Private Equity vs Venture Capital

Both private equity and venture capital make their investments in the companies. However, in the case of private equity, investment is generally made in the companies in their mature stage of working. In contrast, in the case of venture capital, investment is made in the companies in their early stage of working.

Technically speaking, venture capital is just a subset of private equity. Both invest in companies, both recruit former Investment Bankers, and make money from investments rather than advisory fees. But if you take a closer look at them, you’ll see that they’re significantly different.

“Private equity” generally refers to money invested in private companies. Such companies become private through investment. Most finance people use “private equity” to mean firms that buy companies through leveraged buyouts (LBOs) – so that’s how we’ll use it here.

• So private equity, in a nutshell, is an investment by a private equity firm in a specific company. The investment can be partial or a complete one, hoping to earn high returns.
• When we talk about the target company, various changes can be made by the private equity firm. To make it profitable, changes can be made concerning the strategies, management, expenses, etc.
• This change helps the target company to perform better and thus generate good returns for the private equity firm.
• After a period of, let’s say, five years, the private equity sells the company generating a profit and thus high returns through the entire transaction.

Many of you might be curious about what exactly they do and what makes them different from one another. So let’s get started and find the answers. In this article, we discuss the following –

The image below will help you understand what Private equity is.

Let’s consider that you are the one who is watering that big tree. Your vision has helped you choose this one tree from the garden, which you think can bear more fruits once it is nourished with fertilizers and good care.

You have collected the money (for fertilizers) from your friends and family, who also intend to eat the sweet fruits of the tree afterward. With the intention that the tree will bear more fruits, you are watering it regularly.

Now connect this example with what happens in Private Equity.

Let’s take the same example to understand what venture capital is.

Assume that everything remains the same as in the previous analogy for the above image. The only difference is:

• Now you have set your eye on a Small Sapling (instead of a large, fully grown tree)
• Your reason for selecting the sapling is its immune qualities like sturdiness, disease-resistant, shorter fruit-bearing period, etc.
• So concerning Venture Capital, the sapling depicts a startup company, and you(watering the sapling) is the Venture Capital Firm.
• And this is how venture capital works. Venture Capitalists provide funds to startup companies or small businesses with long-term growth potential. (Sapling has immune characteristics described above)
• Here the risk can be high, but so are the expected returns.

Private Equity and Venture Capital Statistics (2014):

• Assets under Management:$3.8 Trillion
• Aggregate capital raised: $495 Billion

PE firms and VCs invest in companies and make money by exiting, i.e., generally selling their investments. But the way they do it is different.

• Venture Capitalists invest in startup funds. But are they sure that all these companies will make it big someday? Chances here are very little for 100% shots.
• Hence venture capitalists expect that many of the companies they invest in will fail. But the hope here is that at least one investment will generate huge returns and make the entire fund profitable.
• Also, venture capitalists invest small amounts of money in dozens of companies, which is why this model works for them.
• But this model would prove a disaster if it is applied by private equity. In PE, the number of investments is smaller, and the investment size is much larger.
• So even if a single company fails, the entire fund would be doomed. And that is why PE funds are invested in mature companies where the chances of failure are 0%.

“So which model produces higher returns?” is the basic question that can arise in your mind.

• Technically speaking, each fund claims to target higher returns, but there are a lot of controversies in this area.
• But the actual scenario: Returns in both are much lower than what investors claim to achieve.
• 20% of returns are targeted by most venture capitals and private equity funds. But what is generally seen is that they can generate returns up to 10%( Except in some cases).
• Venture Capital: Returns are mostly dependent on top firms. They believe in investing in one big winner and making money.
• Private Equity: One can also earn great returns without investing in the largest and most well-known companies.

Private Equity: 

• Due to the LBO boom of the 1980s, there has been a bad picture of private equity firms. Due to those experiences, people have always thought of a PE as a place where companies are bought, people are fired, the company is burdened with debt, and finally, it is sold off.
• The general notion is that they finally sell the company without doing anything to improve operations. But this is the wrong notion in today’s scenario.
• PE firms are now working hard toward improving their companies and finding ways to expand them. And this is true in the case of recessions when there’s not much buying and selling of large companies.

Venture capital:

• It has been involved with a particular company or a project since its inception. Hence they should have a greater bond and involvement with the company.
• As they’re working with early-stage companies, they should have a greater incentive to improve the company.
• However, their involvement depends on the firm's focus, the stage of its business life cycle, and how much the entrepreneur wants them to be involved. But note that there can always be exceptions to the above statements.

Most of the differences that we have seen specifically deal with the theory part of Private Equity and Venture Capital firms.

Now we are going to focus on specific differences between the two, which will help you to determine:

• Interview processes are involved if you want to get into any one of them.
• Who are the people involved in Private Equity and Venture Capital?
• Work involved
• Salary Comparison
• Culture
• Exit opportunities

The main point of similarities in the interview process is that “Both types of firms focus on your background and deal experience.” But that is it. This is the only similarity.

PE:

• Do bear in mind that neither the Private equity interviews are for the light-hearted ones, nor are they a piece of cake. The interview can have a complete case study or modeling test.
• This is because they want to test you since you will spend so much time doing analytical and financial modeling work.

VC:

• Venture Capital interviews are more qualitative and fit-focused, especially for early-stage firms.
• Since Venture Capitals work with smaller companies, hence detailed financial models don’t make sense here. And that’s why they focus on relationships instead.

Private Equity

• Since the financial modeling and due diligence work you do in PE is very similar to the transactions in investment banking, private equity firms focus on recruiting former investment banking analysts.
• Also, consultants and anyone with an operating background can get into PE, but it’s an uphill battle.

Venture Capital

• In VCs, you will see a mix of the population, including ex-bankers, consultants, business development people, and even former entrepreneurs.

PE:

• Especially at large PE firms, the work is not much different from Investment Banking. Although there is less work in comparison, you still spend a lot of time in Excel, valuing companies, looking at financial statements, and conducting due diligence.
• However, the responsibility is more because you need to coordinate with accountants, lawyers, bankers, and other PE firms working on a deal.

VC:

• As you progress from “mega-PE fund” to “early-stage VC,” the work gets less quantitative and relationship-driven.
• Some people dislike this because they hate cold-calling and constantly finding new companies. While some, on the other hand, prefer to talk to people rather than work in Excel.
• So it’s hard to say what’s “more enjoyable” – it depends on whether you descend toward sales, analysis, or operations.

• You will almost always make more money in Private Equity than in Venture Capital.
• The reason is that there is more money involved in private equity, and fund sizes are much larger.
• However, if you want to make big money in venture capital, all you have to do is find a company to invest in, which can be the next Google. But this usually is very rare.
• If you have previous Investment Banking experience, base salaries in both industries are around $100K with widely variable bonuses.
• But on the whole, if you want to make the most amount of money in the shortest amount of time, then Private equity is the option for you.

• The work atmosphere and the culture in Private equity are very similar to Investment banking and attract some more extreme and ruthless bankers.
• The culture in venture capital tends to be more relaxed because people come from more varied backgrounds.
• People in PE more often come from pure finance backgrounds, whereas those in VC tend to be technologists turned financiers.
• Overall the work hours in higher PE firms tend to be longer than the VC, where the approach is a “normal” workweek.

PE Exit Opportunities

• Hedge funds: Many private equity professionals decide to move on to hedge funds, where returns and money can be earned more rapidly.
  Private equity professionals get frustrated by the slow pace and tedious deal-making tasks. Also, it is difficult to become a millionaire overnight; it will at least take 5-10 years.
• Venture Capitalist: Some private equity professionals may also find that doing large deals is not as exciting as investing in startups. Hence the switch to venture capital.
• Joining a Corporate/Portfolio Company: A private equity job involves working with portfolio companies to help them grow. It is, therefore, quite common for private equity professionals to decide to go to work for one of their portfolio companies in a senior position (CFO, CEO, Head of Business Development).
• Other exit opportunities for private equity are:
  • Launching your fund
  • Moving back to advisory roles
  • Secondary funds, Fund of Funds
  • Entrepreneurship

VC Exit Opportunities

• IPO
• Mergers & Acquisition(M&A)
• Shares buyback
• Sale to Other Strategic Investor/Venture Capital Fund

So, private equity vs. venture capital, what are you up for?

• Your inclination towards one of them depends on your goal.
• If you like to work in transaction deals or try to make money in the shortest amount of time possible, Private equity is a better option.
• If you’re more interested in starting your own company one day and you prefer relationships for analysis, Venture Capital is better.
• Hope the comparison made in this article helps you to know the differences and the similarities between Private Equity and Venture Capital.
• Also, checkout Investment Banking vs. Private Equity

This article is a guide to Private Equity vs. Venture Capital. Here we discuss the difference between Private Equity and Venture Capital regarding risk and returns. You may also look at the following articles –

• Angel Investment vs. Venture Capital - Comparison
• How to Get Into Venture Capital?
• Private Equity in India