The dramatic decline in equity markets due to the coronavirus could solve one of the private equity industry’s biggest problems.

Last year, the industry raised over $300 billion in commitments to private equity investments. As a result of his success, the industry entered the year with over $1 trillion in dry powder.

But all that money created a problem. With valuations surging, too much money chased too few ideas. Buyouts became extremely difficult due to valuation concerns. Dry powder accumulated.

Firms do not start earning fees until they deploy cash, so private equity dry powder wasn’t delivering returns.

Private Equity Dry Powder

Valuations have been cut dramatically by the market sell-off. They will likely spill over into private markets before we find a bottom.

The flood of retail closings and supply chain issues may tip the U.S. economy into a recession. This will lower valuations further and create attractive risk-reward setups for buyout investors.

There is a caveat to the development. There will be fewer Private Equity firms when this crisis is over.

To keep potential returns in the zone that attracted investors in the first place, some firms increased the amount of leverage they used when structuring deals. Many of those highly levered deals will fail. This will take the PE firms right down with them. Those that have substantial allocations and energy combined with too much debt will find it difficult to remain viable.

The remaining firms that resisted the urge to chase deal pricing higher could find themselves in a buyer-friendly climate with fewer competitors.

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