How rising interest rates affect business value

Where were you in ’74?

I was a pikkie at Florida Primary school. Prime interest rate was at 7.5% the previous year. At the end of ’73 Prime went up to 8%. South Africa has never seen interest rates that low, since. In 1974 Prime leapt in a series of moves to 9%, 10%, 11% and finally 12% on 7 October. That was a leap of 60% in the cost of borrowing money, in less than a year.

My source is Here is the picture:

South African Prime Rate History graph

I’m no expert on interest rates, but then I don’t think it needs any expert to predict that interest rates are likely to rise soon.

If they do, this is how the value of your business will be affected:

  1. Your business’s monthly expenses will go up if you have any borrowings at all. This will result in lower profits, which in turn automatically results in lower business values. No brainer.
  2. Sellers fearing the worst will be added to the pile of businesses on offer. Extra supply drives prices down.
  3. It will become more advantageous for cash flush people to leave money in bank accounts earning interest, than invested in more risky investments such as businesses. A lowering of demand generally leads to lower prices.
  4. The cost of borrowing to buy businesses will go up – higher interest rates. As a result it will become more difficult for people to borrow in the face of tighter borrowing covenants. In my experience, this results in the inevitable lower outcomes of sale negotiations. Sellers who have to sell, will do so at lower prices.

As I say: I am no expert on interest rates, but I do feel in my water that interest rates may just start ticking up soon. I am old enough to remember interest rates of more than 25%. I talk about those days around the braai today, and nobody seems to remember. The current regime is just as capable of cocking it up as the last one.

Some perspective: 25% Payable on your home loan of R1M, over 20 years will cost R21,000 per month. At the current 8.5% it is costing R8,700 per month. “Prime plus…“ arrangements have been ignored in that calculation.

So in addition to the four points about interest and business value: Consider the discussion the prospective entrepreneur will be having with its spouse about affordability and over extension, before they make any offers on your business.

I’m not suggesting that Prime will rocket to 25% in three and a half years the way it did under PW Botha. But it is worth knowing how interest rate changes can affect the value of your business.


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