How higher interest rates are affecting private equity


June 20th, 2024


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Vesta Software Group

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interest rates private equity

Traditionally, private equity (PE) firms have thrived on low interest rates, using these periods as a time to snap up one company after another before typically turning them around and selling a few years later for substantial profits.

As banks continue to raise and maintain higher interest rates in an effort to keep economies stable and inflation in check, we’ve taken a closer look at how these macroeconomic measures are impacting the world of PE – and what they mean for us here at Vesta Software Group.

How does private equity work?

PE is a form of financing in which a firm invests in a business in exchange for an equity or ownership stake. It can be extremely beneficial for both parties when conditions are right; businesses receive the investment and expertise needed to achieve significant growth, while the PE firm can potentially secure high returns when they choose to exit.

What is the connection between interest rates and private equity?

PE firms are among those most exposed to changes in interest rates because of the two main strategies involved in the process: venture capital and leveraged buyout.

Leveraged buyout

With leveraged buyout transactions, PE firms boost their returns by financing the takeover of a company using little capital, instead relying on (historically) cheap debt. However, as interest rates rise, the cost of borrowing increases and servicing the debts in portfolio companies becomes more expensive.

It’s in these situations where private equity firms often need either substantial increases in efficiencies or significant top line growth in order for a deal to be profitable.

Venture capital

In the case of venture capital (VC), these investments are rarely financed with leverage and, as such, tend to avoid the challenges associated with direct interest rate exposure. However, they can experience indirect impacts, primarily through shifting valuations.

In many cases, VC investors will have the funds to invest, but will choose to delay committing to these as they wait to see how the market adapts. This was reflected in the UK in 2022 (when interest rates initially began to rise) as VC investment stood at $31bn, a significant 25% drop on the previous year.

How do interest rates impact Vesta?

In short – not much! Because our acquisitions are financed by our own cash resources, macroeconomic changes have a much smaller impact on business operations here at Vesta.

Our ‘buy and hold forever’ ethos also means that we’re in it for the long haul. We’re not here to make a quick buck and flip a company to the highest bidder, so fluctuations in markets won’t affect us in the same way as traditional private equity.

We’re always looking to speak to vertical market software companies who want to take the next step in their journey. Get in touch to arrange an informal chat today.