Venture Capital Supply Chain

Based on a few recent conversations, it seems like a good idea to review, at a high level, the basic supply chain for Venture Capital and Private Equity.

Perhaps a good starting place: what’s the difference between Private Equity (PE) and Venture Capital?  In my opinion, not too much: Private Equity generically refers to non-publicly available equity investments that INCLUDE stuff like early- and later-stage venture investments.  Therefore, my definition is that venture capital typically refers to earlier stage (private equity) investments; private equity typically refers to considerably later-stage (traditionally debt-enabled) buy-out type of investments from companies such as Cerberus and Blackstone. And, to be clear, when we talk about the amount of capital raised being $30billion and declining, we’re referrring to early-stage venture capital and not the larger PE/hedge fund markets.

The following picture shows the basic supply chain for venture capital:

The flow of money from institutional investors to target companies

The flow of money from institutional investors to target companies

Starting on the left, the folks who fund the venture investors are the institutional investors. Institutional investors are folks like public pension funds (such as The California Public Employees’ Retirement System or CalPERS) and university endowments (the BIG 5 are Harvard, Yale, Stanford, Princeton, and The University of Texas) I’ll have more to say on institutional investors in a subsequent post. These institutions spread investment risk across multiple asset classes that include higher-risk (and theoretically higher-reward) investments such as venture capital and private equity (along with traditional stocks, bonds, real estate, etc.). When they put money into venture funds, they become “limited partners” of those funds.

In the middle, the venture investors raise new funds every 3-5 years (no hard rule here) from institutional investors and occasionally high net-worth individuals. Funds can range in size from small (under $50m) to quite large (over $1 billion); typically the top-tier VCs raise funds that are $300-$800 million in size these days.  Venture funds can and do over lap (this is an important how-VCs-get-paid fact for later discussion); in other words, before one fund runs out, the next fund is raised. In more established firms, many funds can be simultaneously operating at various life stages.  In particular, as funds are depleted by investments in companies, VCs will keep some percentage of that fund “in reserve” for follow-on investments in companies from that fund.

On the right are the companies that receive investment. These can be companies at any stage of life: start-up to age-old brand name like K-Mart. The terms and conditions and desired outcomes depend on the company, the stage of life, and various other factors.

Of course, customers and employees of the target companies an important part of the supply chain but not covered in this post.

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3 Responses

  1. […] I believe that traditional limited partners are experiencing a liquidity crisis. More on the data and what this means in a future post. But, in […]

  2. “Therefore, my definition is that venture capital typically refers to earlier stage (private equity) investments; private equity typically refers to considerably later-stage (traditionally debt-enabled) buy-out type of investments from companies such as Cerberus and Blackstone.”

    So, if venture capital = early stage private equity and private equity = later stage investments, then is there a difference at all? Seems like if A = B and B = C, then A = C, right?

    • From a technical perspective, you’ve got it right. From a colloquial perspective, VC tends to refer to earlier stage and PE tends to refer to later stage. The differentiation is just the vernacular of the industry.

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