Funding and investment are a complicated business, and they don’t get any simpler as you scale. When you get to the point where you’re thinking you might need some serious cash behind you, two options will likely present themselves: Private Equity (PE) and Venture Capital (VC).
At a glance, it can be difficult to tell the difference between the two. Indeed, VC is, in theory, part of the world of Private Equity. However, in practice, while they are similar, they are aimed at businesses at very different stages in their lifecycles, so it’s worthwhile understanding the difference.
What do you mean by ‘private equity’?
As both VC and PE are, technically, aspects of the same thing, let’s start by taking a look at what private equity actually is.
The PE business is all about taking a company and making it profitable, for the ultimate gain of the lender. Think of it in terms of buying a house. When it works well, a private equity deal is the equivalent of someone coming in with the cash and know-how to help you do up your dilapidated old house in exchange for a share of the profits when you sell it (for a much higher price than you’d otherwise be able to achieve).
The idea from the lender’s point of view is to use their resources to turn something with pre-existing potential into something more profitable, in exchange for a degree of equity.
Is venture capital private equity?
Well…yes. And no. The theory behind private equity and venture capital is much the same: exchanging resources which can turn potential into profit for a share of the proceeds. In practice, however, the two funding types work a bit differently.
Private equity firms tend to take more of a restructuring approach, by investing in established companies with pre-existing management structures, cash flow, solid assets etc. For one reason or another, companies seeking private equity deals may find themselves struggling to maintain their profits. At this point, the private equity firm will step in with their resources and expertise to revamp and restructure the business. If successful, they’ll then reap the rewards in the form of profits and controlling interests.
Venture capital is a rather more speculative affair. While PE firms are focused on solidly established businesses, VCs – as the name suggests – spend their time (and cash) investing in the uncharted territory of new ventures, i.e. startups and SMEs. Again, they’ll offer funding and resources to help their investments to scale (in return for an ultimate share of the profits), but they’re far more interested in future potential than in reviving past glories.
So, what is the difference between private equity and venture capital? Essentially, it comes down to the amount of money on offer, and the kinds of companies it’s offered to.
Private equity vs venture capital
Private equity. PE deals usually involve a hefty amount of money, due to the size of the company involved. This can be very enticing for business owners, however, you must be prepared to cede an equally hefty amount of control. PE firms may wish to entirely restructure, rebrand, and restaff your business and the changes can be quite extreme. It’s often worth it for the increase in profits but you need to be aware of what you’re getting into. PE deals are most appropriate for reasonably well-established businesses which are struggling to gain or maintain their share of the market. Startups and SMEs won’t generally be considered by PE firms.
Venture capital. VCs are more interested in what could be, rather than what is and what has been. If you’re a startup or SME with a clear vision and an MVP (Minimal Viable Product), venture capital might be just what you need in order to scale. Venture capital firms will want to see evidence that your product works, that there’s a ready market for it, that your expectations are realistic, and that you have a good team behind you. They’re less interested in cashflow, assets and the like (although it certainly doesn’t hurt to have these ready to show). The amount of money on offer is usually smaller than you’d get from a private equity firm, but the changes and level of control demanded by VCs are also usually less radical.
So, if you’re still in the early stages of your business journey, chances are that VC is the best option for you. Then, once you’ve got a few years success under your belt and you’re looking to take your business up a notch, or turn things around, PE is the place to go.
And for more on all types of startup funding, check out our Ultimate Guide.