After the March 20 meeting, the Federal Reserve announced that they would again hold rates at the target range of 5.25% - 5.50%. This is the fifth consecutive meeting that rates have remained the same as shown below:
These higher rates have caused some business owners to rethink their plans to finance an acquisition or buyout. However, Alicia Chandler, Oak Street Funding president, addressed these concerns. “Everyone needs to understand that despite the change in the interest rate and the volatility right now, lending is happening.” There are still great opportunities for acquisitions, and succession plans should still go on.
The implications of the rising rates will have a varied impact on the insurance, CPA, and RIA industries. The Federal Reserve is not expected to begin lowering rates until the second half of 2024 as they strive to return inflation levels to 2%. Although both January and February's CPI reports were higher than anticipated, inflation has continued a downward trend and is at a lower rate than January and February 2023. The Fed has indicated they need to be more confident in this trend before reducing interest rates.
Because of inflation levels this, insurers may see a decrease in the number of policyholders as households drop coverage in an effort to save money. Insurance agents will need to market their non-monetary value to retain clients who may seek a less expensive option due to rising costs.
CPAs will likely see a few clients forego services to save money while others will continue to seek advice on managing their P&Ls and navigating complicated taxes.
In the RIA industry, buyers and sellers are both getting more selective, and those holding off on imminent succession or retirement are working to improve their businesses to maximize value.
Although the rates have impacted deal count, Q1 2024 transaction numbers still are very healthy from a historical perspective. Despite the turmoil, deals are still taking place, and Oak Street Funding remains a stable partner for businesses seeking capital to fund acquisitions or succession. As a non-SBA lender, Oak Street can customize deals to meet the unique needs and circumstances of clients.
“To combat the interest rates, we’ve seen more creative seller notes or earnout structures. We’re adjusting our underwriting process to address these adjustments and help our clients adapt to the current environment,” explains Alicia Chandler. For example, previously when rates were lower, a standard acquisition payout might look like the following.
Example of a standard acquisition payout
Today, we have seen more deals where the seller is willing to accept a longer-term seller note or earn out, or even accept less up front with a larger potential earnout on the back side as shown below.
Example of an acquisition payout with longer-term seller note
Instead of a three-year payout structure, the seller may be willing to accept a five-year payout. Additionally, the seller can take an earnout instead of a set payout. This means the seller payments are based on the performance of the business. Thus, if the business meets agreed upon performance metrics, the seller receives a payment. This helps ensure there are funds available to pay the selle.
With creativity and perseverance, prudent business owners will continue to leverage debt to build equity. Business owners should not freeze just because interest rates are higher. In preparing for the future, business owners can:
Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.