Financial Poise
mismatched shoes, symbolizing the differences between private equity and venture capital

Private Equity vs. Venture Capital 101

Private equity funds and venture capital funds, though related, are more like cousins than twins. They are both alternative assets, uncorrelated with the general market. They both pool money from accredited investors through private placement offerings, invest the pooled capital in private portfolio companies, and make a profit through various exit strategies. Shares in PE and VC funds are securities, but they do not have to be registered with the SEC, so they do not have to comply with standard reporting rules.

In PE and VC, the fund manager decides what portfolio companies to invest in, largely without input or approval from investors. Each year the management team earns a fee based on the value of the portfolio and any gains generated from asset sales and, at some point, passes along some of the gains, if any, to investors.

That is about where the similarities stop and the point at which investors should learn how to differentiate private equity and venture capital. For the purpose of making investment decisions, their individual characteristics are sufficiently distinctive that we should treat them as separate asset classes (see chart below).

Private Equity vs. Venture Capital: Differences in Investment Targets

Private equity fund managers tend to target relatively mature companies which may be underperforming or undervalued, with the goal of improving their profitability and selling them for a return on their investment (capital gain) – or in some cases, splitting them apart and selling their assets at a profit. In general, private equity has less tolerance for risk.

Venture investors, on the other hand, target early-stage and expanding companies (often pre-revenue) with fast-growth potential, with the objective of nurturing and growing them quickly, then selling them in M&A deals or taking them public. Venture capital, therefore, is considered less risk-averse than private equity.

The chart below gives a side-by-side comparison of private equity vs venture capital.

Comparison Chart for Investors: PE and VC

Private Equity Venture Capital
Target Companies Mature companies, often under-performing or under-valued Startups, early-stage companies (usually pre-revenue)
Target Industries All industries, usually with established marketplace for the product or service High-growth industries like high-tech, biomedical, or alternative energy
ROI Expectation* ROI depends on the inherent risk of the particular firm and industry. The target can be 20%/yr over five years, more likely 10%/yr or less. Many failures, some solid returns, a few spectacular successes. Expectations must reflect the risks.
Investment Size ($) $100 million to 10s of billions for big PE funds; $10+ million for small funds & individuals < $10 million
Liquidity Horizon 6 to 10 years 4 to 7 years
Share Acquired by Investor/Fund Often 100% control of the company Often minority stake in the company
Funding Structure Equity and debt Often equity only, but it can be structured to fit the needs of both parties**
Investor Active? Investors may be passive concerning management unless the purpose of acquisition is to improve company performance. Investors provide advice, connections, distribution; monitor cash burn; etc.

* ROI = return on investment
** Often a convertible instrument is used and triggered by pre-defined milestones. All entries in the comparison chart are estimates and generalizations.

In Europe, PE professionals further categorize the field into growth capital and mezzanine capital, also called convertible debt.

Both of these fall between PE and VC regarding the life stage of the target companies — growth capital being more established than venture startups and mezzanine being not quite as “mature” as buyout targets.

For more about how these four segments compare, I recommend Chapter 1 of the book Private Equity as an Asset Class by Guy Fraser-Sampson.

Convergence of Asset Classes

In the past decade or so, private equity and venture capital, as asset classes, have been converging in some respects. As venture capital invests greater capital (within fewer transactions), the industry is starting to look more like private equity, and vice versa.

Venture capitalists are rethinking their risky strategies by investing more in late-stage companies, which promise more growth. Meanwhile, private equity’s record-breaking amounts of capital need more places to go, and tech – though typically the sector of choice for venture capitalists – seems to be a promising area for returns. This means that more private equity investors are seeking companies that are not quite as mature.

As the global markets evolve, as the economy changes, and as investors reevaluate their tolerance for risk, private equity and venture capital will continue to change. Knowing the differences in private equity vs. venture capital allows investors to recognize the impact of the changes happening within each.

We think you’ll also like

  1. Small Business Investing: Taking Stock in Main Street
  2. How to Target Regulated Equity Crowdfunding Deals
  3. The Fine Print on Investing in Venture Capital

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

  1. What is a “Private Fund”
  2. Due Diligence Before Investing

This is an updated version of an article originally published on January 30, 2020. ]

©2022. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.

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About David M. Freedman

Dave Freedman has worked as a journalist since 1978, primarily in the fields of law and finance. He is a co-author of Equity Crowdfunding for Investors: A Guide to Risks, Returns, Regulations, Funding Portals, Due Diligence, and Deal Terms (Wiley & Sons, 2015). He currently analyzes turnaround stocks for Dave has also written extensively…

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