Rising interest rates pinch small-business borrowers

Rising interest rates are making traditional bank loans less affordable—or even out of reach—for small-business borrowers, which is driving some of those borrowers to consider other alternatives.

A year ago, the average prime rate, or the rate banks set as a reference for customer loans, was 4%. The prime rate has more than doubled since then, hitting 8.25% in May, according to data from the Federal Reserve.

To put that into context: In early June 2022, when the prime rate was 4%, a 10-year, $200,000 loan at that rate would have had monthly payments of $2,025. At an interest rate of 8.25%, monthly payments on that same loan would be $2,453.

That increase is especially relevant to small businesses, which have fewer options for financing than do large companies and might struggle to find bank financing in the best of times.

“They may have less collateral. Their credit scores may be lower than banks will allow. It could be a number of things” that make financing harder to come by for small businesses, said Stacia Murphy, senior vice president of enterprise development at the Indy Chamber.

Alison Martin, managing director of Indianapolis-based Engage Mentoring, said access to financing has recently become a focus for her firm’s clients. Engage Mentoring works with organizations to create leadership pipelines, and it also offers programs for business owners and executives.

Among Engage Mentoring clients, Martin said, “The conversations have definitely heightened in the last quarter or so, with the tightening of everything, the rising interest rates.”

According to a Goldman Sachs survey released in May, 77% of small-business owners said they were concerned about their ability to access capital. That stands in stark contrast to April 2022, when 77% of those surveyed said they were confident in their ability to access capital.

Seeking alternatives

Leslie Bailey, the co-founder and CEO of downtown coworking and social club Maven Space LLC, actually dropped her plans to take out a loan this year because of high interest rates.

In 2020, Bailey secured a business loan for Indy Maven LLC, a sister company launched in 2019 that offers a media platform aimed at central Indiana women.

The $5,000 loan, which Bailey obtained through the Indy Chamber’s Business Ownership Initiative, carried an interest rate of 3.75%. Monthly payments were $147.

This year, with Maven Space approaching its one-year anniversary, Bailey went back to the Indy Chamber to inquire about a $50,000 loan to make some improvements to the space. When she learned the interest rate would be 9.75%, she rethought her plans.

Instead, Bailey is launching a crowdfunding campaign through IFundWomen, an online fundraising platform for women-led businesses. She’s set a fundraising goal of $100,000 within 30 days of the campaign’s June 2 launch—a doable goal, she said, based on results she’s seen from similar businesses that have run crowdfunding campaigns.

Between the 5% cut IFundWomen will take and the credit-card processing fees Maven Space will have to pay, Bailey said her campaign costs will be about 8%—still less than the 9.75% she’d have paid for a loan.

And the crowdfunding isn’t a loan—it’s money Maven Space does not have to repay.

“Crowdfunding just makes much more sense than any loan through any traditional [source],” Bailey said.

But she acknowledged that crowdfunding is not ideal for every small business.

Setting up a crowdfunding campaign takes a lot of effort, she said, and she wouldn’t have had the capacity to do it while she was working to launch her business.

Crowdfunding also might not make financial sense for a company that makes and sells modestly priced physical products, Bailey said. Many crowdfunding campaigns offer gifts and perks to donors at certain levels. If a candle-maker, for instance, offered candles to donors, the logistics and cost of shipping those items around the country might ruin the financial equation.

But Maven Space will be soliciting funding from local residents, Bailey said, and the rewards will be tied to the coworking space itself. Those who contribute $5,000, for instance, will be offered a party at Maven Space.

Feeling the squeeze

Whereas Bailey walked away from a loan offer because of the interest rate, some small businesses might find it harder to even find a loan right now.

“With higher interest rates, you could see a portion of folks [who are] looking for conventional financing, traditional financing, are kind of running into gaps or running into issues,” said Bryan Jasin, head of business banking at Warren, Pennsylvania-based Northwest Bank.

Northwest is working to open a regional office in Fishers. The bank entered Indiana in April 2020 when it merged with Muncie-based MutualFirst Financial Inc.

Small businesses are getting squeezed from multiple directions right now, Jasin said.

It’s not only that higher interest rates have made borrowing more expensive, he said. Inflation is also a factor: Unless companies can pass along their higher costs in the form of price increases to customers, those companies will see their profits shrink. And smaller profits mean banks won’t be as willing to make loans.

“We want to make sure that they can pay all their expenses of their business, pay all their personal expenses, pay their debt payments and then have a cushion to be safe,” Jasin said.

In some cases, he said, a Small Business Administration loan can be an alternative. Under the SBA’s 7(a) loan program, which is the organization’s primary loan program, private lenders make the loans and the SBA guarantees up to 90%, depending on the amount and loan type. The guarantee serves to protect the bank in case of default.

“Now, [small-business borrowers] have another opportunity to say yes—‘Yeah, we can get you a loan in that program,’” Jasin said.

And Northwest is doing a booming business in SBA loans, he said. Last year, the bank made $15 million in SBA loans. In the first quarter of this year, it had already done $17 million of these loans.

Jasin said Northwest is actively working to grow its SBA business, so it’s impossible to know how much of that loan growth is being driven by the economy and how much is because of Northwest’s efforts.

Economic pessimism

Natalie Robinson, the Indiana state director for the National Federation of Independent Businesses, offered a slightly different take. Most of the organization’s members are companies with 50 or fewer employees.

“Our members aren’t currently reporting they’re having trouble securing loans,” Robinson said.

In a national NFIB banking-focused member survey released in May, 74% of respondents said they had not borrowed money for business purposes in the past three months. Among those that said they had not borrowed money, 85% said it was because they did not need financing. Only 1% cited high credit costs.

But those respondents also expressed pessimism about the economy.

In that same survey, 61% of respondents said the state of their local economy was either “OK” or “bad.” Another 33% said it was good, and 5% said it was excellent. When asked the same question about the national economy, 94% said it was either OK or bad. Only 6% said it was good, and no one said it was excellent.

And when asked when they think the next recession will begin, 55% of respondents said they believe the United States is already in one.

The survey was conducted by email in mid-April, gathering responses from 669 small-business owners.

“They’re not finding business conditions to be particularly good right now,” Robinson said of NFIB’s membership.•