Venture Capital vs. Private Equity: Understanding The Difference

By Matt Dallisson, 22/02/2019

Shutterstockpathdoc/Shutterstock.com

With increasing coverage and interest in startups, fundraising and venture capital, many terms have become more ambiguous than ever. That can leave entrepreneurs pretty foggy on how they should really be approaching raising money.

So, who is funding what? Why does it matter so much if you are launching or trying to scale a venture?

Startup Fundraising

Whether you are still juggling a startup idea or already have data and revenues and are ready to scale, it’s vital to understand who the investors are that will take you to the next level, and what your following milestone or exit is likely to be.

Fundraising and navigating potential exits can be incredibly time consuming and stressful. It can be confusing. The lines have certainly blurred. Far more so in the last couple of years. Different capital sources are playing a larger role in the startup ecosystem. Various players are stretching how and at what stage they will participate.

So, what are the differences between between VCs and PE firms? Who else is providing capital to this space? Who are the leaders that startup founders should be focusing on?

Private Equity

This space has become a little cloudier, with private equity firms diving into all types of new channels like single family rental homes and mortgage lending through conduits. Yet, in their most traditional forms, private equity firms are consider those who buy or get involve with more mature companies.

This means they are looking for established companies that already have established revenues. In some cases these are companies that may have even peaked and need new management to be optimized. Think classical music, farms and assembly lines in contrast with the typical jazz, disruption, or street art style of fast growth startups. They prefer predictability and lower risk. Even if that means lower returns.

This space is also differentiated by leveraged buyouts, in which PE firms utilize debt to complement their equity to acquire more corporate ‘real estate’. These firms are best known for taking majority stakes, if not full buyouts.

According to rankings from Private Equity International top private equity firms include:

 

Private equity is more likely to be your end game, or at least a large part of your exit as a startup founder, rather than an early investor. Though these firms may flow down debt that can be used for some ventures.

Venture Capital Firms

In contrast, venture capital firms are equity investors at an earlier stage in the lifecycle of a startup. Just not as early as most think.

For the most part VCs are funding startups at their latest stages in their businesses. This is changing some. More are participating in earlier funding rounds as they gain experience and competition grows for returns and opportunities. You may find them involved at Series A through D fundraising rounds. Or perhaps even at the seed stage.

VC firms will typically take much smaller portions of companies than their private equity counterparts. They are still investing at a much riskier stage and mostly try to spread their bets as wide as possible.

 

This demonstrates more crossover between traditional private equity and the VC world. Though before you go waltzing into one of these firms in your pajamas, know that they still expect a good amount of solid data and due diligence to make a decision on. They aren’t going to be your first investors on day one.

VCs are also typically looking for a shorter term exit. They have deadlines on their funds, and need to get results quickly. They are often going to push you hard to deliver on their promises to their own investors.

PE is more about numbers while VCs are more about people. However, with both PE and VCs everything starts with a solid pitch deck where the story of the company is told in 15 to 20 slides. For a winning deck, take a look at the pitch deck template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash. Moreover, I also provided a commentary on a pitch deck from an Uber competitor that has raised over $400 million (see it here).

Angel Investors

Angel investors are a much more likely funding partner for most startup founders. Angels are getting better funded, are grouping together, and are making more investments.

Angels are willing to participate in the earliest rounds of fundraising. They are typically basing their investment as you the entrepreneur and the idea, versus any data or profits. Expect to be raising from angels for a round or two before you even approach any VCs. PEs are probably four or five rounds of financing away at this point.

Notable angels include:

Typically the best angels are those that were entrepreneurs before and fortunate enough to have an exit. I have the pleasure of interviewing some of the most successful entrepreneurs on the DealMakers Podcast where they share some of the patterns they are looking for when investing in other entrepreneurs.

Other Startup Investors

Startup accelerators and incubators are another rising form of early funding. They may invest anywhere from $10,000 to over $100,000 and offer an array of intensive programs, resources and training opportunities. These include names like The Founder Institute, Angel Pad, Y Combinator and 500 Startups. They can get you going if it is a good fit and you can get in. Then help you show off your startup to other investors.

Family offices are increasingly investing in startups as well. They don’t want to miss out on the game that VCs and big private equity firms are enjoying. Though they often like the advantage of investing directly, rather than losing returns to middlemen.

Family offices can be quite different when it comes to what they want and their future expectations though. They may be more likely to offer patient capital or to seek cashflow than other types of investors.

Corporate investors are playing a bigger role in the startup ecosystem today too. They are setting up their own accelerators and are making more strategic investments in startups that can propel their growth and extend their reach.

Despite the confusion and ambiguity out there, there can be distinct differences between private equity and venture capital when it comes to raising money and exiting a startup. There are many more options for fundraising and exiting than there used to be too.