PE Backing Your Startup? 5 Key Principles
Technically speaking, venture capital (VC) is a form of private equity (PE). The definition of PE is to invest in a company or entity that is not publicly listed or traded. That said there are many important differences to the point people think of VC as a different asset class than PE.
As a founder should you raise from a PE? This article will help you answer how and when to do so.
1) Time Horizon – VCs, especially early-stage, are looking for potential 10x in potentially 10 years. PE is ideally looking for 4-5x in ideally 4-5 years.
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2) Capital – PE funds are on average 10x or more bigger than VC funds. That gives them large amounts of dry powder and ability to invest at all stages. Other than very large, multi-stage funds, VCs are optimized for a much narrower range of company stages and thus checks.
3) Typical VC Mindset – VCs generally help connect startup founders within their network to accelerate the growth and success curve of the startup, whether it is for hiring or customer acquisition. In addition, most VCs today come with promising wealth of combined experience for their advisory network in order to tap into fields that may be niche or have higher barriers to entry. VCs are not running a company and rarely any single firm will own more than the founder (albeit collectively investors do tend to become majority pos series B). Also, while more common in the past and high-profile cases still make it to the news, replacing a CEO happens in a minority of cases.
4) Typical PE Mindset – PE generally leans towards lower companies who have been largely de-risked. Oftentimes that is later stages, including leveraged buyouts (LBO) of companies that are privately held. PE firms will often look for specific metrics around revenues and EBITDA and will most likely take control positions. They are also (in)famous for hiring and firing employees with the goal of making a company more efficient. Most of their targets historically were private companies that had not raised VC dollars, although 1 in 5 VC-backed companies have exited through buyouts. Notwithstanding what is happening recently in 2022, PE has been growing steadily and the YoY jump from Feb 2021 alone was 33%.
5) So Why And When To Raise From PE – There are indeed good reasons for the norms around when and from who to get investment. Bottomline, it’s about managing risk. If your startup is in a comfortable place and you think you can get PE the type of returns they are looking for, then by all means raise from them. A typical example would be a series C that is growing stably and looking for an IPO in a couple years. Setting a mutually agreeable framework around the PE firm’s involvement in day to day operations is crucial. Another scenario would be if you know the PE can help you with some specific domain expertise or recomposing the team significantly, say reducing the burn of a 200+ team by half in the face of a crisis. Finally, if you don’t have options then take the money that is being offered to you, keeping the right set of expectations.
Primary author of this article is Sharon Huang, co-authoring with Amit Garg. Originally published on “Data Driven Investor.” Sharon is an Associate with Tau Ventures. Amit is Managing Partner and Cofounder of Tau with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). See here for other such articles. If this article had useful insights for you, comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are from the author(s).