Over the past few years, the lines between venture capital and small business private equity have blurred considerably. Some have even begun to use the terms interchangeably, but it is important to remember that, while related, the two are still fundamentally distinct from each other. Private equity and venture capital both invest in companies that need an influx of capital or that may need operational or managerial support. Here are five key differences between the two.
- Company Stage
Small business private equity generally invests in mature companies that have already established themselves and have an overall positive cash flow. These companies may be experiencing a downturn and looking to increase revenue as well as make improvements to their management and operations. Venture capital, on the other hand, is focused on investing in “startup” companies still in the early stages of growth, with less certain futures.
- Company Type
Another key difference between private equity vs. venture capital is the type of company they invest in. Even a group focusing under $2M per year like ValueStreet small business private equity will boast a diverse portfolio throughout a wide variety of industries. Venture capital typically has a narrower focus on small start-ups with little to no track record. Often, these are tech-based businesses that don’t require a lot of capital to get up and running. This brings us to our next differentiator – investment size.
- Investment Size and Percentage Acquired
Small business private equity investment size is often much larger than venture capital. Part of this is due to the fact that private equity firms generally buy larger shares of ownership in the companies in which they invest. Oftentimes, they will purchase the entire company. Whereas venture capital usually invests 50% or less.
- Appetite for Risk
The investment size and percentage acquired are directly related to the investors’ appetite for risk. Private equity generally invests more because their investment in a mature company in an established industry involves very little risk. For example, the same business with an EBITDA of $1M would generally get a larger investment from private equity and less from a VC. The contrast is especially stark when you consider that start-ups have a failure rate of about 90%. In fact, most venture capitalists fully expect that the majority of the companies they invest in will ultimately fail. But they also expect at least one company to succeed creating a return on their investment that more than makes up for the losses.
- Structure and Time
The last key difference involves the agreement’s structure and the amount of time invested. Small business private equity deals with both debt and equity, allowing a combination of cash and debt, but venture capital typically deals only with equity – meaning, just cash. Private equity firms are also fine with spending an average of 7 – 10 years helping a company to reorganize and work off debt. Venture capital investments are focused on realizing big returns in less time. While a private equity investor may expect to see a return of 2 – 4 times their initial investment over a long period of time, a venture capitalist would hope to see a return of 10 times or more in a significantly shorter period of time.
Venture capital vs. Small business private equity: So which is better?
Both small business private equity and venture capital offer funding in exchange for a percentage of ownership in your business, but these fundamental differences make them unique. Now that you are familiar with some key distinctions between private equity and venture capital, you may be wondering which is better for you.
First and foremost, you should consider the current stage of your company and the type of company you have. You should also consider what are your growth objectives. If you’re a small company with less than 2 years in operation and you’re looking to scale up big and quickly, venture capital is a great option for you. Is your business in the tech industry facing an uncertain future but with a huge potential to break out? An alliance with a venture capital partner who is willing to take a bigger risk might be your best way to success. Yet for a well-established small business with a proven track record, private equity can offer more operating cash. If you’re looking for a longer-term partner to offer guidance and help take your existing company to the next level, small business private equity may be best for you. In the end, it is up to you to decide which type of investor makes the most sense for your business and life goals.