Higher for Longer: Impact of Rising Interest Rates on Small Businesses
The market’s new mantra is “Higher for longer,” as the stress of costlier money is expected and designed to be felt by households and businesses. The question now is where this pressure will be most acutely felt. While large cash-rich companies have managed to lock in low rates during the pandemic, smaller businesses face a different landscape.
In 2022, the effective rate of interest on corporate debt for the smallest half of companies in the S&P 1500 jumped to the highest level since 2012. The impact on sole proprietorships and partnerships, which have seen a surge in formation since the pandemic, is particularly noteworthy. Consultancies, building contractors, law firms, medical practices, and similar businesses make up a significant portion of the economy, producing 15% of US GDP and paying out 15% of employee compensation.
Small businesses already face more burdensome debt costs, with interest payments accounting for up to 6% of revenues in 2021, compared to 2% for larger businesses. Furthermore, approximately half of the credit extended to small businesses is floating-rate, compared to one-fifth for larger companies.
The Goldman Sachs economists predict that small business interest payments will rise to around 8% of gross output by the mid-2030s, a 40% increase since 2021. They estimate that the effective interest rate on small business loans is likely to rise by a cumulative 3½-4pp. These rising costs could have consequences for small businesses’ ability to access credit and invest in their growth.
However, there are some mitigating factors. Small businesses have a healthy financial footing, with a financial surplus and strong balance sheets. This could partially offset the drag on hiring and investment caused by higher interest payments. The Goldman Sachs economists estimate a tailwind to capital expenditure growth of up to +4pp in the sector.
While the impact on the broader US economy may be limited, there could be real consequences for smaller businesses. Independent medical practices in underserved communities, for example, may face challenges or closures due to higher debt costs, potentially leading to consolidation by private equity firms.
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