The Bank of Canada’s latest rate cut will help small businesses raise capital, according to one expert, who says lower borrowing costs make debt more viable.
On Wednesday Canada’s central bank lowered its key policy rate by 50 basis points to 3.75 per cent, highlighting that its focus has changed form curbing inflation to maintaining its inflation target. The move marked the bank’s fourth consecutive cut since June.
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 an interview with BNNBloomberg.ca Thursday that the current rate path will be a tailwind for smaller firms. He said it will also help companies that may have been priced out of debt financing in the recent high-interest rate environment.
Before the COVID-19 pandemic, Ching said the policy rate was at 1.75 per cent, meaning small businesses were getting loans at around 6.5 per cent “if they (were) in good standing with the bank.” However, during the pandemic, the Bank of Canada had to raise rates to curb “massive inflation,” he said, bringing the policy rate to a high of five per cent.
“They were increasing rates at a very quick pace. Any businesses that had a prime based loan were all of a sudden paying much higher interest charges,” Ching said.
He added that businesses were borrowing at around 10 per cent amid peak interest rates.
“You can imagine that impact that it had when all of a sudden, your rate changes by three per cent to in two years. Now it’s come back down, the policy rate has now come back down to a much more reasonable level,” Ching said.
Since the policy rate has fallen to 3.75 per cent, he said this brings the corporate loan balance rate to around eight or 8.5 per cent.
“It brings the loan rates back in line to a place where I think that the debt markets are a bit more viable. And certainly, with the trend… we hope to get back to the point where lending rates can get back to about six or 6.5 per cent, which would make things a lot easier for companies to access the debt market,” he said.
Push to equity
Ching noted that the higher rate environment was pushing smaller firms to raise equity instead of taking on debt due to higher borrowing costs. He said that debt servicing costs at an interest rate around 10 per cent would represent a “cash flow problem” and the only alternative for companies is to raise equity.
“So, companies that were typically not that interested to raise equity were forced to do so. Now equity is obviously a common instrument that’s used for small businesses to raise capital, but it’s a lot more desirable when you’re in an industry that has a much higher upside and a much greater multiple valuation,” Ching said.
He added that for certain industries like tech, equity can be a great vehicle to raise capital but may not be ideal for companies looking for organic growth.
The role of debt
Ching also highlighted that debt plays a key role for smaller firms looking to grow.
“Virtually every small business at an early stage needs capital. It takes time to get to a point where you’re cash-flow positive, especially where you’re in growth mode as a small business,” he said.
Taking on debt allows firms to invest in things like marketing or research and development, Ching highlighted.
“If you want to grow, if you want to add products, if you want to chase a new revenue line, if you want to expand it to a new country, you need capital. And there’s typically two ways to raise capital, there’s debt and there’s equity,” he said.