As the U.S. contends with tighter credit conditions, small businesses seem surprisingly well-positioned to absorb the impact of higher interest costs, according to Goldman Sachs Research. Despite being relatively more vulnerable to funding stress compared to larger corporations, small businesses are displaying resilience.
Goldman Sachs economists Manuel Abecasis and Spencer Hill highlight that small businesses typically pay higher interest rates, estimated at around 10.5% in 2019, compared to the corporate sector's 6.5%. Despite this, small businesses will spend around 6% of the sector's gross output on interest payments in 2021, while large businesses will allocate only 2%.
The Federal Reserve's rate hikes, the highest in over 15 years, are yet to have their full effect on small businesses due to the composition of their debt, split between short-term, floating-rate obligations, and longer-maturity term loans.
The economists predict that higher rates will increase the interest burden for small businesses by just over one percentage point by 2024, reaching around 7% of revenues next year and possibly under 8% as term loans mature. Although this exceeds pre-pandemic levels, it aligns with the mid-1990s scenario.
The impact on small businesses' investing and hiring is expected to be modest, with interest payments increasing by less than one percentage point in 2023. This is projected to reduce capital expenditures by approximately 0.1% and labor costs by 0.17% as a share of the sector's gross output.
According to Goldman Sachs Research, the challenge that small businesses face due to higher interest costs will only have a minor impact on GDP growth overall. The expected GDP growth drag from small business borrowing costs is forecasted to peak at 0.1 percentage point this year, gradually waning in 2024 before a modest rise later in the decade during term loan refinancing.
Small businesses are finding alternative funding sources to cope with higher rates. Companies like 7 Generation Games, a maker of educational video games, explored options beyond traditional loans. Watch Guard 24/7, a security staffing company, has experienced solid growth that helps counter higher borrowing costs.
While setting up new banking relationships might be challenging for some small businesses, the sector's strong profits and ample cash on hand contribute to resilience. Retained earnings suggest a financial surplus of 2.5% of U.S. GDP in Q2, reflecting robust profits surpassing wage growth. Small businesses appear well-equipped to weather the ongoing impact of higher interest costs, with a financial surplus of 9.1% as a share of revenues, signaling a positive outlook for growth in capital expenditures.