The opinions expressed by Entrepreneur contributors are their own.
If you are among the many entrepreneurs who are lulled by cheap, low-cost access to capital, you may have been caught by surprise when low-cost variable-rate debt suddenly tripled in price last fall. In what is generally recognized as a pivot, the Federal Reserve has exercised its ability to raise interest rates to cool the economy. As a result, you will want to consider what this means in terms of financing your business.
What was the pivot?
In August 2023, in response to a widespread and persistent inflation shock, the US Federal Reserve initiated one of the steepest rate hikes in history. The goal was to wrest excess liquidity from the economy, and the result was that the cost of borrowing skyrocketed.
A widely held view was that the Fed would not let up until the economy weakened significantly, meaning 2023 was hypothetical have a recession. This vision was accompanied by the idea that only After the economy would weaken if the Federal Reserve began lowering rates. As entrepreneurs, this made us uncomfortable, but at least we all agreed on what was going to happen.
Then, in December 2023, another amazing thing happened: the pivot. In a shock to consensus opinion, the Fed said it would seek to lower rates in 2024. The message was nuanced, but essentially can be analyzed this way: the United States will not Need enter a recession for the Fed to feel that inflation is under control. With month after month of cooling inflation, the position is that it is now appropriate to “normalize” rates, not back to the low levels they were at, but lower than they are today.
What comes next?
For many observers, the absence of recession and a quick turnaround have painted the picture of a “soft landing,” in which few job losses and inflation will be under control. As this picture begins to emerge, what does it mean for an entrepreneur looking to finance their business?
Based on our experience, here are four tactics in 2024 that are important right now:
1. Falling variable rates
The direction of rates is going downwards. When it’s unclear, many think it could happen as early as the spring of 2024, and the consensus points to the summer. How much will rates drop? This is uncertain as many had bet that the prime borrowing rate could fall as low as 1.25% in 2024, with people now thinking it is close to falling to 0.75%. When that happens and how big the prime reduction will be will depend partly on inflation and the broader economy.
Barring any large exogenous shock, rates could fall in 2024. Therefore, it makes sense to issue loans and participate in the downward direction. Many rates not tied directly to Fed funds have already started to fall; Mortgage rates, for example, are already in the high 6% range, down from seven.
Related: How to Finance Your Business Using Banks and Credit Unions
2. Invest in your banking relationship
Massive regulatory changes have meant that banks are increasingly tied down in how they treat customers. The good news is that this has eliminated some biases in the banking industry; the bad news is that banks are slow to make exceptions. However, most people do business with people, and your bank is no different.
For more than a year, smaller banks have been under pressure from sharply rising rates, which have caused many of the bonds they hold to fall in value. The collapse of Silicon Valley Bank and challenges in commercial real estate continue to put banks on the defensive, and as a result, banks will have limits on where they can lend.
You want your bank to understand your business and your plan, and the more time you can give your bank to mingle with its committee and go through the paperwork, the more likely it is that your loan will be approved on time and on time. right rate. There will be fewer bank loans in 2024, so make sure yours is one of them by over-communicating and anticipating what your banker may need to approve your loan.
Related: The Difference Between a Business Loan and a Line of Credit
3. Seek sources of private capital
As traditional banks retreated from lending, private equity rushed to fill the void. Some have called this period the “golden age of private credit.” Free from many of the restrictions that a regulated bank may have, private lenders are generally more expensive but more flexible. Terms for private loans vary greatly, but can be 3 to 7 percent more expensive than a bank loan. Private lenders can often, however, provide you with a longer repayment. Brokers add commissions and fees within this space, while business development companies (BDCs) invest from a dedicated fund structure. For this reason we prefer to work with private lenders and their BDCs.
Related: 6 Steps for Your Small Business to Avoid a Financial Crisis
4. Diversify your credit sources
Credit is like oxygen; it’s pretty boring until it goes away. While keeping up with customers and employees is hard enough, most business owners want their loans to be as simple as possible. But we are in very volatile times, between rate changes and the lending environment. The “pivot” means that lenders behave differently, and as we saw with Silicon Valley Bank, some may disappear altogether. In 2024, entrepreneurs should have a variety of suppliers if possible.
Given how poor consensus has been in predicting the future, it probably makes sense to have a variety of pricing structures. A possible best-case scenario might look like this: both a private lender and a bank, some with variable rates and some fixed. While more expensive and complicated, this structure could provide an insurance policy against what is sure to be an interesting year.