Private equity and venture capital are key components of the 21st century innovation and finance ecosystems. Each serves a specific purpose and is geared toward different types of companies and time horizons. Both are crucial to harnessing the economic and social benefits of smart investment, sustainable companies, and transformative ideas. It is important for chief procurement officers (CPO) to understand the main differences between venture capital and private equity, as well as the broader finance landscape of hedge funds and investment banking. Use of a world-leading vendor management platform such as Proven can maximize the efficiency of the procurement spend and improve return on investment for investors and their portfolio companies in this volatile but exciting space.
Private equity (PE) is reserved for investments in private companies that are not listed on a stock exchange. Private equity investors can also choose to buy-out existing public companies and delist them from stock exchanges, in effect ‘re-privatizing’ those companies. This is often accomplished via a leveraged buy-out (LBO), wherein the private equity firm combines debt financing (loans or bonds) with a percentage of private equity to acquire the company, using the assets of the that company as collateral for the loan. (If management does not want the acquisition to occur, the buy-out is referred to as a hostile takeover.
LBOs—and private equity, in general—are highly complex and often meet with skepticism among the broader public. In the 1980s and 1990s, for example, a wave of hostile takeovers and subsequent large-scale company failures, lay-offs, and bankruptcies turned public opinion against these deals. The collapse of Drexel Burnham Lambert in 1990, and the corresponding 10-year jail sentence for its senior executive Michael Milken, still reverberates as a cautionary
tale of hubris, junk bond financing, and greed. Yet private equity done well is an essential finance tool for management and growth in a complex global economy. Investopedia notes that in 2019, private equity firms held approximately $3.9 trillion in assets, which represented a 12.2 percent increase from 2018. Deloitte finds that in the post-pandemic economy, private equity firms collectively have an estimated $1.5 trillion reserve to tap to acquire and restructure portfolio companies. In addition to LBOs, private equity tools include purchasing an over-leveraged company’s debt, real estate acquisitions, and the creation of private equity investment funds. Private equity targets mature companies that are struggling, but whose past performance and future prospects indicate that there is substantial life left in the product line or brand. Private equity firms conduct extensive due diligence to assess fundamentals such as price-earnings ratios, liabilities, overhead, and cash flows when making acquisition decisions. The acquired companies revert to private ownership, which frees up time and capital for private equity investors to work with management to streamline and revive the company. The distressed company also benefits from access to cash at interest rates lower than most banks would provide. The end of this restructuring process often results in a new public listing. Institutional investors such as pension funds and private equity firms such as Blackstone, Bain Capital, and The Carlyle Group underwrite the bulk of private equity funding. Private equity firms require accredited investors, hence the minimum amount needed to participate in such a fund is generally $250,000, though the required amount of available capital for a would-be investor can reach $25 million in the most prestigious funds. Examples of private equity success include Blackstone’s leveraged buy-out of the Hilton Hotel chain in 2007 and Koch Industries acquisition of Georgia- Power LLC in 2005.
Venture capital (VC) is a specific type of private equity that seeks out investments in startup companies that demonstrate the potential to either disrupt existing industries or create new ones. Venture capital investors look for business opportunities that have high growth potential, which is why venture capital tends to flow primarily to the tech sectors. Venture capital is the lifeblood of Silicon Valley and propels the outsized successes that can produce mega billionaires and/or new ways of communicating and doing business. Instacart, Uber, Facebook, and Pinterest are among the most famous venture capital success stories. Venture capital can be leveraged at the early, middle, or late startup stage, though so-called angel investors tend to focus on opportunities in the earliest, ideation stage. The three main types of venture capital are early-stage financing, expansion financing, and buy-out/acquisition financing. Large VC firms often specialize in different stages of the innovation lifecycle and develop portfolios of strong companies within specific industry sectors.
Sources of venture capital include wealthy investors, investment banks, and specialized VC funds such as Sequioa Capital (whose previous winning bets include Google and Apple), Andreessen Horowitz (Stripe), and Bessemer Venture Partners (Pinterest and LinkedIn). Successful companies such as Facebook (Meta) often launch their own internal venture capital funds to acquire equity stakes in promising companies.
Ultimately, venture capitalists mediate and connect the interests of investment bankers, high- end investors, and entrepreneurs. By providing money at the crucial middle-stage of the classic S-curve—at the point when the young company has moved out of the proverbial garage but before growth rates slow or plateau—venture capitalists who cash out at the optimal time can realize significant returns on investment, while minimizing risk. Yet this is not a game for the faint-hearted. A recent analysis by CBInsights estimates that 70 percent of tech start-ups fail, most often at the 20-month mark after an initial financing round. While the biggest VC successes (with their staggering pay-offs) can generate both awe and envy, deep pockets, financial acumen, industry knowledge, and a tolerance for risk are required to play this game well. Venture capital is thus essential to powering innovation and scaling the best new ideas and companies.
Venture capital and private equity are complicated sectors that require high levels of expertise and strong networks of contacts and information. Salary-wise, venture capital versus private equity compensation patterns tend to privilege PE, but this metric is relative –both of these can become lucrative career paths. BankingPrep estimates that an entry-level venture capital analyst at an established firm can earn between $80,000 to $150,000, while a junior equity analyst usually starts at $100,000. A venture capital principal can earn up to $400,000, as compared to a private equity Vice President at $500,000. At the upper reaches, General Partners in both sectors can earn as much as $2 million per year.
Both VC and PE firms want to maximize returns to their investors. However, venture capital versus private equity returns can differ, depending on variables such as the fund size, investment strategy, and type of business. Time horizons can also vary. In general, according to Blackstone Private Wealth Solutions, private equity projects have a lifecycle of seven to ten years. The goal is usually to acquire a distressed or struggling company, restructure and improve it, and then exit the company for a profit via an initial public offering (IPO) or other sale. 5 PitchBook estimates that the most venture capital funds take eight to twelve years to complete the investment-to-IPO lifecycle. 6 Rates of return between 20 to 30 percent are considered healthy for both VC and PE investors.
Investment banking and hedge funds also have a role to play in this complex finance ecosystem. Investment banks, which are often the pipeline for would-be venture capitalists and private equity investors, provide essential services to deal-makers, including origination (analysis and research) and underwriting. Hedge funds are highly complex pooled funds that can invest in any opportunity that may provide a substantial return on investment. Hedge funds can invest in both private and public companies and their focus, particularly relative to most venture capital funds and private equity, is on maximizing short-term returns. Like PE, hedge funds are most relevant to accredited high and ultra-high net worth investors. The minimum needed to invest in a hedge fund ranges from $100,000 to $2 million.
A leading vendor management platform such as Proven is essential to navigating the demands of venture capital and private equity portfolio management and growth. Creating, scaling, and/or turning around a company requires strategic investments in high-quality vendors. Our data analytics capacity aggregates information about your procurement decisions and vendors to generate new insights for strategy and growth.
Proven has partnered with some of the most innovative companies and funds in Silicon Valley, including Sierra Ventures and SoftBank Group. We are the experts in securing and vetting vendors who can help your portfolio companies thrive. We bring all of the essential vendor information to you on our proprietary platform, allowing you to minimize time expended on the supply side of vendor management and reduce risk for your investors. GetProven ensures the best use of your procurement spend. We focus on the vendors so that you can focus on the success of your portfolio companies.
The future of venture capital lies in recognizing the significance of founder support systems and capitalizing on the opportunities presented by VC platforms.
As a platform director, what marketing strategy mistakes have you witnessed that could be sabotaging a firms ability to attract venture capital? or deal flow?