Assessing Risk: Venture Capital vs. Private Equity
In the first quarter of 2023, U.S. private equity firms did more than $262 billion in deals, according to PitchBook data. That’s encouraging for entrepreneurs and others who want to get involved with private equity investments.
Finding growth-stage opportunities isn’t always easy, though. While private equity and venture capital are investments that drive economic growth, they are also both high-risk and have significant concerns that investors must be prepared to address.
Fortunately, anyone planning to get involved with venture capital investments or private equity firms with the goal of high returns can have some help to make their venture capital funds go further.
At Jack Webb Law Group, we work with venture capitalists and others committed to assessing risk and choosing the right path for their future financial needs. We can help you learn about all the risks associated with venture capital and private equity, which investment strategy is riskier, and how to mitigate those risks with the assistance of a private equity attorney.
What is the Difference Between Private Equity and Venture Capital?
Private equity and venture capital investments are similar in some ways, but the two have some key differences. For example, both refer to firms that invest capital into other companies to make a profit by selling their investments later.
Private equity is invested in companies that are not publicly listed or traded. Their business model usually involves purchasing shares or majority control of these companies to restructure them and turn a profit in three to seven years.
On the other hand, venture capital funds startups and early-stage businesses with high growth potential. Venture capital is generally an investment in a company’s long-term growth rather than making adjustments for profitability and then selling.
The Risks of Venture Capital
As with any type of investment, venture capital involves risk. Early-stage companies are more likely to fail, which could result in the loss of the invested capital. Established companies are less of an investment risk.
Additionally, venture capitalists looking for a good investment often invest in tech. That can be a volatile industry, especially when technology advances and changes rapidly, as AI has recently done.
Usually, venture capital firms (VC firms) invest in a few different companies to reduce their risk and spread it around. They also typically invest less than half of the equity of a company. There’s no majority control that way, meaning the firms have less influence over whether the business succeeds or fails. There’s also typically less money invested than private equity, but the overall risk is higher.
The Risks of Private Equity
Private equity also has its risks. This type of investment targets later-stage companies that are generally less likely to fail than early-stage companies. However, even though the overall risk might be lower, higher initial capital investment is required.
Private equity firms (PE firms) are more likely to invest in varied industries than venture capital, including less volatile industries than tech. That can provide more peace of mind for the investors and the private equity funds they offer.
Which is Riskier: Venture Capital or Private Equity?
Private equity is typically considered less risky than venture capital. It involves investment in less volatile industries and focuses on later-stage businesses. However, both are still risky endeavors, and private equity requires significantly more money than venture capital.
Factors That Affect the Risk of Venture Capital and Private Equity
Venture capitalists and PE firms are always looking for the next IPO, buyout, or other option to help them continue to grow. With that in mind, though, they must understand all the factors affecting their risks.
Industry
For venture capitalists and private equity investors, the industry is one of the most significant risk considerations. VC funds are more likely to be invested in tech, which is a more volatile industry than others because of how innovation disrupts it. Other industries, such as healthcare, are considered safer forms of investment. Likewise, more mature companies are safer investments.
Quality of Management
When looking for portfolio companies, it’s important to complete due diligence and consider the kind of management these companies have. If the management team has a history of success, the company is less likely to fail and cost the investors time and money.
Investor Base
It’s not just about the private companies where investment dollars are heading. It’s also about the investors and the funding rounds. For example, what is the likelihood of an investor defaulting? What happens to the funds if one investor cannot provide the capital?
Investors should also consider how spread out the investment is. Are just a few people giving the majority of the money, or is it spread among several investors? Having a minority stake can be safer than partnerships where a few high-net-worth individuals are relied on for most of the capital.
Portfolio Diversity
Diversifying your portfolio can help reduce the risks associated with one investment going sour and increase liquidity in case capital is needed quickly for something else.
How to Mitigate the Risks of Venture Capital and Private Equity
While there are significant risks with both venture capital and private equity, there are ways to mitigate that risks.
Business Continuity Plan
Having a business continuity plan helps you prepare for the worst. It also makes it easier for institutional investors and others to adapt corporate structures and processes to mitigate potential losses. If you have an equity stake, you should have a continuity plan and an exit strategy. The right continuity plan also helps identify cybersecurity threats.
Portfolio Diversification
Diversifying a portfolio is another way for private equity firms and venture capital investors to reduce risk. It’s important to note that diversifying is more than just choosing several companies. Here are the different ways you can diversify.
Time Diversification
Spread your investments over different time horizons. In other words, you should be choosing some short-term investments, some that are long-term, and a few that are more in the middle, so they aren’t all reaching the same stage of development at the same time.
Stage Diversification
This is another important way to diversify and involves focusing on new companies, more established ones, and businesses in various developmental stages. If you invest in multiple options, the main differences being stages, you can expand your portfolio’s reach.
More Investments
Spreading out the portfolio is a great way to increase its value and reduce your risk. The more wise investments you make, the more likely you are to see at least some of them become successful.
Sector Diversification
Don’t invest all in one field. Spread your investments out into several fields and industries in case one sector struggles in the future. You’ll have investments in other sectors to fall back on.
Geographic Diversification
Invest in companies from multiple countries to reduce the impact of one country’s economic fluctuations. You don’t want to put all your metaphorical eggs in one basket when there are better and safer options.
The Role of a Private Equity Lawyer in Mitigating Risk
A private equity lawyer can help you understand the risks associated with venture capital and private equity. Not only that, but these lawyers are excellent at helping investors structure their investments in a way that minimizes their risk.
A private equity lawyer can keep track of documentation that can protect you during government investigations and any internal or inter-company disputes. That is a great way to reduce risk and have more peace of mind.
The Biggest Risk is Not Taking Any
Private equity and private equity disputes are among our main practice areas at Jack Webb Law Group. We want to help you succeed in your investments and protect you from the risks that could come with them.
As a trusted Jacksonville business attorney, we understand the importance of making sound choices for your business’s future. Whether you’re interested in hedge funds, looking into leveraged buyouts, or learning about an initial public offering, we can help you protect your goals and plans.
Request an initial evaluation today by calling 904-803-4686 or completing the online contact form to speak with a skilled Florida business lawyer at Jack Webb Law Group. We’re here and ready to help.
