Across the financial industry, the term “dry powder” gets thrown around a lot. What started as a slang term with historic ties is now a well-known word with relevance across the global capital markets. In fact, the PitchBook Platform currently tracks more than 12,000 investors whose fund dry powder percentage is at least 10%. In this article, we take a closer look at what dry powder is, its history and a few ways investors can leverage it.
What is dry powder?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. As a highly liquid asset, investors and corporations use dry powder strategically to gain financial success or ease financial stress.
What is the history of the term dry powder?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. A reserve that can be dipped into is a prevalent theme across many industries and jobs, including the financial space.
3 ways investors use dry powderDry 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 2020, total dry powder levels in VC and PE hit unprecedented sums with more than $1.5 trillion available to fund managers worldwide. With more cash on hand than ever, firms grappled with how to deploy it and the impacts it could have on returns.
Here are three ways investors leverage dry powder:
1. To fuel growth for portfolio companiesInvestment 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. To solve near-term liquidity issuesDry 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.
The COVID-19 pandemic had an unprecedented impact on the global economy and reignited fears over liquidity drying up. The black swan event forced investment firms to adjust their strategies, including finding liquidity outside of dry powder. We hosted a webinar on alternative ways to find near-term liquidity that is available to stream here.
3. To capitalize on distressed-debt opportunitiesMarket volatility also presents opportunities for distressed-debt investors. 2020 was a case study in turbulence, as mentioned, and firms had more capital on hand than ever. As of June 30, 2020, private debt funds had about $273 billion of dry powder available, according to PitchBook. Around $66 billion of that capital was held by managers focused on distressed debt, a class of riskier investments in troubled companies with the potential to offer bigger returns. Following the COVID-19 pandemic and economic downturn, more funds have gone to market in order to capitalize on the dislocation. Examples of debt funds in the wake of the coronavirus:
- The KKR Dislocation Opportunities Fund raised $2.8 billion in addition to $1.1 billion SMAs
- The Oaktree Opportunities Fund XI raised $15.9 billion, making it the largest distressed fund ever raised
How entrepreneurs can use data on dry powder while fundraisingUnderstanding how much dry powder an investor has can help founders reach out to the right firm. 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.