Why startups should decide for a Private Equity (PE) instead of a Venture Capital (VC)?
“Be careful what you wish for, it may come true” — Anonymous
When looking for sources of financing you will find multiple options. Two of the most important are usually Venture Capital (VC) and Private Equity (PE). These two options could be the best for your company depending on stage, life cycle, and inclination for control and valuation.
In traditional models, VC investments take higher risk than PE investments, who seek stable cash flows as shown below:
Currently, the division between VC and PE funds has become slightly imperceptible in certain cases. VC Funds raise more capital every day, giving birth to mega-funds (ie. Softbank, A16z, Sequoia), therefore they participate in larger transactions, in which they compete with PE funds. In that same sense, PE funds have raised investment vehicles to be able to invest in disruptive technology and businesses competing with VC funds (ie. Warburg Pincus, General Atlantic). According to a study conducted by Pitchbook in 2019, PE Funds participated in 13.9% of the transactions made by VC investors.
Considering these dynamics in the market, we propose the following matrix as a reference when selecting investors in your capital raising, considering the levels of financing and control that you wish to prioritize. Take into account that lines blurred, and investors might participate in more than one quadrant.
1. Maximize growth
If you are a company with high growth, thinking of maximizing the valuation of your company and maintaining a controlling stake or a high equity stake, the suggestion is to access VC funds.
An example of this is Nubank, a Brazilian challenger bank with presence in Latin America that has raised more than USD$1.1bn from multiple VC funds such as Sequoia, Ribbit Capital and Thrive Capital. In addition, the company has raised debt from Goldman Sachs for approximately USD$100mm, this strategy allows the control group not to dilute itself and to have capital to continue with its expansion.
2. Build to last
This strategy allows the founders to maximize the valuation of their company by giving up a significant part of it. PE funds are the investors by excellence in this strategy, they leverage their capital, relationships and operational knowledge in search of increasing the value of the company.
Now PE funds are allocating capital into VC investments. An example of this is Gojek, a super-app that provides different services such as payments, food shipments, transportation and logistics in Southeast Asia. It has raised more than USD$4.8bn in different investment rounds, taking PE funds a very relevant participation in these investments (ie. KKR and Warburg Pincus with approximately USD$550mm in total).
3. Quick exits
Another strategy to consider are M&A transactions and mainly quick exits. This translates into developing a business model, growing it, and selling it “soon” to a third party. In this way, the entrepreneur and the original investors make a return on their investment quickly.
These types of operations are more common in today’s markets. For example, Gojek has acquired around 12 “small” startups with transaction values in the range of USD$50mm to USD$130mm (ie. Kartuku, Coins, Moka).
4. Super smart money
Another relevant strategy for entrepreneurs is to have access to super smart capital, which in return would give them access to new geographies, new clients, business networks, and knowledge or technology. Under this premise, the entrepreneur probably should not have a focus on valuation, but in the control of his company.
Take into consideration the case of Google Ventures, Google’s Corporate Venture Capital Fund. In 2011 they invested in Nest, a company dedicated to household products such as thermostats and smoke detectors. In 2013 they invested additional capital and in 2014 they reached an agreement for the company to be acquired by Google.
As an entrepreneur you should keep in mind what your priorities and objectives are. Consider the added value that a Venture Capital fund (VC), a Private Equity fund (PE), a Corporate Venture Capital fund (CVC) or a potential buyer brings. Keep in mind the strategies’ focus to either maximize the valuation of your company, seek control to maximize your growth or create a company that lasts.
Also consider alternative strategies that will allow you to have a quick exit or access to smart capital.
“I think it’s important for the founder to say to themselves in the beginning, at what point does my ownership start to demotivate me?” — Ron Conway
Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund.
Ricardo Latournerie. Investment analyst at ACV.