How Changing Interest Rates Impact M&A

Interest rates are going up.  The rise began a few months ago and is likely to continue for the foreseeable future.  Earlier this summer, rates for 30-year fixed mortgages increased a full percentage point in less than a month.  The 30-year Treasury Note bottomed out at 2.82% on May 2, and sits at 3.75% today.

Changing interest rates create unique pressures in the M&A environment.  While they impact valuations in the long-term, they can impact buyer behavior in the short-term.  As interest rates rise, buying a company becomes more expensive.  Therefore, if someone who plans to buy a business believes that interest rates will continue to rise over the mid-to-long-term, then he or she will be motivated to complete a deal quickly rather than risk missing out on the best rate possible.  This can even lead to a “we just need to buy something, anything” phenomenon, as pressure mounts.

Deal activity slowed at the beginning of 2013, most likely the result of a hangover from Q4 2012, but has steadily built through the spring and summer, and this year may shape up as another great year for deals.  Last year, the sellers drove the flurry, trying to close deals before year-end in order to lock in the 2012 tax rates.  This year, we expect buyers to drive the frenzy – and this is a good thing for business owners considering their exit options.  It’s a simple equation:

More Buyers in the Market + Increased Buyer Motivation = Positive Seller Outcome

This may prove to be a short-term phenomenon.  Today, a buyer who is motivated by these factors may be more generous than usual in a negotiation in order to close a transaction quickly.  Over time, however, rising interest rates put downward pressure on valuations.  We expect this type of buyer behavior to last through the end of this year and perhaps the first half of next year, at which point rising interest rates may begin to demotivate buyers – or at least bring them back down to earth.

Of course, all outcomes are pure speculation, since the Fed can choose to hold rates steady, increase them at a more rapid rate, or even decrease them (although I highly doubt the third option will occur).  All we know for certain is that rates are expected to rise, and today this expectation is making markets favorable for sellers.

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