June 22, 2023
Welcome to this month’s GaP Insights where we will explore the effects of interest rate increases on lower middle market mergers and acquisitions (M&A) amidst a weakened economy. We will delve into the perspectives of sellers, buyers, and capital providers. Despite current challenges, we will highlight the positive positions and opportunities that can be seized in this unique financial climate.
Let's dive in!
In a weak economy and with uncertain market conditions, interest rate increases may initially seem like a huge negative for business owners contemplating a sale. However, let's examine the potential positives they can leverage.
a) Increased demand for quality businesses: Despite the challenges of a weak economy, investors often seek refuge in acquiring established businesses during these times. Interest rate increases can signal a potential upturn in select markets, attracting buyers looking for stable and promising acquisitions. Sellers of well-run, quality businesses can leverage this increased demand by negotiating favorable terms, which in turn should produce a lucrative deal for them.
b) Hedge against inflation: High inflationary pressures may accompany a weak economy. For sellers, M&A transactions offer an opportunity to mitigate the impact of inflation. By converting some or all of their business assets into cash, notes payable, or shares of a more resilient entity, sellers can potentially preserve value and protect against the eroding effects of inflation and an uncertain future.
Though they may face challenges in a weak economy and high inflation environment, buyers can identify unique opportunities for growth and strategic positioning.
a) Bargain hunting: In recessionary times, certain buyers will pivot to acquire distressed or undervalued businesses that need rescuing due to economic turbulence or financing challenges. Interest rate increases can be a signal to look for these types of opportunities. Savvy buyers can identify distressed assets, acquire them at attractive prices, and position themselves for future growth when the economy rebounds.
b) Inflation hedging through acquisitions: Another strategy is to acquire best-in-class businesses with tangible assets or pricing power in order to provide a hedge against inflationary pressures. Buyers can strategically pursue acquisitions that offer a natural defense against rising costs and inflation, positioning themselves for long-term stability and value creation.
Lenders and capital providers play a crucial role in supporting M&A transactions – even in challenging financial climates.
a) Enhanced loan portfolio performance: Higher interest rates can improve lending profitability, bolstering a lender’s bottom line and increasing returns on investment. This scenario positions lenders to actively support M&A activities with proven, well-capitalized buyers and fuels economic growth.
b) Selective financing for strategic acquisitions: In a recession, lenders can selectively provide financing for buyers seeking to acquire businesses with strong growth potential or defensive characteristics. By carefully aligning with borrowers and focusing on well-structured transactions, lenders can mitigate risk while supporting key acquisitions that contribute to the overall stability and resilience of the market.
Interest rate increases within a weak economy, high inflation, and a recessionary outlook present unique challenges for lower middle market M&A transactions. However, it's important to recognize the positive positions that can be leveraged in this financial climate.
Sellers can benefit from an increased focus on quality businesses and utilize M&A transactions as a hedge against inflation. Buyers can seize opportunities by acquiring temporarily undervalued assets and using acquisitions as a defense against inflation. Lenders and capital providers can enhance loan portfolio performance and selectively finance strategic acquisitions to support economic growth.
Successful navigation of interest rate increases in this financial climate requires adaptability, astute decision-making, and a focus on long-term value creation. By staying informed, agile, and open to collaboration, participants in lower middle market M&A can overcome challenges and unlock opportunities for growth and resilience.
Disclaimer: The information provided in this article is for educational purposes only and should not be construed as financial or investment advice. Always consult with a qualified professional (preferably a transaction advisor) before making any business or financial decisions related to M&A.
If any of this resonates with you, we encourage you to take our M&A Discovery Questionnaire and talk with us to see if your business makes the cut as one who can still command a great exit in this M&A environment. We will be in touch quickly to discuss the results. Click here to take the assessment.
Gilbert & Pardue Transaction Advisors (GaP) is a Houston-based business advisory firm serving lower middle market and middle market business owners from coast to coast through representation for Mergers & Acquisitions (M&A).
Matt Gilbert and Bret Pardue established GaP to provide owners of lower middle market and middle market businesses – those businesses generally enjoying annual revenue of $10-$80 million – with the quality of M&A representation and value-enhancement services previously only available to upper middle and large businesses. GaP brings highly experienced executives, sophisticated financial and marketing products, proven-effective processes, and fully-integrated expertise to every engagement. No other M&A firm serving the lower middle and middle markets provides the quality of representation and transactional expertise that we do.