DEFINITION OF 'VENTURE CAPITAL'Money provided by investors to startup firms and small businesses with

perceived long-term growth potential. This is a very important source of funding

for startups that do not have access to capital markets. It typically entails high

risk for the investor, but it has the potential for above-average returns.

INVESTOPEDIA EXPLAINS 'VENTURE CAPITAL'Venture capital can also include managerial and technical expertise. Most

venture capital comes from a group of wealthy investors, investment banks and

other financial institutions that pool such investments or partnerships. This form

of raising capital is popular among new companies or ventures with limited

operating history, which cannot raise funds by issuing debt. The downside for

entrepreneurs is that venture capitalists usually get a say in company decisions,

in addition to a portion of the equity.

Private Placement vs. Private EquityTo fund its operating activities, a company can raise cash on financial

markets, such as the New York Stock Exchange or Hong Kong Stock

Exchange. The firm also can work with investment bankers to privately

place, or sell, its equity or debt securities. Investment bankers help all

organizations, including academic institutions, raise money by selling

financial products to private-equity firms.

Private Placemento A private placement is a transaction in which a company raises money

directly from private investors. For most businesses, including the financially stable ones, being able to raise operating cash merely constitutes table stakes -- that is, the minimum required to keep them in the competitive game. A company turns its attention to private placements if it is unable -- or unwilling -- to raise cash via conventional public markets, such as the London Stock Exchange. This may result from a bad economy, prohibitive rates on credit markets, high corporate indebtedness or mediocre operating performance. In a typical private placement, the issuing firm reaches out to

investment bankers who in turn place, or distribute, the company's debt and stock products to a small number of investors.

Private Equityo Private equity is cash that investors pour into a company not listed on a

financial exchange. The term also refers to money invested in a business to un-list, or de-list, it from a financial market -- that is, to buy current shareholders out and convert the company into a privately held company. Private equity often has a strategic impact in an industry's competitive landscape, because the un-listing of a major player could recast the field of organizations in the race to be market leader. This might happen if other publicly traded businesses have access to more liquidity on credit markets and can parlay their resources to grow faster than the privately managed institution.

Relationshipo "Private equity" and "private placement" are distinct terms, but they

interrelate in investment activities. By placing its products through private channels, a company is -- in essence -- reaching out to private investors who ultimately become private-equity holders once they inject cash into the business. Similar to shareholders of a publicly held company, private-equity holders may receive periodic dividends. They also might reap substantial profits if the privately help company ultimately decides to issue common shares on a public exchange.

Personnel Involvemento Various professionals help companies raise operating funds through private

outlets. Besides investment bankers, financial analysts and accounting managers review corporate performance data and recommend the best time to seek private equity. Institutions such as private-equity firms and hedge funds also weigh in on private fundraising, providing cash if money-seeking businesses meet their investment target

Private Equity vs Venture Capital- Which Is Better?

Amongst the newest forms of investment vehicles available for rich individuals

arePrivate Equity and Venture Capital. However it always seems to be a hot

topic of discussion about Private Equity vs. Venture Capital and which one is

better.

Definitions

A private equity investment is made by investor/s as per goals, preferences

and investment strategies of the firm or individual investor. In general private

equity provides working capital to the target company to cultivate expansion,

invest in new-product development, or restructure of the company.

One of the most common investment strategies in private equity is called

venture capital investment or growth capital.

Venture capital (VC) is a strategy where financial assistance is provided to

companies that are at the initial stages of their lives and have the potential to

deliver super normal returns justifying the investments made in them.

The venture capital fund earns money by acquiring equity in lieu of the

investment it makes in the company.

Prime candidates usually are the ones with some novel technology or a

unique business model in relatively newer sectors.

A venture capital fund does its investment after the initial round of funding is

done. The investments are done with a view of generating super normal

returns through events, such as an Initial Public Offering or sale of the target

company to an existing bidder, which unlocks the company’s true value.

Myth Busting

Private equity investments is not new, in fact it has been in existence for

almost a century and was the domain of wealthy individuals and families.

Some of the most famous families like the Wallenbergs, Vanderbilts,

Whitneys, Rockefellers, and Warburgs could be termed as pioneer venture

capitalists. For example, Laurance S. Rockefeller helped finance the creation

of both Eastern Air Lines and Douglas Aircraft in 1938. Eric M. Warburg

founded E.M. Warburg & Co. in 1938, which was the forerunner to the current

entity of Warburg Pincus, one of the largest private equity funds with

investments in both leveraged buyouts and venture capital.

The Wallenberg family created Investor AB in 1916 in Sweden and acted like

venture capitalists for marquee Swedish companies such as ABB, Atlas

Copco, Ericsson, to name a few.

The confusion between the activities arises as the terms are often used

interchangeably even by those who are practitioners of this form of

investment.

Both VC and PE are in the business of buying cheap and selling dear.

However the approach to this challenge is what fundamentally differentiates

the two entities.

Private equity firms usually take interest in a pre-existing enterprise with

established products and having positive operating cash flows. The PE firms

try and restructure aspects of company which will optimize the company’s

financial performance. If the work comes out in a proper fashion then Private

Equity has demonstrated its ability to save poorly-performing companies from

bankruptcy and turn them into viable enterprises.

The venture capital process is usually much messier.  Often, you start with

nothing more than a brilliant idea and the people behind it and work on

realization of the next big idea.

To make things easier, we can say that a PE fund will polish a rough diamond,

whereas a VC firm would make investments in land parcels hoping or the next

diamond mine to be in one of its investments. 

What They Do

Both PE firms and VCs invest in companies and make money by exiting –

selling their investments.

What does private equity do?

 

What does venture capital do?

 How Do They Do It?

It is an oversimplification that private equity firms simply acquire companies,

make lives of employees miserable, saddle the company’s balance sheet with

debt, and then sell the company for a fat profit without doing anything

substantial.

PE firms are not known to be actively involved in fixing a company’s

operations, but they certainly do put in a lot of hard yards to improve overall

management of the company and find ways to expand – especially when it’s a

recession and there’s not much buying and selling of large companies.

Venture capitalists on the other hand, get involved with operational nitty-gritty

of the firm if they feel that the firm in question is wavering on focus, the stage

of the company, and how much the current owners wants them to be involved.

Risk and Return

You might now be wondering, “So which model actually produces higher

returns?”

Although there has been lot of talk, in reality returns in both industries are

much lower than what investors claim to achieve.

Most VCs and PE firms target 20% returns, but there are plethora of VCs who

have given only 10% returns over a 5-year cycle and many pension funds that

invested in PE firms are living with sub par performance.

One difference is that in both the models it is the  firms at the top of the

heap which generate the returns. The reason being that the best deals in case

of both the PE and VC companies almost always go to the top firms.

The People and How They Work

Private equity firms focus on roping in former investment banking analysts as

the modeling and due diligence work is almost in line with transactions in

banking. Non I-Banking people also get into private equity firms if they have

good operational knowledge or have very good contacts in the industry of

focus for the private equity fund.

Venture Capital firms, because of their very nature of business tend to attract

a more diverse mix – you’ll see ex-bankers, consultants, business

development people, and even former entrepreneurs.

Especially at large PE firms, the work is not much different from investment

banking: thus you would be spending a lot of time in Excel valuing companies,

looking at financial statements, and conducting due diligence, which are

standard I-Banking activities.

Additionally you need to coordinate with other entities like accountants,

lawyers, bankers, and other PE firms as per the deal’s requirements.

As you progress from Private Equity to Venture Capital, the work becomes

more relationship-driven and less quantitative. Some people may not like

activities like cold-calling and the pressure of constantly finding new

companies to their liking.

Key Takeaway

To summarize the battle for Private Equity Vs. Venture Capital we may say

that if you are number driven person with a passion for making things better,

then Private Equity is the place to be. You would enjoy the high that big ticket

investments make.

However, if you wish to unearth the next big thing and believe that you have it

in you to find the next Google, Apple or WhatsApp or something which no one

thought would change the world, then Venture Capital would warm the

cockles of your heart.