Venture Capital vs Private Equity.

Understanding which route is right for your startup.

When launching or building a company, it can seem like there are only two ways to go; you can raise venture capital or bootstrap. The first company I co-founded took the venture route whereas my current business was built off its own revenues for the first 6 years. Throughout the course of both of these journeys I have recognised the pros and cons to both options.

If you have a potential unicorn on your hands, then getting venture capital in early can be the difference between winning the market or losing out — especially in winner takes all opportunities — e.g. Uber. With venture capital, you are handing over control (and often the destiny) of your company to investors. If things are going well, this is unlikely to be a problem. However, as soon as you hit a bump in the road, they may not have the time or patience to stick by you as you figure things out.

Bootstrapping your business gives you the chance to do things your own way at your own pace, which leaves you in complete control. However, when you want (or need) to grow faster, you may struggle unless you have a business model that generates the cash necessary for said growth. But this doesn’t mean that you are not just as ambitious ;)

As my current business has started to scale, I have come across a different funding option that I didn’t previously know applied to tech companies at this stage (sub $10m revenues); Private Equity.

If you have a good business that is growing at say 30–50% per year, you are going to struggle to raise VC. Even if you do you are likely to experience difficulty in delivering the growth that VC requires. This is a recipe for quickly losing control of your company. However, Private Equity could be the tool you need to grow the business whilst also delivering on expectations.

How the business model of a VC works
A venture fund typically targets to make 2–3x their fund back over a 10 year lifespan. A private equity fund usually has the same target (or in some cases a bit lower because it is less risky). The difference is how they go about getting there. Typically, a venture fund looks for companies growing at 100%+ per annum. The reason for this is that they need 1 or 2 companies in their portfolio to knock the ball out of the park and return 20x or more. This will make back a large part if not all of the overall 3x return. Then 3–4 companies may return a decent 3–5x and the rest will return a nominal amount or even nothing.

In order to get 1–2 big winners a venture fund must bet big. If your company doesn’t look like it could achieve a 20x return, then they can’t bet on you even if you have a very solid, growing business. That is why they are looking for 100%+ growth rates. If you are growing slower and they did bet on you, they may have a higher chance of making 3–4x their money back. This means one less seat in their portfolio for a 20x winner which reduces the probability of them finding one.

In short if you have a good business that is starting to scale but is at the 30% annual growth level and not growing at 100%+ you will need to look elsewhere.

How Private Equity works
Private Equity funds usually need a similar return over 10 years as their venture capital cousins, but they take a very different approach.

Private Equity funds try to pick less risky companies that will all return 2–4x which, in turn, should give them a 3x return overall. This means that a bootstrapped company growing in the 30% range will give a decent return. Sometimes, even a company growing in the 20% range can give them the return they need.

The one caveat is that you will only get access to Private Equity once your business model is proven and you are generating at least €2–3m in annual revenues. Therefore, this obviously won’t help when you are just starting out.

Different paths to success
At this stage, I’m sure you know all about the VC backed path to building a successful company. There is a ton of blogs, tech media articles and advice on the internet about how to follow that particular path. I wanted to show that there are alternative routes to reaching the same destination. The bootstrapped + private equity approach may take longer but leaves you more in control of your own destiny.

You may have bootstrapped your business for the first few years before requiring funding to grow faster. Maybe you took some angel/seed money early on to develop your product and route to market? In doing so, you may have succeeded in building a viable business that never took off at a fast enough pace to justify a series A from a VC. This alone shouldn’t be a reason to quit on the business as you may have something really meaningful that people are willing to pay for. Private Equity could work as a way of giving your angel investors a decent return whilst also allowing you to invest in building a bigger business. Ultimately this should mean a great return because this model is likely to leave you with a bigger share of the pie.

Remember 50% of a €20m exit is better than 5% of a €180m exit.

Ps. In case you are looking for more information, here is a link to a bunch of private equity funds.