What’s The Difference Between Private Equity And Venture Capital?
We explain the distinction between private equity and venture capital and explore the global private equity and venture capital markets.
If you are not working in or familiar with the finance industry, you might make the mistake of confusing private equity (PE) and venture capital (VC), and use these two terms interchangeably.
PE and VC are similar in the sense that they are both essentially investments in privately-held companies by outside investors, involve the use of similar legal contracts and financial terminology, and serve a common pool of private and institutional investors. Even the way you would aim to enter and exit a PE and VC investment is, in most cases, similar: you buy in low and look to sell high down the line to make a profit.
However, there are some significant differences between PE and VC, and it is imperative that – as a potential investor in a PE fund or VC enterprise, startup founder, or as someone interested in the world of finance – you understand the distinction between these two types of investment
WHAT IS PRIVATE EQUITY?
Private equity refers to investment capital (which can total hundred of millions or even billions of dollars) from institutional or private investors that is pooled into a fund and utilised to acquire equity in companies that are not publicly traded.
The companies targeted by private equity investors tend to be relatively mature, established businesses across a range of industries, which have been operational for at least a few years and have demonstrated the viability of their business models, products, and services. These companies are often, however, underperforming or undervalued, and thus the injection of PE funds is aimed at boosting their profitability and value, and then ultimately selling them around five to ten years down the road to reap a substantial return on investment (ROI).
WHAT IS VENTURE CAPITAL?
Technically a subset of private equity, venture capital is the financing provided to startups and early stage (pre-revenue) small- and medium-size businesses by a group of investors who think these companies have long-term growth potential. VC investors typically target companies in high-growth industries such as technology.
For tech startups, VC fund-raising has become increasingly popular as these companies usually do not have access to capital markets, bank loans, or any other financing instruments.
For VC investors, the risk is higher than other types of investments as these companies do not have a proven track record. The upside, however, is that if the startup does well, the returns can be significant.
THE PRIVATE EQUITY MARKET
According to a recent EY report, the global private equity market is healthier than ever. “PE fundraising continues to climb even as the number of funds raised continues to fall, with closed funds valued at US$415.8 billion, up 11.7% through the end of August 2017,” the report stated.
In 2017, global PE funds raised a record US$453 billion (including VC investments), an increase of nearly 9% from the previous year, according to a report by Preqin.
THE VENTURE CAPITAL MARKET
VC investments have also been surging to all-time highs. Last year, global VC investors pumped a record US$155 billion into startups around the world, according to a report by KPMG.
Chia Teck Yew, Head of Financial Services Advisory, KPMG in Singapore, commented: “Global venture capital investment surged, powered by mega funding rounds in Asia and new quarterly investment highs in the US and Europe.”
One noteworthy trend – highlighted in a recent report by PitchBook-NVCA Venture Monitor – is that VC investors are investing larger amounts of money into a fewer number of companies. These investments are often into unicorns, which are in the later stage rounds of fund-raising.
“Venture capital activity remains healthy, following the cyclical nature of fundraising and capitalising on promising investment opportunities for fund managers. Valuations have remained high as certain tech industries mature and investors benefit from more information on industry dynamics,” remarked John Gabbert, CEO of PitchBook.
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