One financial analyst and an advocacy group say the latest interest rate cut by the Bank of Canada will help small businesses but difficult economic circumstances will persist.
On Wednesday the Bank of Canada cut its key policy rate by 25 basis points to 4.5 per cent, a move that was expected by markets and most economists in a Bloomberg Survey. The announcement to lower borrowing costs followed a previous 25 basis point interest rate cut a month earlier.
Daryl Ching, a CFA and managing partner at Vistance Capital Advisory, which offers accounting and capital raising services to small and midsize businesses, said in a statement to BNNBloomberg.ca Wednesday that despite the rate cut, elevated interest rates still impact small businesses.
“While it is a great sign and a step in the right direction, 0.5 per cent is not going to have a significant impact on business financing in the grand scheme of things,” he said.
“However, if small business loan rates can return to the six to seven per cent range we saw before COVID-19, this opens up the door for small businesses to seek debt financing as a viable alternative if they are looking to grow. Considering the lack of funding available for entrepreneurs in Canada compared to our U.S. counterparts, we need a healthy debt market for companies to thrive.”
According to Ching, small businesses are disproportionately impacted by interest rate fluctuations. This is because the most common form of loan for a small business is a line of credit based on a bank prime rate, which is tied to the central bank’s policy rate, he said.
Ching noted that before the COVID-19 pandemic, the lower interest rate environment allowed businesses in “good standing” to borrow at an interest rate of around six to seven per cent. By July 2023, Ching said these rates grew to around 9.25 to 10.25 per cent interest.
“For businesses that are breaking even or in a loss position, the additional interest is crippling, and entrepreneurs are faced with some significant decisions that include cost cutting, pivoting the business strategy, refinancing or in some cases shutting down their business,” he said.
Simon Gaudreault, chief economist and vice-president of research for the Canadian Federation of Independent Business (CFIB), said in a statement to BNNBloomberg.ca Wednesday that the rate cut is a positive sign for small businesses and shows that monetary policy is working.
However, he added that challenges still exist for independent businesses across the country.
“It has been a few rough years for a lot of SMEs (small and medium-sized enterprises) in Canada. To top it off, the last inflation spike has boosted pretty much all of the costs of doing business, with the ensuing interest rate hikes bringing a reduced demand and higher financing costs,” Gaudreault said.
He added that the Bank of Canada’s rate cut could help small businesses by spurring consumer demand.
“It could also help businesses which have inherited a big pandemic debt, or those looking to invest, by immediately reducing their borrowing costs. Our latest SME financing report shows that two-thirds have variable rate loan products, at prime plus 2.1 per cent on average,” Gaudreault said.
Until the Bank of Canada can reach a neutral interest rate environment, he said small businesses will continue to face difficult economic conditions.
As many Canadian small businesses continue to face difficulties, Bloomberg News reported Thursday that only 13 per cent of small businesses expect to hire over the next three to four months, marking the lowest percentage since January 2021.
Equity markets
Ching also highlighted that higher borrowing costs make it more difficult for small businesses to qualify for a loan as “they will struggle to cover the interest payments,” resulting in many being priced out of financing in the current interest rate environment.
“As a result of all this, the most interesting trend we have seen since COVID-19 is a move towards the equity market. Business owners have opted to sell shares of their business for growth capital and in some circumstances to pay down their high-interest debt,” he said.
However, Ching said that raising equity is “not a great option” for many small businesses as it is time-consuming and owners often have to seed control due to lower valuations.