Private Equity vs. Venture Capital | The In-Depth Guide

Private equity vs venture capital are two critical pillars of private company investments, each with distinct strategies, investment approaches, and risk appetites. While both aim to generate significant returns, their methodologies and target companies differ considerably. This guide provides an enhanced, in-depth analysis of these two investment models, outlining their key differences, similarities, and the value they bring to companies at various stages of growth.

What is Private Equity (PE)?

Private equity firms typically invest in mature, well-established companies with a proven track record of stable revenues and profitability. Private equity investors focus on stable, mature companies and invest significant capital in them, aiming to exert control over the company’s decision-making process and improve profitability by acquiring a majority stake. The primary goal of PE is to optimize the business's performance and enhance its value, often through ownership changes or operational adjustments.

• Focus: Mature, established companies with stable cash flows
• Objective: Drive operational improvements or restructure businesses
• Ownership: Tend to acquire majority ownership or complete buyouts, often involving buyout firms



What constitutes a controlling interest in a company?

Controlling interest does not adhere to a bright line test and it is situation specific based upon the Universal Shareholders' Agreement (USA) and the Articles of Incorporation. The USA defines what constitutes an ordinary and a special resolution. To put in layman terms a shareholder has control over a corporation if they control the Board votes. For example, they have 3 of the 5 Board seats. Or they own 50+% of the shares in a corporation in the case of simple majority. However, a shareholder does not have to have to own 50% or more of the shares.



What is Venture Capital (VC)?

Venture capital firms, on the other hand, focus on early-stage startups with high growth potential. These firms often provide seed funding to early-stage startups. These companies often lack the financial history and stability of more mature firms but present significant upside due to innovation or disruptive technologies.



• Focus: Startups and early-stage companies
• Objective: Foster rapid growth through innovation and market expansion
• Ownership: Typically take minority stakes in multiple companies to diversify risk

How are VC Firms organized?

VC firms are organized as follows:

• General Partner. This is the company that actively raises, manages and administers a fund.
• Limited Partners: The collection of companies or individuals that invest in a specific fund.

Typically, VC firms are looking to make investments that they believe hold great development potential in the future. They go after companies with Big Hairy Audacious Goals (BHAGs) and big Total Addressable Market (TAM).



Who can be a Limited Partner?

Generally speaking these are accredited investors, corporations, financial institutions and government. The bigger the size of the fund that the VC firm raises, the bigger the size of the organization that participates in a fund. It is fairly common for VC firms to co-invest or to participate in a fund of another VC firm.

The largest LP cheques come from institutional investors and asset management firms (think pensions funds, university endowment funds, sovereign wealth funds, etc.).



Venture Capital vs. Private Equity: Top 10 Differences

So what are the differences between venture capital and private equity:



1. Type of companies they focus

The main difference between venture capital and private equity is that, while venture capital chooses to invest in earlier stage companies with great development potential. Private equity chooses later stage, mature companies that are struggling because of inefficient leadership, poor liquidity, inefficient processes, etc. leading to a depressed valuation for a given company.



2. Level of risk

Venture capital investments tends to be significantly higher risk than private equity investment. VC investments tend to focus on early stage companies that are redefining existing or creating new industries. High risk, high potential rewards. On average, VC firms invest in 0.5% of the companies that they evaluate. As such, dealflow is a key area focus for VC firms and many of the deals that VC firms invest in are syndicated.



3. Control over the business

First, keep in mind that you will always lose some control over your company. Private Equity firms seek control over the business while Venture Capital firms typically take up to 25% of the company as part of a financing round. VC firms was the founding team to have as much "skin" in the game as possible in order to drive forward with zealousness. VC firms rely on the founding team and the leadership team to execute on their vision where as PE firms set the vision.



4. Amount of return

Typically, the venture capital returns of a well managed funds produces significantly higher returns than private equity, even though venture capital is riskier. The typical fund has 10% to 20% of the companies generate almost all of the returns. In a fund of 10 companies, 1 or 2 or the soonincorns/unicorns, 4 to 6 generate modest returns, and 1 or 2  turn out to be failed investments.



5. Type of growth

While venture capital investors are interested in long-term growth, private equity investors are only interested in solving the company's problems as quickly as possible, so that they can sell it faster. Generally speaking PE firms have shorter investment horizons although this is not true in all cases.



6. Type of investors

The venture capital investors (aka Limited Partner) usually are high net-worth individuals (typically accredited investors although the securities and exchange commission have started to relax the rules), investment banks or specialized VC funds. Private equity capital primarily comes from institutional investors: asset management firms, pension funds, endowment funds, banks, etc. The most notable exception are family offices. Family offices are typically focused on private equity investment and as the name suggests the money for the investment comes from one high net-worth family.



7. Amount of money invested

This is highly dependent upon the fund raised and the stage of companies that they invest in. Generally speaking VC firms usually usually write checks ranging between 500K and 100M. On the other hand private equity investors usually spent 100 million dollars, because the company they choose is already established. But the two investments have a significant overlap in terms of cheque sizes.



8. Industries they focus on

VC firms usually focus on startups oriented in new and emerging industries (e.g. technology, biotechnology and clean technology), etc.), while PE firms focus on more established and mature industries where they can drive market consolidation.



9. Number of businesses they focus

VC firms typically invest in a multitude of startups at the same time through one of their funds. A typical fund's life is 7 years with 2+2 years to extend + wind down the fund. A successful VC firm start raising a new fund 2 to 3 years into the life of an existing fund. As such a successful firm can have 4 to 6 funds at the same time. On the other hand, private equity investors only focus on several established businesses.



10. Resources used for the investments

Venture capital firms acquire ownership in a company through the investment of capital and provision of services. Private equity investors, on the other hand, use capital to acquire full or controlling ownership of a company.



Private Equity Investment Approach

Investment Strategy

Private equity firms seek to invest in companies they believe have untapped potential or operational inefficiencies that can be optimized. Private equity firms also engage in growth equity investments to support companies with high growth potential. This often involves taking companies private or leveraging debt to increase returns on equity.

• Deal Size: Usually $100 million and above
• Ownership: Majority or full ownership to exert control over business strategy
• Approach: Leveraged buyouts, recapitalizations, and restructurings

Focus Areas

Private equity investments often emphasize:

• Operational efficiency improvements: Reducing costs and enhancing profit margins
• Cost-cutting measures: Streamlining operations to boost profitability
• Financial engineering: Utilizing leveraged buyouts (LBOs) to maximize returns

Exit Strategies

PE firms tend to exit their investments after several years through typically



• Initial Public Offerings (IPOs)
• Strategic sales to larger corporations or industry players
• Secondary sales to other PE firms or financial investors
• Management buyouts are another common method for private equity firms to exit their investments

Hedge funds often play a significant role in the secondary markets for publicly traded companies post-IPO, contrasting the regulatory scrutiny faced by public companies with the less stringent environment of private markets.

Venture Capital Investment Approach

Investment Strategy

Venture capital firms primarily focus on high-growth startups, often in industries like technology, biotech, and fintech, providing crucial venture capital funding to these companies. Venture capital firms prefer investing in startups with high growth potential, diversifying their investments to spread out risk across multiple companies. The risk of failure is higher compared to a private equity firm, but so is the potential for outsized returns if the company succeeds.

• Deal Size: Typically $10 million or less per deal, depending on the relative maturity, industry and TAM.
• Ownership: Usually minority stakes, less than 50% of equity
• Approach: High-risk, high-reward investments aimed at capturing rapid growth

Focus Areas

Venture capitalists generally center their investments around:

• Innovative and high-growth sectors: Technology, biotech, and SaaS
• Specific stages of investment: From seed rounds to later-stage financing. Venture capitalists often collaborate with angel investors during the early stages of investment.
• Targeted regions or sectors: Often concentrating on specific geographies or industries

Exit Strategies

VC firms aim to realize returns through:

• IPOs: Taking the startup public
• Acquisitions: Selling to larger companies seeking to integrate innovation
• Secondary Sales: Selling shares to other venture or private equity firms



Key Differences in Investment Strategies

Venture capital funds are typically directed towards early-stage startups, while private equity funds encompass a broader range of investments in both private and public companies.

Investment Size and Company Types

Private equity firms and venture capital firms differ significantly in terms of investment size and the types of companies they target. Private equity firms typically invest in mature companies with established revenue streams and a proven track record of profitability. These investments often involve substantial amounts of capital, frequently in the hundreds of millions of dollars. The goal is to optimize the performance of these mature companies, often through operational improvements or strategic restructuring.

In contrast, venture capital firms focus on early-stage startups that exhibit high growth potential but may lack a stable financial history. Venture capital firms invest smaller amounts, usually under $10 million, in these startups. The aim is to foster rapid growth and innovation, betting on the potential for significant returns as these companies scale.

The types of companies also vary between private equity and venture capital firms. Private equity firms invest in a broad range of industries, including manufacturing, retail, and IT, where they can leverage their expertise to drive operational efficiencies. On the other hand, venture capital firms concentrate on high-growth sectors such as software, technology, and biotech, where innovation and market disruption are key drivers of value.

Industry Focus and Investment Size

The industry focus and investment size of private equity firms and venture capital firms are closely intertwined. Private equity firms tend to invest in industries characterized by stable cash flows and established business models, such as manufacturing and retail. These industries often require larger investments to achieve significant returns, aligning with the substantial capital that private equity firms are prepared to deploy. Private equity firms provide substantial capital infusion to mature companies to drive growth and operational improvements.

Conversely, venture capital firms target high-growth industries with innovative business models, such as software and biotech. These sectors are typically in the early stages of development and require smaller investments to achieve substantial growth. The high-risk, high-reward nature of these industries aligns with the venture capital firm’s approach of investing smaller amounts across a diversified portfolio of startups.

The investment size also varies depending on the industry. Private equity firms may allocate larger amounts of capital to industries with high barriers to entry, such as manufacturing, where significant investment is needed to drive operational improvements and achieve economies of scale. In contrast, venture capital firms may invest smaller amounts in industries with lower barriers to entry, such as software, where the primary focus is on innovation and rapid market penetration.

In summary, private equity firms and venture capital firms have distinct investment strategies. Private equity firms invest larger amounts in mature companies within stable industries, aiming to optimize performance and drive value. Venture capital firms invest smaller amounts in early-stage startups within high-growth industries, focusing on fostering innovation and capturing market opportunities. The industry focus and investment size of these firms reflect their respective approaches to generating returns.

What are the Differences in Sector Preferences?

PE and VC firms often have different sector preferences due to their distinct investment strategies and risk profiles. Here's a brief overview of typical sector preferences for each:

Private Equity:

1. Healthcare and Life Sciences
2. Technology and Software
3. Business Services
4. Consumer and Retail
5. Industrials and Manufacturing
6. Financial Services
7. Energy and Natural Resources

PE firms often focus on more mature industries with stable cash flows, strong market positions, and potential for operational improvements.

Venture Capital:

1. Technology (Software, SaaS, AI/ML, Blockchain)
2. Biotechnology and Healthcare IT
3. Fintech
4. E-commerce and Consumer Internet
5. Clean Energy and Sustainability
6. Enterprise Software
7. Cybersecurity

VC firms typically invest in high-growth potential startups and emerging technologies, often in more disruptive and innovative sectors.

It's important to note that these preferences can vary widely among individual firms and may change over time based on market conditions and emerging opportunities. 



Operational Focus and HR Strategy

It's important to note that these preferences can vary widely among individual firms and may change over time based on market conditions and emerging opportunities.

Management Approach

PE firms often take an active role in a company's day-to-day operations, making significant changes to improve performance. This may involve replacing or restructuring the management team.



• PE: Hands-on management style, with a focus on financial and operational improvements
• VC: Typically more hands-off, providing strategic guidance but leaving daily operations to the company’s founders

Hiring Strategy

In line with their distinct operational focus, the two types of firms often seek different skill sets when building or advising the management teams of their portfolio companies.

• PE: Prioritizes experienced professionals in finance, operations, and strategy, capable of executing significant business transformations.
• VC: Focuses on entrepreneurs and innovators who can drive disruptive technologies and rapid market growth.

Sources of Returns

Private Equity Returns

Private equity firms typically generate returns through a combination of value-creation strategies such as:

• Debt financing: Leveraging the company to increase equity returns
• Operational improvements: Enhancing profitability through efficiency
• Financial engineering: Using sophisticated financial structures to maximize value

Venture Capital Returns

VC firms focus on creating value through:

• Equity investments: Investing in high-growth companies
• Expansion and scaling: Supporting portfolio companies through growth and scaling phases
• Increased valuations: Benefitting from exponential growth in company value



Which is riskier: private equity or venture capital?

From an investment standpoint, venture capital investments are usually riskier than private equity investments. Higher risk typically leads to a higher rewards. This is due to the fact that the former focus on startups that have a great potential for future development, but are not yet fully established in the market. In any case, you should keep in mind that the return on investment is also usually higher. If you are considering becoming a LP, make sure that you have clear understanding of the risk associated with the investments and that you employ an asset and investment diversification strategy.



Which is better: private equity or venture capital?

It always depends on what you are looking for, the outcome that you are seeking to achieve, the time horizon in mind, etc.

If you are looking for an exit, you are not looking to continue with the company, there is an immediacy of need, the company valuations are well established and understood in the industry, and so forth, then the PE route is a better choice.

However, if you are blazing a path in a new industry, the market size is very large, the funding needs will be continuous, customer revenue may not yet be visible on the horizon, you are on a journey that will take many years to execute, you want to stay on with the company in a leadership capacity, then the VC route is the clear winner.