Interest Rates Just Went Up – Should I Kill My Self-Funded Search?

June 17, 2022

by a searcher from Northwestern University - Kellogg School of Management in Fort Lauderdale, FL, USA

The stock market is going crazy, inflation is through the roof, and now the interest rates just went up. If you’re like me and funding your own search you may be wondering what this means for your search.

Does the latest rate hike mean financing costs will be high now?
What about the risk of future rate-hikes?

So, I thought I’d break down the numbers in a very simple way so I could step off the ledge and get back to focusing on finding a great business to buy.
Let's us a $1M EBITDA business. I try to be conservative in my assumptions so say I pay 4.5x or $4.5M purchase price. Take an SBA loan for $4.1M (90% financed and I’m excluding fees to keep it simple). The payment on a $4.1M SBA loan at a 6% rate, the rate before the latest fed change, would be $550,265/year. The June 15th change increased rate by 150 basis points to 7.5% (if using Prime +275 to be conservative). This seems daunting because it’s a 25% rate increase. However, the new payment at that rate is $590,028/year, just a 7% increase in payment. I want to know what this means for my EBITDA. This is a $39,763 reduction to my $1M EBITDA – just 4% reduction to EBITDA. I’m feeling a little better about the latest rate hike. I will need to come up with operational actions to offset the increasing financing costs, but this doesn’t seem out of the realm of possibilities or a “deal breaker”.
But what about future rate hikes? How bad can it get?. I flexed up the interest rate to 10% which is another 250 basis points increase - or a 33% increase on top of the 25% we just took. All else equal, a 10% interest rate would add another $69,091 in cost. Relative to a $1M EBITDA company this isn't small, but certainly not a reason to walk away from a Search.
My conclusion is that the interest rate changes do not change my view on buying a business at this moment. There will be many challenges to face as a new business owner and many items to consider during the search for the right business but wasting one more second worrying about interest rates will not be on the agenda. Just make those loan payments, grow the business. Be aware of the macro economy, but stay the course.

Reply by a searcher
from Vanderbilt University in North Palm Beach, FL, USA

I'm continuing my self-funded search despite rising rates. It seems to me that rising rates affect most acquirers similarly: buyers won't be able to put as much debt on target companies due to the higher cost of debt service. As a result, returns will be compressed and buyers will either have to 1) settle for lower projected returns, or 2) pay less for the target companies to achieve their targeted returns. Ultimately, purchase multiples will likely decline, and it may be a better time to be a buyer than a seller.

Personally, I'm more concerned about how higher interest rates may negatively affect consumer spending and what that means for the future performance of target companies.

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

I always tell clients that when you are doing business acquisition financing in most cases the term is relatively short like 5 to 10 years, which is much shorter than a standard home mortgage. Although a higher interest rate does impact the payment and what the business cash flow can support, because of the short amortization the impact is usually much less than it would be for a home mortgage loan. The best thing you can do is run the actual numbers, like you did, and figure out how it will impact you, and then if you can get a sufficient reduction in the purchase price or push more of the purchase price to a subordinate seller note, so you do not end up impacted.

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