Venture capital (VC) and private equity (PE) are two very different asset classes. Although both asset classes invest in private companies, PE invests in more mature companies with a lengthy performance record while VC invests in younger companies with a more limited, if any, operating history.
In PE, since the target companies have an established business model, lengthy operating history, and extensive financials, it’s possible to extrapolate from these to the company’s future. Although the actual outcome will be different than any individual’s projection, the range of projections is likely to differ by a small factor. The range of individual projections is unlikely to be more than an order of magnitude apart.
The target companies in VC have limited operating history and limited financials. That is if they have a business model at all. Sometimes they’re in search of a business model. As a result, the investment decision can rarely be based simply on extrapolating a prior performance record. It requires a qualitative assessment and insight rather than number crunching.
This doesn’t mean that valuation doesn’t matter for VC. It does. But the range of individual projections for a specific company are very likely to be an order of magnitude, if not more, apart. As a result, in VC you can afford to be off by a factor of 2 or 3 on the exact size of the outcome as long as you are correct in your assessment of the order of magnitude of the outcome. In PE, being off by a similar factor of 2 or 3 would be lethal.
As such, the profiles of the types of people who succeed in VC and PE are quite different. In PE, you make money by being quantitatively right. The qualitative direction is pretty clear. In VC, the accuracy of your qualitative assessment is the key driver of returns. You need to be in the right ball park quantitatively, but you make money by being right qualitatively.
Knowing whether you prefer and are good at making qualitative or quantitative assessments is key to knowing whether you’re likely to make a better VC or PE investor.
Also published on Medium.