Choking on Dry Powder: Private Equity’s Frantic Scramble to Deploy Capital

It’s nice to have dry powder when so many buyout firms are struggling to raise funds, but there’s a danger that comes with hoarding one’s capital.

Private equity firms have a five-year investment period. If M&A doesn’t pick up, and fast, some ‘05 and ‘06 vintage funds may have to give their money back or ask for fund extensions. A smaller fund means lower fees and, for those that associate success with size, a blow to those delicate private equity egos.

Earlier this week Phil Canfield of GTCR and I discussed the coming expiration-driven M&A flood. We agreed that we don’t expect many private equity firms to willingly part with their capital, and a blogger called Anal_yst wrote a more extensive blog post arguing the point. What that all means is there’s about to be a mad rush of buyout pros desperate to “put money to work,” however they can (but I’m not talking about your firm, dear reader, you would never do that, just everyone else).

So let’s just take a rough look at the numbers fundraising and deal numbers of from the last four years. Here’s the breakdown of US fundraising and deal totals:

$158 billion raised in 2005
$123 billion in deal value

$204 billion raised in 2006
$439 billion in deal volume

$292 billion raised in 2007
$414 billion in deal value

$261 billion raised in 2008
$74 billion in deal value

$64 billion raised in 2009
$39 billion in deal value

In each year except 2006, funds raised outpaces deal values. That margin increases when you consider that the deal value we’ve listed includes debt, and the amount of actual equity deployed is a fraction of that total. In the credit-crunched ‘08 and ’09, fundraising blew deal volume out of the water. At this point, some firms may be wondering if they bit off more than they could chew. Luckily those ‘08 and ‘09 vintage funds have a few more years to blow their cash. But ’05 and ’06 vintage funds that sat on their cash when M&A was easy are cutting it close.

It reminds me of the SPAC story line from 2008. You may remember the rash of SPACs that were raised in late 2007. The “Return of SPACs” was heralded as the major investment banks began underwriting them in 2008, helping bring the shell IPO out of the back-alley and onto Wall Street. Then 18 months passed, and many of them hit their deadlines without finding deals, and the asset class retreated to the sidelines once again. I doubt private equity will go the way of the SPAC, but it’s a similar situation, on a much larger scale.