Dry Powder Definition
Dry powder is an informal term used for describing highly liquid marketable securities, cash reserves, or any other securities that can be utilized for covering future obligations and operational expenses. It can also be used for purchasing an asset or investing in opportunities. Dry powder refers to those securities that can be liquidated on short notice with a minimum effort. It could be treasuries or any other short-term fixed income investment.
A Little More on What is Dry Powder
These cash reserve or highly liquid marketable securities are kept on hand for covering emergency expenses, mostly unforeseen. Venture capital, private equity investment, corporate houses or personal finance, the term can be used in any of these contexts. Having liquid assets on hand is always advantageous for an organization or individual.
Companies keep cash and other highly liquid assets for funding their future capital needs. A company needs capital to run its regular operations. If they invest all their capital in such assets that cannot be liquidated easily on short notice, they might find it difficult to run the operations during a crisis. For example, if suddenly there is an economic downfall and the amount of sale reduced, the company still needs to run the operations and bear that cost. The dry powder on hand come handy in such situations.
Venture capitalists prefer to keep dry powders on hand for grabbing the opportunity of future investment, either in a new startup or in a portfolio company. The term dry powder is most commonly used in the venture capital world.
Individuals also need to keep cash or liquid marketable securities on hand for future emergencies and obligations. These can also be used for investing in an unforeseen opportunity.
References for Dry Powder
Academic Research on Dry Powder
The return of the recap: Achieving private equity benefits as a public company, Shivdasani, A., & Zak, A. (2007). Journal of Applied Corporate Finance, 19(3), 32-41. This article takes a look at how private equity is beginning to change major players in many industries, especially those that made the transition from public to private ownership. The authors wonder if it is possible for public firms to deliver similar levels of performance that match their private counterparts. If such performance is possible, can parts of the private-equity model be replicated for public use? The conditions and factors in the private equity markets are considered and analyzed to address these questions.
The Impact of Own, Rival and Market Effects on Real Estate Private Equity Fund Performance, Hogan, J. D. (2016). This research lays out a background of the real estate private equity industry and explores the factors affecting real estate private equity fund performance through the lens of three factors: own effects, rival effects, and market effects. The author addresses the implications of the analysis for this increasingly favored asset class.
Two Different Ways of Treating Corporate Cash in FCF Valuations—and the Importance of Getting the Cost of Capital Right, Easton, P. D., & Sommers, G. A. (2017). Journal of Applied Corporate Finance, 29(3), 71-79. This article is meant to identify and explain the differences in various methods for calculating free cash flow. Corporate finance texts and traditional financial statement analysis offer conflicting views on the formula that the author addresses through clear, simple examples.
Fund Managers under Pressure: Rationale for Secondary Buyouts.’, Arcot, S., Fluck, Z., Gaspar, J., & Hege, U. (2013). ESSEC Business School working paper. This paper investigates to what extent secondary deals in private equity (PE) transactions are outcomes of opportunistic behavior of the sponsor and/or adverse incentives of the PE contract. Evidence that a secondary deal is significantly more likely if the buyer fund is under pressure to invest and/or if the seller fund is under pressure to exit becomes evident. This article uses data from a comprehensive sample of 9,771 LBO deals in the U.S. and in 12 European countries from 1980 to 2010.
A study of working capital management in Cement Industry in India, Patel, J. R. (2011). (Doctoral dissertation, Saurashtra University). This thesis takes a look at the nature of working capital as it relates to the cement industry in India. The author provides a detailed background of the Indian cement industry with a statistical analysis of the financial operations of numerous firms in the industry. The importance of cash flow and strategic cash flow management is illustrated through real-word examples.
Fund managers under pressure: Rationale and determinants of secondary buyouts, Arcot, S., Fluck, Z., Gaspar, J. M., & Hege, U. (2015). Journal of Financial Economics, 115(1), 102-135. This paper explores the rationale and influences that fund managers experience when they decide to enter into a secondary buyout (SBO) in a private equity (PE) situation. By analyzing a sample of leveraged buyouts, the authors try to determine if fund managers are maximizing value or undertaking opportunistic behavior. The study finds that funds under pressure more often engage in SBOs, and funds that invested under pressure generally underperform.
The determinants of corporate cash holdings, Prenker, T., & Kück, J. (2009). This article seeks to find out what drives firms to hold a certain amount of cash on their balance sheet. The authors take an empirical look at the corporate governance approaches in Sweden and Germany, and the effects that those approaches have on corporate cash holdings. By looking at firm-specific variables, this study employs different financial theories in order to test which approach is more significant in determining the amount of cash held by a company.
Leveraged buyouts and private equity, Kaplan, S. N., & Stromberg, P. (2009). Journal of Economic Perspectives, 23(1), 121-46. This article offers a general overview of the leverage buyout process as it relates to the private equity industry. The empirical evidence on the economies of firms and transactions is considered, as are similarities between the current private equity wave and that of the 1980s. Implications for the future of private equity are also discussed.
Are US Companies Really Holding That Much Cash—And If So, Why?, Zenner, M., Junek, E., & Chivukula, R. (2016). Journal of Applied Corporate Finance, 28(1), 95-103. This article addresses the recent phenomenon of US companies holding larger-than-usual cash reserves. The authors recognize that these large holdings are also associated with companies that have strong cash flow and business performance. Avoidance of taxes, the ability to buy back stock, and the flexibility to quickly invest or respond to market downturns are all cited as reasons for the increase in cash holdings.
Replicating private equity with value investing, homemade leverage, and hold-to-maturity accounting, Stafford, E. (2017). The author of this article offers a method of investing that provides an accounting method that assists in the valuation of a portfolio’s net assets so as to help create a portfolio that mitigates a majority of measured risk. A passive portfolio of small, low EBITDA multiple stocks with modest leverage and hold-to-maturity accounting produces an unconditional return distribution that is highly consistent with that of the pre-fee aggregate private equity index.