What is the Difference Between Private Equity and Venture Capital?
By Lior Ronen (@Lior_Ronen) | Founder, Finro Financial Consulting
The capital market includes two parallel universes: the private market and public market - and they are significantly different.
The private equity industry is estimated to manage around $5.2 trillion in various strategies when most money is managed in buyouts and real estate funds.
Venture capital that receives much of the attention drawn to private market investing accounts for ~12% of the private market.
What is the Difference Between Private Equity and Venture Capital?
First, venture capital is a subcategory of the private equity asset class.
Second, when comparing venture capital to classic private equity (i.e., buyouts), it is essential to highlight its core strategies.
Venture capital invests in projects in which there is a substantial element of risk, typically a new or expanding business.
The rationale behind the VC strategy is to invest as early as possible in new initiatives to gain the highest possible return. Of course, these returns are also associated with considerable risk.
Private equity typically refers to investment vehicles in which a fund buys and restructures companies that are not publicly traded.
Other strategies of private equity, invest in businesses in a more mature and later stage than VCs to take them public and benefit from the significant upside.
Since private equity funds invest in late-stage startups, their check size is typically larger than VCs. However, these days the classic differences between PE and VC start to fade.
Finro Financial Consulting: Private Market Funding Rounds
PE Growth of 2009 - 2019 Between 2009 and 2019, the aggregated amount raised globally by private equity funds increased in ~2.76x.
What drove this explosion in private equity funds?
The primary driver for this sharp growth is the post-global financial crisis (‘GFC’) low-interest rates. The historically low-interest rates around the world drove investors into riskier and less liquid asset classes that generate higher returns.
In the search for better returns than government bonds yielded, investors poured money into private equity funds in various strategies.
At the same time, the stock exchanges around the world experienced a significantly long bull market that inflated valuations of publicly traded companies and directly impacted valuations in the private market.
As valuations grew, private market investors benefited from high returns that drove even more investment into the private equity industry.
Finro Financial Consulting: Global Private Capital Raised
Pension funds, endowments, and sovereign funds increased their private equity allocation further, which increased available funds for private market strategies, inflated valuations, and attracted even more investments and so on.
Another event that impacted the private equity industry is the JOBS Act of 2012.
The Jobs Act, or The Jumpstart Our Business Startups Act, is a law intended to encourage funding of small businesses in the United States by easing many of the country's securities regulations.
The JOBS Act defined emerging growth companies as a business that generate up to $1 billion in revenues in the last 12 months. These growth companies are eligible to file confidentially for an IPO and save them one of the noise and hustle in the IPO process.
The bill also increases the number of shareholders that a company may have before being required to register with the SEC. The law defines the maximal number of shareholders in a private company to 2,000 investors with up to 500 of those to be unaccreidted investors.
The result of the low-interest world combined with the increased valuations and the support from the JOBS Act is that private companies can grow larger than before and remain private longer than they used to.
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