Business Valuation
November 2021
The value of most businesses is based on the buyer’s (real or hypothetical) required rate of return. The required rate of return is, in turn, affected by prevailing interest rates. Lower interest rates tend to cause the value of businesses to increase and vice versa. Prevailing interest rates in the United States are affected by the Federal Reserve’s policy on the federal funds rate. The federal funds rate is the target interest rate set by the Federal Reserve at which commercial banks borrow and lend their excess reserves to each other overnight. The federal funds rate is generally lowered by the Federal Reserve when the economy slows and is raised when economic growth causes excess inflation. The goal of the Federal Reserve in lowering the federal funds rate is to reduce the cost of borrowing, which makes people and businesses more willing to purchase goods and services. Although not directly tied to the federal funds rate, interest rates for mortgages, credit cards, auto loans and bonds tend to follow movements in the federal funds rate.
The Federal Reserve announced after its November 2-3 meeting that the federal funds rate would remain in the 0% to 0.25% range (an historic low) until the economic effects of the coronavirus had waned. Although inflation has recently increased, the pressures causing the increase were thought to be transitory. The Federal Reserve has stated that it will be patient in increasing the federal funds rate, but will not hesitate to act if inflation remains elevated.
In order to achieve some perspective as to the low level of the current federal funds rate, it should be noted that from 1954 (when records started being kept) and prior to 2008 (when an economic downturn occurred prompting the Federal Reserve to lower the federal funds rate) the federal funds rate had a low of 0.63%, a high of 19.1% and an average of 5.69%. It’s easy to see, if history repeats itself, that there is a strong probability that the federal funds rate will increase in the coming years, likely in conjunction with a rise in inflation. The effect of this will likely be a decrease in the values of businesses in general, everything else being the same.
Relevant Court Cases
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Benjamin M. Snyder v. Laura E. Snyder,
Wyoming Supreme Court,
2021 WY 115,
dated October 20, 2021
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In re Marriage of Mullen,
Court of Appeals of Iowa,
No. 21-0485,
dated November 3, 2021
Recent Business Valuation Articles
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“Falling Rates and Rising Superstars,”
by Thomas Kroen, Ernest Liu,
Atif R. Mian and Amir Sufi,
dated October 18, 2021
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“Which Multiples Matter in M&A?
An Overview,”
by Matthew Shaffer,
dated October 20, 2021
Recent Engagements
- Valuation of the class B non-voting common stock of a food service
distributor on a minority interest basis for gift tax reporting purposes.
- Valuation of 100% of the common stock of an HVAC service company
on a controlling interest basis for estate tax reporting purposes.
- Valuation of limited partnership units in an investment holding
company on a minority interest basis for gift tax reporting purposes.
- Valuation of the class B non-voting common stock of a
convenience store and restaurant holding company on a minority
interest basis for charitable donation/income tax purposes.
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