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

Private Equity vs. Venture Capital 101

Private equity and venture capital, though related, are more like cousins than twins. They are both alternative assets that pool money from accredited investors through a private placement offering and make a profit through various exit strategies. They do not have to be registered with the SEC, which requires certain securities to comply with standard reporting rules. However, this is about where the similarities stop and the point at which investors should learn how to differentiate private equity vs venture capital.

Private Equity vs Venture Capital: Comparing Key Characteristics

In simplest terms, private equity firms invest money into private companies.* Venture capital can be viewed as a segment of private equity, at least from an academic point of view.

But for the purpose of making investment decisions, their individual characteristics are sufficiently distinctive that we should treat them as separate asset classes.

Those characteristics include:

  • Target companies
  • Risk-Reward profiles
  • Minimum capital contributions
  • Deal structures
  • Liquidity
  • Tax benefits
  • Control vs. minority share acquired
  • Investor expertise

(There are others, too. See comparison chart below.)

*By private companies, I mean companies whose ownership shares or units are not traded publicly, because the owners want to restrict the number and/or kinds of people who can invest in them.

Differences in Investment Targets

Private equity investors 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.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Basic Investment Principles 101 – From Asset Allocations to Zero Coupon Bonds and Advanced Investing Topics: Unicorns and Pre-Unicorn Scalable Private Company Propositions. This is an updated version of an article originally published on January 30, 2013.]

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About David M. Freedman

David M. Freedman has worked as a financial and legal journalist since 1978. He has served on the editorial staffs of business, trade and professional journals, most recently as senior editor of The Value Examiner (National Association of Certified Valuators and Analysts). He is coauthor of Equity Crowdfunding for Investors, published in June 2015 by…

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