Venture capital vs. private equity: which is right for you?

Private equity vs. venture capital: at a glance

• What do I need to know? Private equity (PE) and venture capital (VC) describe ways of investing in businesses through funds.
• What does it mean for me? PE and VC funds can offer a more active approach to business investment compared with investing through index funds.
• Why does it matter? Understanding the differences between PE and VC can help you decide on the right investment for you - helping start-ups grow or making existing businesses more efficient.

If you’re looking to expand your portfolio, acquiring equity in businesses through specialised funds can represent a more involved style of investing compared with buying shares on the stock market.

In this guide, you’ll learn about the differences between two transformative ways of investing in businesses: private equity and venture capital.

What is private equity?

Private equity typically refers to a type of fund that buys large shares in established businesses. This is different to buying public shares on the stock market, where you’re usually a passive investor, in the hope that the company will make a profit based on their current strategy.

The goal of private equity is to take an active role in a business, gaining control of a company to make changes to operations and strategic priorities.

While it might sound complex, your investment is typically structured through a fund. This means you’re an investor in the companies the fund buys, not a business owner.

How private equity funds work

A PE fund buys a controlling stake, or full ownership, of an established business. The goal of private equity funds is to improve the profitability of a business and sell the stake at a higher price to another buyer.

This process usually lasts around four to seven years. Existing business leaders will often stay on for an agreed period - and may even retain a minority stake to oversee the acquisition and minimise disruption.

While private equity investments can involve higher costs than VC, the focus on established businesses that are already making money can make outcomes more predictable.

But, as with every investment, there’s no guarantee you’ll make money and you could lose what you invest.

Taking control

Compared with publicly listed companies, which can have thousands of shareholders, private equity funds usually own a controlling stake in the business. This means they can use their majority to make decisions the rest of the business, including the founders, must follow.

This often requires a large upfront investment to buy enough control of a business to make changes.

The investment fund assumes significant responsibility for the new business strategy, as it’s accountable for improving profitability for investors.

This is one reason that private equity is often considered lower risk compared with investing in an early-stage start-up. Although both private equity and venture capital funds are generally much riskier than other ways of investing money.

What is venture capital?

Venture capital refers to a type of fund that buys minority stakes in businesses in their early stages. VC funding is typically provided in rounds, with investments increasing as the business hits growth milestones.

Where PE focuses on established businesses, venture capital invests in start-ups and early-stage companies and may act in an advisory role to the business, rather than taking operational control.

Risk and reward

Venture capital firms typically invest in multiple businesses, often at the same time, acquiring a lower stake compared with private equity companies.

There is notable risk associated with investing in venture capital, as few start-ups succeed in the long term. Office for National Statistics (ONS) data reveals that just 38.4% UK businesses survive for five years or more.

You’re also often investing in businesses that lack an established track record of generating revenue. But successful investments can deliver significantly higher returns than PE, given the potential for rapid growth.

Diversifying funding across different businesses at once helps spread risk as part of a balanced portfolio.

What are the key differences between venture capital and private equity?

Venture capital and private equity are comparable investment types because both use your money to build up a fund. Both also limit access to your cash, as you can’t sell your stake quickly if other investment opportunities arise.

But despite these similarities, VC and PE represent distinct investment types. Below, you can compare the differences between venture capital and private equity:

Investing in private equity and venture capital

Traditionally, you would need an invitation to invest in private equity or venture capital. But you can also join a fund through collective investments, such as an Exchange-Traded Fund (ETF), or investment trusts.

Combined with the long-term outlook of both investment types, and the slowing pace of private equity deals in recent years, you may experience slow periods between investment opportunities.

Holding cash in high-interest savings accounts between investments can keep your money accessible and earning, instead of sitting idle until the next PE or VC opportunity arrives.

Frequently asked questions about private equity and venture capital

Which is better, private equity or venture capital?

The right investment for you depends on your preferences, how much risk you’re willing to take on, and how long you’re willing to wait before getting a return on your investment.

Both investment types require you to limit immediate access to the money you invest. And returns can be unpredictable with both PE and VC.

Private equity comes with a comparatively lower risk profile, investing in businesses with a track record of making money. Your investment fund also assumes control over the governance and operation of the company.

Venture capital is a riskier investment but sometimes requires less upfront cash, depending on the fund.

The investment fund buys less equity compared with PE, usually in a range of newer companies without the same established track record of earnings. But successful investments often produce greater returns.

How do I access private equity and venture capital as an individual investor?

Unlike many savings and investments, you usually don’t invest directly in businesses, although this is sometimes possible. It’s more common to access private equity and venture capital through specialist investment funds.

You might be introduced to, or invited into, these agreements through wealth managers or private investment platforms. It’s also possible to invest smaller amounts using collective investments like ETFs.

As a private investment, PE and VC typically involve higher costs than buying shares directly on the stock market. These costs reflect the active management and oversight given to the fund, which can increase investor confidence.

Growing wealth with private equity and venture capital

Private equity and venture capital investments represent a high-risk, high-reward investment strategy for your portfolio.

Depending on how much money you’re looking to invest, selectively investing in PE and VC funds can complement your lower-risk investments, though the right opportunity for you may appear infrequently.

This is where cash can play a supporting role. Building a high-interest cash portfolio can give you access to your money when the right opportunities arise.

Competitive interest rates can help offset the impact of inflation, offering a relatively stable place to hold your cash before you decide to fund riskier investments.

Balance growth and access with Flagstone

High-interest savings can often offer a relatively secure, accessible, and predictable way to hold and grow your money while you wait for your next investment opportunity.

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