Venture Capital vs. Private Equity: Differences
Private equity (PE) refers to off-market equity capital that flows into (usually) already established companies. These often belong to the upper middle class. The most prominent examples from Germany include Fielmann (spectacles manufacturer) or FlixBus (mobility). Off-market in this context means that the shares in the respective companies are not listed on the stock exchange. Compared to venture capital, financing with PE is in principle carried out within the framework of a single transaction. With venture capital, different financing rounds (seed/early stage) are common practice.
The type of financing also differs. While venture capital investors use equity capital, PE investors use a high proportion of debt capital to increase the return on equity (so-called leverage effect). The debt capital is usually secured with the assets of the target company, which involves risks that should not be underestimated. The loan is repaid with the target company's cash flow. In the case of venture capital financing, the capital raised flows into the capital reserves of the acquired company.
As already mentioned, PE companies focus on established companies - usually from the upper middle market. PE managers make sure - especially with regard to debt obligations - that equity investments have a healthy cash flow, a strong market position and a low risk of total loss. However, this is never assured. Venture capital, in contrast, is a form of financing for younger companies in the start-up or growth phase. It begins with or shortly after the start-up phase. The growth potential is greater - especially at the beginning - than with a PE investment, but it is also more risky. Most start-ups are still in the product development phase and have not yet proven themselves on the market. For this reason, venture capital is often also referred to as risk or venture capital. In most cases, these are innovative and technically oriented companies.
Finally, PE managers seek majority ownership in companies to manage restructuring projects with more control. This gives them more influence on the company management. Venture capital investors, on the other hand, generally seek a minority stake in the start-up. Certain control and co-determination rights in strategic decisions are agreed individually, but control of the company should remain with the founding team.
Similarities between VC and PE
Both private equity investors and venture capital investors belong to the group of financial investors. In principle, they are structured as funds - i.e. they collect money from external investors, bundle it in the fund and invest in companies with this capital. The main argument for an investment is the return potential that investors see in a particular company.
In both cases, the goal of an investment is an exit - i.e. a profitable sale of the acquired shares or an initial public offering (IPO). Consequently, it is also clear that it is not a long-term commitment, but a temporary investment. In this context, there are frequent exceptions, especially with venture capital, in which an investor has a strategic interest in the investment. This can happen, for example, if a certain technology is interesting for the investor's own company. The investment is intended to realise a competitive advantage.
The identification and valuation of companies is also similar in many respects. Before a legally effective investment, all investments go through a so-called due diligence process to calculate the "theoretical" investment value. Venture capital investors have to rely on more forecasts when valuing a company, as young companies do not have tangible business figures (e.g. balance sheets, management reports, key figures) with a certain history.
What role do asset classes play for investors?
Both private equity and venture capital are asset classes to which small investors have so far had neither direct nor indirect access. Until now, investors have included large institutional investors (insurance companies, pension funds, etc.), family offices and wealthy private individuals. The financial hurdles are enormous. In Germany, investment amounts of 200,000 euros or more are necessary to use private equity as a building block in one's own portfolio.
We would like to challenge this status quo and have therefore developed an app that allows small investors from 100 euros to invest indirectly in private equity and venture capital funds.
Whether an investment makes sense for you depends on your risk profile. Studies show that private equity has a better risk-return profile than classic stock market stocks. From the point of view of diversification , this is a great advantage. Nevertheless, the risks of both asset classes should never be ignored. Both private equity and venture capital can lead to the total loss of your capital. While we perform extensive due diligence, we cannot completely eliminate risks.
Conclusion
Venture capital and private equity have many similarities, but also fundamental differences. In both cases, investors plan for long-term excess returns and some form of influence over the respective companies.
While private equity focuses on established medium-sized companies, venture capital investors focus on young companies in the start-up or growth phase. Retail investors should be aware of these characteristics, as they have a high influence on the risk of an investment.
Venture capital carries a greater investment risk because it is not yet ready for the market. The risks of loss should not be underestimated with private equity either. Nevertheless, due to the partly solid market position of the target companies, these are less pronounced than with young start-ups. Both forms of financing carry a significant risk of total loss, which investors are rarely aware of because they like to advertise success stories.
