Managing search & acquisition with rising rates

February 18, 2023

by a searcher in San Francisco, CA, USA

How are searchers out there managing their and sellers' expectations around valuations in the context of rising rates? The Fed prime rate as of FEB###-###-#### is 7.75% and I assume the lending rates will be 3% on top of this, in the realm of 10.75% (give or take a few). As is obvious, this really impacts the amount of debt that can be taken in a deal and the net earnings for the searcher.

I would be curious to know from the community how this is percolating to valuations and negotiations around valuations in the current market. Are valuations trending down with sellers lowering their expectations (just like housing markets)? Are searchers pausing their search (probably unlikely)? Are you seeing less options from lenders? Are you as a searcher being open to survive on less SDE in order to get a deal done? Are you planning to buy now and refinance the deal at a later date once rates go down? Any other shifts in dynamics?

I prefer to know more from self funded searchers funding largely through SBA loans and seeking sub $2M EBITDA deals but it would also be great to hear thoughts from other searcher profiles.

Reply by a searcher
from Purdue University in Phoenix, AZ, USA

Sellers seem to be open to more seller carry (which you might be able to get at a more reasonable rate). I'm pushing for more full standby seller carry to improve cash flow. Let inflation work in your favor, in 10 years your inflated EBITDA will make the full standby portion not feel so painful.

Negotiations wise - show the seller the math (and the percentages / ratios) and let them work it out in their head. Float a soft offer that makes sense for you with SBA debt at 10.75% (which will likely be something like a 2.5x multiple). Seller / broker balk. Come back and say you can do X (midway between offer and asking) if they full-standby the delta. Getting paid later is better than getting paid never. That's what sellers get for selling at the end of a business cycle and with high rates.

Will it work every time? Of course not. But the reality is that a lot of deals just don't pencil at 10.75% debt. Better to figure that out quickly and move on.

I want to see PG liabilities (lease + SBA debt) no more than 40% of gross profit for the industry I'm looking at. Devise your own rule of thumb. Stress test your financials and figure out where your break even point is. Could you survive with a 10% drop in top line revenue? 20%? 30%?

One deal I looked at recently was $425k of annual PG payments (lease + SBA) out of $800k gross profit, yielding $225k cash flow after debt service. To me that's just risking too much for too little reward.

Reply by a professional
from Villanova University in West Chester, PA, USA

I’ve had several deals recently be negatively impacted by rate hikes from LOI, due diligence, to closing. It’s made getting to the finish line very tough, and has killed a few deals. Its not that often rates hike so much so quickly that the economics of a deal can change so drastically from initial conversations to closing. I represent clients on the legal side and also completed an acquisition of my own during this time. Going back, I wish I had assumed rates would continue rising several basis points and make my assumptions overly pessimistic from a cost of debt perspective, because it would have helped a lot to have had more of a cushion going into closing. I had to end up putting a significant amount more down to reduce the debt, and even then, the monthly interest cost added over 30% to my monthly costs. So, I would just give yourself as much runway for success as you can in your assumptions. It may limit the deals that are right for you, but it will also put you in a better position for the right deal.

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