What Will Private Equity Do With ‘Dry Powder’?

What’s next for Private Equity? How should GPs think about fundraising, investments, exits and more? What role will technology play – how can GPs be sure they’re not investing in the next industry to be disrupted? And what about LPs – what questions should they be asking as they look for new and better places to seek returns?

What will private equity do with dry powder?These are some of the questions we previously asked Tim O’Connor, Partner in the Private Equity Group at Bain & Company about the industry and the firm’s Global Private Equity Report 2018.

In that conversation, we asked also about the “dry powder” — some $1.7 trillion of uncommitted funds sitting ready to invest. Said O’Connor: “I think there is a huge capital overhang in terms of money that’s been raised by funds that’s still looking for a home to put to work. You’ve got a continued good economy. You’ve got a nice set of financing sources ready and available to lend money to companies. And so that’s meant purchase prices are high, and so that means there’s a steady stream of assets coming for sale because they can earn good returns on those assets.”

We then asked: How does that tension of that pressure play out? Money looking for homes, good economic business environment, homes then looking for money because of the factors that you just described, but then prices being high. How are you sensing the evaluation around valuations?

Said O’Connor: I think the supply demand and balance means that prices are at an all-time high. End of last year the average company was selling for 11.2 times and that was the market clearing price. We work with 78% of equity capital globally and have co-invested alongside our best clients and so have understood market clearing prices, and the average clearing market IRR has gone from the mid 20s to about 18%. So returns have been competed down. I think a lot of people look at private equity as an asset class, but I think it needs to be looked at in the lens of just broader mergers and acquisitions.”

Private Equity Dry Powder

Management consulting firm McKinsey also looked into the “dry powder” reality. They asked Partner Matt Portner, “Is dry powder anything to worry about?”

Said Portner: “There’s a lot of hand-wringing in the industry about dry powder, and there has been for a few years now. What we’ve said previously is that if you look at dry powder more as inventory on hand than as an absolute number, it’s less of a concern, because deal activity has historically kept up with fundraising. That means that if you look at it over time, it’s been fairly consistent how much dry powder the industry has on hand.”

“What’s changed in the past couple years is deal activity has started to fall. And when deal activity starts to fall and dry powder continues to accumulate, that can become a problem overall. Now, add to that that limited partners are putting pressure on their external managers to deploy that capital, and you get an increase in multiples. You get external managers doing deals that they might not otherwise do, at multiples they might not otherwise pay—and that can become a problem.”

McKinsey also asked Senior Partner Aly Jeddy, “Is dry powder a useful industry metric?”

Said Jeddy: “The most disciplined investors have always resisted the idea of focusing on dry powder. The conventional logic has been that, when there is a lot of dry powder, two things can happen. One, fundraising might not occur as robustly, because people might say, ‘Well, what have you done with the money I already gave you?’ Obviously, that’s not happening. We continue to see very robust fundraising.

Now a new report is asking new questions about the dry powder — and about whether “we are in a private equity bubble.” The Financial News piece notes some questions, including:

  • Too much capital chasing too few deals
  • Prices at record highs
  • Secondaries soaring
  • Deal debt rising
  • Talent wars

Clearly, much opportunity and much to watch in the private equity.

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