Small businesses are up against some headwinds in 2023. Higher interest rates and a looming recession mean that securing financing in the new year could be trickier than usual for entrepreneurs. Also, they are facing a one-two punch of higher input costs and persistent supply chain issues due to high inflation and linger effects of the pandemic, respectively. However, after tough sledding in 2022, things could hardly get any worse in the lending market. Let’s explore what business owners can expect in 2023.

Before we look ahead to 2023, let’s reflect on 2022. The Federal Reserve lifted its benchmark rate by 50 basis points in December. While this was a more moderate increase vs. its recent pace of 75 basis points, it thrust rates on small business loans into the double-digit realm, a phenomenon business owners have not experienced in about a decade and a half.

This has many in the small business community wondering how they are going to navigate the financing market in the coming year. Newer business owners who have emerged over the past decade have never seen 10% interest rates on loans before, an eye-popping level that the Fed’s aggressive tightening has permitted. Seasoned business owners may have experienced it, but that doesn’t make things any easier.

This is due to what’s known as the Prime rate and its role in small business lending. The Small Business Administration (SBA) relies on Prime as its index rate, over which SBA lenders have a 3% cap. With the Fed’s lifting of the Prime rate to 7.5% in its most recent decision, the 10% level is now in play, a level not seen since before the Great Financial Crisis.

Business owners may experience sticker shock on the cost of financing due to the pace at which rates have been rising. Over the year, rates have increased twofold from between 5% and 6% less than a year ago to the current double-digit range.

Higher rates hit more than just a business owner’s cash flow. It also affects them psychologically, perhaps even more than the cost of servicing their loans. This is because while the Fed has slowed the pace of its rate increases, it has not stopped them altogether. As a result, business owners fear that their financing costs could still get pricier in 2023 if the Fed stays on this path.

Financing Influencers

Different factors influence the rate a business owner will be charged for a loan. In addition to the Prime rate, these include:

  • Lender: Financial institutions (banks) tend to have the most attractive interest rates. Fintech platforms make it easier for business owners to qualify for financing and faster to receive their funds, albeit at a higher cost usually.
  • Loan Type: The cost of financing also depends on the type of loan product. U.S. SBA loans tend to be the cheapest, with rates between 9.75 and 12.25%.
  • Credit Profile: Similar to a personal loan, a business owner’s credit profile will affect the cost of the financing. The less risk that a borrower presents to the lender, the lower the rate is likely to be.
  • Collateral: Securing a loan with collateral, including property or other assets, lessens the risk for the lender and should result in a lower interest rate.

During times of high interest rates, business owners could focus on more of the forces they can control, such as the loan product or lender they choose, to offset those areas that are out of their control.

Perfect Storm

Meanwhile, business owners are left grappling with a perfect storm of high inflation, rising rates, and a possible recession. From the looks of it, the Federal Reserve has more interest rate firepower left in its arsenal, at least for early 2023. If a recession materializes in the U.S. economy, all bets could be off, and rate hikes might no longer be on the table for a while.

Demand for small business financing is likely to stay strong in this environment. If anything, business owners might wait on the sidelines until the Fed appears to be taking its foot off the rate gas pedal. But with the economic headwinds, they might not be able to wait for too long.