Interest Rate Impact of Deal Structure

February 04, 2023

by a searcher from University of Wisconsin-Madison - Wisconsin School of Business in Milwaukee, WI, USA

Does anyone have insights on how interest rates are changing deal structure? I would generally think that something has to give (multiples, seller financing) especially when SBA is the primary funding. Loosening of debt service coverage seems the least likely to me. Or are deals just moving away from SBA?

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Reply by a lender
from University of Missouri in St. Louis, MO, USA

I think the higher interest rates allows an opportunity for a buyer during negotiations re: seller notes. Prior to last year seller's could get away with high multiples and little/no seller note since (some) bank's were willing to finance the whole deal at 90%+. The higher interest rate allows you to make the seller note more palatable for a seller now. As an example, a $2M SBA loan at 10% (P+2.25%) has and APR close to 10.8% when you factor in the SBA guaranty fee and basic closing costs. So paying a seller 9%-11% interest on a seller note isn't necessarily a high rate today. This allows you the opportunity to push the seller on more favorable terms (i.e. larger seller notes, deferred payments, interest only) and still make it benefit both parties. When the rate on an SBA loan was in the 5's this wasn't as great of an option since the return was weak for a seller and it made no sense for a buyer to pay a high rate of return when the SBA rate was so low. This won't impact the multiple you pay, but could give you an advantage v. other buyer's if you really want a company. Being creative on the purchase price v. the cash at close can hopefully give you a leg up on the competition.

Reply by a searcher
from Tufts University in Jersey City, NJ, USA

At least in our industry we've been seeing rising interest rates translate into downward pressure on multiples and a trend towards more hedged/structured deals utilizing mechanisms like holdbacks, earn-outs, seller financing, longer seller employment agreements, and HoldCo or OpCo equity to reduce Day 1 cash exposure in their deals and hedge against downside as much as possible in a potentially souring economy. Sellers will only get what buyers can rationally justify in current market conditions, and capital being more expensive unavoidably impacts the "what buyers can rationally justify" aspect of that. Sellers who aren't time sensitive may just decide to try to wait out the current market, but those who are in the market right now are looking at a different valuation landscape than a couple years ago when interest rates were at rock bottom.

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