During my career, I’ve worked in both private equity (PE) and venture capital (VC) businesses. Companies that are backed in these distinct ways tend to behave very differently. Which has a big impact on what it’s like to work for a PE or VC-backed company.
To appreciate the key differences, you first need to understand how the investment strategy impacts business operations and flows through the culture of the business.
A tale of two investment strategies
When a PE firm buys a business, they’re usually looking for an established, profitable company in a sector with room for stable growth. The PE firm wants to buy into and own part, all or a large part of the business and continuously improve its profit. PE firms usually seek a growth trajectory sweet spot of 10% to 20%. They want to hold their investment for around three to four years during which time they hope to triple their money.
In contrast, VC investors play a high stakes game. They typically invest early in small organisations that aren’t making any money but have the potential to change the world. The VC’s cash is used to fund the business and help it grow at a rapid pace.
This high risk, high reward approach bakes in the fact that a large number of the businesses VC firms invest in will go “pop”. But the 5% or 10% of companies that do very well will provide huge returns on the original investment and more than cover any losses.
The business opportunities each investor looks for
As a result of their desired growth trajectory, venture capitalists seek business owners with a high-risk appetite. They want companies that will fundamentally change the way we do things. Which means tapping into virgin territories with the potential for global domination. Think companies like Amazon, Facebook or Slack.
PE firms look for smaller numbers of safer bets. Businesses in established sectors that can continue to deliver stable growth and steadily increase profits. PE firms support their portfolio companies to do this by driving efficiencies, enhancing organic growth or through mergers and acquisitions.
This combination of differing business opportunities and investment strategies has major implications for the way PE and VC-backed businesses are run.
Different contexts drive alternative levels of support
From what I’ve seen, PE firms invest in about 10 or 12 businesses at any time. So a company’s Investment Director will have two to four businesses to look after allowing them to get to know each company. High levels of ownership plus lower returns means PE firms have a vested interest in the business’ success. As a result, PE firms want greater oversight and control. Resulting in more accountability to and support from the PE firm.
Because VC firms invest in large numbers of businesses, they can’t be as involved as PE investors. As a result, VC-backed company founders still often own the business. And the VC firm? They just want to see the numbers on a hockey stick-shaped growth chart.
So what does this mean for the outcomes that PE and VC-backed businesses must drive?
Measuring success – fantasy and reality
VC-backed companies need to rapidly spend their investment in an attempt to hit the right business growth drivers. VC firms can burn through cash by:
- Hiring large numbers of employees in an attempt to rapidly progress their mission
- Investing in marketing to secure large numbers of new customers even if they’re not profitable
- Reducing prices to undercut the competition in the hope the business can make customers profitable in future
These tactics are generally designed to drive top-line growth. In many businesses, this growth may be the number of users, while revenue lags behind user adoption and profit lags behind revenue. This is extremely powerful when it works. But it can lead companies to lose sight of what most people would assume is the fundamental purpose of business – profit.
At PE-backed businesses, they live by the maxim, turnover is vanity, profit is sanity and cash is king. In their supporting, guiding role, PE firms ensure their portfolio businesses maintain a close grip on reality. Like most companies, they keep one eye on the future, plan to mitigate risks, maximise opportunities and ensure profitability and longevity. Strategy aligns with what’s happening inside the business and out.
While VC businesses are all about taking lots of risks and seeing which ones stick, at PE companies the focus is on taking small calculated risks. Then seeing what happens before committing more money.
Company culture? The clue’s in the name
Venture capitalists – or maybe we should call them adventure capitalists – inhabit a risky world where everyone needs to quickly spend a lot of money to see if they can grow. The pace is blistering and there’s a lot of pressure. You should only sign up for a VC-backed business in its first three to four years if you want to be stretched beyond your limits.
That’s not to say there’s no pressure in PE-backed businesses. Continually increasing profit means delivering ongoing growth. However, for the management team and employees, the more reasonable 10-20% growth targets means the pressure isn’t too intense. Giving everyone time to think things through before acting.
Rewards – all or nothing riches versus generous incomes
Most VC businesses provide shares to executives and usually the first 10 to 15 employees. The hope is that the business will be wildly successful and everyone will make a tonne of money and buy a yacht. By putting everything on black and hoping they’ve backed a winner, they could win big. But if the business doesn’t become a huge success or it fails, the shares will be worth very little to nothing at all. And everyone will be out of a job too.
In PE companies, the management team usually owns a percentage of the business. They also generate really good incomes, often in the low to mid-hundreds of thousands. Nobody’s going to become the next Elon Musk. But PE company employees still get a big chunk of cash with much less risk attached to it.
As you can see, VC and PE-backed businesses are entirely different beasts, operationally, culturally and in terms of the rewards. Whether the VC crapshoot or a less risky but highly rewarding PE investment is right for your business will be determined by the investors. Either you’re attractive to a PE or a VC or you’re not right for either. In which case you’ll need to carry on as you are, building your business the best you can.
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