3 Takeaways for Business Owners in Light of the Federal Interest Rate Hikes
Monitoring key predictors, like federal interest-rate hikes, as opposed to relying on instincts, provides a far better road map for your business's future.
“We don’t like their sound, and guitar music is on the way out” was the reported response of a major record label executive in 1962 to a demo he listened to from some up-and-coming rock and rollers. He was wrong on two counts: Rock and roll has obviously lived on. And the group which he referred to? The Beatles.
That’s a good reminder for today's business owners: Relying on your “instincts” to determine your growth strategy is risky. Even though some business leaders like Apple's Steve Jobs and Virgin's Richard Branson are recognized for their belief in soft factors (Branson even reportedly said, “I rely far more on gut instinct than researching huge amounts of statistics"), small businesses don’t have the luxury of a corporate cushion to protect them from bad instincts.
Instead, monitoring key predictors, like federal interest-rate hikes, as opposed to relying on instincts, provides a far better road map for the future. According to the latest quarterly Private Capital Access (PCA) Index report from Dun & Bradstreet and our research team at Pepperdine University Graziadio School of Business and Management, the December 2016 federal interest rate hike did adversely affect businesses’ operations.
Mid-sized businesses (between $5 million and $100 million in revenue) reported both a decline in profitability -- down six percentage points from the previous quarter -- and an inability to hire new employees due to the higher interest-rate environment. Profitability was down six points in the first quarter of 2017, versus the last quarter of 2016.
Given that additional rate increases are anticipated for this year, small business owners must keep the potential impact of rate hikes in mind as they consider hiring and expanding over the next year. Specifically, here are three operational principles to follow, to maintain stable, profitable operations:
1. Base operational decisions on contracts that are signed, not those that are anticipated.
This year, we witnessed an increase in reports from businessess that the current financing environment is restricting their ability to hire new employees, and an increase in the percentage of small businesses anticipating that they will seek financing in the next six months for “working capital fluctuations,” compared to small businesses in 2016.
That’s almost certainly a result of rate hikes, which can impact the ability of businesses to borrow capital to maintain facilities, hire employees and expand operations.
Rather than obtaining financing to hire new employees until new business is firmly locked down, consider incentivizing employees to put in additional work, or using temporary contract labor. That may bridge the gap and allow you to avoid having to obtain financing.
2. Monitor economic growth to ascertain likely timing for future rate increases.
We found that fewer mid-sized businesses were able to qualify for credit in early 2017, compared to late 2016. It's likely that slower-than-expected growth in the last few months played a role in that decision, although Fed officials called the slowdown "transitory." If business owners need to access capital for operations, they should stay abreast of developments not only in financing rates, but also national job gains and unemployment trends.
They should factor that into the likelihood of whether or not future rate increases are on the horizon (the next hike could come as soon as June).
3. Consider alternative forms of financing.
Access to loans may be more challenging as traditional lenders tighten criteria for “risky” loans to small businesses. Be careful with "cash advance" forms of financing such as factoring or merchant cash advance since they are very expensive once all the fees are considered.
Asset-based lending (ABL) can be a good option since these loans are inherently less risky for the lender and therefore will typically have a very competitive interest rate. Companies can borrow against nearly any type of tangible asset, including accounts receivable, inventory, equipment, purchase orders and real estate.
The old adage that economic recovery starts on Wall Street and ends on Main Street is still true today, and business owners need to adjust their business strategies accordingly. Instincts are terrific, but for small businesses, there is no substitute for careful monitoring of solid economic indicators.
Dr. Craig R. Everett is assistant professor of finance at the Pepperdine Graziadio School of Business and Management and director of the Pepperdine Private Capital Markets Project. His teaching and research interests include entrepreneurial finance, private capital markets, business valuation and behavioral corporate finance. He has over 20 years of industry experience in management consulting (Accenture) and the aerospace & defense industry (Northrop Grumman). He has also been involved with multiple startup ventures. Everett has been actively engaged in children's financial literacy initiatives over the years, as both a classroom (K-12) financial literacy volunteer for Junior Achievement and a member of the curriculum advisory board for the National Financial Educators Council.