Understanding the impact of inflation on deal valuations

In an economic landscape increasingly shaped by volatility, inflation stands out as a particularly disruptive force in corporate transactions. While inflation has always played a background role in financial modeling, its persistent elevation in recent years has repositioned it as a central factor impacting deal valuations. Far from a theoretical concern, inflation today exerts measurable pressure on both the pricing and structuring of acquisitions, influencing not only future cash flow expectations but also risk allocation, capital structure, and market sentiment. The implications are complex and multifaceted. Inflation does not merely erode currency value or increase costs—it introduces structural uncertainty into forecasting, compresses valuation multiples, and forces both buyers and sellers to recalibrate their assumptions. In sectors with high input cost sensitivity or long-term capital cycles, the consequences are particularly severe.

Recalibrating Discount Rates and Risk Premiums

One of the most immediate ways inflation alters deal valuations is through its effect on discount rates. Traditional models, such as discounted cash flow (DCF), rely heavily on projected future cash flows and the cost of capital. As inflation expectations rise, central banks respond with tighter monetary policy, which in turn increases the risk-free rate—the foundational component of the weighted average cost of capital (WACC). Consequently, even if a target company's performance remains stable, its present value is reduced due to higher discounting. Additionally, inflation heightens uncertainty across industries, leading to an increased equity risk premium. Buyers are demanding greater returns to compensate for heightened macroeconomic risk, supply chain instability, and potential policy shifts. This has the effect of compressing valuations, particularly for companies with cyclical revenue streams or heavy reliance on debt financing. Dealmakers must now evaluate not just the inflation-adjusted cost of capital but the composition and timing of expected returns under a broader set of contingencies.

Impact on EBITDA Multiples and Market Comps

Shifting sector benchmarks

Inflation distorts industry comparables in ways that challenge historical benchmarking. The EBITDA multiples used in precedent transactions or comparable company analysis are increasingly unreliable when inflation volatility is high. For example, margins may temporarily inflate due to pricing power in consumer goods, only to compress later under wage inflation or input cost pressures. This makes it difficult to draw meaningful comparisons to past deals, even within the same sector. For sellers, this environment creates a valuation dilemma: benchmark too high, and you risk deterring buyers who apply heavier discounting to future performance; benchmark too low, and you risk undervaluing the business based on temporary cost pressures. Buyers, on the other hand, must distinguish between transitory margin expansion and structural improvement—a task requiring deep operational due diligence and forward-looking analysis.

Repricing private versus public valuations

Private company valuations often lag public market corrections, but in inflationary environments, this discrepancy can widen significantly. Public market multiples tend to contract rapidly as inflation drives down investor sentiment and capital becomes more expensive. However, private sellers may continue to anchor expectations on peak-cycle valuations, leading to protracted negotiations and increased deal attrition. Bridging this expectation gap becomes a matter of both technical valuation adjustment and psychological reframing. Furthermore, investors in private markets are increasingly adjusting for inflation by focusing on intrinsic value over market sentiment, favoring businesses with strong pricing power, low capex intensity, and variable cost structures. These characteristics offer resilience against margin erosion, making such businesses more attractive and justifying premium valuations even in a compressed market.

Cash Flow Modeling Under Cost Pressures

Forecasting future cash flows in inflationary environments is inherently more complex. Line-item assumptions for costs—ranging from labor to raw materials—must be recalibrated to reflect inflation trajectories that are often nonlinear and sector-specific. Traditional assumptions around cost growth no longer hold. For instance, recurring costs such as utilities, insurance, and logistics are escalating in unpredictable ways, significantly altering net income projections and, by extension, enterprise value. Equally critical is the assessment of pricing power. Companies that can pass on inflationary costs to consumers without sacrificing volume are more likely to maintain cash flow stability. This dynamic is particularly relevant in sectors like healthcare, software-as-a-service (SaaS), and branded consumer products, where customer stickiness and inelastic demand offer a buffer. In contrast, commoditized industries are facing margin squeeze, making aggressive forward cash flow projections highly speculative.

Working Capital Adjustments and Deal Structuring

Inflation significantly impacts working capital requirements, often increasing the capital tied up in inventory and receivables. In deal structuring, this has direct consequences for purchase price adjustments and earn-out mechanisms. Buyers are demanding tighter working capital targets and incorporating more dynamic adjustment clauses to account for post-closing inflationary shocks. Meanwhile, sellers are pushing back against overly conservative net working capital assumptions, arguing that inflation-driven increases are structural rather than operational inefficiencies. In addition to purchase price mechanics, inflation is reshaping the use of contingent consideration. Earn-outs are being structured with inflation-indexed thresholds or pegged to inflation-resistant KPIs such as cash conversion cycles or gross margin stability. While this adds complexity, it also provides a tool for bridging valuation gaps when inflation uncertainty clouds visibility into future performance.

Debt Financing and Leverage Constraints

A high-inflation environment often coincides with rising interest rates, which materially impacts leveraged buyouts (LBOs) and debt-financed acquisitions. As the cost of capital increases, the leverage capacity of buyers decreases, forcing them to rely more heavily on equity financing. This shift not only alters return profiles but also imposes discipline on valuation ceilings. Deals that may have been viable under ultra-low interest rates become structurally unfeasible when debt service coverage is stressed by both higher rates and inflation-induced cost variability. Moreover, covenants are becoming stricter. Lenders are increasingly wary of inflationary pressures on EBITDA, instituting covenants that tie interest coverage ratios to inflation-adjusted metrics or including triggers for refinancing risk. This makes the capital stack more fragile and shifts deal emphasis towards businesses with robust cash flow visibility and low fixed cost burdens. The current inflationary environment demands a fundamental shift in how deal valuations are approached. Beyond adjusting for discount rates or applying inflation indices to cash flows, dealmakers must engage in scenario-based modeling, sector-specific sensitivity analysis, and real-time recalibration of assumptions. Historical comparables and static models are insufficient in the face of rapidly shifting input costs, financing conditions, and consumer behavior. Ultimately, inflation has become a multidimensional force in corporate transactions—affecting not just the math of valuation, but the psychology of negotiation, the structure of deals, and the sustainability of synergies. A nuanced, forward-looking approach that integrates macroeconomic insight with deep operational understanding is no longer optional but essential.