Will Rising Rates Affect your Business’s Value? Well, it’s complicated…
In short, it likely doesn’t have a major effect in the near-term, though the impact of rising rates may ultimately put downward pressure on business valuations. For the purpose of understanding the specific impact on value, let’s set aside any effects rising rates and inflation have on revenues and expenses – those are legitimate, but different for every business.
Broadly speaking, most acquisitions are financed with a mix of debt and equity. Private equity firms, notorious for the “leveraged buyout”, tend to utilize debt in order to maximize returns. The model goes: Use “OPM” (other people’s money) plus some of your own, use cash flows from the business to pay down debt, and at exit all or a portion of the debt will have been repaid and therefore increase the return on the original equity investment.
Most acquirers are aiming for a specific return profile when buying a business, so when the cost of capital (in this case debt capital) increases, they’re forced to find ways to offset the impact of those cost increases in order to maintain the target return. The simplest way to maintain parity in the equation is to reduce the upfront value paid when acquiring the business.
To be clear, a multitude of variables go into the return equation, so to suggest that rising rates will singularly cause business values to decrease is somewhat of a stretch. A mountain of committed capital (approximately $2 trillion as of January 2022) remains on the sidelines, mandated for investment over the next ten years. The supply of that capital juxtaposed against the number of available deals in the marketplace suggests values will remain at historically high levels for the foreseeable future.
If selling a business is something you’re considering, you’d be wise to keep an eye on the Fed’s rate increase strategy.
About Infinity Capital Partners
Infinity Capital Partners is an Oklahoma City-based middle-market investment bank offering a broad range of advisory services to private companies and financial sponsors across a variety of industries. Infinity works closely with owner-operators, shareholders, founders, and management teams of private companies to provide tailored services including M&A advisory, debt and equity placements, recapitalizations, and strategic advisory. For more information about Infinity Capital Partners, including a list of current projects, please visit our website at www.infinitycapitalpartners.com. Securities placed through Infinity Capital Securities, LLC. Member FINRA.
Bryan Vahlberg
Managing Partner
Infinity Capital Partners