Interesting times

When it comes to the cost of borrowing, burgeoning UK ventures have rarely had it so good. Base interest rates are at historically low levels, having been on a downward trend since the late 1980s.
The UK base rate stood at a weighty 15 per cent in October 1989, yet the last change made in August 2005 by the Bank of England saw the rate moved south from 4.75 per cent to 4.5.
However, with the US rate now above that at 5.25 and a further rise likely, the gap between the US and UK is being stretched (UK rates are rarely above those in the US) and many analysts suggest the UK base is due a lift before the end of this year.


Private equity – will it feel the pinch?
Leading figures in the private equity space are cautioning that deals are being financed by too much debt, a risky situation for borrowers that affects both private equity houses and the companies that use them to back their bids. Experts worry that investors may be over-borrowing, storing up huge problems for the future should rates rise.
Philip Marsden, director at Vantis Corporate Finance, explains: ‘When rates go up, finance becomes less available and it becomes more expensive to make acquisitions with debt. In the private equity and venture capital arena, companies making acquisitions have depended on high levels of debt being available, with the banks lending on multiples of EBITDA (earnings before interest, tax, depreciation and amortisation). Now, that multiple will inevitably come down when interest rates go up and that in turn directly affects the mergers and acquisitions market.’

High rates equal strategy shifts
For growing companies, Marsden identifies two key effects of a rising rate environment. ‘There’s the market side, where rising rates affect demand for a growth company’s goods and services, putting the squeeze on spending. As rates rise, growing companies might have to consider the robustness of their forecasts, asking themselves how they are going to contend with lower sales.’
Conversely, when interest rates fall, economic expansion usually follows and this will also have an effect on a company’s strategy. Does the business have enough staff to deal with a swift rise in sales if growth follows suit? Can the business speedily gear up in terms of capacity, or capitalise on acquisitions in a land grab in its sector?
‘The second real effect is on the company directly,’ continues Marsden.
‘If rates rise and the company has been heavily dependent on bank borrowing or asset-based lending, everything becomes more expensive for that company.’
If rates do start to push higher, bankers – ever risk averse – start to become nervous about the quality of a company’s debts and also about the cover for those debts. ‘The profit-to-interest ratio (interest cover) falls and a company might have to pull back by reducing working capital or stocks.’

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