It’s difficult to tell private equity from venture capital because they’re similar. It’s a small world so chances are you’re not involved familiar with the nuances between the two.
If you want to keep it simple you can go by a common saying in the industry,
In Private Equity you start with the numbers and then make everything else into the number.
In Venture Capital you start with the people and then see what numbers you can make.
The problem with a process you don’t improve is that you get what you pay for – inconsistent results. We see this in the fact that only 2% of female founders got only 2% of venture capital dollars in 2017.
There’s nothing wrong with picking portfolio companies or investment partners by gut as it’s backed up by data. So to pick the best option, we need to collect data on their goals and process.
PRIVATE EQUITY VS VENTURE CAPITAL
Private equity means it’s not available to the public to invest in. You and I are in the public so we both can invest in the stock market. This is a public investment option for all us. Investors have more investment strategies.
- PE firms
- Venture capital firms
- Angel investors
Their goal is to buy a company and sell it in 5 years for a much higher price than what they paid for it. Who provide money or capital in exchange for their skills.
Venture capital is a subset of private equity.
The biggest difference is when they invest vs when other private equity investors. Private equity looks for companies with a track record of revenue. Venture capital is open to more risk so they don’t need a track record.
PRIVATE EQUITY INVESTMENT TIMING: PE VS VC
We said one of the main difference between the two types of private equity is timing. Private equity firms focus on companies with historical returns who want to grow.
They’re like traditional financing options and they’ll want a guarantee on their money.
Venture capital funds are open higher risk others aren’t. They expect high rewards for that risk but they’re a great option for companies in the seed or early stages.
PRIVATE EQUITY VS VENTURE CAPITAL STRUCTURE
The structure for a private equity firm and venture fund are pretty similar. Private equity funds are structured like partnerships.
They both range anywhere from 5-10 people. Venture capital funds can be 5X to 6X this size. The size of a firm can depend on assets under management (AUM) meaning how much money are they trying to get a return on.
This is like a Sales organization managing accounts or clients. The more accounts the bigger the staff.
PRIVATE EQUITY FUND STRUCTURE
The private equity fund gets cash from limited partners, general partners. The firm’s job is to use this capital known as “dry powder” to pay for ownership in investments.
These investments are called portfolio companies. The goal is to spread the risk across high quality investments to get the best return.
VENTURE CAPITAL FUND STRUCTURE
PRIVATE EQUITY BUSINESS STRATEGY
Firms raise capital so they have the cash to use when they find an investment. While they’re growing their portfolio company, they get a piece of your profits – typically 20%. This is like a parent company charging their subsidiaries a management fee.
When they sell their investment company, they get a pay day because of the equity the portfolio company gave them when they were purchased.
PRIVATE EQUITY CURRENT PROCESS
Processes are like computers – they don’t last forever. Death is a slow burn. It starts with your work backing up and taking longer than needed but you muscle through it.
Processes act the same way. They drag down your productivity before they bite the dust. We call these growing pains but just like a new computer – you can live with them – or you can upgrade.
Best Private Equity Firms
The best partners invest in processes so you have the greatest chance of reaching your goals. Technical knowledge and industry knowledge are helpful but the business world constantly changing.
If you hire someone for their knowledge today, how do you know they’ll still be the best 5 years from now?
Because they’ve built a continuous improvement process within their culture. Culture is hard to understand. It’s one of those things where you know a bad one when you’re in it!
You can prevent getting stuck in a bad one by qualifying each potential partner. We look for these attributes in all partners and customers:
We look for humility because:
- They’re open to being wrong
- They believe there’s always a better way of doing something
- They listen more than they speak
- They’re constantly failing, learning and improving
We look for grit because the ones who will be left standing at the end of the day are the ones who never quit. We all want to quit at some point so surround yourself with people who push you to keep going.
- Money in the private equity industry and characteristically invest in the buy-outs of mature companies and
- Venture capital firms typically make high risk investments in seed, early, and growth stage companies
- PE firms and VC firms take a piece of ownership (if not 100%) in exchange for investment
- Private equity and VCs hold an investment for about 5 years
- Both PE firms and VC firms take a piece of your profits until they exit their investment
- The best private equity firm, VC fund or investor is:
- A mentor not a dictator
- Listens more than speaks
- Is open to your ideas
- Is open to being wrong
- Has a track record of this iterative cycle:
- Fail, insight, action, improvement
- Has a track record of never giving up
Be mindful of the experience getting to know your investment partner. Every conversation is full of data points to gain insight on whether this is the right partner for you.
This is a relationship that has the potential to change your life. Like any process, you have to put quality upfront if you want to get it right the first time.