Private Equity vs Venture Capital

At the first glance, private equity and venture capital appear quite similar. Indeed, they have comparable structures: in both, firms invest in private companies with plans of selling down the road and making a profit. If you own a company and are considering how outside investors could help you, understanding private equity vs venture capital is relevant.

Private Equity vs Venture Capital: the Similarities

Both venture capital and private equity firms operate in the private market. That means they either invest in privately held companies or, in certain rare cases, invest in a public company and take it private. 

In addition, both types of firms operate with a Limited Partner (LP) framework. In order to raise capital to invest in companies, the firms work with high net worth individuals, institutional investors, or foundations. These investors, called Limited Partners, agree to provide a certain amount of capital, or “committed capital”, for the investment. 

Both venture capital and private equity firms charge their LPs a management fee: typically 1.5-2% of the applicable assets. They also charge carried interest: around 20% of the investments’ profits once the minimum return is met.

And, as stated earlier, the firms have the similar end goal of selling the company at a higher price in the future, thus capitalizing on the investment.

Venture Capital Firms

Venture capital firms differ from private equity firms in a few key ways.

Company Types

One primary way is the type of companies venture capital firms typically invest in. These firms focus on early-stage companies they deem have a high potential for growth. However, there is a catch: just as these companies with an uncertain future could result in a big success, they might fail. So, while the payoff could be higher than private equity investments, the risk is also higher. Common industries for venture capital firms to invest in are technology, information technology, and biotechnology.

Investment Size

Venture capital firms typically make smaller investments than private equity firms: the initial investment is usually between $1 and $10 million. This is because venture capital firms often concentrate on younger companies that are in the earlier stages of business. However, as some successful venture backed companies grow, the additional funding rounds can become very meaningful and raise hundreds of millions of dollars.

Investment Structure

Venture capital firms frequently acquire a minority stake in the company. In other words, they make up less than 50% of ownership. This stake is usually funded with cash, in return for purchased equity, and venture backed firms rarely use debt because these early stage companies need cash to grow, and are often unable to amortize funded debt.

Private Equity Firms

As you may expect, private equity firms are different from venture capital firms in a few notable ways.

Company Types

Unlike venture capital, private equity firms invest in mature companies. Depending on the firm, these companies can vary widely in size— from $5 million to billions of dollars. While these established companies are a lower risk investment than the younger companies of venture capital, they can still need guidance to grow. For example, the company may be operating inefficiently or may need equipment updates. 

In contrast to venture capital, private equity firms focus on a wider range of industries and make more conservative investments. Thus, the potential for very large investment returns is lower than for venture capital— but so is the chance of business failure.

Investment Structure

Unlike venture capital, private equity firms typically use a combination of debt and equity. Mezzanine debt, senior debt, and seller notes are frequently used as leverage. This is because, unlike with startup companies, these developed companies are able to pay back debt from ongoing business operations. 

Private equity firms also usually acquire a majority stake in the company, or over 50%.

Beyond Private Equity vs Venture Capital

There are some investment firms that do not fit a definition. One such firm is 1719 Partners. 1719 Partners has some common ground with private equity: we aim to grow small businesses, we have the transaction experience necessary to close deals, and we have established financing connections. 

But we are unlike standard private equity firms in that we do not invest in companies just to profit from the later sale. Our focus is on our companies’ long term success, and we realize this looks different for each different business. Our mission is to always do what is best for the company, and this means investing thoughtfully and patiently. For this reason, we have no predetermined sell date. In other words, we buy to hold. If you have questions on the pros and cons of private equity, or are curious about 1719 Partners’ mission, please contact us.