- Private equity invests in less companies across all industries
- Venture capital invests in more companies and tend to be focused on technology
- Private equity investments are based off quantitative assessments
- Venture capital investments are based off qualitative assessments
- Both private equity and venture capital firms are beginning to adopt each other’s practices, blurring the distinguishing features of both types of investments
The lines between private equity (PE) and venture capital (VC) can sometimes be blurred, but make no mistake, the lines are there, and there are key distinctions between these two investment types. PE and VC firms both invest in private companies through equity financing and reap returns through eventual exits like acquisitions and public offerings. However, the key differences between PE and VC lie in the facilitation of these investments.
The Investment Portfolio
PE firms tend to invest in more mature companies with a proven track record, while VC firms invest in early stage companies with the potential for high growth. PE firms usually invest in large amounts, north of US$100 million, for a majority stake in the company – usually 100% of the company’s equity. Investments through PE can be made through a mix of equity and debt. Conversely, VCs tend to invest in smaller amounts, usually under US$10 million, to acquire minority stakes. VCs are generally more interested in purchasing pure equity. Essentially, PE firms have several golden eggs in their baskets, while VC firms have many eggs in their baskets, with (hopefully) one or two platinum ones. The diversity of their portfolios tend to differ as well. PE investments can be made in any industry while VC investments tend to be focused on technology and life sciences.
Both PE and VC firms conduct due diligence, but they both have their own way to go about doing it. PE firms rely heavily on the company’s financial history, running the numbers through a multitude of Excel sheets, calculations and projections. VC firms do not have the benefit of financial history. Most of their portfolio companies are still figuring out their go-to-market strategies and have not even made a cent. VC investors tend to rely on more intangible assessments. These include the drive and capabilities of the founding team, product-market fit, and the defensibility of the company’s product against potential competition.
Another key difference is the relationships PE and VC firms have with their portfolio companies. Since PE firms acquire majority stakes, they have virtually complete control over the operations of their portfolio companies. In the 1980s, PE firms were notorious for leveraged buyouts (LBOs), where they acquire companies using loans which they will then finance using the company’s assets, leaving the acquired company bankrupt. LBOs are no longer commonplace in the PE industry, and PE firms now opt to keep a close watch on their portfolio company’s finances and operations to ensure efficiency and profitability, asserting executive decisions when necessary. On the other hand, VCs tend to assume a more advisory role rather than exert direct control over their portfolio companies. Whether or not the advice is heeded depends on the majority stakeholder, who is usually the founder of the company.
Lines Continue to Blur
What has been described so far depicts the traditional model of PE and VC investments. However, recent developments indicate that the industry is changing. PE firms have started displaying more VC firm characteristics and vice versa.
PE firms like KKR and Fidelity have begun launching technology funds, targeting high growth companies. Looking at statistics from PitchBook, PE deal sizes now include amounts under the traditional US$100 million.
VC portfolio companies are now entering later stages, requiring more funds, and VCs are increasing their bite sizes to accommodate these maturing needs. Also, VC investments have started to venture into industries outside of technology to include consumer and retail products like alcohol and mattresses.