Why is yesterday's business valuation no longer relevant?

Buyers worry about paying too much and sellers about selling for too little — and that tension is sharper today. As central bankers raise rates to cool inflation, the rate investors use to discount future cash flows also climbs, so future earnings are worth less in today's dollars and valuation estimates fall. When the cost of capital is higher, buyers expect sellers to lower the price, because the old price can no longer meet their return thesis.

Why have valuations fallen?

- Higher discount rates — rising rates reduce the present value of future earnings, pulling down valuations
- Less certainty in forecasts — uncertain top-line revenue, rising supplier costs and rising labour costs lead buyers to place less credence in projected earnings

How do buyers and sellers bridge the gap?

- Earnouts — buyers defer part of the purchase price and pay it only if the business hits milestones such as an EBITDA or revenue target; in the US, 21% of private M&A deals used earnouts last year, up from 17% in 2021, with EBITDA-based measures (favoured by buyers) increasing
- Tight credit — as acquisition debt grows scarce and lenders tighten standards, buyers must commit more equity, and some turn to sellers to fill the funding gap
- Seller notes — the seller takes part of the proceeds as subordinated debt ranking below senior bank debt; it carries more risk and a higher rate than senior debt but lower than mezzanine. In one example, a deal was funded 31% equity, 39% bank and private debt, and a 16% seller note at 5% interest

Sellers who accept deferred or contingent consideration can still reach the valuations common before inflation, supply-chain strain and rising capital costs became headline news — while reducing risk by no longer holding 100% of the business. The alternative is to not transact, keep 100% of the future risk and hope conditions improve, and hope is not a strategy.

Key facts: why old valuations no longer hold

Rising rates lift the discount rate, lowering the present value of future earnings and business valuations
Forecast uncertainty (revenue, supplier and labour costs) makes buyers discount projected earnings
Earnouts: defer price until EBITDA or revenue milestones are met; 21% of US private M&A deals used them last year, up from 17% in 2021
Seller notes: subordinated seller financing below senior debt; priced above senior debt, below mezzanine
Example deal structure: 31% equity, 39% bank and private debt, 16% seller note at 5% interest
Bridging the gap lets sellers reach stronger valuations while sharing post-close risk

Disclaimer: This article is for general informational purposes only and does not constitute legal, tax or financial advice. Consult qualified advisors regarding your specific circumstances.