Venture capital and private equity funds are two different ways that companies, funds or individuals invest in other companies. While the two types of funds share some similarities, there are also key differences that you’ll want to be aware of. While many private equity and venture capital funds are privately held, some are open to individual investors.
A private equity fund might use its managerial, technological or other expertise to invest in one specific company, hoping to turn it around and improve its profitability. That would allow the fund to sell their investment for a healthy return. Venture capital firms often invest in early-stage companies or startups. They provide capital funds to these companies in exchange for a portion of the company’s equity.
Key Points
• Private equity and venture capital are two ways that people, funds or companies invest in other companies.
• Private equity funds often invest in a small number or even just one company at a time, usually a mature company.
• Venture capital funds generally invest in many different companies that are early in their journey to profitability.
• While many private equity and venture capital funds are privately held, there are some that are publicly traded and open to individual investors.
What Is Private Equity?
Private equity refers to investing in companies that are not publicly traded. Unlike investing in public equities (such as by purchasing index funds or shares of stock of companies listed on a public stock exchange), private equity investors put their money into privately-held companies.
While you might not think of private companies as having shares of stock in the same way that publicly-traded companies do, most incorporated companies do have shares of stock. A small company might only have a hundred or even less shares, all owned by the initial founders of the company.
A private company that is more established, on the other hand, might have hundreds of thousands or even millions of shares owned by a wide variety of people. The stock of private companies might be owned by the founders, employees or other private equity investors.
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What Is Venture Capital?
Venture capital refers to investors and money that is invested into early-stage companies in the hope that they will generate an above-average return on investment. Venture capital investing usually refers to funds or individuals that give money to early-stage companies, but the investment can also be via managerial or technical expertise.
Venture capital money is often invested over a series of “rounds.” Initially there might be an “angel” round or “seed” round, and then Series A, B, C and so on. In each round, companies receive funding from venture capital investors in exchange for a percentage of the company’s stock, at an agreed-upon valuation.
Generally, the earlier the round of venture capital investment, the lower the valuation. This allows the earliest investors to potentially have the highest return on investment, since they also carry the largest amount of risk.
Venture capital and private equity may serve as examples of alternative investments for certain investors.
Key Differences Between Private Equity and Venture Capital
While private equity and venture capital both refer to companies or funds that invest in companies, there are a few key differences that you’ll want to be aware of:
| Private Equity | Venture Capital |
|---|---|
| Generally invests in already established companies | Often invests in early-stage companies and/or startups |
| Often purchase entire companies and work to improve their profitability | Purchase a portion of the companies they invest in |
| Generally invest more money and focus on fewer companies | Firms tend to spread their money around — investing relatively fewer amounts of money in more investments |
Advantages and Disadvantages
When you compare private equity vs. venture capital investing, there are a few similarities as well as advantages or disadvantages to investing in both.
In most cases, comparing the advantages and disadvantages of venture capital vs. private equity depends on your own specific situation or goal. What might be an advantage for one investor could be a disadvantage for an investor with a different risk tolerance or financial profile.
One potential advantage of investing in private equity is that private equity firms often concentrate their money in a small number of firms. This might allow the private equity investors to concentrate their expertise into improving the profitability of those companies. However, some might consider this a disadvantage, since you might lose some or most of your investment if the company is not able to turn things around.
Similarly, venture capital investors typically invest in a number of startups and early-stage companies. One advantage of investing in this manner is that you may see outsized returns if the company succeeds. However, a related disadvantage is that many companies in these early stages do not succeed, potentially wiping out your entire investment.
In that sense, it’s a high-risk, high-potentialy-reward area of investment.
Common Misconceptions
One common misconception about private equity vs. venture capital is that only investors with significant net worth can invest in these fields. While it is true that most actual private equity and venture capital investors are those with access to significant amounts of capital, there are also many private equity or venture capital funds that sell shares of the funds themselves to retail investors.
This may allow even regular individual investors to take part in investing in venture capital or private equity.
💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.
The Takeaway
Private equity and venture capital funds are two different ways that companies invest in other companies. While they share a lot of similarities, there are also some key differences. One big difference is that generally, private equity funds invest more money in fewer companies while venture capital funds often invest (relatively) smaller sums of money in many companies.
While most private equity and venture capital funds are privately held, there are some that are publicly traded and open to individual investors.
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FAQ
Is private equity better than venture capital?
Private equity (PE) and venture capital (VC) are two forms of investing in other companies, and when comparing the difference between VC and PE, it isn’t really the case that one is better than the other. Instead, it will depend on your own specific financial situation and/or risk tolerance. You can also consider alternative investments to both private equity and venture capital.
Which is the riskier option?
Both private equity and venture capital carry some level of risk. In one manner of speaking, venture capital is riskier, since many of the early-stage companies that they invest in will not succeed. However, most venture capital funds mitigate that risk by investing in many different companies. One successful investment may pay off the losses of tens or even hundreds of unsuccessful venture capital investments.
Are there private equity or venture capital funds available to buy?
Many private equity and venture capital firms are targeted towards investors with significant assets and/or a high net worth. However, there are some funds that are publicly traded and thus available to individual investors. Make sure that you do your own research before investing in any one particular private equity or venture capital fund.
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