Venture capital (VC) is money invested into start-ups or similarly young businesses with potential for long-term growth.
Private equity (PE) investment is any capital directed toward a private company or entity. In other words, one that is not publicly listed or tradeable.
Scenario
Venture Capital (VC)
Private Equity (PE)
Investment Stage
VC typically invests in early-stage startups and high-growth companies that are in the seed, Series A, or growth stages of development.
PE primarily invests in mature and established companies, often involved in buyouts or acquisitions.
Investment Focus
VC focuses on investing in innovative, technology-driven, and high-potential startups, often in sectors like tech, biotech, and consumer products.
PE invests in a wide range of industries, including manufacturing, healthcare, finance, and more, with a focus on established businesses.
Ownership Stake
VCs usually acquire minority equity stakes in startups, aiming for capital appreciation upon successful growth or exit.
PEs often acquire majority ownership stakes in companies, exerting significant control over their operations and strategies.
Risk and Return
VC investments carry higher risks due to their early-stage nature but offer the potential for substantial returns if the startup succeeds.
PE investments involve lower risk compared to VC but typically offer more moderate returns, often generated through operational improvements.
Exit Strategy
VCs typically exit their investments through IPOs (Initial Public Offerings), acquisitions, or secondary sales once the startup reaches a certain growth stage.
PE firms exit their investments through various means, including IPOs, selling to other companies, or recapitalization, often after several years.
Investment Horizon
VC investments often have shorter timeframes, with an expectation of exit within 3 to 7 years, although this can vary widely.
PE investments have longer timeframes, often ranging from 5 to 10 years or more, allowing for extensive value creation.
Due Diligence
VCs perform due diligence to assess the startup’s technology, market potential, team, and scalability.
PE firms conduct in-depth due diligence, including financial, operational, and legal assessments of mature companies.
Management Involvement
VCs typically have limited involvement in the day-to-day operations of startups, focusing on strategic guidance and connections.
PEs are actively involved in the management of portfolio companies, implementing operational improvements and strategic changes.
Financing Amount
VC investments are often smaller in scale, with a typical range of a few hundred thousand to several million dollars in early stages.
PE investments involve larger amounts of capital, ranging from several million to billions of dollars, depending on the deal.
Investor Network
VC firms often have extensive networks of connections within the startup ecosystem, including entrepreneurs, mentors, and industry experts.
PE firms have networks that span various industries and may collaborate with management teams and industry experts.
Exit Timeline Flexibility
VCs typically seek exits based on market conditions and startup growth, allowing for some flexibility in exit timing.
PE firms often have more control over exit timing, aiming for strategic moments to maximize returns.
Typical Use Cases
VC is commonly associated with financing tech startups, disruptive innovations, and high-growth potential ventures.
PE is frequently used for buyouts, turnarounds, and restructuring efforts in established companies.
Ownership Duration
VC firms may hold their investments for a relatively short duration, typically between 3 to 7 years, or until a liquidity event occurs.
PE firms often have longer ownership horizons, aiming for value creation over an extended period before exiting.
Capital Structure
VC investments are usually structured as equity or convertible debt, providing startups with funding for growth and development.
PE investments involve various financial instruments, including equity, debt, and mezzanine financing, tailored to the specific deal.
Risk Tolerance
VC investors have a high tolerance for risk, accepting that a significant portion of their investments may not yield returns.
PE investors generally have a lower risk tolerance, seeking more stable and predictable returns.
Strategic Alignment
VC investments often align with disruptive technologies and market innovation, aiming for rapid market growth.
PE investments often align with established companies and industries, focusing on improving operational efficiency and profitability.
Table of Contents
Understanding venture capital
Venture capital is invested into promising businesses by investors or funds in exchange for a minority stake. It’s important to note that venture capitalists inject cash to jump-start the business and take a non-controlling interest in return for their investment.
One of the most prolific venture capitalists is Google. Under a division known simply as GV, the search giant invests in emerging companies with great ideas to help it expand.
Since venture capital is invested in early-stage companies or start-ups with the potential for future growth, the investment itself tends to be riskier.
In some cases, venture capitalists may also lend their skills, contacts, experience, or knowledge in exchange for an equity stake.
The three types of venture capital
Seed capital – for very early-stage companies without a product or established structure. Funds cover product development, market research, or basic setup costs.
Early-stage capital – for growth companies in operation for around two years. These companies are characterized by established management, structure, and increasing revenue. Funds in this case are used to improve productivity or boost sales.
Late-stage capital – for companies undergoing rapid growth that want access to funds to accelerate further. Many of these tend to be market disruptors.
Understanding private equity
Private equity investors make a direct investment in a company that is typically at a more mature stage than those targeted by venture capitalists.
Private equity may be directed toward a company in financial stress, but it is also used to purchase a company, streamline operations, and then sell it for a profit.
Unlike venture capitalists, private equity tends to be invested in exchange for majority control over the business’s operations.
This means private equity investors have more say in how the business is run and have the power to remove executives or make other significant changes.
Key Similarities between Venture Capital (VC) and Private Equity (PE):
Investment in Businesses: Both VC and PE involve investments in businesses or companies with the aim of generating returns on the investment.
Source of Funding: Both VC and PE funds are typically raised from institutional investors, high-net-worth individuals, and other sources to provide capital for investments.
Potential for Growth: Both VC and PE investments are made with the expectation of achieving growth and generating profits over time.
Long-Term Investments: Both forms of investment are typically considered long-term investments, and investors expect returns over a period of several years.
Differences between private equity and venture capital
In addition to the level of control and maturity stage of the company, there are a few more differences between private equity and venture capital:
Private equity firms tend to invest in multiple industries and prefer established markets and businesses. Many venture capitalists, on the other hand, are only interested in tech companies that have the potential to be market disruptors.
Private equity investors tend to ignore emerging markets and instead want more control over saturated markets. Venture capitalists are always looking for the next emerging market as part of their high-risk, high-reward strategy.
Since private equity investments are made on proven businesses in saturated markets, the amounts invested tend to be more than those made by VCs in a start-up. Indeed, PE investments are normally north of $100 million while VC investments tend to be $10 million or less.
Also consider:
Stage of Company: VC focuses on early-stage startups or young businesses with high growth potential, while PE targets more mature companies that may be in need of growth or operational improvements.
Risk Level: VC investments are riskier due to the early-stage nature of the companies and their potential for failure. PE investments are generally considered less risky as they are made in more established and proven businesses.
Investment Amount: VC investments are usually smaller, ranging from a few hundred thousand dollars to several million dollars. PE investments, on the other hand, are often much larger, with amounts exceeding $100 million.
Control and Influence: In VC, investors usually take a minority stake and have limited control over the company’s operations. In PE, investors often seek majority control, giving them significant influence in decision-making.
Industry Focus: VC investors often target technology startups and disruptive businesses, focusing on emerging markets. PE firms invest across various industries and often prefer established markets and businesses.
Purpose of Investment: VC investment is primarily focused on jump-starting early-stage startups and supporting their growth. PE investment may involve acquisitions, streamlining operations, and eventually selling the company for profit.
Investment Timeline: VC investments are made at an early stage and typically take longer to mature and provide returns. PE investments are often made in companies with more stable cash flows, and returns may be realized within a shorter timeframe.
Exit Strategies: VC investors may exit their investments through IPOs (Initial Public Offerings) or acquisitions by larger companies. PE investors often seek to exit their investments through strategic sales or secondary buyouts.
Management Involvement: VC investors may provide advice and support to startups, but they are generally less involved in day-to-day operations. PE investors may take a more hands-on approach and may make significant changes in the company’s management or operations to improve performance.
Geographical Focus: VC investments are often concentrated in regions with a strong startup ecosystem and access to technology talent. PE investments may be more geographically diverse, spanning various countries and regions.
Key takeaways:
Venture capital (VC) is money invested into start-ups or similarly young businesses with potential for long-term growth. Private equity (PE) describes any capital invested in a private company or entity. In other words, one that is not publicly listed or tradeable.
Since venture capital is invested in early-stage companies or start-ups with the potential for future growth, the investment itself tends to be riskier. Private equity is invested into proven companies in proven industries with investors possessing a higher degree of operational control.
Venture capital and private equity investments also differ according to the level of risk, market preference, investment amount, and maturity of the company in question.
Case Studies
Venture Capital (VC) Examples:
Dropbox:
In its early stages, Dropbox secured VC funding from Sequoia Capital to expand its cloud storage solutions. This investment helped Dropbox grow from a small startup to a major player in the cloud storage industry.
WhatsApp:
The messaging app received an investment from Sequoia Capital. The VC funding supported its growth until its acquisition by Facebook for $19 billion.
Slack:
The team collaboration tool secured venture capital investments from firms like Accel and Andreessen Horowitz, enabling it to enhance its platform and gain significant market share.
Uber:
Before becoming a global ride-sharing giant, Uber raised significant VC funding from investors like Benchmark and GV (Google Ventures), facilitating its rapid expansion worldwide.
Private Equity (PE) Examples:
Dell:
In 2013, Michael Dell and Silver Lake Partners acquired Dell in a PE deal. The acquisition took Dell private, allowing it to restructure away from the public eye.
Burger King:
In 2010, 3G Capital, a PE firm, acquired Burger King. They revamped the business strategy, leading to a resurgence of the brand.
Heinz:
The renowned ketchup and food company was bought by Berkshire Hathaway and 3G Capital. This PE deal allowed Heinz to merge with Kraft, creating one of the largest food and beverage companies globally.
Toys “R” Us:
In 2005, the toy retailer was acquired by a consortium of PE firms including Bain Capital, KKR, and Vornado. However, this story serves as a cautionary tale in PE as the company struggled with debt and eventually filed for bankruptcy.
Scenarios Illustrating the Difference:
Early-stage Tech Startup:
VC: A new tech startup, “TechieToys,” has developed an innovative AR gaming device. They seek funding to manufacture their product and launch it to the public. A VC firm sees their potential and invests in exchange for equity.
PE: Not typically involved at this early stage.
Mature Manufacturing Company:
VC: Less likely to be involved since the company is mature and not a high-growth startup.
PE: A PE firm sees that “MatureMachines,” a manufacturing company, has solid revenues but lacks modern operational efficiencies. The PE firm acquires a controlling stake, streamlines operations, and aims to increase profitability.
Innovative Health Startup:
VC: “HealthHive” has developed a wearable that predicts flu outbreaks based on user data. It’s in the prototype stage. A VC firm invests, hoping the product will revolutionize healthcare predictions.
PE: Not typically the primary investor at this early stage.
Struggling Retail Chain:
VC: Not the typical domain for VCs given the lack of rapid growth potential.
PE: “RetailRush,” a retail chain, is facing declining sales. A PE firm buys the company, revamps its strategy, optimizes store locations, and introduces an online presence to rejuvenate the brand.
The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.
Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.
The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.
Venture capital is a form of investing skewed toward high-risk bets, that are likely to fail. Therefore venture capitalists look for higher returns. Indeed, venture capital is based on the power law, or the law for which a small number of bets will pay off big time for the larger numbers of low-return or investments that will go to zero. That is the whole premise of venture capital.
Foreign direct investment occurs when an individual or business purchases an interest of 10% or more in a company that operates in a different country. According to the International Monetary Fund (IMF), this percentage implies that the investor can influence or participate in the management of an enterprise. When the interest is less than 10%, on the other hand, the IMF simply defines it as a security that is part of a stock portfolio. Foreign direct investment (FDI), therefore, involves the purchase of an interest in a company by an entity that is located in another country.
Micro-investing is the process of investing small amounts of money regularly. The process of micro-investing involves small and sometimes irregular investments where the individual can set up recurring payments or invest a lump sum as cash becomes available.
Meme stocks are securities that go viral online and attract the attention of the younger generation of retail investors. Meme investing, therefore, is a bottom-up, community-driven approach to investing that positions itself as the antonym to Wall Street investing. Also, meme investing often looks at attractive opportunities with lower liquidity that might be easier to overtake, thus enabling wide speculation, as “meme investors” often look for disproportionate short-term returns.
Retail investing is the act of non-professional investors buying and selling securities for their own purposes. Retail investing has become popular with the rise of zero commissions digital platforms enabling anyone with small portfolio to trade.
Accredited investors are individuals or entities deemed sophisticated enough to purchase securities that are not bound by the laws that protect normal investors. These may encompass venture capital, angel investments, private equity funds, hedge funds, real estate investment funds, and specialty investment funds such as those related to cryptocurrency. Accredited investors, therefore, are individuals or entities permitted to invest in securities that are complex, opaque, loosely regulated, or otherwise unregistered with a financial authority.
Startup valuation describes a suite of methods used to value companies with little or no revenue. Therefore, startup valuation is the process of determining what a startup is worth. This value clarifies the company’s capacity to meet customer and investor expectations, achieve stated milestones, and use the new capital to grow.
Profit is the total income that a company generates from its operations. This includes money from sales, investments, and other income sources. In contrast, cash flow is the money that flows in and out of a company. This distinction is critical to understand as a profitable company might be short of cash and have liquidity crises.
Double-entry accounting is the foundation of modern financial accounting. It’s based on the accounting equation, where assets equal liabilities plus equity. That is the fundamental unit to build financial statements (balance sheet, income statement, and cash flow statement). The basic concept of double-entry is that a single transaction, to be recorded, will hit two accounts.
The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).
The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).
The cash flow statement is the third main financial statement, together with income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.
The capital structure shows how an organization financed its operations. Following the balance sheet structure, usually, assets of an organization can be built either by using equity or liability. Equity usually comprises endowment from shareholders and profit reserves. Where instead, liabilities can comprise either current (short-term debt) or non-current (long-term obligations).
Capital expenditure or capital expense represents the money spent toward things that can be classified as fixed asset, with a longer term value. As such they will be recorded under non-current assets, on the balance sheet, and they will be amortized over the years. The reduced value on the balance sheet is expensed through the profit and loss.
Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory to companies for tax purposes. They are also used by managers to assess the performance of the business.
Financial modeling involves the analysis of accounting, finance, and business data to predict future financial performance. Financial modeling is often used in valuation, which consists of estimating the value in dollar terms of a company based on several parameters. Some of the most common financial models comprise discounted cash flows, the M&A model, and the CCA model.
Business valuations involve a formal analysis of the key operational aspects of a business. A business valuation is an analysis used to determine the economic value of a business or company unit. It’s important to note that valuations are one part science and one part art. Analysts use professional judgment to consider the financial performance of a business with respect to local, national, or global economic conditions. They will also consider the total value of assets and liabilities, in addition to patented or proprietary technology.
A financial option is a contract, defined as a derivative drawing its value on a set of underlying variables (perhaps the volatility of the stock underlying the option). It comprises two parties (option writer and option buyer). This contract offers the right of the option holder to purchase the underlying asset at an agreed price.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
