Private Equity Fund vs Hedge Fund vs Venture Capital Fund

An investment fund is a special-purpose company which pools the money from many passive investors for collective investment under the management of professional investors. There are several different types of investment funds, differing by (1) the types of assets the fund invests in and the investment strategies used by the fund, (2) the fund structure (a term which generally means the type and amount of fees paid to investment managers, the minimum time that fund investors must leave their money with the fund, and various provisions for what happens in terms of fees and investment lock-ups under various good and bad scenarios), and (3) the laws & regulations which apply to a particular type of fund.

Three common fund types are private equity funds, hedge funds, and venture capital funds. What are the differences between these fund types?

Private equity (PE) funds invest in companies not listed on public stock exchanges. Venture capital (VC) funds also invest in unlisted private companies, but they focus on very young, high-growth companies whereas PE funds focus on older, lower-growth companies. Hedge funds are extremely general and may invest in just about anything.

Those differences in investment strategies among PE funds, VC funds, and hedge funds also motivate differences in fund structure since the risks and time horizons for each type of fund tend to differ substantially. In addition, for funds either based in the U.S. or which have U.S. investors, the laws and regulations differ somewhat for the different types of funds.

Investment Strategy Comparison

Private equity funds invest in the equity and/or debt of unlisted private companies. One common PE strategy is to buy a private business that has a bad management team, replace the management team, renovate the business’s processes to make the business more efficient, and then sell the now more valuable company for a higher price than when it was purchased. Another common PE strategy is to buy stock in small- to medium-sized cash-flowing private businesses which aren’t advertised as for-sale but which have owners that can be talked into selling a percentage of their business.

A venture capital fund invests in start-ups. Sometimes these start-ups have revenue, but sometimes the start-ups are such early-stage companies that they don’t even have revenue yet. Very commonly, even if a start-up getting VC investment does have revenue, it won’t yet be profitable as it will be spending more on R&D and expansion than it is taking in through sales.

A venture capital fund could be considered a type of private equity fund since start-ups are unlisted companies, but the vast majority of investors use the term venture capital with the additional connotation of investing in very young companies with both high risk of failure of each company invested in and a high (e.g. 10-fold or 100-fold) potential return for each company which doesn’t fail.

The term ‘hedge fund’ is used very flexibly for a huge variety of different types of investment funds. Some hedge funds invest exclusively in publicly traded companies, others invest exclusively in physical commodities, others invest exclusively in cryptocurrencies, and yet others invest opportunistically in all of those asset classes and in others as well such as real estate, art, and abstract assets like interest rate swaps.

Unlike PE funds and VC funds, some (but not all) hedge funds use stock shorting, stock and commodity futures, and/or options to profit from market drops instead of just gains.

Fund Structure Comparison

Investment professionals often talk about “fund structure”. This term refers to the conditions, timing, and amount of fees paid to fund managers, whether various expenses incurred by the fund are paid by the fund manager or by the investors in the fund, the minimum investment required to invest in the fund, the minimum time an investor must leave their money in the fund before getting their money back, the conditions under which an investor may be required to leave their money in the fund longer than expected, whether certain investors have priority for getting their money back first, and how specific market and fund conditions may affect both fees paid by investors to managers as well as investors’ abilities to remove their money from the fund.

Fund structure can vary significantly from fund to fund, but on average, the three types of funds under discussion tend to be consistently differentiated along the dimensions of minimum investment time and the open-ended vs closed nature of a fund’s capital contributions,

Minimum Investment Time

Venture capital funds tend to require investors to commit their money for the longest periods of time, frequently 10 years. The reason for this is that VC funds are investing in start-ups which often take a long time to ramp up their business and either become profitable, get acquired, or list their stock on a public stock exchange.

Private equity funds take second place, with investors often required to commit funds for 3-5 years.

Hedge funds usually offer the most liquidity, with typical minimum investment times ranging from one month to one year.

Open vs Closed Fund

An open fund is a fund where investors may contribute money from the fund at multiple different times. A closed fund is a fund where investors must all contribute their money at the same time and then cannot contribute any more money to the fund.

Venture capital funds are almost always closed funds. Private equity funds are also most commonly set up as closed funds. In contrast, hedge funds are most commonly open funds, although there are closed hedge funds as well.

Legal & Regulatory Comparison (in the United States)

In this section, we will focus exclusively on U.S.-based funds, although many countries have similar legal & regulatory regimes governing investment funds.

Of the three types of funds under discussion, venture capital funds are the least regulated, followed by private equity funds which are moderately regulated, and finally hedge funds which have widely varying levels of regulation depending on the type of investments they make but which tend overall to be the most regulated type of private investment fund.

Investment funds have to interact with at least two types of legal & regulatory rules: securities rules and tax rules. In addition, some funds have to deal with commodities rules.

Securities Rules

Private equity funds, venture capital funds, and hedge funds are all examples of private investment funds. Private investment funds are in contrast to public investment funds such as ETFs (exchange-traded funds) and mutual funds. All private funds are exempt from certain securities rules that publicly traded funds must comply with. In addition, the managers of public investment funds must comply with all requirements of the Investment Advisers Act, whereas the managers of private funds may be exempt from some or all of those requirements.

Managers of venture capital funds have the easiest time. Subsection l (lowercase L) of 15 U.S.C. 80b-3 provides a blanket exemption for VC fund managers from essentially all the requirements of the Investment Advisers Act.

Managers of private equity funds and hedge funds have more complex rules that determine whether or not they are exempt from some or all of the requirements of the Investment Advisers Act. Amongst other considerations, PE and hedge fund managers must comply with all rules of the Act if they manage more than a threshold amount of money in their funds.

Commodities Rules

When it comes to commodities rules, both venture capital and private equity funds are generally exempt since they only invest in the stock of businesses.

Hedge funds may or may not be governed by commodities rules, depending on what assets they trade. In addition to hedge funds that trade commodities futures, hedge funds that trade cryptocurrencies must generally comply with commodities rules as most cryptocurrencies have also been deemed to be commodities by the CFTC.

Tax Rules

The taxes for both managers of and investors in venture capital funds are pretty simple, with the income for both almost always treated as long-term capital gains.

The tax situation for private equity funds can be slightly more complex, depending on whether or not the fund holds its stock in private companies for at least 3 years.

The tax situation for hedge funds is the most complicated. Investor income may come in the form of a split between long and short term capital gains or purely as one or another, depending on both a fund’s strategy and on any trading tax elections the fund manager has made with the IRS. Hedge fund managers must also take care to perform careful tax optimization across the various trading tax rules such as wash sale rules and optional trader tax elections.

HMO vs PPO Health Insurance Plan: What’s the Difference?

My great grandparents showing their youthful spirits with funny bobble-heads on their 70th anniversary — My great grandparents on their 70th anniversary

Health insurance plans are often categorized into HMO plans and PPO plans, but what is the difference between these two types of plans?

HMO plans tend to have lower costs and no need to file claims but also strict requirements to use in-network care providers and to get primary care doctor referrals to see specialists, whereas PPO plans tend to have higher costs and a need to file claims but also the ability to use out-of-network providers and to see specialists without referrals.

The differences and similarities are compared in a bit more detail in the table below.

	Health maintenance organization (HMO)	Preferred provider organization (PPO)
Monthly premiums	Typically lower	Typically higher
Copay & coinsurance	Typically lower	Typically higher
Referral requirements	Typically you are required to have a primary care doctor that coordinates all of your healthcare services and provides referrals before you can see any specialist.	Typically you don’t need to have a primary care doctor and are free to have any healthcare service without a referral.
In-network vs Out-of-network Providers	HMOs don’t typically cover any out-of-network care except for true medical emergencies.	PPOs often provide some coverage for out-of-network providers, albeit usually with a higher copay and/or coinsurance and a separate deductible.
Will you need to file claims?	No. Since HMOs operate almost entirely in-network, it’s unlikely you’ll ever need to file a claim since your insurance company pays the provider directly.	Yes. In some cases (especially for out-of-network providers), you’ll need to pay the provider yourself and then file a claim to be reimbursed.
Dental coverage	Available in some plans	Available in some plans
Vision coverage	Available in some plans	Available in some plans

Which plan is right for you?

Ultimately, PPO plans offer more freedom and flexibility but with higher costs in the form of premiums, copay, and coinsurance. If you spend significant time in multiple places or have at least one condition that is likely to require you to visit specialists with an above-average frequency, then the flexibility of a PPO plan may be worth paying for. On the other hand, if you expect to live in the same area for the next year and don’t frequently visit specialist doctors, then an HMO plan might be the better value for your life situation.

You can peruse various options for individual and family healthcare plans on healthcare.gov’s marketplace.

Is It Safe to Share Your Cash App Tag?

My cash tag is shown on Cash App's home screen. — My $Cashtag shown on my Cash App home screen

A $Cashtag (sometimes just called a cash tag or cash app tag) is a unique identifier for an individual or business using Cash App. Is it safe to share your cash tag with strangers though?

Unlike a bank account number, it is 100% safe to share your cash app tag with strangers online. Cash App is designed so that both your cash tag and your cash tag URL (https://cash.app/$yourcashtag) can be shared online without compromising your security.

In fact, the sole purpose of a cash tag is to be shared with others. However, while a stranger will not be able to hack your account or steal your money with only your cash tag, they can use your cash tag to request money from you. For that reason, always verify that you know what a cash app payment request is for before you pay it. There are four common scams that people may use when requesting money from you.

Someone claims to be from cash app customer service, says there is some sort of problem with your account, and asks you to verify your account by sending a small payment. THIS IS FAKE. No one who actually works for Square (the company that owns Cash App) will EVER ask you to send a payment to them to verify anything.
Someone says they will send you money if you first send them a smaller amount of money to verify you are a real person. This is one of the oldest scams in the book. The scammer will take your small payment and never send you the money they promised.
Someone asks you to pay for something in advance (e.g. a puppy from the next litter). Most payments made with Cash App are instantaneous and irreversible which means if you pay a stranger for something you haven’t received yet, they can then take your money and disappear without ever giving you what was promised.
Impersonation scam. In this scam, someone creates a Cash App profile with a picture of either a celebrity or someone in your own life and then requests a payment from you while pretending to be this other person. To avoid being scammed by this, make sure you actually know the other person, verify that their name, cashtag, email, or phone number (whichever is being used to request a payment from you) is correct and doesn’t have some weird typo slipped into it, and verify that the payment is actually for something real.

In general, the way to avoid all of these types of scams is just to ensure that before you make any payment, you verify that you know the person you are paying and that you know what the payment is for. As long as you take those precautions, you can share your cash app tag without anxiety (the cash tag shown in the photo above is my real cash tag).

Is It Safe to Share Your Ethereum Address?

Every Ethereum account has two key pieces of information: a private key (sometimes represented as a 12-word seed phrase) and an address (sometimes also called a public address, ETH address, or wallet address). The private key essentially serves the role of a password to access the account and send cryptocurrency to other accounts. Your private key should NEVER be shared with anyone for any reason whatsoever. But what about your address? Is it safe to share your Ethereum address?

Yes, it is completely safe to share your Ethereum address with anyone. You can even share your Ethereum address with the entire internet by posting it on social media without any risk of Ethereum account hacks.

In fact, Ethereum was cryptographically designed so that unlike a bank account number, an Ethereum address can be shared without any risk to the account. This security is built into the Ethereum blockchain which means it holds true regardless of whether you use Metamask, Trust Wallet, or any other software or hardware wallet.

7 Options to Finance Buying a Small Business

So you want to buy a small business, but you don’t have the money? Don’t worry — there are ways to buy a business that don’t require having all the money upfront, just like there are ways to buy a house or a car without having all the money upfront.

However, financing the purchase of a business isn’t like financing the purchase of a car. Vehicle loans are commoditized to the point where you can pretty much walk into any car dealership, tell them your income, give them permission to pull your credit report, and then walk out with the keys an hour later. Business loans are not like that, and for multiple reasons.

Firstly, every business is unique. That means lenders will generally want to do a lot more situation-specific due diligence before they agree to give you money to buy a particular business.

Secondly (and often non-intuitively for the first-time business purchaser), the word “purchase” has two distinctly different legal meanings when it comes to purchasing a business. The first meaning is called an “asset purchase”, which essentially means you will set up your own LLC or corporation which will then purchase all the assets of the existing business. The second meaning is called an “equity purchase” which means you will directly purchase the equity (i.e. the stock of a corporation or the interest units of an LLC) of the existing business. Depending on whether you buy a business with an “asset purchase” or an “equity purchase” will affect whether some lenders will finance the deal or not.

In this article, I’ll go through seven different options to finance the purchase of a small business: SBA standard 7(a) loans, SBA 7(a) international trade loans, SBA 504 loans, CDFI loans, personal loans, bank loans, and seller financing.

1. SBA Standard 7(a) Loan

An SBA 7(a) loan is a type of loan which is provided by a normal financial institution such as a bank or online SBA lender but which usually has a lower interest rate than other types of business loans since the lender’s risk is mostly covered by a government guarantee. Do note that the guarantee does not directly help you the borrower, only the lender, but it does have the indirect effect of getting you a better interest rate and more likely acceptance of your application.

The SBA 7(a) loan is the most flexible loan of anything the SBA offers. You can get up to $5 million for a business acquisition, and that acquisition is allowed to be either an asset purchase or an equity purchase. You can even use a 7(a) loan to open a new franchisee business as long as the franchisor is listed in the SBA approved franchise directory. You can even get 7(a) financing for a combination of items including buying the business itself as well as inventory (which isn’t typically included in the sale of a small business), and working capital. However, there are a few rules you’ll need to follow in order to use this financing option.

Full Ownership Rule:

The borrower(s) must own 100% of the business after the transaction. The SBA 7(a) program does not lend to any person or group looking to only buy and own a portion of a business. If you already own 50% of a business and want to purchase the other 50%, then the SBA will help you do that, but if you just want to purchase a 50% stake in an existing business, then you’ll have to look outside of SBA options to find financing.

Required Down Payment Rules:

If you are purchasing a business in which you currently have no ownership stake, then you’ll need to put up 10% of the total purchase price & transaction costs. The SBA calls that money an “equity injection”, but it’s pretty much exactly the same as a down payment on a house or car. The seller can cover up to 50% of this equity injection via a loan from the seller to the buyer, but only if that seller debt is fully subordinated to the SBA 7(a) loan.

If you are purchasing a business in which (1) you already have an ownership stake, (2) your ownership stake has not decreased in the past 24 months, (3) you have been actively involved in the business for the past 24 months, and (4) the business balance sheets for the current quarter and most recently completed fiscal year both show a debt-to-worth ratio of no higher than 9:1, then your lender has the ability to reduce or waive the 10% down payment requirement. (Note: this is lender-specific, so if you satisfy each of the four requirements, you may need to shop around for a lender that actually reduces or waives the requirement).

Business Valuation: Internal vs Third-Party Rule

If the amount being financed exceeds $250,000, or if there is a close relationship between the buyer and seller (e.g. they are family members, business partners, or close friends), then the SBA requires a third-party valuation in order to provide 7(a) financing. However, if the transaction amount is less than a quarter million dollars, and the seller and buyer were not closely connected before the transaction, then generally the SBA does not require any third-party valuation of the business before providing financing.

Restrictions

The following types of businesses are generally ineligible from being financed with SBA 7(a) loans:

Businesses involved in lending (e.g. loan packagers, hard money lenders, banks, finance companies, and leasing companies)
Insurance companies (not agents, but the companies actually underwriting the risk)
Investment or trading companies
Investment funds
Any business whose “stock in trade” is money
Pyramid sales plans, regardless of the type of product espoused
Gambling businesses (e.g. casinos, online gambling websites)
Religious organizations
Dealers of rare coins and stamps
Cannabis businesses
Any motel that permits prostitution

You can find additional information about eligibility and how to apply for 7(a) loans on the SBA’s 7(a) Program Info Page.

2. SBA 7(a) International Trade Loan (ITL)

The SBA offers a variation of the 7(a) loan called a 7(a) International Trade Loan (ITL). The terms for this type of loan are more rigid than the terms for a standard 7(a) loan. An ITL cannot be used to buy a business via equity purchase, and it cannot be used to purchase a franchise. However, it can be used to buy certain businesses via asset purchase.

In particular, ITL program loans can be used by an existing business to buy a second business via asset purchase under certain conditions. In order to qualify, the second business’ assets must primarily be facilities and/or equipment that enables the acquiring business to create or expand its international trade.

If you have an existing business and find a second business you’d like to buy that fits that description, then the ITL program can provide up to $5 million in financing with loan maturities up to 25 years if the assets acquired include real estate or up to 10 years if the assets acquired are only equipment, inventory, and/or working capital. You can find additional information about this loan option on the SBA’s ITL fact sheet.

3. SBA 504 Loan

SBA 504 loans cannot be used to buy a business via equity purchase, but they can be used to purchase businesses via asset purchase as long as the assets purchased are some combination of long-term fixed assets, machinery, equipment, or commercial real estate that will be used directly by the acquiring business. Unlike the ITL loan, none of the assets financed can be inventory or working capital, but on the positive side, 504 loans can be used to purchase almost any type of asset-centric business rather than just businesses related to foreign trade as is necessary for ITL financing.

504 loans can be used to finance asset purchase business acquisitions up to $5 million. To qualify for 504 financing, the buyer should (1) be a u.s. business rather than an individual, (2) have a tangible net worth under $15 million, and (3) have an averaged annual net income (after federal income taxes) of less than $5 million for the prior 2 years.

SBA 504 loans are not available directly from the SBA, but only through Certified Development Companies (CDCs). You can use the SBA’s official search engine to find CDCs near you, and you can find additional loan program details from the SBA 504 Loan Info Webpage.

4. CDFI Loan (only some CDFIs will do this)

Community Development Financial Institutions (CDFIs) are some of the least well-known resources available to small businesses. There are over 1200 CDFIs across all 50 states, DC, and even Guam and Puerto Rico, and these organizations exist to provide loans, grants, and financial guidance to start-ups, small businesses, co-ops, and real estate development projects.

CDFIs vary significantly from one to another. Most lend only to businesses or individuals in particular geographical regions. Some focus on lending to women, others to minorities, others to individuals with low incomes, and others will lend to any new business within their geographic region. Some (but not all) CDFIs provide lending options that can be used by individuals. All of these differences unfortunately mean that finding a CDFI that will work with you can be a bit of a search process, but the result can be very worthwhile as some CDFIs offer loans to people with less credit and experience than other lenders require, and sometimes (but not always) the interest rates and loan terms can be better than mainstream loan options. This web tool has a very useful search engine and map to locate CDFIs near you.

Some (but not all) CDFIs provide lending options that can be used to buy a small business. I haven’t seen any CDFIs that will finance equity purchases, but many provide loans to businesses to purchase assets, and this is where the opportunity is. If you have an existing business (or can quickly form one), then your goal will be to find a CDFI near you that provides loans for acquiring assets and then using that loan to buy another business via asset purchase.

5. Personal Loan

If you are interested in buying a business for under $100k and if you personally have good credit, a steady income, and not excessive debt, then a personal loan can be an excellent financing option. With an online lender, personal loans can often be approved within a week, and the money can be in your bank account within two weeks.

There are many online lenders which should be shopped for the best rates for personal loans. A few options include Upstart (up to $50,000), Lending Club (up to $40,000), and SoFi (up to $100,000).

6. Bank Loan

Banks don’t just offer home loans — they also offer business loans. If your credit is great and you have a steady income and low debt currently, then a bank loan can be a good way to obtain a loan to purchase a business. Talk to a few banks near you to see what they can do for you. Be aware however that this is possibly the most difficult financing option on this list as banks really only want to make business acquisition loans to people who have excellent credit, income, and debt levels. Most people would be better off going with either a personal loan or an SBA loan to finance a small business acquisition.

7. Seller Financing (take EXTREME CAUTION)

Seller financing is when the current owner of a business agrees to sell you their business and to loan you part or all of the purchase price. It is sometimes the holy grail and sometimes the trojan horse of business acquisition financing.

On the one hand, seller financing can often come with competitive interest rates, little to no money down, and less stringent credit requirements than other types of business purchase loans. This means seller financing can be an incredible tool for smart business leverage. On the other hand, sometimes the owner of a crappy business will offer seller financing to incentivize suckers to buy their business, take over liability payments, and provide them with a hassle-free income stream. If the buyer is eventually unable to make payments due to the poor quality of the business, the seller will just repossess the business and sell it again to a new sucker, all while keeping the payments the first buyer made up until they defaulted. Don’t be that sucker. How?

How can you distinguish the holy grails from the trojan horses amongst all the seller-financeable businesses for sale?

The first and most critical step is to consider the seller’s motivation, both for selling and for offering seller financing. Do as much due diligence as possible into the seller’s motivations.

If the owner says they are selling because they are relocating, ask enough questions to verify whether or not they actually are. If they really are relocating, try to figure out whether they are actually selling because they want to relocate or whether they are both selling and relocating because they couldn’t make their business work.

If the owner says they are selling to pursue other opportunities, then realize that the seller perceives the business they are selling as an opportunity not worth pursuing. If that’s the case for the seller, think very carefully about whether it’s an opportunity worth pursuing for you. In general, the answer should be no in this situation unless the business has a specific sort of problem that the current owner is not well suited to solve but which you are. For example, maybe the business works great internally but has terrible marketing. If you are a marketing wizard, then maybe this would be a good opportunity for you.

If the owner says they are selling to retire, then realize that the business is not currently in a state in which management can be outsourced. If the owner must sell a business to retire, then the owner is also a critical employee who hasn’t done a good job recruiting other people who can take over, otherwise they’d likely just keep the business as a passive revenue stream. The fact that they must sell means you’d be buying a job as much as you’d be buying a business.

Another important factor that can help you separate the holy grails from the trojan horses is where you sourced this acquisition opportunity. You should be equipped with the knowledge that most business brokers feed sellers unrealistic expectations regarding the fundamental value of their businesses, which means if you found a business for sale through a broker, it more than likely is overpriced and will be difficult to buy at a price that is actually advantageous to you. Furthermore, if a business is listed for sale with a broker AND is advertised as having seller financing available without you needing to specifically ask about it, then the seller is probably desperate to sell, which means the business most likely has some serious issues.

Oddly enough, one of the best ways to source good businesses to buy is to target businesses that are not actually listed for sale but which are having some problems you have the expertise to solve. There are three challenges you must overcome to make this work.

You must find businesses that have some sort of problems but which aren’t listed for sale. This can difficult since the problems are often not apparent from the outside.
You must convince the business owner to sell the business.
You must convince the business owner to provide seller financing.

A great strategy to overcome all of these challenges at once is to have a B2B consulting business. Your consulting business clients will be the start of your business acquisition funnel. Clients will come to you with exactly the type of business problems you have consulting expertise with, which solves the first challenge. You can then negotiate terms that include equity compensation as payment to help them solve one of their problems. For example, you may ask for a 20% stake in their company contingent upon you helping them solve some serious problem in their business. If the problem is significant, the owner will likely accept this offer which gets your foot in the door for the second challenge.

After solving that first problem, if the business has other problems, you can ask the owner if they would be willing to sell you the rest of their company under a seller financing agreement. By solving one of their problems already, you have demonstrated your competence which means the owner now has reason to believe that you would be a good custodian of their business, that you could solve the remaining problems, and that you wouldn’t crash the business into the ground before they had received their full payout. Also, as someone who already owns equity in the business, you already have skin in the game which makes you more trustworthy as a business partner.

Is it Safe to Share Your Venmo on Social Media?

You need two pieces of information to access a Venmo account. The first piece of information is a username, phone number, or email address (any of them can be used). The second piece of information is a password. So is sharing your Venmo username on social media safe?

As long as you have a long, strong password that you don’t share with anyone, then sharing your Venmo username online is perfectly safe and poses no hacking risk to your Venmo account. In fact, you have to share your Venmo username or a linked phone number or email address in order for anyone to ever send you a payment.

HOWEVER, the same information that is needed by someone to send you a payment can also be used by someone to request a payment, so make sure you know that any payment request you receive is from someone you actually know before paying it.

Axiom Alpha

Recent Posts