Private Equity vs. Venture Capital: An Overview

Private equity is sometimes confused with venture capital because they both refer to firms that invest in companies and exit through selling their investments in equity financing, such as initial public offerings (IPOs). However, there are major differences in the way firms involved in the two types of funding conduct business.

Private equity and venture capital buy different types and sizes of companies, invest different amounts of money, and claim different percentages of equity in the companies in which they invest.

Private Equity

Private equity, at its most basic, is equity—shares representing ownership of, or an interest in, an entity—that is not publicly listed or traded. Private equity is a source of investment capital that comes from high net worth individuals and firms. These investors buy shares of private companies—or gain control of public companies with the intention of taking them private and ultimately delisting them from public stock exchanges. Large institutional investors dominate the private equity world, including pension funds and large private equity firms funded by a group of accredited investors.

Because the goal is the direct investment in a company, a lot of capital is needed, which is why high net worth individuals and firms with deep pockets are involved.

Venture Capital

Venture Capital is financing given to startup companies and small businesses that are seen as having the potential to break out. The funding for this financing usually comes from wealthy investors, investment banks, and any other financial institutions. The investment doesn't have to be just financial, but can also be offered via technical or managerial expertise.

Investors providing funds are taking a risk that the newer company delivers, and doesn't deteriorate. However, the tradeoff is potentially above-average returns if the company delivers on its potential. For newer companies or those that have a short operating history—two years or less—venture capital funding is both popular and sometimes necessary for raising capital, particularly if they don't have access to capital markets, bank loans, or other debt instruments. The one downside for the fledgling company is that the investors often get equity in the company and, therefore, a voice in company decisions.

Key Differences

Private equity firms mostly buy mature companies that are already established. The companies may be deteriorating or not making the profits they should be due to inefficiency. Private equity firms buy these companies and streamline operations to increase revenues. Venture capital firms, on the other hand, mostly invest in startups with high growth potential.

Private equity firms mostly buy 100% ownership of the companies in which they invest. As a result, the companies are in total control of the firm after the buyout. Venture capital firms invest in 50% or less of the equity of the companies. Most venture capital firms prefer to spread out their risk and invest in many different companies. If one startup fails, the entire fund in the venture capital firm is not affected substantially.

Private equity firms invest $100 million and up in a single company. These firms prefer to concentrate all their effort into a single company since they invest in already established and mature companies. The chances of absolute losses from such an investment are minimal. Venture capitalists spend $10 million or less in each company since they mostly deal with startups with unpredictable chances of failure or success.

Special Considerations

Private equity firms can buy companies from any industry, while venture capital firms are limited to startups in technology, biotechnology, and clean technology. Private equity firms also use both cash and debt in their investment, but venture capital firms deal with equity only.

These observations are common cases. However, there are exceptions to every rule; sometimes one firm type does things out of the norm for its kind.

Key Takeaways

  • Private equity is investment capital in a company or other entity that is not publicly listed or traded.
  • Venture Capital is funding given to startups or other young businesses that show potential for long-term growth.
  • Private equity and venture capital buy different types of companies, invest different amounts of money, and claim different amounts of equity in the companies in which they invest.

Advisor Insight

Rebecca Dawson
Silber Bennett Financial, Los Angeles, CA

With private equity, multiple investors’ assets are combined, and these pooled resources are used to acquire parts of a company, or even an entire company. Private equity firms do not maintain ownership for the long term, but rather prepare an exit strategy after several years. Basically, they seek to improve upon an acquired business and then sell it for a profit.

Whereas, a venture capital firm invests in a company during its earliest stages of operation. It takes on the risk of providing new businesses with funding so that they can begin producing and earning profits. It is often the startup money provided by venture capitalists that gives new businesses the means to become attractive to private equity buyers or eligible for investment banking services.