If you’re considering selling your business in the near future, you may have taken notice of the recent news that interest rates are about to start going up, perhaps 3 or 4 times this year alone, after being near zero for several years. You may have asked yourself – or you should have asked yourself – how will that impact your exit strategy. Here are my thoughts on that question.
- If your exit plan is to pass the business to your family and get paid out of future earnings, no problem, no material issues. Except that you perhaps need to consult with a smarter financial advisor to help you design a better win-win strategy.
- If your exit plan is to sell the business to a large strategic buyer who will pay you in publicly traded stock or simply write you a check out of their bank account, no problem. As long as you look carefully at the required holding period for the stock. You may have noticed some volatility in stock prices recently, with the greatest risk among fast growing, capital-hungry companies.
- If your exit plan is to sell the company to an investment fund or private equity firm that has cash ready to deploy – and there is still lots of that around these days – take the money and run. Unless a big part of your sell price is contingent on future success of the business, called an “earnout” – but that’s a topic for another post.
- However, if your exit plan is to sell the company to a buyer who will borrow money to finance the purchase – whether someone found by your ibanker or broker or even an ESOP – the amount they are willing to pay is almost certainly going to go down as the cost of their money goes up. Any lender will certainly take that into consideration in determining the value of the asset purchased vs. the amount of money borrowed, and in many cases the lender’s decision – reflected in that metric called Loan to Value (LTV) could make or break a deal.
So, will a couple of rate hikes torpedo your deal? Not likely. But if your exit strategy requires you to make some pretty significant improvements in your company’s bottom line or operational performance before you go to market, and you don’t know how long it will take to make those improvements or how to measure their financial impact on the value of your business, I’d say you have a problem.
Consider the possibility that the US Prime Rate – 3.25% today – could increase in the next couple years by 50% or more. A loan of $10 million that might cost the borrower $325,000 a year today could cost them $500–600K a year down the road, likely out of your pocket, however indirectly.
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