5 Questions with Kemp Anderson

1. What’s going on with interest rates?

There is a tug of war between increasing prices (inflation) and the Federal Reserve — the controller of interest rates in the U.S. The Federal Reserve’s mission is to keep the U.S. economy running at that perfect temperature. When the economy runs too “hot,” market distortions like inflation and the asset bubbles can arise. Too “cold” and we can enter periods of economic recession with GDP growth and investments declining.

2. How does the Fed change rates?

Generally, the Fed changes the interest rate on reserve balances. This is the interest rate that banks hold their reserve balance accounts at the Federal Reserve. Since the Fed is paying higher interest to financial institutions on reserve balances, short term interest rates are lifted to match this risk-free opportunity.

3. How do higher rates affect my business?

Higher interest rates increase the cost of credit throughout the economy, meaning loans and other credit products get more expensive for businesses and consumers. Depending on how you purchase fleet or inventory, it is important to understand the terms of those agreements, as you may be paying more than you were in a low-rate environment.

4. How does this impact acquisitions?

As interest rates rise, the future value of a dollar goes down. Said differently, it costs more to borrow and finance deals. Gone are the days of the cheap debt, and with greater scrutiny on our financial institutions after the collapse of several banks, credit is going to be harder and more expensive to find. The good news is a large portion of strategic buyers don’t rely on heavy debt financing, and private equity firms are still sitting on a substantial amount of cash that they raised in more relaxed macroeconomic environments. In the years to come, multiples may start to get squeezed, however, the industry remains strong and a safe haven for buyers. So, with today’s current low tax structure and high demand for well-run pest control companies that continue to receive high multiples, it is still a great time to sell.

5. Do interest rates affect private equity activity?

Private equity firms are impacted by rising rates in some instances because of their reliance on debt to fund portions of acquisitions. As the Fed raises rates, the cost of debt gets higher, which increases the cost of purchasing a company using debt. PE firms have already raised a substantial amount of capital in a low-rate interest rate environment that they will need to deploy in the years to come. It will be interesting to watch how transactions are structured in a world where debt is no longer cheap. We expect to see an increased reliance on equity roll over by owners and a push for owners to hold larger notes.