Spin Doctor asked about the difference between merchant banking (MB) and venture capital (VC). It’s probably helpful to explain private equity (PE) as well since they’re all similar in certain ways but different in others.
PE and VC are similar in that they involve pooled funds in which the manager ("general partner") is largely managing other peoples’ money (OPM) (with a sliver of their own capital, typically). In the case of VC the money is typically invested in the equity of private, early-stage companies. Generally not a lot of debt is used because these investments ("portfolio companies") are risky enough as they are. PE, on the other hand, typically involves investing in the equity of private, mature (as opposed to early-stage) companies. Most PE funds are really leveraged buyout (LBO) funds in which a lot of debt is used in the portfolio company’s capital structure (to, theoretically, increase the equity holders’ returns if things go as planned). So, the two big differences between VC and PE are (1) the stage in the corporate life cycle of the portfolio company (VC – early; PE- mature/late), and (2) the amount of leverage/debt applied to the portfolio company (VC – little/none; PE – a lot).
Then there are merchant banks (MBs). MBs are most similar to PE funds but with a several differences. As mentioned above, PE funds are funded largely with OPM – outside capital – while MBs are typically funded by the owners’/managers’ own capital. PE funds typically have a life span of 8-10 years. MBs are perpetual in nature. PE funds typically layer on a lot of debt to their portfolio companies; MBs typically use a lot less debt. Most PE funds don’t offer advisory services to their portfolio companies (although many do), while MBs typically do. PE companies are typically focused on internal rate of return (which sometimes leads to a short-term focus) while MBs focus on a multiple-of-capital (a longer term approach). Some MBs also offer debt financing, trade credit, and other financial products that PE funds do not. There are some other subtle differences but those are the big ones.