Will Increased Interest Rates Affect Business Values?


Bill Grunau

Business Brokers Help Sell My Construction Company Considering Interest Reates

With interest rates rising recently business buyers and sellers may wonder, “Will increased interest rates affect the value of a business being sold?” Spoiler… small changes in interest rates do not dramatically affect the value of a business or the net after debt service.  In fact, a 0.25% interest rate increase only increase the annual debt service by roughly $3,000 per year on a $1 million transaction.

While rates have risen from a recent low of 3.25% in 2008 to 8.5% in effective July 2023 and holding as of April 2024, these are higher than recent rates, but not all-time highs. The all time high Prime Rate was a whopping 21.5% in December 1980 and the all-time low rate was 1.75% in 1947, in May of 2000 the rate was 9.5% and it was generally between 4% and 8% throughout the 2000’s, until it was dropped after the recession.

Historic US Prime Rate 1947 thru 2023

The Prime rate has increase to 8.5% has driven up the maximum allowable SBA 7a loan to 11.5%. While 11.5% is the maximum SBA 7a loan rate as of April 2024, few banks are charging this because the SBA business acquisition lending market remains very competitive. In fact, we have one lender offers SBA 7a loans at 7.6%, 10 years fixed, as of April 2024, which is below the current Prime Rate.

In theory, as the cost of capital increases the value of a business or income property (such as commercial real estate and investment properties) will decrease. This is because the increased debt service expense reduces the net income and therefore reduces the amount a buyer would pay for the business or property.

The economic theory behind this is sound, and this tends to be the case with investment properties, but it does not always hold absolutely true. In the Orange County and Los Angeles commercial real estate markets prices have continued to increase steadily in spite of recent interest rate hikes. Likewise, business values have not been affected by recent increases in the prime rate and SBA loan rates. So why is this?

Business value multiples have generally stayed the same as interest rates have gone up and down. Business values are driven more by earnings than the cost of capital. In fact, the cost of capital is a minor factor in most business acquisitions as long is interest rates are in the historically normal ranges. The ultra-low rates after the recession of 2007/2008 did not increase business values and now that rates are increasing to normal levels they are not decreasing the value of businesses. Business values did drop after the 2007/2008 recession, but this was a result of decreased earnings, the multiples remained largely the same.

For commercial real estate and investment properties in Southern California prices have continued to increase as a result of high demand and a strong economy in Orange County and Los Angeles.

What is the Effect of a 0.25% Interest Rate Increase on Net Income?

Let’s look at some hard numbers as an example to illustrate why small changes in the Prime Rate and subsequently the SBA lending rate have a minor affect on business value.

Let’s say Steve Smith is considering buying a business for $1,000,000. For this example we’ll assume the business has Discretionary Earnings (DE) of $300,000 which would put the multiple at 2.85X DE (note this is a typical multiple for this size business depending on the industry).

The maximum SBA rate is Prime Plus 2.75%, so we will use the max rate for these examples. We’ll use the SBA minimum down payment of 10%, or $100,000 for maximum leverage which will show the maximum effect of interest rates.

If Steve was considering buying this business in June of 2017, the Prime Rate was 4.25% and the max SBA rate was 7%. The annual debt service would be $125,397 and the net after debt service would be $224,603. That’s a nice return on $100,000 down!

Let’s see how that same business acquisition would look in December 2017 with the Prime rate at 4.5% and the max SBA rate at 7.25%. The annual debt service would be $126,793 – an increase of $1,396 per year, and the net after debt service would be $2223,07. Still a very a nice return on $100,000 down!

So how does it look today with a Prime Rate of 5.25% as of October 2018 and a max SBA rate of 8.0%? The annual debt service would be $133,034 – an increase of $7,637 per year from the June 2017 rates, and the net after debt service would be $216,966. Again a very a nice return on just $100,000 down and this deal still makes sense.

June 2017Dec 2017June 2018Oct 2018
Acquisition Price$1,000,000$1,000,000$1,000,000$1,000,000
Discretionary Earnings$350,000$350,000$350,000$350,000
Down Payment $$100,000$100,000$100,000$100,000
Down Payment %10%10%10%10%
$ Financed$900,000$900,000$900,000$900,000
Prime Rate4.25%4.5%5%5.25%
Max SBA Rate7.0%7.25%7.75%8.0
Loan Term10 years10 years10 years10 years
Annual Debt Service$125,397$126,793$129,611$133,034
Net After Debt Service$224,603$223,207$220,389$216,966
Additional Annual
Debt Service Cost 
over June 2017

At Pacific Business Sales we are experts in transactions with SBA financing and most of our transactions use SBA financing. We have excellent relationships with several SBA PLP (Preferred Lender Program) banks and as your Business Broker we will present your business to our preferred SBA lenders to get a preliminary approval (subject to buyer qualifying). If you are a buyer you can be confident that the SBA financing shown in our Confidential Business Review has been reviewed and approved by our SBA lenders.

Bill Grunau

About the Author

Bill Grunau

Bill has over 20 years of experience as a Business Broker specializing in industries ranging from manufacturing to construction/contractors, technology and software, B2B services, distribution-3PL, and healthcare. His transaction experience includes successfully closed transactions as both stock sales and asset sales including transactions with licensing such as contractors, healthcare, and companies with government contracts in Orange County and other Southern California locations. Bill works closely with a team of financial advisors specializing in tax strategies to minimize taxes on the sale of a business and are available to advise clients on how to minimize the tax liability on the sale of their business. Bill is the author of “Own Your Future, Straight Talk about How to Buy a Business and Build Your Future” Bill has a BS in Electrical & Electronic Engineering studying at Cal Poly Pomona and West Coast University and also studied at Claremont Graduate school EMBA program.