The proper funding can make all the difference between success and failure in business growth and investment. Whether you're looking to launch a startup or take your established business to the next level, deciding between venture capital (VC) and private equity (PE) funding is crucial.
Venture capitalists (VCs) typically invest in early-stage, high-growth startups, providing capital for innovation and scaling1.On the other hand, private equity (PE) firms acquire mature companies and restructure them for profitability before exiting3.
In this article, we'll explore what venture capital and private equity are, their key differences, and how to determine which is right for your business. We’ll discuss each of their works, the types of companies they invest in, and how to approach them to secure the proper funding for your growth.
Definition and purpose
What is a venture capitalist?
Venture capital (VC) is the investment individuals or firms make in startups and early-stage companies with high growth potential1. VCs are critical in helping young businesses scale and reach their full potential by providing financial backing and strategic guidance.
- Investment size
VC investments typically range from a few hundred thousand to millions of dollars, depending on the business's stage1. Early-stage startups receive smaller investments, often in the Seed or Series A rounds. On the other hand, mature businesses in late-stage funding rounds secure more significant amounts.
- Risk tolerance and expected returns
Venture capitalists are known for their high-risk tolerance as compared to other investors. They are more willing to invest in unproven businesses with the potential for massive success. Because of this, VCs expect high returns, often aiming for at least 10x their investment if the company becomes successful.
- Equity stakes and involvement
VCs typically take equity stakes in the businesses they invest in. The size of the investment and the company's valuation determine the amount of equity they receive. In exchange for their investment, VCs may also take an active role in guiding the business.
This involvement can include mentorship, strategic advice, and access to a network of contacts to help the company grow1. In some cases, VCs might join the board of directors to assist in decision-making.
What is private equity?
Private equity (PE) are investment firms that buy and restructure established companies. Unlike venture capitalists, PE firms target stable and profitable companies2. Their investments aim to improve the business's operations and sell it for a profit.
- Investment strategies
PE firms use two primary strategies: leveraged buyouts (LBOs) and growth capital. In a leveraged buyout, PE firms acquire a company using a combination of debt and equity2. Growth capital is where a private equity firm provides funds to expand a company or support its growth initiatives.
- Ownership control and exit strategies
Private equity firms seek to acquire a controlling stake in the companies they invest in. They can significantly influence the company's operations, bringing changes that lead to profitability.
PE firms typically have an exit strategy in mind, which could involve selling the business to another firm, taking it public through an IPO, or restructuring the company for a future sale2.
Key difference between private equity and venture capital
Investment stage and business type
The first key difference between venture capital and private equity is the stage of the business they invest in.
- Venture capitalists mainly focus on early-stage startups. They consider technology, healthcare, or green energy companies key to innovation and growth potential3. These businesses are often unproven but have the potential for rapid growth.
- Private equity firms mainly target established businesses that have been successful for several years. These businesses may need restructuring, additional capital to fuel growth, or strategic changes to increase profitability.
In short, VCs are looking for companies with the potential to disrupt markets and achieve exponential growth. At the same time, PE firms are more interested in stable, proven businesses that can benefit from operational improvements.
Ownership and control
Another key difference between VCs and PE firms is the level of control they seek over the companies they invest in.
- Venture capitalists- typically take minority stakes in the companies they invest in. While they provide valuable advice and support, VCs do not generally control the business's day-to-day operations3. Their involvement is more on helping the company grow and scale to profitability.
- Private equity- firms usually hold a majority stake in the companies they invest in, allowing them to influence the business significantly. This controlling interest gives them the upper hand in making significant operations, strategy, and restructuring decisions3. PE firms thus have more control and a more direct role in shaping the company's future.
Risk and return expectations
Venture capitalists typically invest in early-stage businesses with a higher degree of risk. These companies have unproven business models, and there's a significant chance that they may fail.
As a result, VCs expect higher returns on their investments and often aim for returns of 10x or more3. They are willing to accept the potential for significant losses in exchange for the possibility of considerable gains if the company succeeds.
Private equity firms tend to invest in more stable businesses. While these companies may still need improvements, they have a proven record of generating revenue and profits.
As a result, the risk for private equity firms is lower than that of venture capitalists. The expected returns are more moderate as PE firms look for steady, predictable growth rather than explosive gains.
Investment structure and funding approach
The structure and approach to funding also differ significantly between venture capital and private equity.
Venture capitalists typically provide funding through rounds, each intended to help the company reach certain milestones1. For example, a startup may first receive Seed funding to develop its product, followed by Series A funding to scale operations and acquire customers. As the company grows, it may raise funds in subsequent rounds.
Private equity firms, on the other hand, typically acquire entire companies using a combination of debt and equity. In a leveraged buyout, for example, a PE firm borrows funds to purchase a business using the company's assets as collateral. Once the acquisition is complete, the firm improves operations, reduces costs, and increases profitability before selling or taking the company public1.
Involvement and decision-making
Venture capitalists and private equity firms differ in their level of involvement in a business's operations.
Venture capitalists are actively involved in the businesses they invest in. They provide strategic guidance by helping with hiring key executives or offering connections to industry experts or potential customers3. However, VCs typically do not control day-to-day operations and rely on the startup's management team to run the business.
Private equity firms, by contrast, are much more directly involved in managing the companies they invest in. Because they usually acquire controlling stakes, PE firms have a say in key decisions, such as restructuring, cost-cutting measures, and strategy3. They may even replace executives or bring in outside experts to drive change.
When to choose venture capital or private equity
When to seek venture capital
Venture capital is ideal for startups and early-stage businesses with high growth potential but needs funding to scale. If you're developing an innovative product or technology and need financial backing to take your idea to market, VCs are the right investors to approach3. VCs are particularly helpful for businesses in emerging industries that require significant funding to grow quickly and capture market share4.
Working with VCs also offers networking opportunities and strategic advice, which can help guide your business toward long-term success.
When private equity is the better choice
Private equity is the better choice for established businesses looking to scale further. If your company has a proven business model and needs capital to fuel expansion or restructure operations, PE firms can help take your business to the next level3.
PE firms are particularly suited for companies that need operational improvements or want to make significant changes to drive growth. Their hands-on approach and ability to acquire controlling stakes allow them to implement meaningful changes to improve profitability and increase the company's value.
Can venture capital and private equity work together?
Venture capital (VC) and private equity (PE) can sometimes work together in a business. VCs and PEs serve at different stages in a company’s lifecycle. They can sometimes work together, especially as a business grows and transitions from one phase to the next5.
Early-stage businesses often rely on venture capital to fuel innovation, product development, and market expansion. However, as a company matures and becomes more established, its capital needs evolve. At this point, private equity firms can step in to support further growth, improve operations, or guide the company through restructuring.
A hybrid investment strategy occurs when VC and PE firms are involved at different stages of the business lifecycle. For example, a business may start with VC funding to scale rapidly and later transition to PE investment for operational efficiency and expansion.
In other cases, VCs and PEs may partner in joint investments by combining their innovation and strategic management expertise.
A transitional funding model is a business strategy that helps a company evolve its funding as it grows. It offers financial stability and guidance, especially when preparing for an exit, such as a sale or IPO5. In conclusion, VCs and PEs can collaborate, offering the necessary capital, knowledge, and resources to help businesses grow and achieve long-term success.
How your pitch deck influences investor decisions
A well-crafted pitch deck is an investor's first impression of your business. Whether you pitch to a venture capitalist (VC) or a private equity (PE) firm, a well-structured pitch deck can distinguish between getting a meeting and being overlooked.
A great pitch deck grabs the investor's attention, highlights your business's uniqueness, and provides enough detail to help them understand how investing in your venture will benefit them4.
When creating a pitch deck for:
Venture capitalists:
- Highlight the innovative nature of your product or service
- Showcase the significant market opportunity your business can address.
- Demonstrate how you plan to scale your business rapidly and capture market share.
Private equity firms:
- Focus more on the financial aspects of your business.
- Prove revenue streams and a clear path to profitability, so your pitch emphasizes financial stability, growth strategies, and operational improvements.
Creating a pitch deck that resonates with VCs and PE firms requires understanding their expectations. Fortunately, professional services specializing in crafting investor pitch decks that meet these expectations are available. Propitchdeckservices is a leading provider of investor pitch deck services. It offers expert guidance and customized decks that align with investor expectations. A strong pitch builds investor confidence by fostering trust in your vision and execution ability.
In conclusion, understanding the differences between venture capital and private equity can help you make the right decision for your business. This decision depends on whether you want to scale or look for growth capital. Choosing the right investor lets you position your business for long-term success and achieve your growth objectives.
Sources used in this article;
- Private Equity vs. Venture Capital: What’s The Difference? https://www.investopedia.com/ask/answers/020415/what-difference-between-private-equity-and-venture-capital.asp
- Private equity vs. venture capital: What’s the difference?: https://pitchbook.com/blog/private-equity-vs-venture-capital-whats-the-difference
- Private Equity vs. Venture Capital : https://corporatefinanceinstitute.com/resources/career/private-equity-vs-venture-capital/
- What Investors Look For In A Pitch Deck: https://benjaminball.com/blog/what-investors-look-for-pitch-deck/
- Demystifying Investments: Understanding Private Equity vs. Venture Capital https://gunungcapital.com/demystifying-investments-understanding-private-equity-vs-venture-capital
