Venture Capital vs Private Equity

Differences Between Venture Capital and Private Equity

What is Venture Capital?

Venture capital means investing in small, expanding businesses with typically high growth potential.

What is Private Equity?

Private equity, also known as company acquisition, means acquiring equity in a non-public company by buying its shares.

Venture Capital vs. Private Equity

Venture Capital is often confused with private equity, meaning acquiring a portion of a company, because both are essentially investing in a business. However, venture capital and company acquisition are fundamentally different investments for the reasons below:

1) Equity Dynamics: Issuing New Shares vs. Buying Existing Ones

In an investment in the form of Venture capital, the company issues new shares that are in turn acquired by the Venture Capital investors. This way, the investment amount goes to the company itself, not to the owner of the company, and has to be spent on the business just like the starting capital of the company.

By issuing new shares and increasing the capital of the company, the founder’s ownership percentage is diluted despite the founder having the same amount of shares after the capital injection as before. The percentage of ownership that becomes available – as a result of the founder’s percentage being diluted – is acquired by the Venture capital investors.

On the other hand, in Private Equity (Company Acquisition), the investors buy some or all of the shares from the shareholder(s). This way, the funds go to the shareholders, not to the company itself, and the total capital of the company remains the same.

In short, in Private Equity, the business does not benefit from the investment unless the investor injects additional funds or helps the business in other forms such as technical or managerial expertise.

2) Potential and Profitability: Small Businesses vs. Established Companies

The second most important difference between Venture Capital and Private Equity is that in Venture Capital, the investable companies are small businesses that have yet to reach their potential and generate significant returns on the investment. In Private Equity, however, the investable company is typically an established company with an attractive ROI (Return on Investment) rate.

In short, Venture Capital is typically reserved for long-term investments with no return in the short term but potentially high return in the long term, whereas Private Equity investor expects returns in the short term and strives to increase those returns in the long term.

3) Contributions Beyond Capital: The Prevalence of Non-Monetary Resources

Both in Venture Capital and Private Equity, some or all of the investment can be non-monetary resources such as marketing platforms, offices, facilities, equipment, and employees. However, due to the nature of Venture Capital and the fact that small businesses need such expertise and platforms more, non-monetary investments are more common in Venture Capital.

4) The Founder’s Influence: A Key Factor in Venture Capital Decisions

In Venture Capital, the founder’s expertise and qualifications play a major role in the investment. In fact, it is not uncommon that the founder’s expertise becomes the main reason and the condition for a Venture Capital investment, as the company would be uninvestable without its original founder.

On the other hand, an investment in the form of Private Equity relies on the corporate structure (its employees and systems in place) much more heavily than the company’s founder(s). In fact, it is not uncommon that a company’s founder(s) is replaced by the investor’s own team shortly after a Company Acquisition.

Venture Capital as an Instrument of Investment

As a conclusion, Venture Capital is a well-known investment type and is used by sophisticated investors to diversify their portfolios. However, due-diligence and realistic valuation are vital parts of Venture Capital investments.

Differences between venture capital investments and private equity investments can be confusing. Turkish Investment lawyer Baris Erkan Celebi and his investment law firm in Turkey offer legal consultancy on how to invest in venture capital in a legally secure way.