There are significant differences between the ways in which private equity entities and venture capital firms do business. These differences are as follows:
- Maturity level. A venture capital firm invests in start-up or growth-stage businesses, with the intent of increasing their initial value. A private equity firm is more likely to invest in a more established business, and then improve its operations in order to increase the value of its investment.
- Investment trigger. A venture capital firm is looking for a high-grade management team, which it can rely upon to create a high-value business. A private equity firm looks for undervalued assets, which it can use its expertise to enhance.
- Investment level. A venture capital firm usually takes a relatively small, non-controlling interest in a company, and relies upon the existing management team to enact the changes needed to increase the value of the business. A private equity firm is more likely to buy all of a target company, so that it has complete control over the operations and financing of the entity.
- Investment scale. A venture capital firm likes to limit the amount of its investments, since each start-up in which it invests is at high risk of failure. Conversely, a private equity firm may plow large amounts into its investees, on the grounds that these more established firms are unlikely to go bankrupt, which reduces the risk of loss.
- Investment type. A venture capital firm is more likely to buy an equity position in its target companies, while a private equity firm could also loan funds, or provide a mix of equity and debt to its investees.
- Diversification. A venture capital firm likes to spread its investments among many investees, so that a few losses on some investments are offset by gains elsewhere. A private equity firm tends to concentrate its funds with a smaller number of companies.
- Expected growth. A venture capital firm needs one or two businesses in its investment portfolio to be a clear winner, which funds its flat or losing investments. A private equity firm targets a reasonable return on all of its investments.
In short, the only things that these types of investors have in common is that they have money to spend - in all other respects, their paths to earning a return are entirely different.