a lit fuse: excess dry powder and high valuations turn up the heat on PE firms.

Private equity firms today have an unprecedented stronghold of "dry powder" — cash reserves used to cover future obligations, purchase assets or make acquisitions. In fact, they've got about $1 trillion of uncommitted capital on tap right now, just waiting to be deployed. That's a major milestone for PE firms, whose share of total available capital today is at its highest level since 2012. 

Meanwhile, PE-backed exits so far this year are down across the board and they’re also proving to be less profitable. For example, PE investors obtained only 41 profitable exits during the second quarter of 2019, versus 77 such exits during the same period in 2018. So it’s unlikely that total PE-backed exits in 2019 will match last year’s impressive figures. In other words, all of that dry powder is proving to be something of a paradox. 

From a high level, the situation can be summarized as follows:

  • More capital than ever is being allocated to private equity firms without a corresponding increase in the number of quality deals on the market.
  • Increased capital has also increased the competition. As a result, many PE firms are being forced to bid for and (if the bid is successful) buy portfolio companies at entry valuations and EBITDA multiples that make additional value-creation more challenging. 

Globally, too, the picture is steadily changing, as recent forecasts indicate. 

  • While North America still accounts for the majority of dry powder, the size of that majority share is declining. Today, it's estimated to be only slightly more than 50 percent.
  • More and more available capital is being earmarked for Asia. The region's share of global dry powder has more than doubled since 2006.
  • Dry powder in Europe appears to be holding steady, representing around one-fourth of total capital available worldwide.

The types of investments favored by PE firms are also in flux. Most notably, while the number of exits increased in 2018 across virtually every industry, the sectors driving the most significant increases in exit values were all tech-centered: consumer tech, IT, IT-enabled services and similar. Other sectors, like retail, are facing headwinds as well. 

challenges and opportunities cascade for PE leadership

This paradox — excess dry powder together with record valuations at entry — is creating a host of new challenges for PE firms. Above all, the question is: How confident are you that your target companies will continue to grow and generate attractive earnings multiples at the time of exit, given that valuations at entry are currently so high? And what’s your value-creation plan for making that happen?

If you don’t have good answers to these questions, one approach is to slow your capital deployment and wait out the frothy market. In fact, that’s something many PE firms appear to be doing already, as reflected in the reduced number of acquisitions and exits. Where year-end 2018 logged 1,202 exits totaling $427 billion — a new record high — the current forecast shows PE-backed exits in 2019 failing to keep pace after a sluggish first half of the year, with only 371 transactions totaling $110 billion. 

Clearly, however, operating in a "holding pattern" doesn’t align with the demands of investors. LPs want their GPs to deploy their capital. So it seems a better, longer-term plan for PE firms is very much the order of the day.

human capital underpins value-creation 

The fact that PE firms collectively report around $1 trillion in dry powder right now is a significant milestone for the industry. But to deploy that capital with confidence, GPs need to build robust value-creation plans — and that means having the right people to execute them at portfolio companies. 

Of course, value-creation plans are rarely liner. Business are constantly changing, adapting and transforming in order to grow. Bringing in experts who can improve the operational efficiencies of target companies, and help plan for the exit and beyond, will be one of the keys to success. Viewed in that light, human capital has probably never been more important to value-creation than it is today — and that’s one way partnering with Tatum can pay dividends on your company’s balance sheet. 

Recently named one of America's Best Executive Recruiting Firms by Forbes, we work consultatively with PE firms to find the right human capital to execute value-creation plan. And with demand for C-suite leaders like CFOs and finance VPs/directors forecast to grow more than 18 percent in the next 10 years, that can make a world of difference. 

For now, in any case, one thing is clear: PE firms will continue to grow and find investors willing to invest capital in their funds. And while LPs are making a long-term bet with their commitments, GPs must take action today to create and implement value creation plans for existing and prospective companies. PE leaders will do well to have cogent answers ready, strategies in place and the talent they need to secure profitable exits when partners and investors come clamoring with the more immediate question: Why isn't my money being put to work today?

Connect with Tatum today to learn how we can help — and why so many leading PE firms rely on us to solve their most critical business challenges.

about the author
Jeff Harris

Managing Director, Tatum

Jeff Harris is a Managing Director with Tatum Executive Search and has more than 20 years of experience in executive search, management consulting and sales. He is a trusted advisor to his clients helping them identify senior level executives at critical inflection points. He has worked extensively to recruit senior executive leaders in C-level management positions across multiple industries for some of the fastest growing companies in the world. His diverse career includes work with private equity and venture capital firms as well as consumer/retail, industrial, healthcare and technology.