The OfficeHours Guide to Private Equity Part 3: Private Equity Investment Types

Once you have determined to pursue a career in private equity, it can be daunting to figure out which type of fund to work for. In this post, we outline the major ways to categorize PE funds to help determine which segment of the market is most attractive to you. We will explore the differences between buyout, growth, and VC funds. In subsequent posts, we’ll look at different sector- and strategy-specific funds, as well as how the size of the fund impacts the type of investments it does.

At the highest level, PE funds can be further broken down by which stage of a company’s life cycle they invest in.

1. Buyout (acquire entire businesses)

2. Venture Capital (minority investments at the earliest stage of a company)

3. Growth Equity (in between buyout and growth investing)

1. Buyout Funds

Buyout funds have two defining features: 1) they take control stakes in companies and 2) they employ the use of leverage as a significant portion of the purchase price

1. Stake: Control stake (>50% ownership, oftentimes close to 100% ownership)

2. Lifecycle: Companies have a mature and proven business model and generate reliable free cash flow

3. Growth Rate: single digit to mid-teens growth rate; higher for some industries like tech/SaaS

4. Debt: The ability to raise debt comes with certain implications: companies that can raise debt typically have meaningful free cash flow

5. Risk and Return Profile: PE investors do not expect any 0’s in their portfolio. The companies they invest in have a track record of growth and generating cash flow, so the investment is de-risked, and every portfolio company should hit a 2-3x return.

6. Day-to-Day: very quantitatively focused with granular analysis at a line item level; LBO modeling is a big part of the job

7. Compensation: Highest compensation in PE. First year PE associates (2-3 years out of college) can make $300K+

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2. Venture Capital

VC funds are on the opposite end of the spectrum and invest in early stage companies, even those that might be pre-revenue and pre-product, let alone those that have achieved product-market fit

1. Stake: Minority stake (<20% ownership); a smaller check gets you a bigger portion of the company to compensate for the greater risk taken

2. Lifecycle: The earliest stage of a company’s existence. Some VC checks (angel and pre-seed) can be in companies that are pre-product and pre-revenue; it could just be two founders and an idea. Others invest in companies with a version 1.0 product that is still figuring out product-market-fit.

3. Growth Rate: Company should be growing double or triple digits as it gains market share and acquires its initial few waves of users

4. Debt: VC’s take equity stakes in companies. Since the companies are so early into operating and don’t have reliable free cash flows, raising debt is often not a possibility. While venture debt exists, it does not comprise the majority of capital flowing into VC investments

5. Risk and Return Profile: VC’s understand that most of their investments will probably not work out (0x or 1x return). However, their goal is to fund the company that returns a 10x or even a 100x to make up for the rest of the portfolio losses. Because VC is a numbers game, sourcing every opportunity and being an attractive firm to partner with is of paramount importance. It’s the whole game. For this reason, you will see VC’s highly active in brand building such as on social media platforms like Twitter or LinkedIn.

6. Day-to-Day: VC is less focused on analyzing specific numbers (often there aren’t any to analyze since the company isn’t built out) and more focused on finding the next unicorn in a given space. A lot of emphasis is given to understanding market sizing and unit economics so that there is an eventual path to profitability at scale. VC’s write a lot of checks and hope they don’t miss the next 100x company like Stripe.

7. Compensation: Lowest compensation in PE. First year VC associates (2-3 years out of college) can make $120K+

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3. Growth Equity

Growth funds are in between VC and Buyout. They usually invest in companies with product-market-fit but not yet highly profitable. These companies are usually cash flow negative or close to breakeven profitability.

1. Stake: Growth funds can invest either minority or majority stakes in companies. Most growth funds invest minority stakes, though many firms are expanding their investment strategy to do “growth buyouts” such as TCV and Summit Partners.

2. Lifecycle: Companies have achieved product market fit and are looking to accelerate growth on a proven business model. Growth capital is used to fuel growth initiatives such as adding product lines, entering new markets, making new hires, etc. Some of these companies do not need the growth capital but choose to take it to accelerate growth and achieve liquidity for the founders.

3. Growth Rate: Double digit growth rates; very high growth companies that are climbing up their J curve

4. Debt: Usually pure growth investors do not utilize debt. However, growth buyout firms will use debt, whether a few turns of ARR for SaaS businesses or a few turns of EBITDA for those growth businesses with positive cash flow.

5. Risk and Return Profile: Somewhere in between PE and VC, growth investors expect some homeruns but also understand some of their companies won’t launch into the high growth trajectory they expect.

6. Day-to-Day: A big focus on revenue modeling, including cohort analysis, market sizing, and ****finding a path to profitability. Less quantitative than Buyout funds but more quantitative than VC funds.

7. Compensation: Middle compensation in PE. First year Growth equity associates (2-3 years out of college) can make $200K+ (though some bigger growth funds pay like their buyout peers at $300K+)

Each of the three types of PE funds vary greatly with their investment philosophies and day-to-day, which we will explore in the next posts. Read more about this directly on our Blog.

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