Rate Cuts Begin: How the Fed's Decision Could Ignite M&A Activity

Analyzing the recent decision by the US Federal Reserve to cut interest rates by 50 basis points, we can't help but feel excited about the potential impact on exit markets for privately held companies.

This highly-anticipated move marks the first US interest rate cut in four years, and I believe it will significantly lower borrowing costs for businesses and likely increase M&A dealmakers' appetite.

The Fed's choice to lower rates by half a percentage point instead of the more common quarter-point cut signals a relatively dramatic approach to their easing campaign. More cuts are expected in the coming months, with Carlyle CEO Harvey Schwartz predicting three rate cuts before 2025 in a recent CNBC interview.

Even strategic buyers in M&A are sensitive to high interest rates, as they increase the cost of capital.

We are already seeing the effects of easing monetary policy in Europe, where rate cuts by the European Central Bank, Swiss National Bank, and Sweden's Riksbank in Q2 helped drive a 17% rise in M&A deal value over the previous quarter, based on PitchBook data.

The lowering of interest rates by the Federal Reserve is likely to have several positive impacts on lower middle market M&A activity:

Increased Deal Flow

Lower interest rates generally stimulate M&A activity across the board, including in the lower middle market. This is expected to happen for a few key reasons:

• Reduced borrowing costs make it easier for buyers to finance acquisitions.
• Lower rates can improve company valuations
• The overall economic environment tends to become more favorable for deal-making.

Improved Financing Options

With lower interest rates:

• Debt becomes cheaper, allowing buyers to potentially take on more leverage for acquisitions.
• Private equity firms may find it easier to finance deals
• Banks and other lenders may become more willing to provide acquisition financing.

Increased Buyer Interest

Lower rates are likely to stimulate buyer interest in the lower middle market:

• Strategic buyers may become more active as their cost of capital decreases.
• Private equity firms, facing pressure to deploy capital, may increase their focus on lower middle market opportunities.
• The overall risk appetite for acquisitions tends to increase in a lower interest rate environment.

Potential Valuation Impacts

While lower rates generally support higher valuations, the effect in the lower middle market may be nuanced. But overall, improved financing terms could allow buyers to pay higher multiples for attractive targets.

Considerations for Sellers

For lower middle market business owners considering a sale:

• The improved deal environment may create more exit opportunities.
• Timing remains crucial, as the full impact of rate cuts on M&A activity will likely materialize quickly, but in an election year there are questions about changes to capital gains taxes.

While the rate cut is expected to have a positive impact on lower middle market M&A, it's important to note that other factors, such as sector-specific trends, and individual company performance, will also play significant roles in individual deal activity and valuations.