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Tuesday, November 8, 2011

Understanding Venture Capital as a Type of Private Equity Investment

JoAnn Lombardi
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Most people don’t know understand the concept of private equity and venture capital when it comes to financing business investments.

 

Often, both terms are used interchangeably, but each is different. Venture capital refers to a significant investment made in a new venture of technology often by one person or an entity. By contrast, private equity refers to raising funds to purchase equity in a business through a private offering.

 

Only one third of all private equity funds can be considered “venture capital” funds.

 

It’s important to understand these concepts, especially if you’re looking to engage in an M&A or midmarket transaction.

 

Private Equity Financing – This is when a private company or firm raises funds to buy equity in either:

 

  • A private business or group of private businesses; or
  • A public company in order to make it private.

Private equity financing is an investment that’s raised through private offerings in order to buy equity in private businesses or public companies in order to make them private.

 

Venture Capital – The most common type of private equity financing, this involves investing funds at a high risk of loss but, at the same time, has a high possible return.

 

Most investors will utilize this type of financing when they desire a capital gain instead of an interest income or dividend yield. In exchange for common stock, an individual venture capitalist or venture capital group will receive a major stake in the high-risk company.

 

When an individual or group decides to go into a venture capital endeavor, there are several stages that are involved from “seed” capital on a trial basis to the “exit” stage when a stake is sold. At each stage, the stake increases, where the venture capitalist may own as much as 80 percent of its equity if the company goes public.

 

Return on a Venture Capital Investment


As a type of private equity financing, the venture capital investor makes investments in privately-held businesses or public companies going private. They hold the investment long enough to experience the share price appreciating. When the company goes public, the payoff can be exponential. This can happen through an initial public offering (IPO) or returning to public ownership in a reverse buyout.

 

Due to the high risk of the investment, a venture capitalist expects a high return, usually in the area of 35 percent. This high target is established due to the high rate of loss in overall investments – approximately third yield negative returns. The average return on venture capital investments range between 12.5 and 24 percent, often realized when the company receiving the venture capital financing goes public.

Since only one percent of all deals purported to these type of funds succeed, consult with a VR business intermediary whenever you are considering a private equity investment. You can then determine which funds and individuals should be approached with your investment opportunity.

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