Venture capital and investment banking are two of the most important driving forces behind business growth and economic prosperity. They help startups, small businesses, and large businesses source funding. Both venture capitalists and investment bankers must assess promising investment opportunities, weigh risks, and decide where to invest funds for business growth.
Although they are both integral parts of a business's growth, they differ in many ways. In this guide, we will compare the roles of venture capitalists and investment bankers and the roles they play in a business's maturity.
Let's first discuss each individually to better understand the differences between venture capital and investment banking.
What Is Venture Capital?
Venture capital (VC) is a type of private equity funding. In this part of the finance industry, venture capital funds will make money or capital investment into a company. The investment may also be technical or managerial.
The process of venture capital funding is a complex one that involves many steps. First, a venture capitalist will conduct a thorough analysis of the company they are considering investing in. This analysis will take into account factors such as the company's management team, the market for their product or service, and the competitive landscape. Once the venture capitalist has determined that the company is a good investment opportunity, they will negotiate the terms of the investment with the company's management team. This may include the amount of money that will be invested, the percentage of ownership that the venture capitalist will receive, and the timeline for the investment.
Typically, the core concern of venture capital is to seek out potentially profitable startup companies and small businesses that may undergo long-term growth. This type of investment is mainly focused on small companies that show promising growth potential rather than large enterprises. However, venture capital firms also invest in larger companies that are looking to expand or enter new markets.
Although investing in smaller companies and new startups can be risky, the venture capitalist has the benefit of being able to enjoy above-average returns. This is because the venture capitalist is able to invest in companies at an early stage, when the potential for growth is high. As the company grows and becomes more successful, the value of the investment increases, resulting in a higher return for the venture capitalist.
Venture capital funding is one of the most popular forms of funding for new companies, startups, and ventures who cannot raise money through bank loans. Banks tend to avoid giving loans to startups and small businesses that don’t appear to have any credit of their own. Businesses that are rejected startup loans then seek out venture capital companies.
In this way, venture capital is part of the core economic engine that generates job growth, spurs innovation and invention, and helps cultivate new business models. Venture capital firms play a crucial role in the growth and development of the economy, by providing funding to innovative and promising companies that may not otherwise have access to the capital they need to succeed, making venture capital an essential component of any startup business plan.
Largest Venture Capital Companies Worldwide
Here are a few more of the largest venture capital firms in the world:
- Andreessen Horowitz: Andreessen Horowitz is a California-based venture capital firm that was founded in 2009. They invest in companies across various stages, from seed to growth, and across multiple industries, including software, fintech, and healthcare. Some of their most notable investments include Airbnb, Lyft, and Slack. Visit their website
- Kleiner Perkins: Kleiner Perkins is a venture capital firm based in Menlo Park, California, that has been investing in technology startups since 1972. They have invested in companies such as Amazon, Google, and Twitter. Kleiner Perkins has also been involved in the funding of many successful startups like Slack, Ring and Discord. Visit their website
- Bessemer Venture Partners: Bessemer Venture Partners is a global venture capital firm that was founded in 1911. They invest in companies across multiple industries, including cloud computing, cybersecurity, and healthcare. Some of their most notable investments include Pinterest, Twilio, and Shopify. Visit their website
- Index Ventures: Index Ventures is a venture capital firm that was founded in Switzerland in 1996. They invest in companies across multiple industries, including fintech, healthcare, and cybersecurity. Some of their most notable investments include Dropbox, Squarespace, and Slack. Visit their website
- GV (formerly Google Ventures): GV is the venture capital arm of Alphabet Inc., Google's parent company. They invest in early-stage companies in various industries, including healthcare, artificial intelligence, and cybersecurity. Some of their most notable investments include Uber, Nest, and Slack. Visit their website
These firms have a strong reputation for investing in successful startups and have played a significant role in shaping the technology industry. They continue to be major players in the venture capital world and are always on the lookout for promising new opportunities.
What Is Investment Banking?
Investment banking is a type of banking that provides various services to companies, governments, and other organizations. Investment banks help these entities raise capital by underwriting new securities. Underwriting means that investment banks buy the securities from the issuing entity and then sell them to investors. By doing so, investment banks assume the risk of the securities' sale and guarantee the issuing entity a certain level of funds. This guarantees the issuing entity a certain level of funds even if the securities do not sell as expected.
Apart from underwriting securities, investment banks offer several other services to their clients. These services include:
- Help in project financing: Investment banks provide advice on how to finance a particular project, including financial modelling services. They analyze the project's feasibility and recommend the best way to finance it. They also provide guidance on how to attract investors and structure the financing. This helps the issuing entity obtain the funds they need for their project.
- Facilitate brokerages: Investment banks act as intermediaries between buyers and sellers of securities. They facilitate the buying and selling of securities by connecting buyers and sellers. They also provide market analysis and recommendations to their clients on when to buy or sell securities.
- Provide investment advice: Investment banks provide investment advice to their clients. They analyze the market and recommend specific investments based on the client's needs. They also provide market research and analysis to their clients to help them make informed investment decisions.
- Help in initial public offerings (IPOs) when a company goes public: Investment banks help companies go public by advising them on the IPO process. They assist in preparing the company for the IPO, including valuation, pricing, and marketing the shares to investors. They also underwrite the shares and guarantee a certain level of funding to the company.
- Aid in mergers and acquisitions (M&As): Investment banks provide advice on mergers and acquisitions. They assist in finding potential merger or acquisition targets, valuing the targets, and negotiating the terms of the deal. They also provide financing options for the deal and help structure the financing.
Investment banks provide these services to their clients for a fee. The fee is usually a percentage of the funds raised or the value of the transaction. Investment banking is a critical aspect of the financial industry and plays an essential role in helping companies and organizations raise capital.
Largest Investment Banking Companies Worldwide
Here are a few of the largest investment banking firms in the world:
- Goldman Sachs: Goldman Sachs is a global investment banking and securities firm that was founded in 1869. They offer a range of services, including investment banking, securities, asset management, and wealth management. Some of their most notable clients include governments, corporations, and high-net-worth individuals. Visit their website
- JPMorgan Chase & Co.: JPMorgan Chase & Co. is a global investment bank and financial services company that was founded in 1799. They offer a range of services, including investment banking, commercial banking, securities, and asset management. Some of their most notable clients include corporations, governments, and institutional investors. Visit their website
- Morgan Stanley: Morgan Stanley is a global investment bank and financial services company that was founded in 1935. They offer a range of services, including investment banking, wealth management, and asset management. Some of their most notable clients include corporations, governments, and high-net-worth individuals. Visit their website
- Citigroup: Citigroup is a global investment bank and financial services company that was founded in 1812. They offer a range of services, including investment banking, commercial banking, securities, and asset management. Some of their most notable clients include corporations, governments, and institutional investors. Visit their website
- Bank of America Merrill Lynch: Bank of America Merrill Lynch is a global investment bank and financial services company that was founded in 1914. They offer a range of services, including investment banking, commercial banking, securities, and asset management. Some of their most notable clients include corporations, governments, and institutional investors. Visit their website
Venture Capital vs. Investment Banking: Key Differences
What distinguishes an investment banker from a venture capitalist? There are several differences between these roles. A straightforward comparison of venture capital and investment banking should provide an idea of how they differ.
Here are some of the key differences between the two.
Venture capital and investment banking services differ primarily in the very core of their business models and how they function.
- Venture Capital: Venture capital firms focus on investing in startup companies and small businesses, providing monetary funds to help these businesses grow and succeed. They receive equity in the company and a share of the profits in exchange for their investment. They may also offer advice and guidance on company matters to help shape the direction of the company.
- Investment Banking: Investment bankers provide a wider range of services to a greater number of clients. They offer financial advice and support to companies, including assistance with mergers and acquisitions, financial investment advice, and issuing securities. Their broader focus allows them to help a large number of companies achieve their financial goals and grow their businesses.
Both venture capital and investment banking services are important fundraising services that provide companies with the necessary capital to grow and succeed, despite their different approaches.
The main difference between venture capitalists and investment bankers is in the pattern of investment they follow.
Venture capitalists tend to invest directly in a firm in the form of equity, whereas investment bankers serve as intermediaries in mergers and acquisitions and play other supporting roles. They both generate profit in different ways.
- Venture Capital: Typically, venture capitalists look for returns on their investment in a startup or small business, which is their net profit. In most cases, venture capital companies will also sell their shares once the startup has established itself or has achieved sufficient growth. Once the share sells for more than the amount they invested in the company, the venture capital can generate a high rate of return on their investment.
- Investment Banking: Investment banks, on the other hand, charge fees for their particular services and earn profit in this way. They may charge different fees depending on the exact service they offer. Moreover, since they offer a more diverse range of services than venture capitalists, they also have multiple income streams. The total fees of the investment bank may range between 3%-10% of the total capital raised or the value of the mergers and acquisition deal.
Types of Clients They Target
The next major difference is in the type of clients they target for their services.
- Venture Capital: Venture capitalists seek out companies with a large potential for long-term profit by analyzing factors such as the strength of the management team, the market for their product or service, and the competitive landscape. This is how venture capitalists make investment choices. They mainly target start-ups and small businesses, even though the investment may carry significant risk.
- Investment Banking: Investment bankers target firms with established growth and a proven track record of exponential growth. They may target established organizations or, in some cases, even government entities. Moreover, investment bankers look for companies that have achieved maturity, unlike venture capitalists who invest in companies with the hope that they will achieve maturity and offer high returns.
Level of Risk
The level of risk shared by venture capitalists and investment bankers differs greatly.
- Venture Capital: Venture capitalists face a much higher level of risk than investment bankers. This is because they tend to invest in companies that have yet to gain maturity, with no means to guarantee high returns. While estimations and assumptions are put into each investment decision, a high degree of risk will always remain.
- Investment Banking: Investment bankers don’t face the same level of risk as venture capitalists. Most of the companies they deal with are established and have already gained maturity. Moreover, since investment bankers have more diverse sources of income, they also have reduced risk in earning a profit. However, this profit may not be the same as that of venture capitalists.
Is Venture Capital Better Than Investment Banking?
There is a current debate over which of the two is better to choose between investment banking and venture capital. While it is an interesting topic, it is also important to note that both services have their pros and cons.
Venture capital is known for having a lot of risks. It is a high-risk investment that may lead to massive returns or losses. On the other hand, venture capital has the potential for massive returns on investments. Most venture capitals are even known for gaining up to 10x as much in returns, which can be a great advantage for investors.
Investment banking, on the other hand, is known for being a safer choice. It may not offer the same massive returns as venture capital, but it is a stable and secure investment. Investment banking is an excellent choice for those looking for a secure investment with a lower risk factor.
When it comes to choosing between investment banking and venture capital, you should weigh the potential risks and profits involved. Both have their pros and cons, and it ultimately comes down to what you are looking for in an investment.
Overall, while venture capital may be riskier, it can also offer higher returns. Investment banking, on the other hand, is a safer choice but may not offer the same massive returns as venture capital. It is essential to understand the risks and benefits of both before deciding which one is right for you.
When to Consider Venture Capital?
Venture capital is best suited for new businesses that do not have access to stock markets or enough income in their initial phase to take out loans. Such businesses may also find it difficult to secure loans from traditional banking services.
It is important to remember that venture capital companies are looking for companies with large revenue potential. If you believe that your company can deliver this by the time the investment period comes to a close, it is worth pursuing. Most VCs seek a minimum gross internal rate of return (IRR) of 30% on their investments.
Also, note that you can opt for venture capital after investment banking.
When to Consider Investment Banking?
Investment banking is a comprehensive financial service that offers a range of solutions to businesses, governments, and other organizations. One of the primary reasons to consider investment banking is when a financial advisor is needed to provide strategic advice on a variety of financial matters. Investment bankers are experts in analyzing the financial landscape and providing recommendations that can help businesses make informed decisions.
Another aspect that makes investment banking an attractive option is its ability to facilitate mergers and acquisitions. Investment bankers can help negotiate a fair price, structure financing, and provide advice on the integration of operations. By acting as intermediaries between buyers and sellers, investment bankers can ensure that both parties' interests are protected while achieving the best possible outcome.
Additionally, investment banking can help businesses protect themselves from takeovers by other companies. Investment bankers can assist in developing strategies that will make it difficult for other companies to acquire the business. They can also provide guidance on restructuring the company to make it less attractive to potential buyers.
Venture capital and investment banking are both crucial to driving growth in any industry and play important roles in the final system. By comparing venture capital vs investment banking, you can gain a better understanding of their differences. If you're a startup looking to raise funds, it's important to understand how to attract funding from venture capitalists, as they are a popular form of funding for new companies, startups, and ventures that cannot raise money through bank loans.
Although both assist businesses with their financial proceedings, their services differ significantly. Venture capital firms invest in equity for startups, while investment banking firms manage mergers and acquisitions, act as financial intermediaries, and provide financial advice.
Venture capital (VC) invests in small companies that show promising growth potential, while investment banking provides a range of financial services to established companies
VC firms focus on investing in startups and small businesses with a large potential for long-term profit, while investment bankers target firms with a proven track record of exponential growth
The primary function of VC firms is to invest in equity, while investment banking firms manage mergers and acquisitions, act as financial intermediaries, and provide financial advice
Venture capital is riskier but can offer higher returns, while investment banking is a safer choice but may not offer the same massive returns as venture capital
Venture capital is best suited for new businesses that do not have access to stock markets or enough income in their initial phase to take out loans