How do people think rising rates will affect prices in Small Business space

March 18, 2022

by a searcher from Harvard University - Harvard Business School in New York, NY, USA

After yesterday's Fed notes/discussion was wondering if anyone had any thoughts on how rising rates will affect this industry? It has been a LONG time since rates have seriously risen and naturally you would think that if debt became more expensive, multiples would come in, etc... Let me know if that is on point or to what extent that is the thinking

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Reply by a lender
from University of Missouri in St. Louis, MO, USA

Rising rates will probably take some time to kick in but it should impact multiples in the future.This coupled with inflation will push some of these multiples down unless liquidity is still easily available for bigger down payments.The SBA loans that were done over the past couple of years were unique in their EBITDA/SDE leverage.This is because rates were artificially low, and banks were protected from poor decisions made prior to Covid (CARES ACT, PPP, etc,).Additionally some banks used the 90% guarantees to push deals through at high leverage even though it wasn't necessarily prudent from a standpoint of looking out for your customer.A lot of high leverage deals that only worked on an LTM and were never tested for rate sensitivity (assuming the rate is floating) will likely experience some paid overthe next 24+ months..This will likely cause some banks to tighten when they start to have some defaults.It should also mean buyers with access to capital/larger down payments will become more attractive to sellers since leveraging 90% in a rising rate environment is dangerous and less common.That said, I would expect this will likely take a while to shake out as there are still a lot of buyers chasing deals.

Reply by a searcher
from Saint Louis University in St. Louis, MO, USA

I agree with Colin. It will likely take persistently higher rates before multiples come in as sellers are reluctant to decrease prices and buyers are plentiful. Once highly leveraged deals fall apart on financing, we could see sellers move on price. Cash/equity purchases will be stronger; however investors could want a higher return to compensate for a higher discount rate. While this is true on the macro level, certain industries which benefit from rising rates may not see multiple compression.

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