The terms venture capital (VC) and private equity (PE) are often used interchangeably, but while the two strategies are similar, they each possess several distinct characteristics. VC actually falls under the broad umbrella of PE. More specifically, venture capital is the earliest stages of PE investment, typically when companies have little or no revenue. Companies that seek venture capital will often go through multiple financing rounds with different valuations—the successful ones, that is. VC financing rounds typically involve multiple investors and small chunks of equity. As the valuation and operating costs of the company should be theoretically be growing with every financing, each round tends to be bigger than the last. PE deals, on the other hand, tend to involve a single firm and the acquisition of a majority, if not all, of the company’s equity. However, there can also be minority private equity investments, referred to as growth or expansion deals.
Due to the nascent nature of companies in the VC space, these deals tend to have even a higher risk profile and reward potential than traditional private equity investments. The earliest stage of venture financing is known as the seed round, which usually involves a smaller amount of equity and lower valuations. After the company has begun to develop a prototype and a more comprehensive business plan, it will often seek additional capital through one or more early stage financings.
Early stage venture rounds—the next phase after seed rounds—is where more established VC firms and corporations may begin invest, with seed-round investors usually continuing to play a role as well. Venture capital firms often provide their portfolio companies with resources, connections and advice but have less hands-on involvement than with a traditional PE investment. Companies that have shown an ability to generate revenue—and perhaps even turn a profit—advance on to late stage venture financings and may be ready or close-to-ready for some sort of liquidity event, most often a corporate acquisition or IPO.