Influence of inflation on corporate transactions
From economics, we all know that a higher interest rate policy can be used as a tool to counter inflation. The business press frequently reports that higher interest rates are making corporate transactions more difficult. However, a closer look reveals a differentiated picture. The yield on ten-year German government bonds was just over 6% for the previous 20 years before the financial market crisis in 2008/2009. And please believe me — I’ve been doing this for more than 20 years, too: even then, there were very, very sensible M&A transactions. Against this backdrop, the current interest rate level is still favorable over a longer observation period. Certainly, the interest rate level has an influence on the company valuation via the cost of capital.
Rising interest rates lead, ceteris paribus, to lower company values and prices. In my opinion, however, the decline in the number of transactions is due less to rising interest rates than to a significant increase in uncertainty on the part of buyers. This uncertainty is triggered by the sum of the events of the last three years. First, with the COVID pandemic, we had to survive a situation that no entrepreneur had ever experienced before in his entrepreneurial life. When this crisis seemed to have been overcome, the upward trend was abruptly interrupted by the Russia-Ukraine war. In my opinion, there is no end in sight here and therefore no forecast can be made about energy and raw material price developments. A few years ago there was the buzzword VUCA  ; in this uncertainty, a common reflex is to “keep powder dry”, i.e. not to spend existing financial resources on corporate transactions, but to keep them within the company to finance operational challenges.
Another factor that we have not had too many problems with in the past is the technical handling of inflation in business valuation. The basis for an income-based business valuation is the planning calculation of a company. This planning calculation on a nominal basis must also take into account inflation-related price effects in the modeling of the income statement and balance sheet. In addition, the so-called terminal value, i.e. the infinite continuation value in the financial mathematical valuation calculation, is an important influencing factor. This terminal value is determined with the aid of a perpetual growth rate. The factors influencing this growth rate are inflation, growth and retention. In the past, these complex interrelated factors were mapped at 1% growth rate in the vast majority of cases. This parameter, which is sometimes assumed to be rather typical, must now be reconsidered in every evaluation. Again, the business valuation process becomes rather more complex. All of the above factors add another element of uncertainty to the valuation of subhems. Overall, this increases the entrepreneurial risk and as stated above — many entrepreneurs hesitate when making acquisition decisions.
 Acronym referring to “volatility”, “uncertainty”, “complexity” and “ambiguity”.
In addition to the subjectively perceived increasingly expensive shopping at the weekend, inflation is also seen when looking at stock portfolios. The DAX and other indices reach record levels. Normally, this should be a sign of a good economy and bubbling corporate profits. However, this is currently not the case, so that in my view these highs ultimately represent a further sign of inflation. Stocks, as real assets adjust to price increases and, in particular, listed companies with pricing power are naturally also in a position to be able to compensate for inflation effects on both the income and expense side. Against this backdrop, the highs on the stock market are largely due to inflation as much as to other factors.
I’ve gotten into the habit of judging new technologies by their serving function.
The topic of artificial intelligence, which is currently being conjugated up and down in all media, has long since found its way into everyday M&A. However, in my opinion, the term artificial intelligence is often used too superficially and in many cases simply means cleverly formulated algorithms that make certain digitization-capable processes run faster. — This still has nothing to do with AI. If you’ll pardon the expression, it’s not as if we haven’t been doing complex database queries, scenario calculations, Monte Carlo simulations, and the like. We have been doing that for a very, very long time. Of course, applications are increasingly being used that can extract tables from existing documents in due diligence processes, for example, or even create them, as in the case of lease overviews, but at the moment I can’t see any real influence on the outcome of corporate transactions. In technical transaction support, digitization — with or without AI — can ensure efficiency and robust processes.
However, artificial intelligence can only ever be as good as the definition of the input parameters. However, many influencing factors cannot be parameterized or are still subject to intransparency. For example, business leaders will not provide their corporate strategies en détail as input parameters to “feed” AI systems. In recent years, there have been many attempts to establish matchmaking platforms. These platforms were supposed to bring buyers and sellers together; so far with — let me put it charitably — moderate success. For decades, the M&A industry has had databases that classify companies based on industry codes. Now it seems relatively simple to superimpose these industry codes and thus identify companies that should be strategically relevant to each other. If, in addition, one balances financial circumstances according to the motto “who can afford whom,” it is obvious that such matchmaking platforms should represent added value. In practice, however, there are a large number of other influencing factors that are not recorded in such databases. This can be, for example, the speed of industry consolidation, the strategic fit of product portfolios, innovations or the like. No business leader is currently willing to parameterize their business strategy in detail and thus create the basis to define the input parameters for AI flawlessly. From there, considerations of strategic fit will continue to be the preserve of humans. Trust and empathy “still matters”.
About Arnd Allert
After ten years in corporate banking at Deutsche Bank and in a management position in steel trading, from 2000 managing director of an M&A consulting firm for corporate transactions. Founder and managing partner of Allert & Co. since 2003. Several advisory board and board of directors mandates. — Many years of experience as a lecturer at universities on the topics of “Corporate Finance”, “Mergers and Acquisitions” and “Negotiation Strategies”. CVA, Certified Valuation Analyst. Graduate of Harvard Law School’s PON Program on Negotiation.
Author of the book “Successfully Negotiating M&A Transactions in Small and Medium-Sized Businesses” and “Distressed M&A”. Co-author with: “Modern Restructuring Management” and “Selling Companies in Crisis”.