Private Equity vs Venture Capital, Angel/Seed Investors

The major difference is at what stage of a business they invest in.

Author: Kevin Henderson
Kevin Henderson
Kevin Henderson
Private Equity | Corporate Finance

Kevin is currently the Head of Execution and a Vice President at Ion Pacific, a merchant bank and asset manager based Hong Kong that invests in the technology sector globally. Prior to joining Ion Pacific, Kevin was a Vice President at Accordion Partners, a consulting firm that works with management teams at portfolio companies of leading private equity firms.

Previously, he was an Associate in the Power, Energy, and Infrastructure Investment Banking group at Lazard in New York where he completed numerous M&A transactions and advised corporate clients on a range of financial and strategic issues. Kevin began his career in corporate finance roles at Enbridge Inc. in Canada. During his time at Enbridge Kevin worked across the finance function gaining experience in treasury, corporate planning, and investor relations.

Kevin holds an MBA from Harvard Business School, a Bachelor of Commerce Degree from Queen's University and is a CFA Charterholder.

Reviewed By: Patrick Curtis
Patrick Curtis
Patrick Curtis
Private Equity | Investment Banking

Prior to becoming our CEO & Founder at Wall Street Oasis, Patrick spent three years as a Private Equity Associate for Tailwind Capital in New York and two years as an Investment Banking Analyst at Rothschild.

Patrick has an MBA in Entrepreneurial Management from The Wharton School and a BA in Economics from Williams College.

Last Updated:August 29, 2023

What Is Private Equity vs Venture Capital, Angel/Seed Investors?

PE, VC, and Angel Seed have a few key differences. The significant difference is at what stage of a business they invest in. PE invests in businesses with already established operations. VC invests in startups that have taken their first few steps, and angel seed invests in the founding stage. 

PE has the lowest risk, lowest return rate, and the highest capital investment. It is the most meticulous and performs "due diligence" to see if the company meets its primary objective of rapid growth. Likewise, it invests in both equity and debt.

Even though venture capital and seed investing are private equity divisions, they function differently. Notably, angel seed investors do not exercise "due diligence" or are less meticulous about the company's quick financial success.

Venture capital is in the middle, with mid-range capital investment, moderate risk, and average return. It is less particular because its objective is growth, typically investing in equity and convertible debt.

Angel investors invest only in equity. Early business stages restrict the company's access to debt markets. It is the least diligent, prioritizing growth/slow growth. Lastly, it has the highest risk and return and typically the lowest investment amount. 

What is Private Equity?

Private equity is an alternative investment that consists of capital not listed on the stock exchange.

It comprises funds and investors that buy and sell private companies or engage in buyouts of public companies that result in them getting delisted from stock exchanges.

Its funds can be used to:

The industry comprises two types of investor entities: institutional investors (ex: pension funds) and accredited investors, comprised of high-net-worth individuals (HNWIs). 

HNWIs dominate the industry because direct investment, which private equity entails, requires a substantial capital outlay. 

A minimum amount of capital is required for investors to enter the industry. It can range from 250,000$ to millions more. However, it can yield high returns for investors who can afford it.  

This type of fund has two types of partners:

  • Limited Partners (own 99%)
  • General Partners (own 1%)

Limited partners have limited liability, meaning that their private assets are not at risk in case of bankruptcy. However, general partners have total liability and are responsible for executing and operating the investment. 

The compensation in the industry is relatively high. At the middle market level, associates can earn six figures in salary and bonuses. However, going up the corporate ladder, vice presidents earn roughly half a million, while principals make more than 1 million per year. 

There is a range of different types of private equity firms that depend on their investment preferences. For example, some firms consider themselves passive investors. They rely wholly on management to grow the company and generate returns. 

Other firms are more active and thus consider themselves active investors. Active investor firms can have an extensive contact list and C-level relationships. Investment banks compete with private equity firms to buy good companies and fund growing ones for the most profit. 

Types of PE transactions

The types are:

1. Distressed Funding (Vulture Financing)

It is an investment in companies with underperforming units or assets. The intention is to turn the company's performance around by making changes to management and operations or selling its assets for a profit (assets can include real estate, intellectual property, etc.).

2. Leveraged Buyouts

The most common type of private equity entails acquiring a business to enhance its operations and financial standing before reselling it to a buyer at a profit or issuing an IPO.

3. Real Estate PE

It invests in commercial real estate and real estate investment trusts (REITs). This type of funding surged after the 2008 financial crisis crashed real estate prices. 

It generally requires a higher minimum capital than other private equity funding types, and investor funds are typically locked away for several years. There is a course on the WSO website that teaches you about Real Estate Modeling used by private equity firms to assess their investment. 

4. Fund of funds

This type of funding involves investing in other funds, primarily mutual funds, and hedge funds. They offer a backdoor entrance to investors who do not meet the minimum capital requirements to enter such funds. However, they have higher management fees.

5. Venture Capital

It is a type of PE that involves investors providing capital to entrepreneurs in the early stages of their company. On the WSO website, there is a course related to the PE deals process that teaches you about the financial modeling used by private equity firms. 

Private Equity Advantages and Disadvantages

Companies favor private equity because it allows them to access liquidity alternatively to conventional financial mechanisms like stock exchange and bank loans. 

Some forms of private equity, such as Venture capital, likewise finance ideas and early-stage companies. Additionally, if a company gets delisted from a stock exchange, PE can provide funds for unconventional growth strategies away from the eye of public markets. 

However, private equity does have unique challenges. For instance, it can be difficult to liquidate its holdings because there is no ready-made order book that matches buyers, and a firm has to search for a buyer first.   

The pricing of shares in a private equity firm is determined by negotiations between buyers and sellers, not by market forces. 

Likewise, the rights of private equity shareholders are generally decided on a case-by-case basis through negotiations instead of a broad governance framework like in public markets.  

Since multiple characteristics of private equity involve negotiation between buyers and sellers, it is more prone to conflict.

What is Venture Capital (VC)?

Venture capital is a branch of Private Equity that involves financing startup companies, and small businesses investors believe have long-term growth potential.

Through independent limited partnerships, significant chunks of a company's stock are created and sold to a select group of investors in a venture capital deal. Limited partnerships consist of two members:

  • Limited Partners - do not partake in managerial decisions 
  • General Partners - oversee and manage the business 

Getting funding from a venture capital firm involves submitting a business plan, after which the firm will thoroughly investigate the company's business model, products, management, and operating history, among other things. This process is called due diligence. 

The research process for companies is meticulous because Venture Capital tends to invest large sums of capital in a few places, leaving less room for mistakes and failure.

Once the Due Diligence is complete, the investor or venture capital firm will pledge to exchange capital for equity. The funds are typically released in rounds rather than all at once. The investor can monitor the firm's progress before releasing additional funds. 

Many venture capital professionals have prior investment experience and tend to focus on the industry they are most familiar with. 

An investor typically leaves the firm after 4 to 6 years by initiating a merger, acquisition, or an Initial Public Offering (IPO). 

A VC investor must always be up-to-date with current financial news and other outlets that might affect their investment in a particular industry. 

Due to the rapid growth of Silicon Valley, the majority of deals financed by VC firms are in the technology industry. VC has expanded over the years and is predicted to continue evolving due to the constant flow of innovations. 

Venture capital has become a critical part of any startup's funding. The WSO has a helpful course on Venture Capital and financial modeling used by VC firms. 

Venture Capital Advantages and disadvantages

Although risky, VC is attractive to investors because of its potential for above-average returns. Likewise, companies seek venture capital firms to get early investment alternatives to other forms of funding, especially if they lack access to capital markets, bank loans, and other debt securities. 

The only downside is that the equity investors receive can entitle them to company decisions. When the company requires additional funds than forecasted, it has to give up a larger share of ownership, leading to the owners losing their decision-making power. 

The conflict between owners and investors could also hinder decision-making and affect the company's success. 

Likewise, the owner will be more pressured to grow the company as quickly as possible to satisfy investors, even if slow growth is more realistic. Funds are usually released based on performance, and underperforming companies can lose their business quickly. 

What is Angel Seed?

Typically, Angel Seed investing comes from an HNWI looking to invest in the very early stages of startups in exchange for equity. They can typically be the first funding source a business receives and are also known as private investors, seed investors, and informal investors. 

Most of these investors have excess funds and are looking for higher returns than traditional investment opportunities do not provide. In addition, they provide more favorable terms because they are investing in the entrepreneur's idea, not the viability of the business. Their goal is to help startups take their first steps.  

They do not have to be "accredited investors," meaning they do not have a net worth of 1 million in assets or have made an income of 200 thousand for the previous two years. Anyone with the funds and will to invest can be this investor. 

Accredited investors usually have proficient industry knowledge and choose to target and understand the company's mission well. Likewise, they commonly use their money and sometimes group as a syndicate to provide more funding. 

There is also crowdfunding, which lets many investors come together and pool their money, with each person investing a small amount in exchange for a small share of any eventual profits if the company proves successful.

They are commonly the first source of business funding before venture capitalists step in and investment bankers raise funds on public markets. 

These investors can lose their money if the chosen company fails during its starting stages. This is why investors have an exit strategy to minimize the risk. 

Professional private Investors look for opportunities with a defined exit strategy, such as acquisitions and initial public offerings (IPOs).

A generally successful portfolio of this type of investor can have an effective internal rate of return of 22%. 

Angel Seed Advantages and Disadvantages 

Startups need this type of investor because they are desperate for funding, and he or she believes in their idea and does not impose harsh requirements, unlike other types of funding (ex: loans). 

Since this type of investor usually has industry experience, they can provide great insight into the business venture and be helpful in decision-making.  

The nature of the investment depends on the individual investor. Some prefer to be in more control of the decision-making while others do not. The investor chooses to what extent they want to fund the business and how many increments the business gets this capital.  

This type of investing is risky. Therefore, investors usually keep it at a low percentage (ex: 10%) of their portfolio. Likewise, this type of investor can be hard to find without a network. It can often be a family member or close contact with the owner.

Angel Seed History

Private equity was mainly on the sidelines after WW2. However, Venture Capital, a brand of PE, was formed before WW2 in 1946 by George Doriot, who is considered "The Father of Venture Capital." 

He started the American Research and Development Corporation (ARDC) and raised $3.5 million to invest in companies that commercialized technologies developed during WW2.  

Their first investment was in a company whose mission was to use x-ray technology for cancer treatment. The $200,000 that Doriot invested turned into $1.8 million when the company went public in 1955.

After the second world war, venture capital fueled America's Technological Revolution in the 1970s. Silicon Valley had a rich and emerging venture capital ecosystem. Today's major companies, like Apple and Intel, were able to grow their operations thanks to the funds received at that time. 

Private equity firms rose to prominence as a preferred method for struggling businesses to raise money away from the public markets during the 1970s and 1980s. As a result, the industry started growing, enabling more capital to be available, and the size of an average transaction in private equity increased. 

In 1978, A professor named William Wetzel at the University of New Hampshire studied how entrepreneurs raise capital in the early or "seed" stages of their business. He began using the term "angel" to describe investors who funded those companies. That is how this investing was born.

The private equity sector grew proportionately in profit and debt until the 2008 recession when it plummeted. This happened because institutional venture capital investors, who made a significant part of the industry, were less inclined to give out their funds at the time.  

Since the financial crisis, private credit funds have accounted for an increasing share of business at private equity firms. They function by raising money from institutional investors and giving it out to companies that cannot access corporate bond markets. 

These funds have less demanding terms and shorter time frames than private equity funds. As a result, these areas of the financial services sector are among the least regulated. The funds, which charge high-interest rates, are also less affected by geopolitical concerns, unlike the bond market. 

Private Equity vs. Venture Capital vs. Angel/Seed Investors

The critical difference between the three is the company's growth stage at which the funding is received. Informal investors are the first of the three to fund a business, followed by venture capital and then private equity.

Seed Investors give out funds before the company has established operation, VC firms give out funds at the organization's early stages, and private equity firms give out funds to primarily established and running businesses. 

After that, the company likely goes to an Investment bank (IB) to raise funds through public markets. Private equity is the alternative to the conventional way of raising capital, and most businesses use it before issuing their IPO. 

Although venture capital and Seed Investing are private equity subsidiaries, they do not act the same. Especially angel seeds because these investors do not perform "due diligence," meaning they are not as meticulous about the rapid profitability of the company. 

Private equity is most meticulous because it gives out the most capital of the three. But, likewise, the amount of capital varies. Typically, private equity firms have more capital than VC and informal investors. In turn, they receive more equity and control over the company. 

Since private equity is broader, it can apply to any industry. However, venture capital is limited mainly to startups in technology, biotechnology, and clean technology.  

Private equity firms use cash and debt in their investment, and venture capital firms deal with only equity and convertible debt securities. Informal Investors exclusively deal with equity due to the inability of the company to issue debt in its starting stages. 

The earlier the business's stage is, the higher the risk. It is generally the riskiest and most unpredictable for Informal Investors. However, they can profit the most due to the positive nature of the risk and return relationship.     

Which one is more profitable? 

Informal investors have the highest risk and the highest possible returns. For example, they could multiply their initial investment by 100. However, the high-risk results in many of their investments are failing and losing all their invested money. 

Venture capital has less risk, and its return is lower. They could multiply their investment by ten if they succeed. Since the risk is lower, they are more likely to succeed and could make more profit than informal Investors. 

Lastly, Private equity has the lowest return of 15-20% IRR. However, receiving PE funding is meticulous, and the capital is high. Therefore, most times, there is a profit, and since the capital amount is high, the profits are high despite a lower percentage return than the other two.

Hence all three options can be the most profitable depending on their investments and the type of investor's preferences. For instance, more risk-averse investors could opt for angel investing due to its more independent nature and possible high returns. 

However, other investors who dislike risk might prefer to do VC or PE. It can also depend on the investor's expertise and the industry he or she is most familiar with. 

Key Takaways

Investment Business Stage

  • PE invests in the latest stages out of the three.
  • VC invests in the pre-profitability stages.
  • Angel Seed invests in the earliest stage (founding).

Investment Size

  • PE has the most significant investment size, ranging from a few million to even billions.
  • VC size of the investment can range from a couple million to ten million.  
  • Angel Seed varies the most regarding the investment size and is usually the smallest of the three. It can range from 10,000 to a couple of million.

Type of Investment

  • PE typically invests in equity with leverage 
  • VC invests in equity with convertible debt since the company does not have access to debt markets at that stage.
  • Angel Seed invests in only equity.

Level of Risk and Return

  • PE has moderate risk (low chance of losing all money) and the lowest returns of approximately 15-20% IRR.
  • VC is riskier than PE, with a moderate chance of losing all money, and has a return rate of x10 of the initial investment.
  • Angel Seed has an extremely high risk of losing all money but has a high return of x100 of the initial investment. 

Choosing between the three for investors can depend on their industry expertise and how averse to risks they are. Thus, investors use financial modeling to assess the profitability of investments to facilitate their decisions. 

Researched and authored by Anja Corbolokovic | Linkedin

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