Private Equity vs. Venture Capital: How They Differ

Private Equity vs. Venture Capital: What’s the Difference?

By Catherine Brock – Updated Nov 17, 2023 at 2:08 PM

Key Points

Private equity investing usually involves buying and managing non-public distressed companies, with the goal of increasing their value.
Venture capital (VC) funds early-stage start-ups with high growth potential.
Private equity and VC investing both carry risks but offer significant profit potential if objectives are met.

Curious about the relationship between private equity and venture capital (VC)? Let's review the similarities and differences of these two investing strategies and the reasons each might be worth pursuing as part of your portfolio.

Private equity investors make controlling investments in distressed companies to make them more profitable and increase their value. VC investors fund early-stage companies with high growth potential. VC is considered a subset of private equity.

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Both private equity firms and VC firms provide financing to non-public companies with defined profitability goals. Despite the shared mission, however, the mechanics of the two investment disciplines are slightly different.

Key differences to note are the stage of the funded company, the size of the investment, the type of funding, the exit strategy, and the level of risk.

Stage of funded company: VC money goes to early-stage start-ups. Private equity deals can involve mature companies that were once profitable but have since become distressed.
Investment size: Private equity firms often seek to control their target companies and turn them around. This can require massive investments of time and money. VC firms may make smaller investments for minority interest in a larger number of target companies. This can reflect the high failure rate associated with early-stage companies.
Type of funding: Private equity firms can use a combination of debt and equity to invest, while VC firms typically use only equity. VC firms are not inclined to borrow money to invest in companies that have never been profitable, despite the possibility that they may become profitable.
Exit strategy: Private equity firms generally aim to sell the companies they turn around, while VC firms tend to have more flexibility with their exit strategy. They may sell their interest in the company, or they may benefit from an initial public offering (IPO), merger, or acquisition.
Level of risk: VC investments are considered riskier than private equity investments because start-ups without a profitability track record are more likely to fail. Private equity firms usually seek out companies that were once profitable and need to be turned around.

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Private equity firms focus on acquiring and managing companies, ultimately to improve profitability and the company's value. They might establish operational and strategic control over the target company through an LBO or a management buyout. On the other hand, VC strategies are aimed at early-stage companies that may become extremely profitable one day.

Both strategies have potential risks and rewards. With diversification, both can play a role in a well-rounded investment portfolio.

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About the Author

Catherine grew up in Southern California wearing a lot of black and trying to perfect the art of sarcasm. Prior to joining The Fool as a contract writer, Catherine was climbing the corporate ladder in marketing roles and dabbling in too many side hustles. When she's not writing, she can be found riding a horse in the country or shopping online for clothes.

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@catherinejbrock

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