The term “dry powder” is financial slang and refers to a company’s or investor’s highly liquid securities which are kept on hand to finance future obligations, purchase assets, or invest in opportunities. Such capital also may be kept on hand to provide emergency operational funding.
The term “dry powder” originates from the days when military battles were fought with cannons and guns requiring loose gunpowder. The gunpowder needed to be kept dry in order for it be effective – and now the term is used metaphorically in reference to the financial world, and keeping liquid securities on hand ‘just in case.’
Dry powder securities usually include cash reserves, Treasuries, and other fixed income securities. Any investment or security that can be converted quickly to cash may be considered dry powder.
Why dry powder?
Keeping drypowder on hand can offer an advantage over other businesses with less-liquid assets on hand. Often, businesses will stock up their ‘dry powder’ in anticipation of tougher economic conditions in the future. A prime example of this was Ford Motor Company’s build up of cash reserves prior to the 2008 financial crisis. They correctly anticipated a tight credit market in the wake of the stock market collapse.
Large cash reserves especially are beneficial to SMBs (Small and Medium Businesses) during times when security and other investment prices fall. Not only do cash reserves maintain their value, but they can be used to purchase stocks at substantially lower prices during periods of economic decline. When the market eventually recovers, the business has the potential to be in a stronger financial position than before.
How does dry powder effect an acquisition or partnership?
Any SMB looking to purchase or partner with a private equity firm should consider the entity’s levels of dry powder. Higher levels often mean a higher valuation and should be considered in negotiations, as dry powder allows for future acquisitions and other avenues of growth.
How does dry powder effect credit?
The more liquidity an organization has, the better the bargaining power when it comes to obtaining credit. Credit institutions will assess an organization’s level of liquid assets (dry powder) to determine how much cash it has on hand to to meet immediate debt obligations. The more dry powder a business has, the less risk the lender faces, and the lower the interest rate will be for the borrower. Conversely, businesses with very little liquidity pose more risk to a lender, and they are more likely to face higher interest rates.
Is it possible to have too much dry powder?
While it is good practice to keep some dry powder on hand, too much can actually be a risk for your business. Too much cash and other liquid securities can reduce a company’s ability to grow, as it sits idly – not offering much of a return in terms of investment. Each business owner, in consultation with his advisors and on an ongoing basis, should decide what the correct amount of liquidity the company’s balance sheet should have.
Holly also founded ExitPromise.com and to date has answered more than 2,000 questions asked by business owners about starting, growing and selling a business.