Venture capital Vs. Private Equity

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. 

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.

According to its website, GV has now funded more than 500 portfolio companies with a core focus on life sciences, frontier technology, enterprise, and consumers.

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

  1. Seed capital – for very early-stage companies without a product or established structure. Funds cover product development, market research, or basic setup costs.
  2. 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.
  3. 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.

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.

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.

Read Next: Venture Capital Advantages and Disadvantages, Angel Investing, Micro-Investing, Bootstrapping.

Connected Financial Concepts

Circle of Competence

circle-of-competence
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.

What is a Moat

moat
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.

Buffet Indicator

buffet-indicator
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

venture-capital
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

foreign-direct-investment
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

micro-investing
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 Investing

meme-investing
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

retail-investing
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 Investor

accredited-investor
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

startup-valuation
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 vs. Cash Flow

profit-vs-cash-flow
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

double-entry-accounting
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.

Balance Sheet

balance-sheet
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).

Income Statement

income-statement
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).

Cash Flow Statement

cash-flow-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.

Capital Structure

capital-structure
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

capital-expenditure
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

financial-statements
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

financial-modeling
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 Valuation

valuation
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.

Financial Ratio

financial-ratio-formulas

Financial Option

financial-options
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.

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