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Although they often overlap, private equity and venture capital (VC) are not the same things. Certainly, private equity and VC are both types of financial investing interested in turning a profit by buying at a low price and selling once the asset appreciates. However, they approach this objective in vastly different ways.
To bring you up to speed about the differences between private equity and VC, we put together this introductory guide to these two types of funding.
PE vs. VC: A Primer
Private equity (PE) and VC raise pools of capital which are used to invest in companies with high growth potential. Together, PE and VC investment firms represent a massive share of private markets worldwide, with roughly $4 trillion in assets under management and another $500 billion in aggregate capital raised.
When a company is considered “VC-backed,” this refers to the fact that they have raised capital from venture capitalists. In contrast, firms that are backed by private equity often means that they are majority-owned or solely owned by a PE firm like the Carlyle Group or the Blackstone Group.
You can think of PE and VC firms are opposites. On the one hand, PE investors take an existing profitable company, acquire it, and restructure it to optimize its performance. On the other hand, VC firms take smaller, often not-yet-profitable firms headed by a promising management team and provides them with working capital and mentorship.
List of Largest VC and PE Firms by Capital Raised
Private Equity Firms
- The Blackstone Group ($58 billion)
- Kohlberg Kravis Roberts ($41 billion)
- The Carlyle Group ($40 billion)
- TPG Capital ($36 billion)
- Warburg Pincus ($30 billion)
Venture Capital Firms
- New Enterprise Associates ($17 billion)
- Intel Capital ($9.8 billion)
- Oak Investment Partners ($8.4 billion)
- Insight Venture Partners ($7.6 billion)
- IDG Ventures ($6.8 billion)
The relative dominance of private equity firms over VCs attests to the fact that PE firms generally buy and restructure companies that aren’t publicly traded. Many private equity firms engage in leveraged buyouts of private companies. This explains why PE firms boast far greater assets under management compared to VCs.
The Mentor Factor
Venture capital firms seek out young, early-stage growth companies, primarily focused on technology and tech subcategories (i.e., fintech, biotech) to acquire a minority stake. Since they tend to focus on smaller companies with little market penetration, VC firms share their expertise with the company’s upper management and provide active mentorship.
This philosophy stands in stark contrast with PE firms, which take a far more paternalistic role. Unlike venture capitalists, PEs generally buy a controlling stake in a firm and make sweeping structural changes to ensure it’s performing optimally and generating maximum returns.
In What Ways Do VCs Differ From PE Firms?
To answer the question, “what is the difference between venture capital and private equity,” we’ve listed their most important differences below.
Stake Acquired
The percentage of the company acquired differs vastly between PEs and VCs. On one hand, PEs virtually always purchase 100 percent of the acquired company. Venture capital, by contrast, takes a minority stake in the firm they’re investing in. Instead, VCs provide mentorship to an existing management team rather than assume full control of day-to-day operations.
Investment Size
Venture capital rarely exceeds $10 million USD. Private equity, on the other hand, can reach into the 10-figure range (yes, that’s $10 billion and higher). The size discrepancy points to the fact that VCs tend to take smaller, non-controlling shares in startups and early-stage tech companies.
Acquisition Structure
It’s often said that private equity investing is another way of saying “leveraged buy-out.” This type of financial transaction, headed by private equity firms, involves the purchase of privately-owned companies using a combination of equity and debt. That is, the acquiring firm uses borrowed money to finance the acquisition (hence it is “leveraged”) and uses the acquired firm’s cash flow as collateral to secure the loan.
Conversely, venture capital firms do not acquire companies at all. Rather, they use only equity to invest in companies without borrowing capital or leveraging assets to make the investment.
Gestation Period
Private equity firms tend to take longer to exit after acquiring a company than VCs do after purchasing a stake. The average private equity firm holds onto its acquisition for five to ten years before looking for a buyer. Venture capital firms have a shorter-term investment strategy, often exiting between four and six years.
The Bottom Line
VCs are oriented toward people, while PE firms invest in the optimization potential of a company’s underutilized assets. Venture capitalists look for teams heading up startups that have a strong potential to break out in the market, whereas private equity groups buyout established companies.
During the early stages of a company’s growth, VCs are the more palatable solution for entrepreneurs and business owners looking to acquire startup capital between the first and fourth rounds of funding. As the company approaches maturity, PE firms provide a viable exit strategy for the business owners looking to cash out on their project.
The Difference In A Nutshell
The first major difference between PE and VC firms is the stage at which they invest in companies. Whereas venture capital firms invest in early-stage companies and startups, private equity firms buy mature companies.
The crucial second distinction between PE and VC investment firms is that the former invests in businesses across all industries and sectors, while VCs tend toward technology and biotech. Third, VCs acquire minority stakes whereas PE investors always seek to purchase firms outright. Last, PE firms use a combination of debt and equity financing and tend to exit after a longer time horizon than venture capitalists.
Whereas venture capital invests in the potential of the human beings heading a company, private equity investors in the numbers game—they look into the operational efficiency of a company and restructure it to unlock its maximum financial potential.
Liam Hunt, M.A., is a financial writer covering global markets, monetary policy, retirement savings, and millennial investing. His commentary and analysis have been featured in the New York Post, Reader's Digest, Fox Business, and Forbes.
