The terms “private equity” and “venture capital” are sometimes used interchangeably, but they aren’t the same thing. While both terms refer to firms that invest in private companies in exchange for equity, they go about it in different ways.
What is private equity?
Private equity is when a group of investors makes a direct investment in a company. Private equity investors typically focus on mature companies that are past the growth stage. They will often provide funds to a business that’s in distress.
They will also sometimes buy out a business, improve its operations and then sell it for a profit. A private equity investor’s goal is always to make the company worth more than it was so they can generate a return on their investment.
[Read more: How to Choose the Right Private Equity Funds for Your Business]
Pros and cons of private equity
One of the advantages of bringing on a private equity investor is that you’ll have access to more than just cash— you’ll also get that person’s expertise. If they have experience within your industry, a private equity investor may help you find opportunities for improvement.
However, a private equity investor will usually take a majority stake in the company, which means they have a say in how the business is run. They have the power to get rid of executives or make major changes to the business.
Private equity investors have the power to sell the company if they think it’s the right move. Investors are on board to make money, so if the right opportunity comes along, selling is a real possibility.
Anytime you bring on investors, you’ll give up a certain amount of control over your business.
What is venture capital?
Technically, venture capital (VC) is a form of private equity. The main difference is that while private equity investors prefer stable companies, VC investors usually come in during the startup phase.
Venture capital is usually given to small companies with incredible growth potential. This type of investment is not easily obtained and tends to be riskier, but VC investors get involved because of the potential for very high returns.
[Read more: How to Raise Venture Capital Funding]
Pros and cons of venture capital
VC funding can be very helpful for new companies in the early stages of growth. Like private equity investors, VC investors can lend their knowledge and expertise to the process.
This can help you minimize your risk and avoid many of the mistakes that startups make in the beginning. New businesses still have a high rate of failure, so it can help to have an experienced team offering guidance. VC investors also tend to be well-connected and can help you find new opportunities.
However, when you raise a funding round, you dilute your equity and issue shares to your investors. And if you need to raise additional rounds, you’ll reduce your ownership and control over the company even further.
What is the difference between private equity and venture capital?
While there is some overlap between private equity and VC funding, there are also many differences between the two. Here is an overview of some of the biggest differences:
- Type of business: Private equity investors look for well-established businesses. These investors often look for businesses that are struggling due to ineffective leadership or poor processes. They then come in, make significant improvements and sell the businesses for a profit. The return on investment is lower, but they also take on much less risk. In comparison, VC investors look for companies with very high growth potential and as a result, are willing to take on more risk.
- Control over the business: Anytime you bring on investors, you’ll give up a certain amount of control over your business. Private equity investors require a majority stake in the company, whereas VC investors only ask for a minority stake.
- Exit strategy: Private equity investors look to improve a business and then turn it around for a quick sale. They aren’t interested in being involved in the business for a long time.
In comparison, VC investors are interested in the long-term growth of the company. They want to receive a substantial payout and are committed to sticking around until that happens.
[Read more: How to Find the Right Investor]
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