You might have heard of the terms Private Equity and Venture. Young working professionals scouting opportunities for investment or ambitious entrepreneurs looking for funding opportunities are more likely to have come across these terms. With the new wave of startups and the digital uprising, people across all generations are keen on understanding these terms that pertain to the financial landscape and how it impacts their entrepreneurial pursuits. 

Private Markets & Public Markets: How do they differ from each other?

Before we dive deep, let us draw a clear distinction between private markets and public markets. Companies that operate within the public markets offer participation to public investors by floating shares that can be purchased and subsequently traded in a stock exchange. However, for private companies, their funding comes from private investors and such companies offer participation to their investors in terms of equity in exchange for funding. Private Equity & Venture Capital together form the Private Market.

What is the difference between Private Equity & Venture Capital?

Private Equity and Venture Capital both raise funds for private companies in the form of their funding. However, Private Equity is more applicable to a company that has progressed through its initial stages and has a defined market share, and is at a more mature stage of its life cycle. While venture capital is typically suited for companies that have been recently floated or are at their early stages of operations and work.

Technically speaking, Venture Capital is a subset of Private Equity. They both invest in companies and they both aspire to make money from investments instead of advisory fees.

What is a leveraged buyout (LBO)?

As the term itself denotes, a leveraged buyout is a combination of equity and a substantial amount of debt that the Private Equity (PE) firm leverages to its favor to buy out a significant stake in the company.  With this leverage to their advantage the PE firm works to improve the existing structure to improve profitability so that repaying the outstanding debt becomes a real possibility in the near future.

After bringing the firm back to profitable ways and posting high returns on their initial investment, when the PE firm decides to sell one of its portfolio companies after a period of time, the firm profits thereby distributing the excess returns among limited partners that were party to the initial investment. At this stage it is quite common for the private equity-backed company to go public as well, the most recent example relevant to this scenario is Paytm, the Indian Digital wallet service which very recently announced its IPO to go public. The buyout of Flipkart by Walmart is a typical example of an LBO and if recent reports from Walmart’s management hold, that will likely go public in the near future.

Some famous PE-backed New Age Brands:

• EQ Office: A Chicago-based owner and operator of office buildings in the US
• Panera Bread: A St. Louis-based owner, operator, and franchisor of retail bakery-cafes
• Refinitiv: The developer of financial data and risk analytics tools headquartered in New York City
• PetSmart: A Phoenix-based retailer of products and services for the lifetime needs of pets
• Toms Shoes: The manufacturer of shoes and footwear accessories headquartered in Los Angeles

Prominent Global PE firms:

• Kohlberg Kravis Roberts: A PE firm operating out of New York that invests in financial services, energy, and business products.
• The Carlyle Group: A firm based in Washington D.C. that targets commercial products, retail, and transportation.
• The Blackstone Group: A New York-based firm invested in real estate, public debt, and secondary funds.
• Harbour Vest Partners: A firm specializing in information technology, 3D printing, and industrials, headquartered in Boston.
• Audax Group: A firm based in New York interested in software

How does Private Equity work in reality?

Private equity is essentially an investment directed by a private equity firm in favor of a private company with the hopes of earning a high profit through investment. The target company or the recipient company can be managed by the private equity firm to this effect by restructuring the company’s working policies, strategies, management, and enhancing their service features with a view to generating profitable revenue. These changes once incorporated improve the company’s performance and generate high revenue, thereby generating returns for investors. After a specific number of years, generally around 5, the private equity firm will typically sell their stake thus, enjoying heady returns through the entire transaction. 

Private Equity vs. Venture Capital: A Closer Look

When Private Equity investment is the source of funding, the recipient is usually a company that has been in the industry for a substantial period of time and has posted proven success. PE firms usually come in at a stage when the industrial unit or the company is lagging due to operational inefficiencies with the assumption that once these inefficiencies are addressed suitably, the company will be back to its winning form and generate profitable revenue. The PE firms usually claim a high stake in lieu of their investment, 50% or more ownership is not uncommon and that gives them the authority and leverage to make alterations in management, policies, and strategies to get the recipient company back to its winning form.

Venture Capital investment firms provide initial stages of funding and mentoring guidance to startups. They are the source of nurture and growth for these young companies to grow into substantial industry leaders. Hence, it comes as no surprise that Venture Capital firms typically take a minority stake in the recipient firms, and the entire arrangement is focused on impacting growth and is not motivated essentially by immediate profits. The growing success of young tech-based startups backed by VC firms in rising through their ranks rapidly to become a steady and formidable player in the industry has caused a change in a lasting trend. More and more PE firms are now investing in buyouts of tech startups backed by Venture Capitalists as opposed to their usual choice of rooting for an established company that is going through a phase that needs attention.

Some Famous VC-backed Startups:

• Juul: The San Francisco-based manufacturer of e-cigarettes and nicotine products.
• Stripe: An online payments processing platform headquartered in San Francisco.
• SpaceX: The Los Angeles County-based designer and manufacturer of rockets and advanced spacecraft.
• Waymo: Formerly the Google self-driving car project, develops self-driving technology in the Bay Area.
• Ripple Labs: The developer of a blockchain platform headquartered in San Francisco.

Prominent VC firms:

• Venrock: A firm based in Palo Alto, CA which specializes in tech, software, and cloud services.
• Accel: A VC firm that targets SaaS, fintech, and information technology companies in their early stages and is headquartered in Palo Alto, CA.
• Benchmark: A San Francisco-based firm invested in consumer services, communication, and software.
• Sequoia Capital: A firm headquartered in Menlo Park, CA interested in fields such as nanotechnology, financial services, and healthcare.
• Madrona Venture Group: A Seattle-based firm that invests in e-commerce, gaming and digital media, media, and infrastructure.
• Dallas Venture Capital (DVC): A Dallas-based early-stage venture fund investing in Software, AI/ML, IoT, XR, and other emerging technologies launched by enterprise-focused entrepreneurs.

The Advent of a Private Market more valuable than Public:

In the past, whenever an established company needed to raise capital, they would go public in a bid to raise a large amount of cash from public proceeds which they would use to scale operations at their end. However, in the recent past, the trend has changed and with private investors dominating the market, the private market has changed drastically.

With private investors dominating the markets with available funds, it has made it conducive for private companies to acquire capital funding without needing to go public. The availability of access to capital funding has given birth to a rise of more startups, enabling dreams and ambitions of entrepreneurs, thereby empowering the power of an idea and imagination.

As the private markets start growing with access to funding, they continue to add value and deliver new opportunities creating scope for further expansion. Changes in the private market have also impacted the increment of venture debt and growth equity, the two main investment strategies that connect VC to PE.