for investors, lines have blurred. Some VC firms have moved into expansion and growth areas, and some firms also provide debt financing (venture debt) to pre-revenue companies. Some traditional PE firms are also moving down the chain, raising dedicated funds focused on early-stage start-up investments.