M&A is highly responsive to changes in interest rates. It’s easier and cheaper, at least on the debt side, to finance acquisitions in a low-interest-rate environment as acquirers can borrow more cheaply. This should drive higher deal-making activity. Indeed, most large-scale acquisitions are debt-financed, where lower rates alleviate some of the pressure from interest payment post-acquisition. This really works quite well for private equity firm since such an environment can really be supportive of LBOs, where in a target company is funded with borrowed money. However, with high interest rates, the cost of borrowing increases, and so does that of funding acquisitions.
More often than not, it would then be slow M&A activity-since the margins on deals need to be higher to offset the increased financing cost. As the interest rates rise, the value of the target companies falls with it. This is because high discount rates reduce the present values of future cash flows. In this case, the prices offered by the acquirers become lower. 2. Leveraged Buyouts (LBOs)