“Scientists have developed a powerful new weapon that destroys people but leaves buildings standing — it’s called the 17% interest rate.”
– Johnny Carson
An interesting concept – interest. It’s great when you’re earning it. It kinda sucks when you’re paying it. But either way, its compounding performance can be impressive when the rate rises to 10% and higher.
As far as the sale of businesses is concerned, a rise in interest rates, at the obvious value level:
- From the buyer it is:
- more expensive to borrow money to buy businesses (or to “leverage” the acquisition)
- harder for buyers to convince banks that the deal is a good one
- more attractive to earn interest with cash money in the bank than to risk it in a business
The result is that there are fewer buyers of businesses. Demand is lower.
- For the business owner it is:
- more difficult to do business as an economy slows down
- more difficult to meet monthly interest payments which are higher
- difficult to hear of more customers struggling to pay on time
- an attractive option to exit the business and put the cash in the bank
The result is that there are more businesses on the market for sale, all chasing a shrinking number of prospective buyers. Supply is higher.
Economics 101:
Lower demand leads to lower prices
Higher supply leads to lower prices
Those two statuses lead to an interesting situation, where far from the basic economics of buying potatoes at the market, the buyers in the case of businesses, are risking a lot of money. The result is that they are more careful in a situation where they do not need to be pressed by the risk of losing any particular opportunity to a competing buyer. They have time to look at many other businesses for sale at the same or similar asking price. This puts pressure on the sellers. This leads to lower prices.
There is another compounding problem. When interest rates rise, expenses go up and profits fall. Lower profits are less attractive to buyers of businesses. Values of businesses fall.