Private Equity vs. Venture Capital

“Sorry, I’m not interested in venture capital.”

This is a pretty common response I receive when speaking to business owners and CEOs. People often confuse the terms Venture Capital and Private Equity, using them interchangeably. And while they may overlap in many ways, investors in both arenas approach investments from fundamentally different perspectives.

Here at DW Healthcare Partners, we typically look at mature companies with established products and/or services with recurring cash flows. As Private Equity investors, we use a combination of equity and debt to structure a deal, striving to optimize financial performance and allocating capital to strategically grow the business. How do we do this? We look at both unique organic and acquisitive growth opportunities that perhaps have not been fully explored or utilized. We are a strategic partner that can help take an already successful business to the next level.

In many regards, Venture Capital is the opposite of everything above. Companies are typically earlier-stage ventures with unpredictable cash flows, less infrastructure, and products or services that have not been fully (or even partially) commercialized. Allocating capital to an idea that has not been fully developed is a much different value proposition than the typical Private Equity model. As a Venture Capital investor, you are typically more interested in innovation and disrupting the market. A Private Equity investor looks to restructure a mature business via acquisitions and optimizing operations.

Now that we have established the main differences, the similarities are more straightforward. Both types of investors raise capital from Limited Partners (LPs) that include pensions, endowments, fund of funds, and high net worth individuals. Capital is then invested into private companies at a multiple and hopefully sold at a higher multiple years later. Buy low, sell high. You get the idea.

So how have Private Equity funds performed versus their venture capital counterparts? Good question. PE has not only outperformed VC but also all other private capital asset classes as measured by a one-year internal rate of return (IRR) of 20.5% through Q4 of 2017.[1] It is worth noting VC had the most significant uptick with its one-year rolling IRR moving from 7.6% to 11.7% over the previous quarter.

[1] PitchBook, “Global PE & VC Fund Performance Report” (Q4 2017)

IRR by Fund Type

This is not to say that Private Equity is a better asset class than Venture Capital but it is definitely less volatile for the more risk-averse investor. VC investors seemingly find more spectacular winners (Uber, Airbnb, etc.) but also more failures as a whole. Adding to the complexity, valuations in the private markets remain highly uncertain. A high growth company that is able to continually fundraise will forgo an IPO and subsequent disclosure and quarterly scrutiny. This probably explains why VC investors typically hold longer than the standard three to five-year hold period of PE investors. According to the WSJ, “venture funds more than a decade old still have as much as 40% of their total value in unrealized investments, while funds from 2011 onwards have more than 85% of their value unrealized.”[1] What does this mean for investors? Private Equity funds, as a whole, return more cash more often to investors.  Overall, cash flows for both investment classes trend similarly as seen below.

[1] Wall Street Journal, “Venture Capital vs Private Equity: Who’s the King of Cash?” (March 20, 2018)

Private Equity Cash Flows

Venture Capital Cash Flows

Interested in learning more about private equity and how a strategic partner like DW Healthcare Partners could maximize your company’s growth potential? Please feel free to contact us. 

Alex Bronstein
alexb@dwhp.com
416-583-2434