As interest rates continue to rise, the impact on asset purchases and acquisitions will be felt across the economy. From real estate to private equity, the rise in interest rates caused by inflation will have many impacts on the structure of deals and the amount of transactions executed. What may be less clear is what this could mean for companies — in particular, those looking to execute Mergers and Acquisitions (M&A) over the next 18 to 24 months.
In this article, we’ll take a closer look at how rising interest rates affect mergers and acquisitions.
Central banks, interest rates and acquisitions
When it comes to interest rates, central banks are among the most important players. Central banks set benchmark interest rates for their countries, which in turn influence a host of other economic factors. The Fed has made it clear that it intends to fight inflation hard by increasing the federal funds rate by selling bonds.
For companies looking to execute mergers and acquisitions deals, central bank policies on rising interest rates is crucial to watch. If interest rates are rising, this can increase the cost of borrowing money – and thus can affect the viability of a potential deal.
More cash, equity and profits
When interest rates are low, companies can borrow money cheaply. This can be a huge advantage in M&A deals, as it can help companies and private equity investors fund larger acquisitions using leverage than in higher interest rate scenarios.
However, as interest rates rise, borrowing money is becoming increasingly expensive. This makes companies more wary about taking on too much debt in mergers and acquisitions. Instead, they opt for more cash and stock transactions — and less debt.
This shift toward more cash and stock deals is likely to continue in the coming months, as companies prepare for higher and possibly more interest rates. Difficult merger and acquisition process.
More paused and canceled M&A deals
While the impact of rising interest rates on M&A deals has been largely positive so far, there have been some negative outcomes as well.
First, rising interest rates cause volatility among companies. This leads to more paused transactions and even canceled deals.
In addition, companies are becoming increasingly wary about taking on too much debt in M&A deals, in part because banks are tightening lending requirements on the M&A deals they undertake.
This causes many investors to either walk away from deals altogether or choose adjustments to the structure of deals by paying cash, or – and in most cases – opt for larger gains from company sellers.
But most buyers don’t want to have to spend more shares than necessary because doing so tends to mess with cash returns. Moreover, sellers fighting off future performance were less inclined to accept huge wins with little promise of progress.
All of this is happening because companies are preparing for higher interest rates in the coming months.
More importantly, higher rates tend to have a direct and measurable negative impact on business valuations, which in turn makes more sellers reticent to sell.
Opportunities and advantages of higher interest rates on mergers and acquisitions
While there are some negative consequences of higher interest rates on M&A deals, there are also a number of positives.
First, companies are becoming more wary about taking on too much debt in M&A deals. This makes them choose more cash and stock transactions – and less debt.
This shift towards more cash and stock deals is likely to continue in the coming months, as companies prepare for higher interest rates.
This increased caution could be a good thing, as it could lead to more sustainable M&A deals. In addition, it can lead to more rational decision-making between companies – as they weigh the costs and benefits of any potential deal more carefully and adjust what were previously somewhat frothy business valuations.
Another benefit of higher interest rates is that it makes it more expensive to borrow money. This could lead businesses to become more disciplined about their spending, and could help control excesses in the economy.
Finally, higher interest rates can lead to a stronger economy in the long run. This is because they can help curb inflation, which can have a negative impact on economic growth.
Change the timing of transaction consumption
When interest rates rise, some sellers may be tempted to shy away from executing trades. This may be due to the fact that borrowing Money is becoming increasingly expensive.
However, it is important to remember that higher interest rates should not cause sellers to shy away from executing trades. There are a number of positives to consider, including more cash and stock deals and a stronger economy in the long run.
So while there may be some negative consequences of higher interest rates on M&A deals, there are also a number of positives. Sellers should not be discouraged from executing deals – they should weigh all the pros and cons before making a decision.
considerations for buyers
commercial buyers and private equity investors You must continue to be opportunistic in the current market, despite the high interest rates. The potential benefits of higher interest rates – such as more cash and stock deals – should not be overlooked.
In addition, companies must be careful about taking on too much debt in mergers and acquisitions deals. This is because banks are tightening the lending conditions on the mergers and acquisitions deals they undertake.
Finally, buyers should be prepared for higher interest rates in the coming months. This can slow deal flow, so buyers should act quickly when a good opportunity arises.
exchange for sellers
When considering mergers and acquisitions in environments of increasing interest rates, business sellers should consider the following:
1. Sellers must carefully weigh all the pros and cons of any potential transaction before making a decision.
2. Sellers should be careful about how they structure deals, including debt service coverage ratios over current cash flows, particularly if their deals involve a lot of M&A debt.
3. Sellers must be prepared for higher rates of interest in the coming months.
4. Sellers should consider opting for more cash and equity transactions and less in the form of dividends and debts.
5. Sellers must be opportunistic in the current market, despite the high interest rates.
While sellers do not want to sell themselves short, higher prices can present their own opportunities and challenges that must be considered before closing a deal with any buyer.
In the worst case scenario, rising interest rates could kill a potential deal outright. This is because higher borrowing costs could make the transaction too costly for the acquiring company.
So far, we’ve seen that rising interest rates can have mixed effects on mergers and acquisitions. On the other hand, higher borrowing costs can make it more difficult to execute trades. On the other hand, a strong economy (often associated with higher interest rates) can lead to more favorable terms for buyers in M&A transactions.
The bottom line is that companies need to be aware of how changing interest rates will affect their M&A plans — and stay up to date on central bank policies.