Once again we are here with the brilliant Tyler Tysdal to clean up some of your investment concerns. Tyler has worked in investment his whole life and from fund manager to angel investor there isn’t much which the man hasn’t done in this business. Today we are going to be looking into private equity and venture capital and aiming to clear up any misconceptions which you have between the two. These investment vehicles are certainly very similar but there are some key differences which we need to understand, let’s take a look.
Private equity is a pooled fund of investment which is used in the takeover or the partial takeover of a privately listed company. The PE firm will buy shares in the company, usually one which is going through difficulties or seeking extra investment in order to push for growth plans. Once the investment is made then the PE firm will be instrumental in the future of the company, placing members of their team on the board of directors and having a key say over what the business does. A typical leveraged buyout looks like this;
- PE company borrows $4bn and adds $4bn of own funds to purchase company A which is going through tough times.
- PE firm restructures management team, sells assets and streamlines workforce.
- Company A is sold for $10bn after 3 years when the market is buoyant and the company value has risen.
- PE firm repays loan and shares the $2bn profit amongst investors
Venture capital is similar to private equity in that it is a vehicle which looks to invest heavily in businesses but that is where the similarities end. A venture capital investment is always an investment in a new company or startup. The venture capitalists will look to impact opportunities with its investment and through its experience, generally seeking a 49% stake in the company. Venture capitalists will play a key role in the decisions which the business makes and they will use their expertise to help this company to get off the ground.
Beyond the types of company which PE and VC invest in, there are some further differences which can help us separate the two. To begin with there is the levels of risk attached to both of these investment vehicles, with a VC investment carrying much more risk given that in general it is an unknown quantity. The amount of shares greatly differs as well and VC investment very rarely seeks more than a 49% stake in a new company. Whilst a PR investment will involve the PE company to get heavily involved with the decisions that the business makes, VC investment requires much more involvement and support in nurturing the new business.
As you can see, whilst both of these models could certainly be considered as private equity, the stark contrasts between the two investment models is what we can use to separate them.