What are the key differences between Venture Capital and Private Equity Investors?

Those three magic words: What are the key differences between Venture Capital (VC) and Private Equity (PE) Investors?

We were at the Localization World conference in Dublin in June and there was a moment when Bryan Murphy, CEO of Smartling, took to the Process Innovation Challenge (PIC) stage following host Dave Ruane’s lead. His intervention addressed “knowing your audience when looking for investment” (incidentally, a topic we are frequently asked about at Lion People Global), and explained the key differences to remember between VC investors and PE investors.

This question to Bryan in the context of the PIC is so relevant, given that many disruptors and innovators are well aware of obvious differences between VC and PE, whether they throw their hat in the Innovation Challenge ring, fly under the radar, or join an accelerator program. However, sometimes, in our observation, they still need help with the right pitch and Investor Memorandum angle. 

If I were to put you on the spot and ask you what the key differences between VC and PE are, is it possible you may think of some of these?

And you would not be wrong. When Bryan answered the question, he anchored his response around 3 keywords to highlight what VC fundamentally focus on, and did the same for PE.  

Venture Capital – Team, TAM and Transformation 

Team – what are the team’s profiles and what support they will require, given that venture capitalists often take an active role in the companies they invest in, providing not only capital but also mentorship, strategic guidance, and industry connections. As a result, they are really looking for a team that they feel can get the job done and ideally a strong founder with a good track record. 

Total Addressable Market (TAM) – what business problem is the company solving, what is the size value of the TAM and what are the most valuable segments. VC depend on company growth and valuation increases, so the TAM opportunity must be extremely well researched and attractive with a potential to deliver high returns at an exit scenario a few years down the line. It’s also important that the true TAM is significant, i.e. the size of the market that the product solves for is large enough. Sometimes companies consider an overall market size as their TAM (for example the translation market is often quoted as being worth 55B USD) which is multiples bigger than the true TAM for their product offering.   

Transformation – the companies must exhibit exponential growth and product leadership potential in the following 5 years. Given the early-stage nature of the investment, VC assume higher risk (in fact they expect most portfolio companies to fail) in exchange for the potential of outsized returns from a few big winners. 

Private Equity – ARR, Growth, Exit 

Annual Recurring Revenue (ARR) – a definition of a mature company is not only size and longevity, but also stability. PE look for predictability and sustainability in any business portfolio they invest in to be able to build from a solid foundation. There is no appetite for volatility. 

Growth – the key question to answer here is “where does the growth come from?”, PE scrutinize both the growth trajectory and the growth potential to determine value creation, expansion/diversification strategies and priorities for capital allocation. PE use a combination of equity and debt for their deal structures, therefore growth and scale must be realized profitably. 

Exit Plan – the strategy, timeline and key actors vested in value creation towards exit must make sense, they must build confidence all around, and be well calibrated and risk-mitigated with all manner of contingencies in place. PE do not tolerate high risk situations, and with the level of investment requirement leaving value on the table is not an option. 

To illustrate with an example, a technology company that had been working towards an exit at high revenue multiples after several rounds of VC funding and many years in business hit a revenue growth plateau first and then saw a number of clients walk away. This happened while investing heavily in sales, marketing and R&D to launch new products that would successfully revert the revenue trend, and having to manage all other expenditure tightly to put the brake on cash burn. This scenario required a two year turnaround to ensure that ARR, growth and risk would be addressed, and so an exit involving PE at the desired valuation was no longer viable. Instead, another round of VC funding had to be raised. 

Venture Capital and Private Equity are viable sources of capital for businesses, they cater to different types of companies and investment strategies. Venture Capital is geared towards nurturing innovation and growth in early-stage startups, accepting higher risks for the potential of extraordinary returns. In contrast, Private Equity focuses on enhancing the value of mature businesses through strategic improvements and restructuring, aiming for stable, long-term gains. Understanding these distinctions can help entrepreneurs and investors make informed decisions aligned with their financial goals and risk tolerance. 

When you are preparing your next pitch, presentation, or investment elevator ride, maybe you will keep in mind who you are talking to and what 3 magic words they really want to hear.