Across the financial industry, the term “dry powder” gets thrown around a lot. Admittedly, this creates some murkiness. What started as a slang term with historic ties is now a well-known word with relevance across the global capital markets; however, there are varied meanings depending on the context. In this article, we’ll specifically discuss dry powder from a private equity and venture capital perspective. Continue reading for a closer look at what dry powder is, as well as its history, how investors use it when available—and how PitchBook’s data can help you get ahead.
What is dry powder in finance?
For venture capital (VC) and private equity (PE) firms, dry powder refers to the amount of committed, but unallocated capital a firm has on hand. In other words, it’s an unspent cash reserve that’s waiting to be invested. The term “dry powder” dates back to the 1600s when warring armies used gunpowder to fire guns and cannons. Not only did soldiers have to store stashes of the powder for use at any given time, but they had to keep it dry in order for it to be effective in combat.
Dry powder in private equity (PE)
In the years since 2021, PE firms have become more cautious in how they deploy their capital. As such, our analysts have explained there is currently a disconnect between buyers and sellers. Many PE firms would prefer to hold onto existing assets, rather than sell them at an undervalued price—leading to an accumulation of dry powder.
As noted in PitchBook’s 2023 Annual US PE Breakdown, dry powder has in PE has actually increased 9.3% since 2021. As of March 31, 2023, it was up to a record high of $955.7 billion.
Dry powder in venture capital (VC)
The story is similar in the venture capital space. While VC dry powder is at a record high of $302.8 billion, 57.5% of the total sits in funds with commitments of $500 million or more, and 68.6% resides in 2021 and 2022 vintage funds.
3 ways PE and VC investors use dry powder
Dry powder can be used in many ways. For example, a venture capital firm could deploy some of its cash reserve to invest in a promising healthtech startup. A private equity firm could leverage its dry powder stockpile to buy out a distressed company and a corporation may reserve its capital in preparation for an add-on acquisition.
However, deciding how and when to spend this cash reserve is not always clear cut. In a stalled exit environment with liquidity constraints, it can be difficult for firms to maintain and efficiently use their capital. And even if they have more cash on hand than ever, many firms still grapple with how to best deploy it.
With this in mind, here are three potential uses for dry powder:
1. Fueling growth for portfolio companies
Investment firms often go head-to-head while bidding, and more dry powder could mean the difference between closing the deal or not—especially in a competitive market. When it comes to portfolio companies, investors may use their cash stockpile to support and fuel growth in the areas where they need to. At the same time, reserving too high a level of dry powder could stifle growth or limit the value of investments.
2. Addressing near-term liquidity issues
Dry powder can also be thought of as a safety net in case of an economic downturn. In the world of alternative assets, where volatility and risk are a given, it can be extremely beneficial to have cash on hand. Firms or businesses with more dry powder are better positioned than their competitors, especially during prolonged periods of turbulence. Often, when a company needs short-term liquidity, it will turn to dry powder first. When a company does not have enough liquid assets or wants to find alternative solutions for short-term liquidity issues, it can look to other avenues.
3. Capitalizing on special situations and distressed-debt opportunities
Market volatility also presents opportunities for distressed investment if investors have cash on hand and some tolerance for risk. At a time when others may be hesitant to invest, some firms use dry powder to strategically acquire distressed assets at discounted prices. If the market rebounds, they hope to then achieve strong returns.
How entrepreneurs can use PitchBook’s dry powder data
Understanding how much dry powder an investor has can help founders reach out to the right firm. Remember, timing is key—a VC firm might be interested in your pitch, but if they don’t have enough money available for the transaction, you’ll likely have to try again. PitchBook lets you sort investors by the amount of dry powder they have, and provides details on investor preferences, previous investments and more. All of this information can be critical to founders as they raise funding for their business.
Interested in fund performance? Download the latest PitchBook Benchmarks report, which includes a range of performance statistics across PE, VC, debt, real assets, fund-of-funds and secondaries strategies.
