Private Equity vs Venture Capital

Difference Between Private Equity and Venture Capital

Both of the private equity and the venture capital make their investments in the companies where in case of the private equity investment is generally made in the companies which are in their mature stage of working whereas in case of the venture capital, investment is made in the companies which are 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 BankersInvestment BankersInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc.read more, and they both 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.

The term “private equity” generally refers to money invested in private companies. Such companies become private through investment. Most people in finance, though, 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, with the hopes of earning high returns.
  • When we talk about the target company, there are various changes that can be made by the private equity firm. Changes can be made with respect to the strategies, management, expenses, etc. to make it profitable.
  • 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 5 years, the private equity sells the company generating a profit and thus high returns through the entire transaction.

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Many of you might be curious as to 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 –

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  1. Private Equity Course - 35+ hours Videos
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  4. Financial Modeling Course - 50+ hours Videos

Private Equity vs. Venture Capital Infographics

Who are they?

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

Private equity vs venture Capital Analogy

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Let’s consider that you are the one who is watering that big tree. Your vision has helped you to 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.

You:Private Equity Firm
Tree:Target Company (Either Potential Company or Company in need of Restructuring).
Your friends and family who contributed funds for the fertilizers:Investors contributing Funds to Private Equity Firm;
Sweets Fruit which is intended to be distributed amongst all:Returns from the Transaction which are distributed to Investors
You charging fee for taking care of the Tree on behalf of everyone:Private Equity Firm charging Management fees for the Transaction

Let’s take the same example to understand what is Venture Capital.

Assume that everything remains the same as the previous analogy that we saw with respect to 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 with respect to 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 the startup company or small businesses that have long term growth potentials. (Sapling having 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

If you wish to gain Private Equity Skills Professionally, then you may look at this Private Equity Course

Comparative Table

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.

DifferencesPrivate Equity
StagePE firms buy mature, public companies.VCs invest mostly in early-stage companies.
Company TypesPE firms buy companies across all industries.Venture Capital is focused on technology, biotech, and clean-tech companies.
% AcquiredIt is seen that the PE firms almost always buy 100% of a company in an LBOVenture Capital only acquires a minority stake which is usually less than 50%.
SizePE firms make large investments. ($100 Million to $10 billion)VC generally makes smaller investments which are often below $10 million for early-stage companies.
StructurePE firms use a combination of equity and debt.VCs firms use only equity (Cash)

Risk Appetite

  • Venture Capitalists invest in start-up funds. But are they absolutely 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 1 investment will generate huge returns and make the entire fund profitable.
  • Also, venture capitalists invest small amounts of money in dozens of companies, and that 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 in the near future are 0%.

Return Differences

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

  • Technically speaking, each fund claim 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 what is targeted by most venture capitals and private equity funds. But what is generally seen is that they are able to 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 out of it.
  • Private Equity: One can earn great returns without investing in the largest and most well-known companies also.

Involvement in Target Company’s Operations

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 simply bought, people are fired, then 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 towards improving the companies and findings ways to expand it. And this is absolutely true in case of recessions when there’s not much buying and selling of large companies.

Venture capital:

Most of the differences that we have seen are specifically dealing 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 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

PE and VC Interview

The main point of similarities involved 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 a case study or modeling test.
  • This is because they want to test you since you are going to 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 companies that are smaller hence detailed financial models, don’t make sense here. And that’s why they focus on relationships instead.

People Involved

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 then it’s an uphill battle.

Venture Capital

  • Whereas in VC’s you will see a mix of population including ex-bankers, consultants, business development people, and even former entrepreneurs.

PE and VC – Work

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 while you are working on a deal.

VC:

  • As you progress from “mega-PE fund” to “early-stage VC,” the work gets less quantitative and more relationship-driven.
  • Some people actually 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.

PE and VC – The Pay

  • You will almost always make more money in Private Equity than in Venture Capital.
  • The reason: In private equity, there is more money involved, and fund sizes are much larger.
  • However, if you want to make big money in venture capital, all you have to do is to find a company to invest, which can turn out to be the next Google. But this usually is very rare.
  • If you have a previous Investment Banking experience then, 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 Culture

  • The work atmosphere and the culture in Private equity are very similar to Investment banking and attract some of the more extreme and merciless bankers.
  • The culture in venture capital tends to be more relaxed also 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 as compared to the VC where the approach is a “normal” workweek.

PE and VC – Exit Opportunities

PE Exit Opportunities

  • Hedge funds: A lot of 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 start-ups. Hence they switch to venture capitals.
  • Joining a Corporate/Portfolio Company: A private equity job consists of 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 own fund
    • Moving back to advisory roles
    • Secondary funds, Fund of Funds
    • Entrepreneurship

VC Exit Opportunities

Which One Should You Choose?

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

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

Reader Interactions

Comments

  1. Gerald says

    Thanks sir for this inside

  2. J says

    This is a great article! Thank you from the office manager at this VC/PE firm who they’re starting to let in on meetings :)

    • Dheeraj Vaidya says

      Thanks for your kind words!

  3. Kim Tressik says

    From roots to fruits, you have beautifully covered every point of Private equity vs Venture capital. Some of these I had not even heard before & I’ve definitely learnt a lot.

    • Dheeraj says

      Thanks Kim!

  4. Mahika Khanna says

    Sir, If anyone has a business idea can they directly approach a venture Capital firm? Or are there any specific requirements?

    • Dheeraj says

      You can directly approach Venture Capital firm with your business idea. Just you have a “proof of concept”, then i don’t think you will find any issues with raising funds.
      Thanks,
      Dheeraj

  5. Prachi Mishra says

    Hi Dheeraj. Thanks for your amazing articles as always. Can you let me know that private equity falls under which category? sell side or buy side?

    • Dheeraj says

      Hi Prachi,

      Private Equity in crude sense can be classified as a buy side as PE firms manage a portfolio to be invested.

      Thanks,
      Dheeraj

  6. john says

    I have an internship from a VC ( nova founders capital) but also an internship offer from a small PE company. I am unsure which one to take. Would taking the VC job pigeon hole me as I will not be exposed to heavy finance modeling?

    • Dheeraj says

      Hi John, a tricky question. I am not sure what kind of work the VC have planned for the internship.

      Very difficult to compare and contrast VC and PE as both jobs are equally exciting and I am sure you will learn lot of financial modeling for sure in both.

      Best,
      Dheeraj

  7. Nilesh Trivedi says

    1- VCs will do beyond early stage as well..lately, many of them either raise separate follow on funds to ‘follow on’ their early funding and/or special purpose vehicles to achieve so. Also, mature is not the right way to describe PE target companies. PE looks for stable, predictable cash flows, so that they can leverage. PE deals are leverage financed, heavily, so cash flows act as a good collateral on the financial debt they take to invest/acquire those companies.

    3- There are markets in the world where VCs do take more than 50%..mostly emerging markets, but I know of cases, where the VCs act like PE investors, without actually operating the company and f**k everything up.

    4- VCs will do more than $10M as well…

    5- Lately, in the last 5 years or so, Convertible Debt has become a popular instrument for seed stage financing, and many micro-VCs participate (though they hate it secretly) through this in companies

    6- Very misleading is this time horizon thingy. Because, VCs don’t have majority ownership, and to add, there are bunch of other investors in the company, exits in stipulated time aren’t guaranteed. There are lesser options for VCs in this area than PE investors since PE can rely on cash flow to service debt and as a result, keep going without exit. VCs are screwed if they don’t get liquidity. And guess what, we are seeing this (not the screwy part yet, but will in 2 years) in today’s tech market…lots of Private IPOs but no Public stuff.

    Salary Structure: This isn’t right either. For VC firms, there is a direct correlation to ‘Fund Size’, since the fund size dictates the management fee and the management fee is what pays salary. The bonus structure in VC is also not guaranteed every year.

    • Dheeraj says

      Hi Nilesh,

      Thanks for your inputs. Not sure why your comment got marked as spam and i could not read it. I will proof read the article and make the suggested changes.

      Best,
      Dheeraj

  8. Sandra Geller says

    Thanks Dheeraj for the comparison. can you tell me if the Modeling part for private equity and Investment banking is similar.

    • Dheeraj says

      Hi Sandra,

      The modeling part of PE and Investment Banking is mostly similar. The complexity depends on the access to the data. Additionally, the Private Equity models focus more on the IRR and cash flows.

      Best,
      Dheeraj

  9. Siddhartha Rane says

    Hello Dheeraj Sir,

    I am in my final year graduation and I am really interested in private equity as a career. What should be my future step with respect to my academics?

    Also, the article looks Great.

    • Dheeraj says

      If you are interested in Private Equity, go for CFA and also learn core finance skills like valuations and financial modeling. A good place to start could be this Free Financial Modeling Training.

  10. Mohd Haneef says

    Amazing explanation! i wonder had my teachers at school taught me the way you explained, where would have i been now?

    • Dheeraj says

      Thanks Haneef :-)

  11. JASIR says

    THANKS SIR FOR SHARING THE TOPIC

    • Dheeraj says

      thank you Jasir!

  12. Dipu Kumar says

    Hello Dheeraj,
    I am a frequent reader of your article and I must say I enjoy reading them. The way things are described and the topic chosen are very relevant for finance professionals like me who are in early stage of their careers.
    thank you so much for theses articles.Looking forward to get some more.

    Regards
    Dipu Kumar

    • Dheeraj says

      Thanks Dipu. I am glad that you find these articles useful.

      Best,
      Dheeraj

  13. Kaustubh says

    Thanks for sharing all this with excellent presentation and in a simple language.

    • Dheeraj says

      Thanks Kaustubh :-)

  14. Erica Milton says

    The Article looks Great. Thanks for the infograph as well. I was trying to get an infograph on this topic for a long time and finally found it here.

    • Dheeraj says

      thanks Erica!

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