To pursue the best funding option for its specific needs, it’s important that any business looking for additional investment understands the difference between traditional private equity and venture capital. Technically, venture capital is a form of private equity investment because a venture capital investment involves taking a private equity stake in a business, but the terms are used separately as they each have their own specific attributes and focus.
Here, we highlight how private equity and venture capital investments differ, which type of business they are each designed for and where to go to secure either type of funding.
What is private equity investment?
Private equity can be an investment by:
- A high-net-worth individual often called an angel investor
- A company focused on private equity investment
- An institutional investor such as a pension fund
Although some private equity investments involve buying a business outright, more typically private equity companies, funds or individual investors take an equity stake in a business. The businesses they look to invest in tend to be fast-growing, well established, unlisted businesses and they look to work with them for the medium to long-term - think four to seven years. At this point, they will seek to exit the business by selling their stake and will hope to make a substantial profit.
Private equity is often secured to assist management buy-outs or management takeovers and the private equity investor will expect to work closely with the business’s leadership team to help run and develop the business. If you want to retain complete control of your operation, you may find the involvement of a private equity firm stifling. If you are, however, keen to harness the skills of expert advisors who can help you make efficiency savings, enhance your supply chain, boost sales and take a detailed look at your entire operation, you may find the input of a private equity investor invaluable.
What is venture capital investment?
As already mentioned, venture capital is a branch of private equity investment. It is specifically designed for start-ups, entrepreneurs, and innovative, young, small businesses with fantastic potential to grow and scale. Venture capital can be an investment from a single angel investor, often a highly successful entrepreneur interested in helping other businesses mimic their success, or a financial institution. Although businesses from all sectors attract venture capital investment, it tends to favour innovative companies in emerging sectors such as tech.
Unlike traditional private equity investment, venture capital is not always solely a financial investment. It can also be an investment of say, technical or sales know-how or leadership skills. An investor gives their time and knowledge and often, but not always, money too, in return for an equity stake in a company. And, because the risk involved in venture capital investment is greater than traditional private equity investment, the venture capitalists may expect a much larger return.
The support in terms of financial funding and expertise gained from a venture capital investment can be fantastic and can be what takes a business from beetling along satisfactorily to full steam ahead. Just as with traditional private equity investment, however, it will mean relinquishing some control over your operation and requiring you to accept advice.
The venture capitalist will aim to exit your business after four to six years, going by past statistics.
Private equity vs venture capital
|What is private equity best suited to?||What is venture capital best suited to?|
|For established businesses looking for medium to long-term capital investment||For start-ups or scale-ups looking for early-stage investment of time, expertise, and capital|
|For fast-growing companies that are not listed on any stock exchange||For start-ups or emerging companies entering scale-up stage|
|For businesses willing and able to accept outside involvement||For businesses willing and able to accept outside involvement|
|Investment term typically four to seven years||Investment term typically four to six years|
How to secure private equity or venture capital backing
Before you start seeking private equity or venture capital investment, you must ensure that your business is attractive to investors. This means that you need to know your numbers, have all your accounts up-to-date and be ready to prove that you are running a sound and growing operation. You will need to pitch your business to investors and before they hand over significant sums of money, time, or expertise, they will ask you some very probing questions. If you don’t have all the answers or if your answers give them reason to doubt the security of your business, they are unlikely to invest.
When you’re confident that you’re ready to face investors, you need to actively seek them out. Your local business network is a good place to start. These websites may also prove useful:
- The Angel Investment Network has over 250,000 angel investors looking to invest different sums of money all ready to hear your pitch, and you can now pitch to them online.
- Pitchbook provides data on the private equity and venture capital market in the UK and worldwide.
When your business is in a position to benefit from additional funding, our team of corporate solicitors is ready to advise you on whether to look for a traditional private equity deal, opt for venture capital, or both, as well as considering other alternatives such as crowdfunding. We will also be able to look over or draw up all the associated documentation including term sheets, and share cap tables, and offer more general advice discussing any concerns you may have about the investment process.