What is dry powder?
People often create informal or slang terms in a particular field. In finance and investments, we have some, and that includes “dry powder.” It refers to marketable securities that are like cash because they are too liquid. And since we said that, this term could also mean an entity’s cash reserve that will take care of future obligations, buy assets, or make acquisitions. If we say securities and dry powder together, we could mean treasuries or other investments that are short-term fixed income. Hence, we can readily liquidate them immediately when emergency funds are needed to buy assets.
Tell me more about dry powder.
It is ironic how we say the dry powder is highly liquid. But basically, it refers to the cash reserves or liquid assets that one can readily use. First, we say that they are cash reserves. They are short-term securities that one can market. Usually, they are already on hand in case a sudden obligation comes in the future. Hence, dry powder is also applicable in personal finance, corporate environment, venture capital, or private equity investments.
Having dry powder readily on hand is an edge to others who hold not too liquid assets. Let us say that you kept a massive amount of cash on hand. You want to be ready for any sudden opportunities that will require immediate funding. In this case, we can consider this money that you hold as your dry powder.
Dry powder in different scenarios
Now, let us talk about dry powder one by one from different perspectives.
- Corporate environment. In this perspective, dry powder is the cash amounts and current assets that the company can use to fund working capital needs. Let us say that a company invests most of its cash in a long-term inventory that is not easy or quick to sell. In this case, it has less dry powder. If there is an economic problem and the company gets affected, customers will most likely refrain from purchases. Now, the company has illiquid inventory, but it still needs to pay operating costs. We see that the company was not able to consider the economic downturn when it reduced its dry powder. A company should always have enough dry powder on hand to keep its daily operations running.
- Venture capitalists. These people would usually need massive dry powder on hand to invest in new opportunities or give more funding to portfolio companies to speed up growth. They avoid most investments because they do not want to reduce or lose their capital too fast.
- Personal finance. It is suitable for individuals to keep dry powder for sudden obligations, emergencies, and great opportunities. A person who owns dry powder holds a portion of their net worth in cash or marketable securities. They are always readily available there once needed.
Now, let us end with some highlights.
Dry powder means the cash or the marketable securities that are highly liquid, low-risk, and are convertible to cash. Dry powder funds are kept in hand to be used when there is an emergency. Most venture capitalists use dry powder to invest in opportunities along the way.