For the tenth consecutive time, the Federal Reserve raised the federal funds rate on May 3 (this time from 5% to 5.25%). Since March 2022, consumers have felt the strain of ever-increasing interest rates. That same stress has infiltrated its way into conversations regarding the future of M&A and what companies can do to keep M&A transactions moving forward. However, instead of only looking at the negative (which is admittedly not hard to do with the constant threat of economic slowdown), are there approaches M&A attorneys can use to take advantage of rising interest rates?
Higher Interest Rates = Less Debt and More Equity
In 2021, M&A experienced a historical high in the number of completed transactions. With low interest rates, businesses were able to easily (and cheaply) borrow money. Unfortunately, increasing interest rates have made borrowing money more expensive and riskier. Many businesses have started to shy away from taking on debt in order to complete M&A transactions, and the debt that is secured for deals is more expensive, which either impacts valuations or requires buyers to commit more equity to complete the deals. M&A attorneys can leverage a buyer’s desire to take on less debt by encouraging a mixed cash and stock transaction (including a rollover of a portion of the seller’s equity). In this way, sellers can continue participating in the achievements of a company they helped build, while also capitalizing on its success. For buyers this could mean preserving cash and borrowing power for future growth. Instead of taking on additional debt and reducing cash flow in the future, buyers can offer more stock in order to protect future cash availability.
Does Caution Mean Better M&A Transactions?
While it is true that rising interest rates have caused increased caution throughout the M&A world, this caution could be beneficial for all parties. For the past several years, market forces have resulted in buyers agreeing to higher purchase prices and valuations in order for their offers to be competitive. Buyers were eager to utilize low interest rates and the relative ease of borrowing to encourage fast (but in certain instances, unsustainable) growth and expansion. Now looking back at the “M&A transaction boom,” it is not surprising to hear buyers question the deal terms and valuations in certain acquisitions. Even if rising interest rates have put pressure on valuations and slowed the pace of some M&A transactions, M&A attorneys can use this relative slowdown as leverage to negotiate better deal terms for their buy-side deals. Buyers can return to more traditional metrics and multiples to value potential targets. Although buyers may remain eager to “buy, buy, buy,” rising interest rates can be used as a tool to reevaluate quick spending and negotiate deal terms that may ultimately mean more successful transactions in the long run.
Moving Forward
Even if rising interest rates make buyers and sellers more nervous to consummate a transaction, there are ways in which M&A attorneys can utilize the higher interest rates to benefit both their buy- and sell-side deals. Attorneys should remain mindful of all the effects of higher interest rates, including the negative, but should continue to develop creative and tailored solutions to keep their M&A transactions moving forward.
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