Private Equity vs Venture Capital vs Angel Investors: what you need to know about private capital

The world of private equity can be complex, and if your business is looking for investment it is important to consider what type of private equity investment is right for you.

Private equity covers many types of private investment. For example, Venture Capital and Angel Investors are both types of private equity investment. Despite different ways of operating, all kinds of private investment firms need to realise substantial gains for their investors.

In this article we explore the differences between the types of private equity investment and their respective advantages and disadvantages for your business. If your business could benefit from private equity investment but you aren’t sure where to start, download our free basic guide to private equity.
 

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Private Equity vs Venture Capital

All venture capital is private equity, but not all private equity is venture capital.

In general for private equity investors, the more established the business, the lower the risk. Venture Capital is a form of private equity investment that focuses on early stage, high growth businesses. Venture Capital firms specialise in these early-stage ventures and taking on the higher risks in return for the opportunity of realising huge gains.

The types of funding offered by VC firms may vary, but usually falls under three categories;
 

Early Stage: Pre-seed and seed

• Pre-seed

  If you have a business idea but need capital to be able to produce a full business plan or prototype product, then you are looking for pre-seed funding. While you not necessarily need to show any revenue, you will need to convince potential VC investors that there is a need or a market for your idea.

  This is the riskiest type of investment for a venture capital firm but also can realise the biggest gains.

• Seed

  If you have a viable business or product but need capital to further prove out the product fit. then you will be looking for seed funding. You will, however, need to show you have a viable product or service and explain how the investment will grow sales and revenue.

• Series A and Series B Funding

  'Series A' funding is usually related to businesses that have revenue flow that can demonstrate product market fit, but in order for the business to employ the relevant people and invest in sales and marketing, to take advantage of opportunities that are presenting themselves, they require investment.

  Series B funding follows, for businesses looking to scale up. The sums involved in Series B funding are much larger than in Series A, and so investors require solid figures to back it up – proof of profitability and concrete plans for the next stage of growth.

  A business that seeks Series B funding is usually doing so to enable to launch of a new product or to take their existing product into a new territory.
   

Thinking about exit from Day 1.

Venture capital investors will always have one eye on the next stage of investment. They will want to understand what impact your business strategy and their investment will have on the potential for making a return on exit.
 

Venture Capital: advantages and disadvantages for your business

Advantages

• Can provide funding even if your business has little or no revenue and/or profit
• Your investors can be specialists in driving growth and developing businesses
• Investors can use their knowledge and relationships to create new business opportunities
• Unlike debt, there are no repayments and therefore no immediate extra demand on your cashflow
   

Disadvantages

• VC investors usually require a stake in the business in return for investment
• Additionally the VC will often take a seat on the board and expect to be involved in decisions made by the management team.
• It places more reporting and governance requirements onto a founding team that may already be stretched.
• You will need to build the business aggressively focused more growth, if that growth isn’t achieved, further funding rounds may be difficult to come by.
   

VC vs Angel Investors

What is an Angel Investor?

Angel Investors are high-net worth individuals investing their own money, or sometimes grouping with other ‘angels’ to invest, on their own terms. This is a form of private equity even though the money isn’t invested through a traditional private equity house or firm. Angel investors tend to deploy their capital in industries that they are familiar with or have experience in.

Finding angel investment often relies on having connections in your industry and is not as publicly available as other types of private equity. However, some ‘Angel groups’ provide a link between businesses seeking investment and potential angel investors.
 

Angel Investors: advantages and disadvantages

Advantages

• Angel investors are often experts in their industry, so having someone with that knowledge on board can be of major help to your management team
• Angel investors are often personal connections, so may be more willing to take a risk on you and your management team than other forms of funding.
• They also have a different appetite to risk so can be an excellent source of funding for very early-stage companies
• Angel investment can be secured more quickly than from an institutional investor. This is because the Angel fulfils the function of the investment committee, so can process decisions far more efficiently.
   

Disadvantages

• Angels will typically invest less than an institution would therefore reducing the size of a funding round.
• Angels will have less access to capital than a VC so generally have more limited ability to provide follow on funding.
• There is no national database of angel investors so are much harder to identify and initiate discussions.
• Sometimes angels will invest outside of their area of expertise so validating this prior to accepting investment is critical.
   

Private Equity Investment

While venture capital and angel investors are types of private funding, the most common type of investment in businesses comes from conventional private equity firms or houses. Private equity firms are categorised by the size of their investment funds – from small-cap firms (less than £10m) to large-cap firms (more than £500m). Private equity firms raise capital privately from businesses, financial institutions and individuals to invest in their portfolio companies.

Like venture capital firms, private equity firms will often have a mandate be it industry, sector or geographical area they normally invest in. Where private equity firms differ from VC, however, is the size of the investments they can make and the maturity of the businesses they tend to invest in. While VC firms and angel investors are focused on early-stage funding, private equity firms will invest in businesses more mature businesses so long as there is the potential for substantial growth.

The portfolio companies tend to be more mature, with sustainable income and growth. However, the rule of thumb for PE investors is the ambition to more than double the value of their investment in three to five years which can be challenging and risky.

To get private equity investment, you will have to demonstrate that your business is not only profitable but is scalable with a high degree of growth potential.
 

Advantages and Disadvantages of Private Equity for your business

Advantages

• Investment is more flexible and could be used to fund growth in the business and/or shareholder cash realisation
• Private equity investment usually entails a degree of professionalisation ensuring the business grows profitably
• PE investors will bring a focus to achieving a successful exit ensuring decisions are made in this context
• Having a well known PE investor on board improves the financial standing of the business, often giving credibility in areas such as raising bank lending or buying other companies.
   

Disadvantages

• Many PE investors will require a majority stake in the business.
• PE investment will often involve the introduction of debt, whether from a bank or the PE house. The business will be required to fund these debt facilities
• Investors will focus on achieving an exit in 3-5 years
• PE investors will have legal mechanisms that could result in changes to the management team if targets are missed.
   

Ultimately, all forms of private investment exist to make money for the investors. By helping your business grow, they are seeking to make significant profit. It is always worth remembering this when looking for private equity investment. Whether it is venture capital or private equity, your investors want to be assured of significant growth in the value of their investment and will always be mindful of their exit strategy. Your investors will always have one eye on the next phase, whether that is selling the business, taking it to the public markets or to another PE firm. You should do the same.

Use our free and comprehensive guide to explore the different private equity options for your business, how the world of PE works and what investors look for – get the private equity guide here.