Learn how the Fed's recent rate cut impacts tech companies, increasing valuations, driving investment, and fueling growth through fundraising, IPOs, and M&A opportunities.
On September 18, 2024, the Federal Reserve made a significant move, cutting interest rates by 0.5 percentage points in an attempt to stimulate the slowing economy. This decision, the first major rate cut since 2020, brings the Fed’s benchmark rate to a range between 4.75% and 5%. While much of the focus has been on the general effects of lower borrowing costs for consumers and small businesses, tech companies stand to benefit uniquely from this development.
Michael Seaman, CEO of Swipesum, sheds light on why this rate cut is particularly exciting for tech companies and investors alike.
At their core, tech companies—especially startups and early-stage firms—are typically valued based on revenue multiples. This relative measure compares a company’s revenue growth to its peers, but there is also an absolute measure that determines fair value: discounted cash flow (DCF), a model that values companies based on their future positive cash flows.
Here’s why the Fed rate cut matters in this context:
Tech companies often operate at a loss, especially during their growth phases. For these companies, profitability might be years away, with positive cash flows projected far into the future. The DCF model discounts future cash flows back to the present to determine their current value.
As Seaman explains, the farther into the future the cash flow, the larger the discount, because “a dollar tomorrow is worth less than a dollar today.” The rate used to discount future cash flows is tied to the risk-free rate, which in turn is influenced by the Fed funds rate.
The foundation for the discount rate (or risk-free rate) is closely tied to the Fed funds rate. When the Fed cuts interest rates, the cost of capital decreases, meaning that the discount on future cash flows is reduced. As a result:
For tech companies with a long runway before they become profitable, lower interest rates make their future potential more valuable today. This increases optimism among investors, making them more willing to invest in these companies, whether through fundraising, IPOs, or mergers and acquisitions (M&A).
With lower interest rates, the tech sector becomes an attractive option for investors looking for higher returns. Here’s why:
Lower interest rates often drive mergers and acquisitions. When borrowing costs drop, larger tech companies or private equity firms can finance acquisitions more easily, leading to a surge in M&A activity. Additionally, smaller tech companies become more attractive acquisition targets as their valuations increase due to the lower discount on future earnings.
For tech companies, especially those in growth mode, now is the time to take advantage of the lower borrowing costs and increased investor interest. Here are a few ways to leverage the Fed’s rate cut:
Though the Fed’s rate cuts will take 6-12 months to fully filter through the economy, the tech sector could see more immediate benefits in terms of investor interest and higher valuations. However, it’s essential to remember that while lower rates are favorable now, they are also a response to slowing economic growth and rising uncertainties.
Michael Seaman’s insight underscores the unique position tech companies find themselves in with this rate cut. As future-oriented businesses, tech companies will benefit from the reduced cost of capital, higher valuations, and greater access to funding. The rate cut may also be a harbinger of increased M&A and IPO activity in the months to come.
Conclusion
The Federal Reserve’s rate cut marks a significant turning point for tech companies. Lower interest rates increase the value of future cash flows, raising company valuations and driving more investment into the sector. Tech companies should seize the opportunity to ramp up fundraising, explore M&A, and consider IPOs as investor optimism grows. While the economic outlook remains uncertain, the Fed’s decision provides a clear boost for the tech industry, positioning it for growth in a lower-rate environment.
For tech companies focused on future growth, this rate cut could be the financial catalyst that drives long-term success.
To have a conversation with Michael Seaman, just reach out.
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