Difference between Private Equity and Venture Capital

Private Equity vs. Venture Capital: Definition

Private equity can be defined as equity or shares that represent the ownership and interest of an investor in a company or organization that is not listed or traded publically. It can be said as a source of capital investment for companies gained from firms and individuals with high net worth. The main intention behind the buying of shares of the private companies or gaining control over the public companies are-

  1. To take the company’s control by purchasing equity in private manner and later earn profit from sale of same.
  2. Delisting these companies from the public stock exchanges.

Venture Capital Firms

Private equity in India is largely, dominated by investors from foreign background. If we talk about private equity around the world, then the data shows that investors from large institutions dominate this sector. It includes large private equity firms that are funded by accredited investors group and pension funds.

Venture capital, on the other hand can be defined as a capital fund solution or finances provided to potential small businesses and start-ups that are on the verge of breaking out. These entities are required to raise capital from such sources when the prices of their assets increase above the area of resistance or when it decreases below the supported area. The investors providing these funds can be of any class of investors i.e. investment banks, financial institutions or organizations and wealthy investors. The investments can be offered in form of expertise in technical and managerial field and not just financial terms.

Whenever, we talk about capital funds for any companies, it is assumed that investors that are providing the funds to these companies are in a way gambling because there is a mere possibility that the newer company may or may not deliver the desired results or returns. The choice between private equity and venture capital firms depends on the difference between them. A distinction between them can help with which one to choose. Here we have the difference between private equity and VC fund in India on the basis of various factors.

  1. Company types for private equity and venture capital firms:

The private equity firms are likely to invest in wider range of industries rather than the venture capitalist which mainly invest in the Technological, education, health care and life sciences sector.

  1. Size of the deal and the percentage acquired by both:

Usually, it has been seen that typically a private equity firm has acquired a majority share or a 100% stakes while investing. While the venture capital firms have acquired minority stakes or shares in a company.

  1. Creation of valuation:

When it comes to source of returns or value creation, it has been seen that things have not changed for the venture capital sector whereas different trends have been recorded for private equity firms. For venture capital, the growth and the valuation of the company at the current time decides the rate of return on investment. But with private equity firms when 10% equity financing is used for acquiring a company, the rate of returns totally depends on the financial engineering factor. When there is an average of 40-50% contribution of the equity then growth of the EBITDA becomes more valuable for the firms.

  1. Structure, stage and risk involved:

When we compare between private equity and venture capital firms regarding their structure, stages and risk involved in both, it has been noted that both types of investment funds are quiet similar in this factor. They have to begin their journey from the growth-stage deals. This has changed the culture of the potential returns and traditional risk profiles.

  1. Focus on operations:

 This factor is not one of the major factors to draw a difference between private equity vs venture capital as the structure of operation can vary from firm to firm. Most of the private equity investors focuses on the operations in the middle market to improve them, whereas there have been numerous examples of venture capital funds that have shown involvement in improving the operational structure.

  1. Work and culture in both the firms:

The private equity firm requires more technical work. The work environment in them is almost similar to the banking sector as more time is spent on making and coordinating the whole deal. In venture capital firms, the work culture is similar as well as they have to spend time in finding the potential investments and companies to invest. So no major difference is there between the two.

  1. The human resource strategy:

 The venture capital tends to hire more diverse staff and members while the private equity firms that are mid-sized or large sized tend to hire investment bankers at the junior level of staff without much of diversification. The venture capital in India during COVID-19 has shown that more of these firms have better human resource strategies and have provided with more employment.

  1. Process of recruitment:

 Both types of firms use the on-cycle and off-cycle recruitment process while hiring the staff for junior levels. The smaller private equity firms use the off-cycle process of recruitment which is similar to the process used by the venture capital firms.

However, they tend to have a difference while selecting a candidate. Both of them seek different qualities while hiring. The private equity firm while hiring a candidate seek the prestige, experience in making deals and the ability to complete the modeling tests and scenarios.

The venture capital firms on the other hand seek ability of the candidate in networking, building rapport, market understanding and bringing in the deal because there hiring process is more qualitative. 

  1. Salary composition in private equity and venture capital firms:

 In both the fields, the salary composition has three main components namely,

  1. Base salary
  2. Carried interest
  3. Bonuses and perks

In the private equity firms, a person earns more of the three mentioned components which is 30 to 40% more than what is paid in venture capital firms. But it largely depends on the size of the deal closed by the employee.

  1. Opportunities of exiting an investment:

 The exit strategies for private equity firms are not that specialized in comparison with the exit opportunities with the venture capital. It is easier for a private equity to convert to venture capital firms but the reverse is highly difficult.

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    Author: Anil Agrawal
    EZYBIZ India Consulting LLP, New Delhi. The firm is business and tax consultancy firm providing consultancy in Taxation, Regulatory, Transfer pricing, Valuation, Corporate funding and Business set up matters. He may be reached at 9899217778 or anil@ezybizindia.in.