Cost of Capital Impact on M&A

Cost of Capital Impact on M&A

Why NOW is the time to sell!

Collectively we have seen a sharp spike in the cost of capital as it relates to federal banking rates for both consumer and business lending. This has resulted in downstream increases across the financial buyers and investors within our IT services industry. While the change in rates appeared rather quickly and ramped up even faster as the federal government struggled to slow inflation, it did take a little longer for those impacts to be felt in our deal flow. 

Today we are working on several combinations where financial buyers or investors are either spearheading or funding the transaction and we are starting to see the rates play a larger role in the fundamental affordability of combinations whether its working capital needs or cash consideration at close. What we do know is that we are seeing increased urgency in consolidation as the likelihood of a rate cooldown is unlikely. 

We recommend that sellers start to consider the impact of the rising rates and the capital expense that will be incurred as a result of cash at close in addition to the operational funding of things like integration and growth.  The fact remains that with rising costs will come the need to look at valuations differently. As an example, if the cost of capital on unsecured business loans increased by 6% over the last 180 days you can expect the offset of that to appear in the valuation of the selling entity.  Even cash flush organizations are going to start hoarding cash on the balance sheet to prepare for a likely economic downturn.  While the economic crunch typically fuels growth in things like technology and innovation as a means to reduce long-term operating costs, it does slow transactions as companies turn to more organic solutions to drive growth while they measure and assess risk from shrinking categories. 

At Revenue Rocket we leverage several factors when working with sellers on determining valuations prior to entering into a process to sell the business, and cost of capital is always in play.  The opportunity to capitalize on the momentum to sell to ensure you stay ahead of the increased focus on the price of money, is narrowing and we are urging sellers and investors to act quickly.  

What happens if your deal is pending close and the cost of capital increases for the buyer? Well, that varies based on many factors.  One being the purchase agreement and the levers installed to address things like source of proceeds and costs collectively. Another is the possibility of the affordability of a combination being stretched out of tolerances.  Deals do fall apart based on financing all the time, so it is imperative to account for these provisions within your LOI’s and Definitive agreements. 

For more information on getting ahead of the cash crunch or to better understand how to protect your translation or growth strategy check out our various resources below: