The terms “venture capital” and “private equity” are often interchanged and confused, though they are as different as apple and orange. Venture capital (VC) is investment in a business which needs equity funding to grow, usually because it cannot generate enough cash itself from its existing commercial activities to meet its requirements and achieve its desired goals. The investment is needed before the company is generating any cash at all- to finance research and development (R&D) for a product or a technology.

In all cases, venture capital is often used to help a company to survive the early stages of loss making. Venture capital is, therefore, associated with a high degree of risk and would need to provide its contributors with a return high enough to compensate that risk. Before resorting to venture capital funding, a start-up company will typically be wholly owned by its founders and management. Generally businesses that raise venture capital are in the seed or start-up stage of development. These two stages are usually characterized by a small number of entrepreneurs who have come up with a new business idea with the potential to grow and prosper. If a company raises venture capital after these initiatory stages, it may be contemplating an evolutionary change (e.g., introducing a new activity in addition to an existing one). The new capital to be invested in the business will not be paid out to existing or former owners.

On the other hand, private equity is totally different. It typically involves acquiring a matured business with a proven operational track record from its current owners, either by a management buy-out (MBO) by the existing management, a management buy-in (MBI) with a new team acquiring an existing business, or a hybrid of the two- i.e., buy-in management buy-out (BIMBO). In all cases, all or most of the funding goes outside the business to pay off previous owners. Most businesses funded by private equity are well established, profitable and cash generative. High amounts of borrowing (leverage) are used to generate better returns on the equity investment, and the generated cash flow will be used to service and repay the debt. Therefore, they are inherently lower risk than businesses funded by venture capital.

For more, see: comparison between venture capital and private equity.