Private equity is sometimes confused with venture capital because both of them refer to firms that invest in companies and exit by selling their investments in equities.
Private equity and venture capital invest in different types and sizes of companies, invest different sum of money, and their percentages of equity differs in the companies in which they invest.
VC and PE firms both raise capital from accredited investors known as limited partners (LPs), and they both do so in order to invest in privately owned companies. Their aim is same: to increase the value of the businesses they invest in and then sell them in the form of equities.
According to pitchbook, They mainly differ in the following ways:
- The types of companies they invest in
- The levels of capital invested
- The amount of equity they obtain through their investments
- When they get involved during a company’s lifecycle
VC vs PE-
Venture capital firms mainly invest in start-ups and mentor them. These firms are chosen by the VCs after performing a rigorous research and these are generally high growing firms. VCs give them funding in exchange of minority stake of equity in the start-up(less than 50% stakes). Some of the famous VC firms are Accel , Sequoia capital etc.
Whereas , Private equity firms provide funding to the well established traditional businesses. For example, recently KKR & Co. invested in Reliance Industries buying 1.28 % stakes in exchange of INR 5,550 Crores. PE firms generally invest in those business which are deteriorating because of some inefficiencies. They invest with an assumption that once those inefficiencies are corrected the business will go back to being profitable. Some of the famous PE firms are The Blackstone group, KKR & Co. , Warburg Pincus LLC etc.
How does venture capital work?
To raise the fund needed to invest in companies, VC firms open a fund and ask for commitments from limited partners this way the risk is being shared between them. Using this process, they’re able to gain funds that they invest into companies with high growth potential after a rigorous research and analysis. As companies grow, they go through different stages of the venture capital. If a VC firm has invested in a company and that company is successfully acquired or goes public, the firm makes a profit and distributes returns to the limited partners that invested in its fund. The firm also makes a profit by selling some of its shares to another investor in what’s called the secondary market.
Some of the VC backed companies are — JUUL , Stripe, Airbnb.
How does private equity work?
Similar to that of VC, PE investors also raise funds from limited partners to form a fund also known as a private equity fund and invest that capital into companies which are having the traditional business or can say which are well established. However, the PE firm invest in the companies which usually look different from the start-ups VC firms get involved with. Private equity investors might invest in a company that’s stagnant, or potentially distressed, but still has growth possibilities.
The VC and PE firms differ from each other in a lot of aspects. The biggest of them being the different types of companies they invest in. They do possess some similarities as well but their working style and strategies differ a lot from each other.