As 2013 came to a close, the highest rates of worldwide “dry powder” was recorded. “Dry powder” refers to the money given to private equity by investors but remains uninvested.
While a considerable amount of capital raised by private equity is necessary for the firms to be successful, an excess of capital can prove to be more toxic than beneficial. The problem with too much dry powder is that after a set amount of time, any unused cash is returned to the investor (typically about five years). Once such a large amount of capital is reimbursed, it could prove difficult for private equity firms to raise additional funds.
It is estimated that the private equity industry currently retains over $1 trillion in dry powder capital as of the end of 2013. Compared to the data before the Recession hit in 2008, this is a massive spike. Only slightly over $1 billion worth of dry powder existed worldwide in 2008.
The most significant reason behind this large jump in dry powder has been due to a lack of worthy deals. The goal of private equity firms is to buy a business that will have a significant return on investment, and currently few businesses are delivering this type of return. Many businesses have been struggling simply to stay afloat during the Recession, and therefore show little potential for considerable growth. Instead, private equity firms have been holding out for less risky prospects, and clearly there has been a drop in the number of successful businesses since the economy’s downturn.
Private equity faces a dilemma at the head of 2014: invest the money in riskier deals in order to utilize the excessive capital, or continue to wait until only the most paramount deals arrive. Either of these choices prove considerable risk. If the investments made do not prove to have a high enough ROI, investors will cut ties with private equity and invest their money elsewhere. However, if the dry powder continues to pile up, once their life spans have ended (and a majority of these loans will end quite soon), then the PE industry will be left with little capital and few future investor prospects.
One fact that gives hope to the private equity industry is that many countries worldwide are expected to see substantial growth over the next year, causing more plausible investments to turn up. Unfortunately, the projections are not as positive for the United Sates, as the recovery from the recession has continued to be slow.
The positive outcome from all of this dry powder lies in the hands of the business owners. Those who are looking to sell now find themselves awash in opportunities, should their business prove to be a worthwhile investment.
If you are a business owner interested in selling your business to a private equity firm, please contact George & Company. We are M&A intermediaries with an exclusive list of potential business buyers. We would be happy to help you find the appropriate buyer for your mid-size company.