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What Changing Interest Rates Mean for Small Business Owners

The COVID-19 pandemic sparked a lot of economic changes. 

At the outset of the pandemic, Canada’s federal government injected significant money into the economy to support people who lost their jobs or had to temporarily close their businesses. Provinces and municipalities also followed suit with their own targeted programs.

Now, the country is looking to recover, but faces historic levels of inflation. To combat this, the Bank of Canada is raising interest rates. 

While raising rates may be necessary to curb inflation, it can also cause challenges and issues for business owners. Here’s what you need to know.

Why are interest rates increasing?

When the government injected cash into the economy during the pandemic in the form of corporate supports, community aids, and direct payments, it increased the money supply. The Bank of Canada also decreased interest rates to around zero per cent, which incentivized people to take on more debt and increase their spending. 

Both of these actions were arguably necessary to help Canadians weather the pandemic. However, they resulted in increased inflation as easy credit clashed with disrupted supply chains.  People had a lot of money to spend, with limited places to actually spend it.

The government and Bank of Canada have a couple tools to get inflation back under control: the government can reduce its spending,  (particularly on direct cash programs) or the BoC can adjust its benchmark interest rate.  

The Bank of Canada website says this about the connection between interest rates and spending: 

Higher commercial interest rates mean people and businesses pay higher interest on loans and mortgages. This discourages them from borrowing and spending and puts the brakes on the economy and inflation.

In short, the Bank of Canada hopes that raising interest rates will make people think twice before spending. This will lower demand and, in turn, lower inflation driven by excess demand.

How interest rate hikes affect business owners

Entrepreneurs face a dual challenge when interest rates go up: not only is their business potentially affected, but they are potentially affected as individuals. 

How rising interest rates affects business

Debt becoming more expensive as interest rates rise can lead to two negative outcomes for entrepreneurs: 

Growth becomes more difficult: A lot of growth is fueled by debt, such as taking on a loan to buy new machinery or acquire another business. When interest rates are higher, it’s more expensive to service that debt, meaning that investing in growth may not look so attractive when you factor in costs of capital. 

The resulting change is that entrepreneurs looking to grow may not be able to afford the debt to do it. This isn’t necessarily a bad thing, since there are other options such as revenue or equity-fueled growth, but it removes one commonly used pathway. 

High interest rates could lead to recessionary pressure: If interest rates slow down spending enough, the country could go into a recession. While recessions are by definition short-lived, they can be incredibly painful.

From a business perspective, recessions can mean less revenue as people tighten their spending because they can’t use debt to buy things. Further, people with existing debts will likely need to severely lower their spending to accommodate higher repayment costs caused by interest rate swings. 

This means your business could be in the dual situation of having both lower revenue and limited access to debt. 

How rising interest rates affect entrepreneurs as private citizens

Higher interest rates make items purchased with debt more expensive. This includes: 

  • Mortgages, construction loans, and Home Equity Lines of Credit (HELOC).
  • Car loans.
  • Other loans (boats, etc.).
  • Consolidation loans for amalgamating debt. 

For individuals who fuel their lifestyle with debt, this means a significantly higher carrying cost that could push you over the financial edge. 

For individuals who live more frugally or don’t take on significant debt, you may not feel the pinch immediately. However, it means that big life events that typically require taking on debt,  like buying a home, may incur higher monthly payments. 

Arguably, the increased costs of debt will be balanced out by a decrease in inflation, so it’s possible you won’t feel the strain on your pocket book in the end. However, you may feel it in the short term as lenders react to immediate interest rate changes, but inflation takes awhile to respond. 

What entrepreneurs can do to manage through change

While a higher interest rate environment can make business a little more difficult, there are opportunities you can take advantage of: 

Do an expense audit: If you’re concerned business may dip, run through your fixed expenses to see what you might be able to cut. Also name your variable expenses so you can get a better sense of how expenses might go down if business also drops.

Limit debt-fueled spending: If you currently spend with debt, consider lowering that spending amount so you aren’t impacted by higher interest rates. One caveat is that using debt to buy revenue (for instance, another cash-flowing business) can be a good idea in any environment. In all cases, it’s critical to run your own analysis to ensure whatever debt load you have is a good idea for you and your business.

Build an emergency fund: From both a business and personal perspective, it’s good to have three to six months of expenses tucked away so you can continue to operate your business and continue to survive personally if there is a recession.

Build an opportunities fund: If profits are good right now, store some cash to take advantage of any business opportunities that arise, since debt may not be readily available or affordable.

Think about revolving debt versus installment debt: If you do take on debt, consider a revolving line of credit rather than a fixed loan, since you’ll have more flexibility on the amount you take and your repayment schedule. Regardless of the path you choose (or don’t choose), make sure you read all the fine print on any debt you take and do your own analysis to ensure taking on debt is the right decision for your business.

Consider buying distressed assets: When interest rates rise, some businesses may become insolvent. If you’re in a strong cash position or are willing to take on some debt or sell equity, you may be able to acquire these businesses for much cheaper than if you’d purchased them when they were strong. While you take on the other organization’s debt in the short term, you could end up significantly benefitting when the economy turns back around.

Business as (un)usual

Interest rates have been relatively steady for a decade, and few entrepreneurs actively remember the high inflation and interest rates of the late 1980s and early 1990s. So while you need to keep conducting business as usual, you also have to be aware of what’s going on in the broader economic environment and consider how it impacts your business. Further, it’s important not to panic. The economy has withstood––and can withstand––interest rate changes and inflation. It may be the first time in your adult life you’re experiencing these fluctuations, but it’s far from the first time in Canada’s history. 

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