By Hillary Canada
Posted in The Wall Street Journal on February 3, 2015. Original article can be found here.
Private equity deal makers are steeling themselves for an increase in interest rates, according to a new survey from the New York chapter of the Association for Corporate Growth.
More than 40% of the 125 midmarket executives polled by the trade group said they believe the Federal Reserve will start to increase interest rates in the third quarter, while just one in five predicted rates would remain unchanged.
As The Wall Street Journal’s Jason Zweig wrote last week, analysts and market strategists predict that for stocks, a rate hike “will be a good thing,” assuming “the Fed will raise interest rates only when it is confident that the economic recovery is robust.”
It is harder to say whether an increase would be a “good thing” for the private equity industry.
The low interest rate environment has been a boon for buyout shops, providing ample liquidity for firms to finance transactions and pay themselves dividends by adding debt onto the companies that they own.
But in other ways, the vast ocean of cheap debt has proved to be too much of a good thing. With plenty of financing available, and plenty of competition from corporate acquirers desperate for growth, prices have skyrocketed. Deal makers are anxious to avoid repeating the same mistakes of the past decade—specifically paying top dollar for companies like Caesars Entertainment Corp. and Energy Future Holdings Corp., only to see them tumble into bankruptcy.
In that sense, a rate hike is seen by some industry executives as beneficial and necessary to normalizing valuations—a strong, sobering cup of coffee after a wild night of drinking.
An increase could also drive more deals by inducing entrepreneurs to sell their businesses, said ACG New York Executive Director Bobby Blumenfeld.
The low interest rate environment doesn’t present great options for business owners looking to reinvest proceeds of a sale, said Mr. Blumenfeld. “Where are you going to put your money?”