Private equity “dumpster-diving” could drive a big increase in deals in 2013

You can find some gems in there
You can find some gems in there
Image: Getty Images / lbusca
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Private equity (PE) firms are getting tired of biding their time. For years, they have sat on their hands, waiting for the market to settle and more opportune investments to return. Bain Capital estimated that, at the beginning of 2012, PE shops had $927 billion in “dry powder” (pdf)—liquid funds from investors that had not yet been used—but were still hesitant to go into any deals amid a gloomy economic outlook. With interest rates low and yield in liquid investments increasingly hard to find, PE investors with spare cash have been frustrated watching those assets sit idle at low returns.

However, all that could change by the end of this year. The US will have chosen a new president; Congress will probably reach a deal to prevent the worst impacts of America’s “fiscal cliff”; and China’s economic slowdown may show further signs of abating. The majority of the 127 corporate development officers surveyed by deal networking firm AxialMarket said they believe that private equity firms are about to go on a shopping spree in 2013.

That would clutter the M&A market. Of those surveyed, 88% said they saw PE firms’ dry powder as a threat to more traditional M&A. If PE investors flood back into the markets, it will increase competition for deals and in some cases close out corporations looking to make strategic mergers and acquisitions.

Even more importantly, there’s a huge drive to use funds while they are still available. Limited partners (LPs) are allowed to withdraw money they’ve put into PE funds after five years if it hasn’t been invested. Bain writes:

Adding to the pressure to do deals is the fact that a sizable portion of the dry powder earmarked for buyouts—48% of the total—is held in funds raised during the big 2007 and 2008 vintage years. The clock is ticking loudly for these funds. Unless that capital is invested by the end of 2013, GPs may need to release LPs from their commitments and forego the management fees and potential carry it could generate.

“PE firms are scouring everywhere for good deals,” explains Sumeet Shah, Assistant Director of Business Development at Gotham Consulting Partners. “It’s gotten almost to a point that they’re dumpster-diving because many firms are running into increasing competition from strategics to other firms with better-performing funds.”