Dry Powder is a commonly used term in the world of Private Equity, though it has significance for Venture Capitalists and Angel Investors as well. The general course of events for a PE firm raising a fund is to receive capital commitments from investors, seek out investments and then deploy capital. The money the firms have raised but not yet deployed is referred to as dry powder.
Q. So this is a big idea among PE firms, but also Venture firms and for angel investors. Let’s talk PE today.
A. As you’ve been discussing this week, PE firms take in big capital commitments up front, before they start making investments… you get the money, then go looking for deals to do. Those accumulated but unspent dollars are the firm’s dry powder — dry “gun powder” of course. And right now, there is a huge amount of it out there; the biggest PE firms are sitting on enormous piles of cash, looking for deals. Many folks are concerned that that, along with all the cheap financing currently available, will lead to the firms paying up too much for the same few deals they’re all after.
Q. So, what’s the pressure to spend it? Why can’t they just wait for more certainty in the economic outlook?
A. Pretty simple: they have to give the money back if its not invested in a certain period of time, and/or cancel the capital commitments the investors have to the funds. That means the management company would no longer will get its 2% management fee on that money.
Q. Several of these firms are now public, so what’s the implication for their investors?
A. It’s a bit tricky. To be clear, remember that we’re talking about two sets of investors here: the institutional investors who put risk capital up inside the PE funds, and the public stockholders who have a stake in the management companies that run those funds. These two groups are invested at different levels, and to some extent have different interests.
The current situation is a good example, and may present an awkward conflict between the investors in the underlying funds– who of course don’t want the firm to overpay for a deal– and the public investors, who don’t want the firms to give up their 2% management fees. That basic conflict dynamic has always been present, but now that so many of the big firms are public, there’s a huge complicating factor at work.
Q. So we can expect to see more deals done over the next many months?
A. That would be a good bet, especially as the economic picture seems to be brightening a bit. But don’t forget that the money doesn’t have to be spent here; Europe is coming into favor as a place to find distressed businesses, and assets that are being shed by banks to comply with the new capital requirements.