In the finance world, most of us are familiar with traditional financial institutions (banks, insurance companies, and stock broking firms). However there are other institutions that play a huge role in the financial markets – Private Equity Firms.
There are basically 7 Private Equity strategies;
- Venture Capital
- Real Estate
- Growth Capital
- Mezzanine Financing
- Leveraged Buyouts
- Special Situations
- Fund of Funds
This article attempts to explain the differences between Private Equity firms and Venture Capitalists, even though VC is a subset of PE.
Private Equity
Private equity (PE) funds invest and acquire equity ownership in private companies, typically those in high growth stages or which are underperforming. PE firms do not hold invest in publicly traded companies i.e. companies listed on the stock exchange.
There are various types of private equity firms, and depending on strategy, the firm may take on either a passive or active role in the running of the company.
Passive involvement is common with mature companies with proven business models that need capital to expand or restructure their operations, enter new markets, or finance an acquisition.
Active involvement will mean that the firm plays a direct role in restructuring the company, reshuffling the senior management or providing advice and support.
Venture Capital
Venture capital is a subset of private equity. Venture Capital refers to investments made in startups with little or no track record of profitability. They generally focus on sourcing, identifying, and investing in what they believe are entrepreneurs and startups that will succeed and bring large returns.
VCs expect that a lot of the companies they invest in will fail, this is the reason why they invest small amounts of money in dozens of companies to spread the risk hoping that a success in one of the startups in their portfolios will cover the losses in other startups.
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Private Equity
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Venture Capitalists |
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| Investments | Private equity firms invest in larger, mature, private companies that are underperforming or undervalued. | Venture Capitalists invest in startups, small to medium sized enterprises |
| Funding Structure
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Equity and Debt | Equity only |
| Investment Size
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Venture Capitalists invest amounts ranging from $100m to $bn | Venture Capitalists can invest as low as $5,000 to $10million, although these amounts can be bigger depending on what stage of funding. |
| Fee Structure | 2/20 fee structure.
2% annual management fee on committed capital, 20% carry on any investment profits. |
2/20 fee structure.
2% annual management fee on committed capital, 20% carry on any investment profits. |
| Investment Horizon
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5-10yrs
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Typically 4-7yrs |
| How Returns are made | A private equity firm will make returns when they exit their investments or sell companies for a higher price than what they paid to purchase them. | Venture capitalists make returns when cash is returned on liquidity events e.g. when the startup gets acquired, exits or does an Initial Public Offer. |
| Liquidity
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Highly illiquid | Highly illiquid |
| Acquisition Percentage | Private equity firms almost always buy 100% of a company. | Venture capitalists usually acquire a minority stake in a startup, usually less than 50%. |
| Top Concerns | Fees, economic environment, illiquidity | Fess, valuations, competence of team members, viability of idea, illiquidity. |
| Portfolio | Private equity firms usually have a few companies in their portfolio. | Venture capitalists usually have dozens of companies in their portfolio. |
| Profile | Private equity firms recruit people with an investment banking background because the transactions usually involve financial modelling and due diligence work. | In a venture capitalist firm, you’ll see a mix of ex-bankers, consultants, and former entrepreneurs. |
Examples of Private Equity firms with presence in Nigeria include;
• The Abraaj Group
• Actis
• Adlevo Capital
• AfricInvest Capital Partners
• Capital Alliance
Actis, a private equity firm that invests exclusively in Africa, Asia and Latin America had investments in Mouka foams, and The Palms Shopping Mall.
Examples of Venture Capital firms that have funded Nigerian companies include;
Tiger Global – IROKO TV, JOBBERMAN
Kinnevik – KONGA
Omidyar Network – Hotels.ng
Nice…I’m very impressed at this explanation. However, judging from the activities of both PE and VC, I want to ask if it’s possible for a company to be both a Private Equity, and at the same time be a Venture Capital firm.
Secondly, are there statutory requirements for any company that wants to be a PE or VC?