Basically, it’s about what stage of development the company seeking investment is. If it is an established, mature business, you are talking about a private equity deal. If it is just an idea not yet mature, that would be venture capital. Venture capital usually takes minority stakes in businesses and typically more than one venture capital house will invest at the same time.
Startups are financed mostly by VCs until they go public (if they do go public), as PE firms generally stay away from them. In the event that they decide not to go public and the VCs are looking for a way out, then PEs can potentially acquire all shares of the firm and make it private.
Interestingly, private equity used to be the umbrella term for buyout firms and venture capital firms before it evolved into three main private investment firms: private equity, venture capital and growth equity. So technically, all venture capital firms are private equity firms.
However, the basic differences between private equity and venture capital include:
The size of private equity and venture capital investments are in orders of magnitude in difference. Private equity deals with long-term investment with intent to acquire a controlling interest in their target company. While venture capital investments are smaller and incremental over a span of time.
Also, venture capital often have one or more co-investors in a syndicate that takes form during a round of investing, whereas PE firms invest on their own. PEs have more power to invest on their own due to their use of debt.
Companies backed by PEs are usually relatively mature and at the very least, have a few years of operating history. These are profitable firms that can use their positive cash flow to finance growth and to service debt. They take controlling interests in mature, performing companies, and look at ways to make them worth more, then exit by hopefully selling the company for more than it was worth when they bought it.
Meanwhile, VCs can invest in a company at any stage in its development and now, VCs look to get earlier and earlier into companies. A best-case scenario for a VC is to invest early in a startup, continue investing as it gathers more funding and becomes more successful, and then profit when it has its IPO or acquisition.
Risks and returns
VC-backed companies are usually not profitable or if they have been profitable historically, they use the VC capital to accelerate growth and are unprofitable during this high growth period.. They invest in many companies, while some may fail, some break even, and a few bring in a big return.
PE funds, on the other hand, operate in a highly structured way. Their whole model is to invest in a company, improve it, and sell it off for a higher price. PE-backed companies are profitable firms that can use their positive cash flow to finance growth and to service debt.
Private Equity companies focus on hiring people with investment banking backgrounds. It’s possible for people with other resumes to break into the PE world, but it’s difficult. Meanwhile, VC funds tend to have a more diverse teams with bankers, consultants, business development professionals, and even past entrepreneurs.
Most VCs have an “entrepreneur in residence” who can be either a figurehead (who doesn’t do have to do with the fund on a regular basis, but lends them their prestige) or actually helps pick winning companies.
In Nigeria, private equity firms include , , and . While venture capital firms include , , and .