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Private Equity vs. Early-Stage Investing

Private Equity vs. Early-Stage Investing
By Adam Sharp
Date February 11, 2020
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Vanguard, a titan in the money management world, recently announced it will begin offering private equity products to its institutional clients.

A number of people have asked me why Vanguard is getting into startup investing. The simple answer is this: It’s not. Private equity (as the term is used here) is very different from startup (early-stage) investing. But the confusion is understandable.

Private equity investors typically invest in mature companies, often ones that are struggling. The goal is to buy the underperforming business, turn it around and sell it for a higher price. Private equity firms usually take a majority stake in the business. Private equity firms also usually target private companies. But they occasionally go after what they see as underperforming public companies as well (Dell is an example).

Private equity firms often use a large amount of debt to buy companies. This is known as a leveraged buyout (LBO). I believe that what we commonly call private equity should really be referred to as LBO. But it seems like that ship has already sailed.

The most widely discussed recent private equity LBO is KKR and Bain Capital’s acquisition of Toys R Us. They saddled the store with a lot of debt, and Toys R Us eventually went out of business. You can read more about that story in Barron’s here.

Early-stage investing, as you all know, is very different from private equity. Early-stage investing includes venture capital, angel investing and equity crowdfunding.

Here, firms and individuals take minority stakes in promising young companies. Yes, technically investors are buying private equity, but it’s very different from what most people mean when they say private equity.

Early-stage investors will often take board seats at companies they invest in, but they do not take over management as private equity firms usually do.

And whereas private equity firms invest across all industries, early-stage investing tends to focus on high-growth areas like software and biotech.

In early-stage investing, the goal is to invest across many promising startups. When done well, a few huge winners will make up the majority of returns. Each startup is a high-risk, high-reward investment.

In private equity, the goal is often to turn companies around and sell them for 2X to 3X the purchase price over five years. It is a more conservative strategy. But it does carry risk, especially considering the amount of leverage that is often used.

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