2023 has not seen as many or as aggressive interest rate hikes when compared to 2022. Currently, this year the Feds have only raised the Federal Fund Rate by 100 basis points (bps), not including an anticipated additional hike this year, while last year’s hike was 425 bps. On one hand, this is a breath of fresh air since it provides some stability in the marketplace and gives the signal that the Feds believe the interest rate hike is slowing down inflation. On the other hand, it’s important to remember the effects of interest rate hikes on valuations.
Interest rates affect transaction valuations in a variety of ways with some examples being higher borrowing costs, scarcity of deals, and adjustments in consumer spending. Higher borrowing costs lead to lower valuations in assets since in the Discounted Cash Flow model the present value of future cash flows is lower with higher borrowing costs. Scarcity of deals may arise as either organizations may hold off on selling their organization or the overall competition for deals increases. Due to increased rates consumers may spend less as credit card or mortgage rates are higher leading to lower bottom lines for organizations.
Going forward into 2024 it will be interesting to see how financial groups respond to the effects of two years of consistent interest rates hikes. We have seen firms incorporating this year’s anticipated final interest rate hike into their models, however, if the Fed does not hike rates again will this mean firms underpaid or missed other opportunities? Additionally, it will be interesting to see if changes in consumer spending affect organizations’ bottom line, and ultimately if organizations will choose to exit or wait for rates to drop, therefore increasing valuation. Compared to pre-pandemic valuations, current multiples are still lower, however, they did not suffer a drastic drop compared to 2022. Despite this drop, multiples have remained strong even with aggressive rate hikes which begs the question of
whether 2024 will see the multiples bubble pop.
Interested in learning more about how interest rates might impact your business? Contact Jon Molayem at Acquivest.