Battle of the finances: venture capital vs. private equity

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If a business is searching for a source of external funding, it can turn to various sources. Some of these sources may be vastly different, such as venture capital (VC) and private equity.

Although both are forms of private financing and the investment horizon is roughly similar, that does not mean they are the same.

Where they meet

Private equity and VC firms are similar in the fact that both ultimately invest in companies, resulting in financial return in the form of management fees and carry, which is a percentage of profits managers receive from exit proceeds. Furthermore, in most cases, both set up a fund with a management structure to raise third party capital later deployed to investments. Both funds are also illiquid, which means that assets cannot be freely traded or exchanged or even converted to cash.

Where they diverge

VC and private equity firms are structurally similar, yet their underlying assets are different, according to Fares Ghandour, partner at Wamda Capital, a Dubai-based VC firm.

Fares Ghandour. (Image via Wamda Capital's website)

That said, private equity is a form of external financing in which working capital is raised and invested in mature businesses, and provided to promote expansion, fund development or improve a firm’s existing functions. Private equity is usually centered around taking a profitable existing company with existing cash flows, then restructuring that company to optimize financial performance. 

Marwan El Banna, a Waha Capital associate, said his private equity experience taught him how various ecosystems interact because private equity has broad scope in terms of industry.

Private equity firms tend to be more engaged in financial analysis and valuations than VC firms,” El Banna said. “Although VCs run financial models and perform valuation exercises, business plans are more difficult to predict at early stages of the business due to the high level of uncertainty.”

Private equity firms are usually more involved in the management and operations of a business than VC firms, according to Ghandour.

“Private equity firms buy out existing shareholders of an existing company with existing profitability,” Ghandour said. “They also tend to own majority stakes, which is why they play a role in the management of a company, unlike most VC firms.”

Venture capital is a form of private equity offered to businesses with high risk, but with high potential of return on investment (ROI). Contrary to private equity, VC is associated with risk: it invests in smaller ventures and businesses that may or may not grow enough to reach sufficient scale in revenue or profitability. The VC industry needs to provide adequate ROI to attract funds from Limited Partners (LPs), good returns for its own participants, and sufficient upside potential to entrepreneurs to attract high-quality ideas that will generate high returns.

Few examples from the region

A number of VC firms exist in the region, some of them include Jordan-based Silicon Badia, Lebanon-based B&Y Venture Partners and UAE-based Wamda Capital which has a digital tech investment portfolio, including remote IT service company Geeks. There are also multiple private equity firms including the Jordan-based Foursan Group, Lebanon-based Ahli Investment, and UAE-based Waha Capital  which has various investments including in the MENA Infrastructure Fund, an infrastructure equity investor and fund manager.

Marwan Al Banna. (Image via Marwan Al Banna's Linkedin)

Complementing each other
“Venture capital and private equity are usually complementary rather than contradictory,” Ghandour said. They may be both used to fund the same types of business. However, VC is more commonly associated with early stage ventures that need a push of funding to get off the ground, while private equity can come later with other follow-on investments to help the business reform management or to revamp the business’s operations once it is established. What is more, a private equity firm can sometimes provide exit opportunities for VC firms closing their fund cycle.

According to El Banna, the gap between private equity and VC firms has been narrowing in recent years as global tech-focused private equity firms, such as Vista Equity Partners, Silver Lake, and Thoma Bravo, are gaining traction. However, global diversified private equity giants, such as KKR, Carlyle, and CVC, have raised tech-focused funds to focus on hardware and software.

“Regionally, this seems to be the trend as well,” El Banna commented. He added: “At Waha, we have seen a larger number of technology companies in recent years looking for private equity funding since tech companies are growing to reach private equity deal sizes.” He explained that regional private equity firms are also gaining comfort around the sustainability of such companies and around the valuation and exit routes of these opportunities. In recent years a number of regional private equity firms have solidifies their interest in the space with deals such as Abraaj’s investment in Careem, Gulf Capital’s investment into, Standard Chartered Bank’s investment into before it was acquired by Amazon, and Swicorp’s participation in Fetchr’s latest investment round. “I  would not be surprised if regional private equity firms also raise tech-focused funds over the coming years,” El Banna concluded.

Feature image via Pixabay.

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