Unpacking company investment stages to help find your fit.
Part five (of seven)
In the fifth of our series of seven articles (in which we unpack the different stages of growing a business) we delve into the differences of private equity and venture capital – and find out what bringing in venture capital actually means.
Private Equity vs Venture Capital
Flash overview: Venture funding refers to an investment that comes from a venture capital firm and describes Series A, Series B, and later rounds. This funding type is used for any funding round that is clearly a venture round but where the series has not been specified. On the other hand, a private equity round is led by a private equity firm or a hedge fund and is a late-stage round. It is a less risky investment because the company is more firmly established, and the rounds are typically upwards of $50M (approx. £35.5M).
Although there are distinguishing factors between VC and PE, the lines are becoming increasingly blurred. Some companies are receiving big sums of investment from private equity, having already sucked up serious banknotes from venture capital firms. Case in point - Postmates, an on-demand delivery unicorn, has benefitted from mixed funding.
It’s unclear how much the two will continue to overlap, but – as with all areas of business – they’ll continue to evolve, driven by a desire to, equally, unlock the potential in businesses, and chase the dollar.
Venture Capital: Rocket launchers
Aside from stages, it’s worth knowing your private equity (PE) from your venture capital (VC) as this may have significant consequences on your fit – or lack of – within a particular business.
Venture capital is the money that helps lift a business off the ground. A VC firm is an early doors investor that gives a start-up the crucial capital it needs to get the business off the ground.
VCs are laser-focused on growth, which can come at the expense of profitability. This mindset means they’re more inclined to invest in companies with stellar growth potential and direct them to accelerate quickly, but not always sustainably.
If VCs were in a race, it would be the equivalent of running a marathon at full speed and, if a company doesn't finish the race, they hope another one of their investments will dash through the finish line at pace making up for the loss of the other.
“The long run is what puts the tiger in the cat” – Bill Squires, coach to illustrious marathon greats including Bill Rodgers, Alberto Salazar, Dick Beardsley, and Greg Meyer.
Despite the ongoing global pandemic, figures from data firm, CB Insight, show that VC funding hit a new high last year: US-based VC-backed companies raised a record of nearly $130B in 2020, up 14% year-over-year. And according to previously unreleased data from PitchBook, reported by Reuters, in the first nine months of 2020, US VC firms invested $88.1 billion (£68.58B) in tech startups, up from $82.3 billion in the first nine months of the previous year. What’s even more remarkable is that tech investments represented 78% of venture capital investments in 2019. Over in the UK, the Guardian wrote that technology companies attracted a record $15bn (£11.2bn) in venture capital funding in 2020, including the creation of seven “unicorn” firms (those valued at more than $1 billion). Now add in that some of the biggest VC hits of all time include Facebook, WhatsApp, Alibaba, and Zynga, and it’s no surprise why VCs and tech start-ups are often thrown in the same box. But VC bucks fund all kinds of ventures, too, like Blue Bottle Coffee and WeWork.
The wonga in a VC’s wallet comes from its limited partners. Depending on the fund’s size and setup, this can include high net worth individuals, their family offices, institutional investors like charitable or university endowments, pension funds, fund-of-funds, and other money management firms.
Traditionally, general partners (GPs) – the folks in charge of the firm – also invest in their funds. It’s their way of keeping some “skin in the game” and aligning interests between GPs and LPs (Limited Partners).
VCs tend to make “riskier” investments and diversify by spreading them across multiple companies. That way, if one or more of the businesses fail (which is a reality in the game of investment), the fund stays afloat. And if a couple of the companies take off, then the firm is in the money.
With the venture capital market becoming ever more saturated, VCs are often in a chess match that creates a paranoia of..."FOMO" (fear of missing out) sometimes leading to ridiculous valuations. The silver lining in how these deals work is that the last $$ in are the first $$ out. So, in the worst-case scenario, the Series C investor will get their principal back before the Series B and before the Series A… on a waterfall! Therefore, the latest round of investors may "give" on the valuation knowing they sir in a Senior Equity Position in a bad outcome. This varies based on investor sentiment but traditional rules should apply over the long term of venture investing. Many investors try to make their move by offering a suite of services, specifically tailored to a subset of companies and used to put the game in check to become significant stakeholders in their portfolio businesses.
To give you some examples, Forbes recently reported that leAD Sports & Health Tech Partners and InStudio Ventures have teamed up to create The Draft, a U.S.-based seed and venture capital fund focusing on the sports tech industry, which some experts estimate to reach a whopping $30 billion by 2024. Expect full stadiums! The pilot fund will raise an initial $5 million, investing in around three start-ups per year with areas of focus being fan engagement, health and wellbeing, and esports.
Another exploding segment is at-home fitness. TechCrunch recently reported that Future had raised $24 million in Series B funding for its $150/mo workout coaching app, while strength training start-up, Tonal, backed by the likes of Amazon and basketball superstar, Steph Curry, just announced another $250 million inflow (taking total investment up to $450 million) after its sales in 2020 grew more than eight times year over year. New York-based Ergatta, the gamified connected rowing machine, is the latest to receive some of that windfall, announcing a $30 million Series A investment win.
A final point of note is that VCs may occupy seats on the company’s board of directors. You’d expect this would offer additional governance and control rights over portfolio companies, but that’s not strictly the case. The upswing in multi-tier voting share structures (usually favoring founders), along with a recent tendency to defer to the founder authority, means directors don’t hold as much power as they did previously.
Look out for Part 6 in this series, in which we deep dive into private equity.