The terms “private equity” (PE) and “venture capital” (VC) crop up frequently in cybersecurity investing discussions. This is because PE and VC firms often commit thousands or millions to help cybersecurity companies grow.
A clear understanding of private equity and venture capital is a must if you are exploring cybersecurity investments. Knowing how both work and their respective pros and cons will equip you to map out and execute your cybersecurity investing strategy accordingly.
Overview of Private Equity, Venture Capital, and the Cybersecurity Market
Businesses increasingly need security technologies to guard against remote workforce attacks and cloud security threats. This could drive cybersecurity spending worldwide. It could also lead to new private equity and venture capital investment opportunities in the cybersecurity market.
What Are Private Equity and Venture Capital?
Private equity refers to ownership or interest in a company that is not publicly traded or listed. It is an investment capital source that comes from high-net-worth individuals or firms. PE investors can purchase stakes in a private company with plans to take it public. They can also obtain majority control of a public business, with the intent to delist the company from a stock exchange and make it private.
Venture capital is a form of PE that’s generally used to fund startups and small businesses. Typical VC investors include banks and other financial institutions. While PE is always monetary, VC investors can offer help in other areas. The capital can consist of financial contributions and expertise in management or other areas.
How Private Equity Works
Private equity investors raise capital from limited partners and use it to create a fund. They then invest their funds in private companies. Here’s what to keep in mind:
- Some PE investors choose to put money into private companies that appear stagnant or distressed but provide growth opportunities. Others take advantage of a leveraged buyout (LBO).
- An LBO involves the purchase of a majority stake of a company using both equity and debt. Those who take the LBO approach work to improve the company’s profitability. This helps an investor lessen the company’s financial burden and the amount of debt that eventually needs to be repaid.
- An LBO or another PE investment that is successful might prompt those involved to sell the company. This is usually done if investors can earn a significant profit from their original contributions. The returns from the sale of a PE investment are distributed to limited partners that contributed from the get-go.
There is also the option for PE investors to take a company public. This involves filing for an initial public offering (IPO), so the company can sell stock.
How Venture Capital Works
Private equity investors seek out limited partners then set up a fund, but venture capitalists take the opposite approach. A VC firm, for example, opens up a fund and requests commitments from limited partners. This allows the firm to get a pool of money together it can use to invest in private companies that display high growth potential.
A company can go through one or more funding stages after a VC investment. The more stages involved, the more the company can raise, and the more likely it becomes that the business will go public or be acquired by another organization. The VC firm makes a profit based on its initial investment if the company goes public or gets acquired. The firm then distributes the returns to its limited partners.
There may be times when a VC firm decides to sell some of its shares to another investor via a secondary market. This benefits the firm, since it can earn a profit without giving up full control of its investment. The secondary market investor can still get in on a potentially lucrative opportunity as well.
Choosing Between Private Equity and Venture Capital
When it comes to pursuing private equity and venture capital opportunities, consider your investing goals. Those interested in earning money in the short term may prefer PE options. Those willing to stay with an investment many years in the future to maximize their return may be better off with VC investments.
Keep in mind that you can go back and forth between both types of investment opportunities too. PE investors can exit a company and move forward as venture capitalists, or vice versa. It also pays to understand the differences between PE and VC investments before getting involved in either or both options. Those who know how the approaches differ can thoroughly weigh the pros and cons and choose the right one based on their investing goals.
8 Ways Private Equity and Venture Capital Differ From One Another
Private equity and venture capital firms invest in private companies and work with limited partners. Both also want to increase the value of their investments, to the point where they can turn a substantial profit from them. But the similarities between the two end there.
Key differences between PE and VC firms include:
1. Types of Companies They Invest In
Private equity firms are more prone to invest in mature companies in traditional industries. Their venture capital counterparts, comparatively, may be more inclined to invest in startups and small businesses competing in technology sectors like the Internet of Things (IoT) and 5G.
2. Amount of Capital Invested
A private equity firm may have a minimum investment requirement of anywhere from $250,000 to $25 million. The amount of capital required for a VC investment varies based on a firm’s approach and practices.
3. Amount of Equity Obtained Through Investments
Expect a private equity firm to hold 50% or more ownership of a private company. Venture capital firms are more likely to maintain less than 50% ownership of a business.
4. When They Get Involved in a Company’s Lifecycle
Private equity firms tend to look for private companies that have fallen on hard times but appear poised to grow or continue to grow. These companies tend to be in prominent industries as well. Venture capital firms, on the other hand, tend to get involved with businesses in their early stages. They serve as investors and mentors that do what they can to help these companies realize their potential.
5. Level of Risk
Most private equity investors are risk-averse, since even a single failed company could cause their fund to fail. Venture capital firms, meanwhile, are more open to high-risk, high-reward investment opportunities.
6. Operational Priorities
A private equity firm is likely to invest in a business and let it operate as it usually does, whereas a venture capital firm may get deeply involved in its operations. Venture capitalists tend to take a hands-on approach and will help a business identify operational improvement areas. They may also offer business tips, suggestions, and recommendations as they try to get the most value possible out of their investment.
7. Investment Structure
Private equity and venture capital investors both use equity. Where the two differ, however, is in the fact that PE firms also use debt.
8. Value Creation and Sources of Return
Private equity and venture capital firms, like any other investor, want to earn as much as possible, as quickly as possible. How they do so differs, however. PE investors explore ways to help businesses grow and pay down debt. VC investors search for opportunities to help companies boost their valuations.
Consider the opportunities available on private markets as you try to decide whether to move forward with a PE or VC investment. This could put you in a position to capitalize on cybersecurity investing opportunities that offer substantial growth potential.
Common Pitfalls of Private Equity and Venture Capital Investments in Cybersecurity
The cybersecurity market offers opportunities to invest in companies that deliver Security-as-a-Service (SECaaS), endpoint detection and response (EDR), and other innovative solutions. Even investors who explore cybersecurity investment opportunities in depth may encounter issues, however.
Key challenges for those who invest in cybersecurity companies include:
- An Evolving Space
The cyber threat landscape is constantly evolving, so investing in a company that delivers cybersecurity products that work well today does not guarantee the business can provide solutions that will remain effective in the years to come.
- Reluctance to Share Details
Cybersecurity companies may be vague about how their solutions solve cyber and IoT security challenges. They may do so over concerns that too much disclosure will enable others to reverse-engineer their solutions.
- The Right Team
A thorough evaluation of a cybersecurity company requires investors to look at its solutions and its team. A team that lacks the commitment to achieve outstanding results is unlikely to deliver solutions that match market expectations now and in the future.
You don’t need to face these challenges on your own. Partner with a private equity and venture capital cybersecurity-investing expert, and you can receive tips and guidance to help you address these and other challenges.
Contact an Expert About Private Equity and Venture Capital Investment in Cybersecurity
It can be a challenge to find someone with investment savvy and expertise in cybersecurity. Option3Ventures operates at the forefront of the cybersecurity investing frontier, having assembled a team of leaders from each space.
We are a PE fund that offers cybersecurity expertise to help investors identify and capitalize on myriad opportunities that will also bolster our national security. Contact our team today for more information about investing in cybersecurity companies.