Do increases in federal funds rates affect the sale of my business?

Demystifying Valuation, Economic Damages + Forensic Accounting

In basic terms, the federal funds rate refers to the target rate that commercial banks borrow and lend their cash reserves overnight. The federal funds rate influences short-term treasury interest rates and indirectly affects everything from home and automobile loans to credit card rates.

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This month the Federal Open Market Committee increased the federal funds rate by 25 basis points (.25 of a percent) from .25% to .50% and it is expected by the end of 2022 the federal funds rate will be close to 3.0%.

If treasury yields follow suit (all indications are that they will) then the risk-free rate of return will increase as the federal funds rate increases. This is important since the risk-free rate is a component of an investor’s overall discount rate.

So, how does this impact private company valuations? All things being equal and in simplified terms, a 20% discount rate can translate to a 5x EBITDA multiple and if the discount rate increases by 3% due to the increase in the federal funds rate, a 5x multiple turns into a 4.3x multiple and has the effect of decreasing valuations.

If you have any questions regarding the federal funds rate, contact your Henry+Horne advisor.

Michael R. Metzler, CPA, ABV, CMA, CGMA, ASA