Will Prime Rate Increases Affect Small & Mid-Sized Business Sales and Acquisitions?

Bill

Bill Grunau

As professional business brokers, we follow the prime rate and SBA loan rates closely.  From March 2020 through March 2022 we enjoyed a prime rate at a historic low of 3.25%, which translated to a maximum SBA loan rate of just 6%.  The last time the Prime rate dropped to 3.25% was in December 2008 and before that in 1955.  Interest rates over the past two years have truly been at historic lows; consequently, so have SBA loans and other business loans. 

Back-to-back interest rate hikes by the Fed in March, May, and June of 2022 raised the Prime Rate from 3.25% to 4.75%, with SBA loan rates increasing from 6% to 7.5% (note this is the maximum allowable SBA loan rate, some banks may offer lower rates).  Successive interest rate hikes, with more expected to come, have left many prospective business buyers concerned about financing costs for their acquisitions.  However, as shown below, the picture is not as bleak as the media is painting for small to mid-size business sales and acquisitions. As business brokers, we know this from our over 20 years of experience selling businesses with SBA financing.  

The Acquisition Financing Perspective: Impact of a 1-Point Increase to SBA Loans

Psychologically, we all react negatively to increases in interest rates.  When we see news of the Fed raising interest rates by 0.75% in one bump, the immediate response is to assume the loan you are contemplating is going to cost a lot more money and maybe the deal you are working on won’t pencil out anymore.  In fact, this is far from true.  

The table below compares the effect of a 1-point (1%) increase in lending rates on $1 million, $5 million, and $10 million loans business acquisition loans.  As you can see in the example below, a 1-point increase in SBA lending rates on a $1 million loan reduces the net after debt service by just $6,185.  

Comparing the Effect of a 1 Point Interest Rate Increase on Acquisition Cost and Debt Service

Acquisitions and purchases of small to mid-sized businesses were steady when SBA rates were as high as 9%, and even above 10%, in the not-so-distant past, so we have quite a ways to go before one can say the lending rates are abnormally high and endangering acquisition activity and business sales.  With that said, there may be a knee-jerk reaction to the “sudden” change and this may slow or pause acquisition activity for a while.  But if one looks at the actual impact of say, a 1-point increase in lending rates, it isn’t all that dramatic; the rate increases don’t make solid deals fall apart.  

Of course, it is disappointing and frustrating to see interest rates on the rise, and yes, debt service is going to increase; but, one has to remember that interest rates are increasing from historic lows and returning to historically normal levels.  A solid deal will still pencil out and make economic sense; and if it doesn’t, it was likely a weak deal to begin with.  

Small and Mid-Sized Business Sales Survive Rate Increases Better than Wall Street

Business media may be full of stories about Wall Street M&A activity slowing as the rates increase, but these are highly leveraged deals, with very tight cash flow, and counting on optimistic growth projections to generate the cash flow necessary to service the debt and make a profit.  These deals will fall apart because there simply is no margin for increased lending costs, slower economic growth, or increased operating costs.  It is likely, therefore, we will see increasing media attention as to the decline of Wall Street, Fortune 500, and tech business sales and acquisitions. 

Small and mid-sized businesses are generally not directly affected by these economic factors.  Firstly, small & mid-size business acquisitions are not done on razor-thin deal margins.  The banks won’t underwrite the deal and a small business buyer would never take that level of risk.  Secondly, Wall Street and big companies are subject to the wild swings of the stock market as well as the overall economy.  Many small businesses continue to thrive when the general economy slows.  Case in point, while the general economy struggled in 2020 due to COVID, many of the businesses we sold had strong years in both 2020 and 2021.  Small business financial performance doesn’t necessarily follow the stock market.  

The bottom line is that if the deal and company are solid, it will survive the upcoming higher interest rates, and the effect will be minimal.  

For more information about selling your business contact us.  Pacific Business Sales specializes in the sale of industrial businesses including manufacturing, technology companies, 3PL, construction, healthcare, e-commerce, and aerospace companies.  Our team of professional business brokers will guide you through the process of selling your business, working closely with you to ensure the best outcome.  

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Bill Grunau

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Bill Grunau