You have probably heard the terms Private Equity Fund and Venture Capital if you deal with the world of finance and investment. To a layman this may sound like the same thing because they share a few similarities.
Yet it is to be noted that they cater to different markets, and they often have different strategies. If you are an investor, an entrepreneur, or even a finance enthusiast, you should know the differences between the two.
We shall take you through in detail what a private equity fund is, what the private equity fund structure is, and how it fares against venture capital. Let us also discuss how each of its respective investment strategies differ, the risk-return profiles, and the target companies.
What is a Private Equity Fund?
A private equity fund is essentially a pooled investment model. It directly invests in private companies. Or in certain cases it takes private ownership of public companies. There are firms that manage these funds. The private equity firms raise funds from various institutions. It could be from pension funds, insurance companies, endowments, or even high net worth individuals.
In a typical case, the private equity fund would focus on mature companies. These companies are chosen based on certain factors. They often need restructuring, need to make improvements in their operations, or just need an influx of funds. The aim of these investors is to improve the value of the company so that they can sell it at a profit. This could be through an initial public offering (IPO) or through mergers/acquisitions.
Private Equity Fund Structure
A private equity fund has a proper structure of partners. Namely, limited partners (LPs) and general partners (GPs). The limited partners, as the name suggests, do not take part in the day-to-day management of things. These are the investors who mainly contribute capital to the private equity fund.
But they have limited liability. General partners on the other hand do more of the management part of things. They usually contribute only a small portion of the money, but they usually have to be responsible for generating the returns.
They also must do daily operations such as decisions regarding investments, managing the portfolio companies, and overseeing the exits. Additionally, the general partners would also charge the limited partners a management fee and a performance fee. Now that we’ve outlined private equity, let’s look at what venture capital is and explore the differences between the two.
What is Venture Capital?
If you look at it, venture capital (VC) is basically three subsets of private equity fund. Working is a bit different though. A firm that deals in venture capital would invest in startups. These early-stage companies should have high potential for growth. In a way, venture capital firms are taking on a big risk by investing in companies that have no history of generating revenue. They may not even have an established market presence.
The main aim of VCs is to create new players in the market. They fund and nurture startups to create disruptive technologies. They would also actively guide these entrepreneurs to build their business strategies, networking efforts, and give operational advice. In exchange for this, they would get equity in the company.
Key Differences Between Private Equity Fund and Venture Capital
1. Investment Strategies
The strategies are quite straightforward. A private equity fund would focus on mature companies. These established companies would have proper business models in place. So, the private equity fund would provide the money that is required to restructure, improve the operations, and support its growth.
Whereas venture capitalists on the other hand would focus on startups. These early-stage businesses are usually innovative and show high growth potential. These companies are often rooted in technology, with the potential of scaling up.
2. Risk-Return Profiles
Both friends of investment are high risk. Private equity funds could be categorized as moderate to high risk. In contrast, venture capital can be categorized as particularly high risk. This is because a private equity fund invests in a day yet predictable market with predictable returns. In the case of VCs, the venture capitalists invest in a potential market with potential returns, if the company succeeds.
3. Target Profiles
Private equity funds seek companies with steady cash flow, a strong market presence, and opportunities for operational improvements, while venture capital focuses on visionary founders with innovative products and scalable business models, often investing in companies that have yet to achieve profitability.
4. Ownership and Control
Private equity funds often acquire majority control (50% or more) of target companies to drive significant changes and implement strategic initiatives, while venture capital investors typically hold minority stakes (less than 50%) as startups aim to retain control over their businesses.
5. Exit Strategies
Private equity funds aim for exits through IPOs, mergers, or sales to other firms, typically within 4-7 years, while venture capital investors prefer IPOs or acquisitions but often have a longer investment horizon, depending on the startup’s growth trajectory.
Overlaps Between Private Equity Fund and Venture Capital
Despite their differences, private equity and venture capital share key similarities. Both invest in private companies, seeking to grow their capital by targeting firms that are not publicly traded.
They acquire equity stakes in exchange for funding and actively engage with the businesses they invest in, with private equity focusing on operational improvements and venture capital providing mentorship and guidance to startups. Ultimately, both aim to achieve high returns, albeit through different methods and timelines.
Conclusion
Choosing between private equity and venture capital depends on your goals and risk tolerance. For investors, private equity is ideal for those seeking steady, predictable returns from mature company’s cash flow, while venture capital attracts individuals with a higher risk appetite and a passion for supporting innovation.
For companies, established businesses aiming to optimize operations may lean towards private equity, whereas startups with disruptive ideas are better suited for venture capital funding.
Understanding the differences between a Private Equity Fund and Venture Capital is crucial for making informed decisions, whether you’re an investor or an entrepreneur. While private equity focuses on stabilizing and growing established businesses, venture capital bets on the potential of startups. Both play vital roles in the economic ecosystem, driving innovation, creating jobs, and generating wealth.
