What Does Dry Powder Mean?
Dry powder is an informal term that refers to highly liquid securities, cash reserves and any other security that can be converted to cash right away to meet debt obligations, cover operational expenses or invest in opportunities. Having a lot of these liquid assets on hand gives organizations a financial advantage over others who do not and also plays an important role in credit.In context of M&A, dry powder means the amount of capital that is available to financial or strategic buyers for investment in strategic acquisitions, portfolio companies or add-on acquisitions.
Divestopedia Explains Dry Powder
Higher levels of dry powder as it relates to private equity or strategic buyers can lead to higher valuation multiples and increased deal making, as these entities search to deploy this capital in suitable high quality acquisition targets. A mid-market business owner considering a private equity partner should examine the amount of dry powder in that is held by the private equity group to support future acquisitions and other corporate growth initiatives. Assessing the dry powder of strategic buyer may help a mid-market business owner in their negotiation, knowing that the buyer needs to put their money to work and has more cash to pay a higher purchase price.
In the context of dry powder in an organizations, higher levels gives a higher bargaining power when it comes to credit negotiations. Any credit institution that is willing to give a loan to an organization will look into its dry powder levels to ascertain the amount of cash reserves it has on hand to meet the immediate debt obligations. If there is enough dry powder, then the bank may be willing to give a loan at lower rates because their risk is reduced. Conversely, lower amounts of dry powder will reduce the leverage of organizations as they have to accept loans at a higher rate to compensate for the higher risk.
Moreover, dry powder gives organizations a cash buffer against unforeseen financial disasters and poor economic times. For example, an organization that anticipates a recession or a fall in the demand for its products or services would increase its dry powder so that it will have assets that can be liquidated quickly. Lower levels of dry powder will not give organizations the same level of financial flexibility. This option for quick liquidation can also help to meet its operating expenses or to purchase future assets.
At the same time, companies should not keep too much money as dry powder as it reduces their ability to grow and expand. This cash or cash-like reserve will just be sitting within the company without any use and this could prove to be detrimental for the company in the long run. For this reason, companies should decide on the right amount of dry powder at any given point in time.