Interest rates are the price of money. It determines not only what saving earns, but also what borrowing costs - whether a mortgage for a house or a financial lease. Interest rates affect our entire economic system, and their state therefore matters to all of us.
Interest rates act as the heartbeat of our financial system. It affects consumption, prices, investments, investments, debt, currency and many other economic variables.
Developments in interest rates also have an impact on the M&A landscape, as the number of M&A transactions is strongly related to the availability of capital, fundability and valuations - factors that are all affected by interest rates. It is therefore interesting to examine this relationship more closely.
Borrowing costs money
The relationship between interest rates and financing is fairly obvious. The higher the interest rate is, the more expensive borrowing becomes, meaning that the supply of capital increases, and the demand for it decreases. This generally translates into less willingness to finance, both for individuals and businesses.
Selling shares
When businesses want to grow, investments must be made. Entrepreneurs have two options in this case when they want to use third-party capital: borrowing money or attracting liquidity by raising equity (selling shares).
Partially selling shares can be a strategic choice to achieve growth with a partner that has financial resources, capacity and/or industry knowledge.
Interest rates and M&A transactions.
Raising financing during times of high interest rates is an expensive option. As a result, businesses may more often prefer to raise capital in these times by raising equity and working with a partner to further growth and innovation.
Parties interested in acquiring businesses often use financing to do so. These costs will increase in times of high interest rates. However, businesses are valued lower in times of high interest rates, so this offsets each other. This works as follows:
When interest rates are high, investors can achieve higher returns with virtually no risk by choosing safer investment instruments such as bonds or savings accounts. This means that for investors, riskier projects typically need to yield higher returns during times of high interest rates to still make such investments attractive to them. This is also known as opportunity costs. The required return causes investors to value a business or project lower as a result when interest rates are higher.
In short, the above implies that times of high interest rates can increase the number of M&A transactions, while at the same time the average sales proceeds per transaction are of a lower level.
Low interest rates
When businesses want to grow and interest rates are of a low level, raising capital through financing is more advantageous, making this option more attractive to entrepreneurs than partially selling shares.
Potential buyers can finance more when interest rates are low, however, so business valuations are generally higher. High business valuations make it more attractive for shareholders to sell the entire business.
