Private equity and venture capital investing are similar in that in both cases, investors are putting very large sums of money into private companies, with the hope of increasing the value of their initial investments. Private companies are firms that are not traded on a public stock exchange, like NASDAQ. Both private equity and venture capital investors need to have deep pockets, because investments are in the millions of dollars. However, taking a closer look at the two types of investing, it’s clear that there are significant differences.
Private equity investing generally deals with companies that are already established. Private equity investors typically invest through private equity firms which will buy ownership in underlying companies. Most private equity investors are institutions such as endowments, the investment offices of high net worth families, pension funds, and the private equity firms themselves. A private equity firm will look for companies where it can buy ownership in the firm and then increase the overall value of the firm.
The firm may buy companies and overhaul operations to increase revenues or may buy a company in a growing industry and assist management in running the company. Typically, the private equity firm will own most, if not all, of the company in which it is investing. The private equity firm then takes control of the company. Because of the nature of buying mature companies, it is not unusual for a private equity firm to invest $100 million into one company.
Unlike private equity, venture capital entails investing into startup companies and fledgling businesses where there is a calculated chance for major growth. The money for funding venture capital investments often comes from venture capital firms, investment banks and other types of financial institutions. A wealthy individual investing his or her own money in a startup company is called an angel investor.
Because investors funding these small companies are taking a risk on a startup company to survive and thrive, they are betting on a big payout to compensate for risk. A difference from private equity is that venture capital investors typically spread out their investments among several startups to diversify their risk. Venture capital investors also usually invest into a smaller percentage of the ownership of a company, whereas private equity firms take a major stake in the underlying company.