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As of late, private equity as an asset class has witnessed banner year after banner year. But this heightened popularity can give way to new challenges, including the management of private equity dry powder levels.
Along with increased investor enthusiasm for the asset class and market turbulence thanks to heightened inflation and an erratic Covid recovery, this convergence of events has led to a period of record-high dry powder in private equity. While down from its historically high levels earlier in the year, dry powder rates that climb too high could spell concern for investors and increased pressure for private equity managers.
At venture capital and private equity firms, “dry powder” is cash that’s been committed by investors but has yet to be “called” by investment managers in order to be allocated to a specific investment.
This term dates back to the 1600s, when it referred to stashes of reserved (and still-dry) gunpowder that could be accessed during combat. In the sense of private equity, this reserved gunpowder is compared to investors’ committed capital – it’s there for the taking when private equity managers have a demonstrated reason (rather than battle, an investment with exciting potential to generate returns for the manager and their investors) to access it.
Even though dry powder sits with investors until it’s called by private equity managers and deployed into an investment, as committed capital, dry powder is included as part of a private equity manager’s assets under management.
Dry powder in private equity sits around $1.2 trillion as of Q3 2022, according to Pitchbook.
Its current rate is down slightly from its previous record, $1.8 billion, at the beginning of 2022. This peak followed an impressive surge in private equity investing alongside continued pandemic financial market opacity, giving some managers pause on moving forward with deals and making it harder to deploy the capital as fast as they were raising it.
At private equity dry powder’s peak in January 2022, the largest 25 firms – led by Blackstone, KKR & Co. Inc., and Ardian – held 25% of this uninvested capital. Additionally, roughly half of the capital was relatively “fresh,” according to Pitchbook, with a vintage year of 2019 or later.
As the amount of private equity dry powder has risen overall, the time to collect it has compressed. Preqin data reports that the average fundraising cycle between 2013 and 2018 declined by 10 months. This pace continued to quicken throughout 2021.
Holding steady, meanwhile, is the level of dry powder relative to unrealized assets. This ratio has been holding around 30% for the past 10 years or so, due to shorter investment periods, higher market valuations, and other factors. In other words, firms have been investing capital at a similar rate as they’re raising it.
While dry powder represents possibility, it also signifies pressure. Limited partners expect their investment to be committed in a timely manner, and with trillions of capital on the sidelines, competition to find the next unicorn is tougher than ever.
General partners face the delicate balancing act of meeting their LPs’ timing expectations while still performing ample due diligence for any investments. Also, the risk of holding too much uncommitted capital and not being able to deploy it – in the event of a recession or other market pullback – is always present.
Needless to say, GPs have their work cut out for them in managing their active deals against their dry powder reserves. In addition to the regular fundraising needed to keep dry powder levels steady, deal management and portfolio monitoring must be precise. Along the way, strategic LP communications are essential to address any concerns that funds are lying fallow. One GP’s “dry powder” can quickly become an LP’s “missed opportunity,” especially as LPs already face a precarious balance of their own by overseeing their private equity pacing models and cash management activities.
Automated workflows through private equity software can streamline processes to save time, reduce risk, and ensure committed capital is being managed efficiently. The right tools can also help alleviate stress on valuable employees during a time when talent retention is a challenge.
No matter how mature your PE firm is—whether you’re just getting started or have over $1B in committed capital – Allvue has solutions to help manage the front-to-back-office workings of your firm.
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