Interest Rates and Your Multiple - The Connection Nobody Explains

You’ve spent fifteen years building a company worth $12 million, and a private equity buyer just offered you 4.5x EBITDA. Eighteen months ago, a similar company in your industry sold for 6x. What changed? Not your growth rate. Not your margins. Not your competitive position. What changed was the Federal Reserve’s interest rate policy and with it, the math your buyer uses to determine what they can afford to pay.

Executive Summary

The valuation multiple you receive when selling your business depends partly on factors completely outside your control, specifically, the cost of capital available to your buyers. This article explains the leveraged buyout (LBO) model that private equity sponsors use to calculate maximum purchase prices, showing how interest rate changes flow directly through to offer prices. Understanding this connection between macroeconomic conditions and transaction outcomes helps business owners make informed decisions about exit timing.

When interest rates rise significantly, LBO models show measurable purchase price capacity declines. Industry data from multiple sources including PitchBook and LCD News suggests that rate increases from 2022-2024 contributed to median lower middle market multiples compressing from approximately 6.5-7.0x in 2021 to 5.0-5.5x by late 2024, a decline of roughly 20-25%. For a business generating $2 million in EBITDA, this compression translates to a difference of approximately $3 million in enterprise value before transaction costs.

We’ll walk through the LBO valuation model step by step, show you how to read credit market conditions, and provide a framework for incorporating interest rate considerations into your exit planning timeline. The goal isn’t to make you a financial engineer but to ensure you understand why the offer you receive reflects more than just your company’s intrinsic value.

Important caveats: First, this analysis applies primarily to businesses where leverage financing is common (typically service companies, light manufacturing, distribution, and technology businesses). Asset-heavy industries like real estate or capital-intensive manufacturing may show different patterns. Second, this article explains how rates affect multiples, not how to predict rate movements. Do not use this information to conclude “rates might rise, so I should exit now.” Rates could rise, fall, or stay stable. Focus on what you control (business improvement) and let rate changes inform your timeline rather than dictate it.

Introduction

Most business owners understand that their company’s value depends on revenue growth, profit margins, competitive advantages, and operational efficiency. Fewer understand that their ultimate sale price also depends on what’s happening in credit markets thousands of miles away. This knowledge gap can lead to frustration, missed opportunities, and poorly timed exits.

The connection between interest rates and your multiple runs through the leveraged buyout model, the financial framework that private equity sponsors, family offices, and even strategic buyers use to determine maximum purchase prices. In an LBO, buyers use debt to finance a significant portion of the acquisition. PitchBook data suggests that leverage ratios for companies with $2-10 million EBITDA averaged 55-65% of purchase price during 2018-2021, declining to 45-55% in the 2023-2024 period as credit conditions tightened. The cost of that debt directly affects how much buyers can pay while still achieving their target returns.

This creates a paradox for sellers: you may have built a more valuable company this year than last year, but receive a lower offer because credit conditions have tightened. Understanding this dynamic doesn’t give you control over interest rates, but it does give you the ability to set realistic expectations based on current market conditions and optimize the factors within your control.

Lower offer prices in high-rate environments reflect the mathematical reality that debt is more expensive, not that PE sponsors are behaving unfairly or that your company has become less valuable. Understanding this distinction helps you negotiate effectively and interpret offers accurately. You can’t argue that “your company is worth the same as in 2021” because financing costs have genuinely changed, but you can ensure your company’s relative standing within the current market commands appropriate premiums.

The LBO Valuation Model Explained

To understand how interest rates affect your multiple, you need to understand the basic mechanics of a leveraged buyout. This isn’t about mastering financial engineering but about seeing the constraints that define what buyers can pay.

How Private Equity Determines Maximum Purchase Price

Private equity sponsors start with their required return, which varies by fund size and strategy. According to Preqin’s GP Perspectives research, lower middle market funds (those acquiring companies with $2-10 million EBITDA) typically target gross IRRs of 22-25%, while larger platforms often target 15-18%. These are gross returns; after management fees and carried interest, net returns to limited partners typically run 3-7 percentage points lower. For our analysis, we’ll use a 22% gross IRR target, which is representative of the lower middle market.

Sponsors work backward from that requirement to determine the maximum price they can pay for your company. The calculation involves several variables: how much debt they can obtain, what interest rate they’ll pay on that debt, how much cash flow the business generates to service that debt, and what exit multiple they expect to achieve when they sell the business in five years.

Here’s a simplified example with explicit assumptions. Assume your company generates $2 million in annual EBITDA, with 6% annual EBITDA growth projected over a five-year hold. A buyer expects to sell at 5.0x EBITDA in five years. With 6% annual growth, year-five EBITDA would be approximately $2.68 million, yielding expected exit proceeds of $13.4 million.

If the sponsor needs to roughly triple their equity investment to achieve a 22% gross IRR over five years, they can invest approximately $4.5 million in equity. The remaining purchase price comes from debt. In a low-rate environment where they can borrow at 6% (SOFR plus a 400-500 basis point spread), they might support $6.5 million in debt, enabling a total purchase price of $11 million, or 5.5x your current EBITDA.

The Debt Capacity Constraint

Here’s where interest rates enter the equation. Debt capacity isn’t determined by how much a lender will theoretically provide but by how much debt service the company’s cash flow can support while maintaining adequate coverage ratios.

Institutional senior lenders typically require debt service coverage ratios (DSCR) of 1.2x to 1.5x at closing, with maintenance covenants sometimes stepping down to 1.1x in year three and beyond. Per SBA lending guidelines and standard middle market practices, DSCRs of 1.25x are common for bank credit facilities. Subordinated lenders may accept lower ratios, sometimes approaching 1.0x. When interest rates rise, each dollar of debt requires more cash flow to service, directly constraining how much debt the buyer can use.

Let’s trace through a complete example with transparent assumptions:

Starting assumptions for a $2M EBITDA company:

• EBITDA: $2,000,000
• Less: Cash taxes (25%): ($500,000)
• Less: Maintenance capex (3% of estimated $8M revenue): ($240,000)
• Less: Working capital changes (estimated): ($60,000)
• Free cash flow available for debt service: $1,200,000

At 6% interest rate with 1.25x DSCR requirement:

• Maximum annual debt service: $1,200,000 ÷ 1.25 = $960,000
• With 7-year amortizing debt (principal + interest), maximum supportable debt: approximately $6.5 million
• Interest expense at 6%: $390,000 annually (year one)

At 9% interest rate with same DSCR requirement:

• Maximum annual debt service remains: $960,000
• But each dollar of debt now costs more to service
• Maximum supportable debt drops to approximately $5.0 million
• Interest expense at 9%: $450,000 annually (year one)

With $1.5 million less debt available, the buyer has two choices: invest more equity (which reduces returns below the 22% target) or pay a lower purchase price. Since private equity sponsors are accountable to their own investors for achieving target returns, they typically choose the latter. In this scenario, the maximum purchase price might drop from $11 million to $9.5 million, a decline from 5.5x to 4.75x EBITDA, without any change in your company’s underlying performance.

The Return Requirement Reality

Private equity funds aren’t arbitrary in their return requirements. Their investors (pension funds, endowments, family offices) have chosen private equity over other asset classes specifically because of the return premium it offers. According to McKinsey’s Private Markets Annual Review research, institutional LP return expectations for PE typically range from 12-18% net returns depending on risk profile and liability matching requirements, with pension funds often at the lower end and family offices spanning the full range.

While return requirements can theoretically flex downward in response to rising rates, disciplined PE investors rarely lower return hurdles for individual deals. The fund manager who accepts a 15% return on one deal to “get it done” faces questions from LPs about why they’re paying PE fees for public-market-like returns. This discipline is what creates the pricing constraint you experience as a seller.

That said, in extremely tight credit markets with limited deal flow, some sponsors may pursue lower-return deals or accept compressed multiples, particularly as fund investment periods near expiration. This is the exception, not the rule, and it doesn’t change the fundamental math that higher rates constrain pricing.

Interest Rate Sensitivity Analysis

Understanding the general relationship between interest rates and multiples is helpful. Seeing specific scenarios makes the impact concrete.

Quantifying the Impact

Consider a business with $2.5 million in EBITDA, stable cash flows, and moderate growth prospects. We can model how different interest rate environments affect the maximum purchase price a private equity buyer can pay while achieving a 22% gross IRR over five years.

Table Assumptions:

• Current EBITDA: $2.5 million
• EBITDA growth: 6% annually (reaching $3.35M by year 5)
• Exit multiple: 5.0x (year 5 enterprise value: $16.75M)
• Target IRR: 22% gross
• Debt structure: 7-year amortization, floating rate (SOFR + spread)
• DSCR covenant: 1.25x minimum
• Tax rate: 25%
• Maintenance capex: 3% of revenue

This table illustrates a key point: moving from a 5% to an 11% interest rate environment reduces the maximum payable multiple by approximately 1.6 turns, a difference of $4.0 million in enterprise value for the same company with the same performance. The compression from “Low” to “High” (a 400 basis point increase) represents a 21% decline in purchase price capacity. Note that these figures represent enterprise value before transaction costs, which typically run 8-12% of deal value and reduce net proceeds to the seller.

Current Market Context

As of late December 2025 (rates subject to daily change), the Federal Funds rate stands at approximately 4.25-4.50%, with SOFR around 4.3%. Adding typical PE lending spreads of 400-600 basis points per LCD News data, all-in borrowing costs for lower middle market acquisitions range from 8.5% to 10.5%, placing the market between the “High” and “Elevated” scenarios in our table.

Industry data from PitchBook and other middle market research providers suggests that median EBITDA multiples for lower middle market transactions have stabilized at approximately 5.0-5.5x, compared to 6.5-7.0x during 2021. This represents compression of roughly 1.5 turns, consistent with the rate-driven impact our model predicts.

Why Some Deals Still Happen at High Multiples

You might wonder why you still see headlines about companies selling for premium multiples even when interest rates are elevated. Several factors can override the LBO math:

Strategic premium: Corporate buyers acquiring companies for strategic reasons (geographic expansion, technology acquisition, competitive elimination) may use balance sheet debt rather than deal-specific leverage. Strategic buyers often pay 1.0-1.5x premium multiples due to synergy value, but require different preparation including management presentations, synergy justification, and cultural fit assessment. But even strategic buyers have costs of capital affected by broader credit conditions. Their corporate treasury calculates hurdle rates that reflect current interest rates, so the effect is present, just less acute than for pure financial sponsors.

Exceptional growth: Companies with demonstrated ability to grow EBITDA significantly can support higher purchase prices because buyers model larger exit values. A company with 15-20% annual EBITDA growth might support a multiple 0.5-1.0x higher than a flat-growth comparable, even in elevated rate environments. For example, a stable company might fetch 4.2x in a 9% rate scenario, while a high-growth company might achieve 4.8-5.0x. Growth is valuable, but it doesn’t fully offset rate compression.

Premium deal structures: Some transactions use earnouts, seller financing, or equity rollovers that reduce upfront cash requirements. While this can result in higher headline multiples, sellers should understand the tradeoffs. For example: a 5.5x headline multiple might translate to $13.75 million total consideration on $2.5M EBITDA, but only $9 million at closing, with $4.75 million as an earnout over three years contingent on reaching EBITDA targets. The cash received at close is typically lower, and contingent payments carry real risk.

Fund deployment pressure: Private equity funds must deploy committed capital within defined investment periods (typically 4-5 years). As those periods near expiration, sponsors sometimes accept lower returns rather than return capital to investors.

But for typical lower middle market transactions involving companies with $2-10 million in EBITDA and moderate growth profiles (5-10% annually), the LBO math constrains pricing in ways that track closely with interest rate movements.

Reading Credit Market Conditions

Understanding that interest rates matter is the first step. Knowing how to read current conditions enables you to assess timing implications for your exit.

Key Indicators to Monitor

Federal Funds Rate: The Federal Reserve’s benchmark rate influences all borrowing costs. Changes signal the direction of credit conditions, though private equity borrowing costs move with some lag. Available free at federalreserve.gov.

SOFR (Secured Overnight Financing Rate): This rate replaced LIBOR as the benchmark for floating-rate loans. Most private equity acquisition financing is priced as SOFR plus a spread, typically 400-600 basis points per LCD News data. Available free at newyorkfed.org.

Leveraged Loan Market Conditions: The health of the syndicated loan market affects how much debt private equity sponsors can obtain. Metrics like new issuance volume, average spreads, and leverage multiples indicate market appetite for financing acquisitions. LCD News and PitchBook provide regular commentary (subscription required for full access).

High-Yield Bond Spreads: Spreads between high-yield bonds and Treasury securities indicate risk appetite. Wider spreads suggest tighter conditions and lower leverage availability.

A Decision Framework for Monitoring

Monitor these indicators quarterly. Here’s a practical framework:

• If the Fed Funds rate changes by more than 100 basis points from your last check, or if the Fed signals a significant policy pivot, revisit your timeline assumptions with your advisor.
• If rates drop 100+ bps in six months, multiples likely to improve; you may have flexibility to extend your timeline if you’re not operationally ready.
• If rates hold at 5%+ for 12+ months with no signs of easing, multiples likely to remain compressed; consider accelerating if other conditions are favorable and your business is prepared.

You’re looking for trends, not trading opportunities. Quarterly awareness is sufficient. Don’t obsess over daily movements.

Exit Timing Implications

Understanding the interest rate-multiple connection creates a framework for thinking about exit timing, though it shouldn’t be the only factor in your decision.

When Timing Matters Most

Interest rate sensitivity affects your exit value most significantly when:

Your likely buyer universe is dominated by private equity: Financial sponsors are most constrained by LBO math. If your probable acquirers are strategic buyers with clear synergy value, rate conditions matter less (though they don’t disappear entirely, as strategic buyers also have costs of capital). Understanding your likely buyer mix is critical: if 70%+ of probable acquirers are PE-backed, interest rate conditions significantly affect your valuation.

Your company has stable but unspectacular growth: Companies with 15%+ annual EBITDA growth can command premium multiples in any rate environment because buyers model larger exit values. Companies with 5-10% growth are more subject to rate-driven multiple compression.

Leverage is typical for your industry: Software and SaaS companies with recurring revenue can often support 65-75% leverage even in high-rate environments due to cash flow predictability. Manufacturing, construction, and project-based businesses typically support 40-55% leverage. Your industry’s leverage norms affect how sensitive your valuation is to interest rate changes.

Your business falls in the $2-10M EBITDA range: This analysis applies primarily to lower middle market businesses where leverage is a meaningful financing component. For smaller companies under $1M EBITDA, equity financing often dominates (reducing rate sensitivity but potentially limiting buyer pool). For larger companies above $15M EBITDA, institutional lenders may offer more favorable terms based on credit quality.

The Timing Dilemma

Business owners face a genuine dilemma: waiting for better rate conditions might mean waiting indefinitely, while proceeding now means accepting current constraints. Rate timing carries significant risk. Owners who delay exits waiting for better conditions may face business deterioration, health issues, or competitive threats that outweigh any multiple improvements that eventually materialize.

Let’s test this dilemma numerically. Assume your company generates $2M EBITDA at a current 4.5x multiple ($9M value). If you wait three years and achieve 7% annual EBITDA growth while multiples remain compressed at 4.2x, your exit value would be approximately $2.5M EBITDA × 4.2x = $10.5M. That’s a $1.5M improvement despite multiple compression.

But if growth rates are minimal (2% annually) and multiples don’t recover, you exit at $2.12M × 4.2x = $8.9M, a decline from the current $9M. The decision depends on your confidence in growth, not on rate timing.

Several additional considerations inform this decision:

Personal timeline: If you need to exit within a specific window for health, family, or lifestyle reasons, rate conditions become secondary to personal requirements.

Business trajectory: A company on an upward trajectory may benefit from waiting, not for rate changes, but for continued performance improvement that supports higher absolute values even at lower multiples.

Market position: If competitive threats or industry disruption could affect your future performance, locking in current value might outweigh waiting for better rate conditions.

Reinvestment opportunity: Capital from a sale must be reinvested. Higher interest rates, while compressing acquisition multiples, also provide better returns on invested capital post-sale. A 5% risk-free return wasn’t available in 2021.

Strategic Buyers as an Alternative

When interest rates compress PE multiples, strategic buyers may offer a valuable alternative path. Strategic acquirers (typically larger companies in your industry or adjacent sectors) often pay premium multiples because they can realize synergies unavailable to financial sponsors.

When strategic buyers offer superior outcomes:

• Clear operational synergies exceed 20-30% of standalone value
• Geographic or product line expansion justifies premium pricing
• Technology or talent acquisition drives strategic value
• Competitive elimination provides defensive value to acquirer

When strategic buyers may be inferior:

• Limited strategic buyer universe in your sector
• Integration risks threaten value realization
• Cultural fit concerns create execution risk
• Longer due diligence timelines and regulatory scrutiny

The economic comparison typically shows strategic buyers paying 1.0-1.5x premium to PE offers when synergies are present. But strategic processes often take longer, involve more management presentations, and require sellers to articulate synergy justification clearly. If your business has obvious strategic value to identifiable acquirers, current rate conditions may matter less than if you’re primarily a PE target.

A Framework for Decision-Making

Rather than trying to time interest rate cycles, we recommend a framework focused on elements within your control:

First, maximize the value you control. The difference between a mediocre company and an excellent company in your industry typically exceeds the multiple compression from interest rate changes. A company commanding a 1x premium multiple because of exceptional performance outweighs a 0.5x penalty from elevated rates.

Second, understand your buyer universe. If private equity represents your most likely acquirer (70%+ of probable buyers), rate sensitivity matters significantly. If you’re more likely to sell to a strategic acquirer with clear synergy value, rate conditions matter less (though they don’t disappear entirely, as strategic buyers also have costs of capital).

Third, prepare thoroughly regardless of timing. The companies that achieve premium multiples in any rate environment are those with clean financials, documented processes, diversified customer bases, and strong management teams. For a business with basic financial controls and documented operations, this preparation takes 18-36 months. If your business requires significant operational cleanup (documenting processes, reducing customer concentration, developing management depth, or reconstructing clean financials), plan for 24-48 months. The timeline depends on your starting state, not just your end goal.

Exit preparation costs are substantial. Beyond time investment, expect direct advisory costs including investment banker fees (1.5-2.5% of transaction value), legal and accounting fees ($150,000-$300,000 for middle market deals), quality of earnings reports ($75,000-$150,000), and ongoing advisor fees ($50,000-$200,000 annually during preparation). For a $10 million transaction, total direct costs typically run $400,000-$800,000. Understanding these costs helps you evaluate net proceeds realistically.

Fourth, maintain flexibility if possible. If you’re in the operational cleanup phase and market conditions improve sharply, the decision isn’t automatic. A business that’s 90% ready operationally but could be 95% ready in six more months might be better served finishing preparation than rushing to a favorable rate environment. The risk of a buyer discovering issues post-letter of intent (which costs time and reduces multiples) often outweighs timing benefits.

Actionable Takeaways

Learn basic LBO math: You don’t need to build models, but understanding that buyers work backward from return requirements to maximum purchase price helps you interpret offers and negotiate effectively. Ask your advisor to walk through the math for your specific situation using current rate assumptions.

Identify your likely buyer universe: Determine whether financial sponsors, strategic acquirers, or other buyer types are most likely to acquire your company. If 70%+ of likely acquirers are PE-backed, interest rate conditions significantly affect your valuation. If strategic buyers dominate your space, rate effects are present but less acute and you may command premium multiples through synergy value.

Monitor key indicators quarterly: Track the Federal Funds Rate (federalreserve.gov) and SOFR (newyorkfed.org). If rates move 100+ basis points or the Fed signals policy shifts, consult your advisor about timeline implications.

Adjust expectations to current reality: If you’ve been assuming valuation multiples from the 2019-2021 period, recalibrate. Current lower middle market multiples of 5.0-5.5x represent the environment until credit conditions ease. Your advisor can provide relevant comparable transactions from recent quarters.

Focus on controllable factors: While you can’t influence interest rates, you can influence revenue concentration, EBITDA margins, management depth, recurring revenue percentage, and documentation quality (all factors that affect your specific multiple within any rate environment). A 1x premium for operational excellence exceeds the 0.5x penalty from rate compression.

Budget realistically for exit preparation: Plan for $400,000-$800,000 in direct advisory costs for a middle market transaction, plus significant management time investment over 18-36 months. These costs reduce net proceeds and should factor into your go/no-go decision.

Build flexibility into your timeline: If possible, create a 24-36 month window during which you’re prepared to transact. This flexibility allows you to move quickly if conditions improve or if an exceptional opportunity emerges, without rushing before you’re ready.

Avoid rate prediction traps: This article explains mechanisms, not forecasts. Don’t conclude “rates will rise, so I should exit now.” That logic could cost you $2-3 million if you exit prematurely instead of completing operational improvements that support higher value even at compressed multiples. Equally, don’t indefinitely delay hoping for better conditions. Rates may not improve on your preferred timeline.

Conclusion

The connection between interest rates and your multiple isn’t mysterious once you understand the leveraged buyout math that private equity sponsors use to determine maximum purchase prices. When debt becomes more expensive, buyers can afford to pay less while still meeting their return requirements. This mathematical reality means your company’s value (at least to leveraged buyers) depends partly on macroeconomic conditions beyond your control.

This understanding shouldn’t discourage you from pursuing an exit in elevated rate environments. Companies still transact. Industry data shows lower middle market deal volume in 2024-2025 running at approximately 80% of 2021 levels, not zero. Multiples have compressed from 6.5-7.0x to 5.0-5.5x in the current environment, which is significant but not catastrophic. A $2M EBITDA company that would have sold for $13M in 2021 might sell for $10-11M today. After accounting for transaction costs and reinvestment opportunities at higher rates, the effective difference in lifestyle may be smaller than the headline numbers suggest.

The transactions that make headlines are the ones that close. For every deal at 4.5x in an elevated-rate environment, there may be an attempted seller who withdrew at lower multiples or an owner who decided not to sell because conditions were unfavorable. Understanding this selection dynamic helps you set realistic expectations.

What this understanding should provide is context. When an offer comes in below what a neighbor received three years ago for a similar company, you’ll know that credit conditions explain part of the difference. When you’re deciding whether to exit now or wait, you’ll have a framework for weighing rate considerations against business improvement opportunities. And when you engage with buyers, you’ll understand the constraints shaping their offers, knowledge that enables more productive negotiations.

Your multiple depends on many things. Interest rates are one of them. Now you understand why and you know to focus your energy on the factors you can actually control.