Inflation and the attempt to offset it with higher interest rates is impacting almost all areas of the economy and people’s everyday life. In the world of business sales, where the leverage and financing of deals play a vital role, one would think that the potential repercussions of accelerating interest rates will be enormous and disastrous. While I understand that thinking, I do not agree. Of course, there will be the usual nay-sayers who decide they cannot move forward to buy a business now because interest rates are rising. These are almost certainly the same folks who cannot pull the trigger on buying a business no matter the state of the economy.
Business buyers simply need to get used to a new basis. The low interest rates we have experienced in recent years were not always the case, and businesses did not stop selling. Anyone who wants to buy or sell a business needs to block out the noise, adapt, and adjust their thinking.
Block the noise!
Individual buyers don’t be dismayed
For individual buyers who may finance through a combination of SBA-type loans or seller financing, the increase of a few percentage points will have a marginal effect on cash flow. Even if rates skyrocket, if the business cannot adequately service the debt because of the increased cost of debt service, then it is probably not a good business to buy regardless of the interest rates. There is also the leverage that a buyer can now have with a seller to negotiate lower selling prices, longer notes and even a short-term holiday from paying the note once they take over.
Private equity firms have to buy businesses
For many institutional buyers such as private equity firms, they do not have a choice; they must deploy capital. If they do not invest their funds, they have to give it back to their investors, and I guarantee that is not happening. In this sector, PE will adapt as they always do. They will likely leverage less which means more equity into each deal, and it may serve to lower multiples from their insane current levels. Further, the low interest rates of recent years have caused over-leveraging. It has led many PE firms to make bad investments in their rush to tie up deals, and in some cases to forgo their usual detailed underwriting in their haste to get deals done when deal flow is tight.
Sellers can have an advantage
Sellers who offer balance of sale financing will now be able to get a higher rate, or there can be an even better option to use the higher rates to close a deal. That is, offer a prospective buyer a rate below prevailing ones to get the deal to the finish line. A seller can even use this strategy to get a higher purchase price by offering a buyer better deal terms. Use the approach of “I’ll take your terms and you pay my price”.
It’s how you look at it
Having seen the ebbs and flows of business sales over three decades, for me the current hysteria in the market is nothing to worry about. Deals will continue to get done. Creative sellers will use the market to their advantage. Buyers who do not adjust their thinking will be left on the sidelines as they always are, whether the economy is flourishing or floundering.