When interest rates started to rise last year, Richard Stevens, president of Hartford-based Severance Foods, was quick to lock in rates on about $1.75 million of his company's existing debt. Now he's getting even more aggressive: He's thinking about borrowing $1 million to buy equipment that will allow his 30-person, $4.5 million company, which makes private-label tortilla chips, to develop specialty products such as veggie chips. He had originally planned to make the purchase in a year or two. No longer. "We're going to speed up our timetable a bit and borrow now, because the longer we wait, the more it's going to cost us," says Stevens.
Smart moves
The Federal Reserve's Open Market Committee has been boosting its fed funds rate, causing the prime rate to move to 6 percent as of June, up from 4 percent last summer. While longer-term rates have stayed low, "Rate increases are something everyone has to think about," says Stuart G. Hoffman, chief economist at PNC Financial Services Group in Pittsburgh.
Even though borrowing remains historically cheap, the average rate on a small business loan has climbed to 7 percent from 6 percent during the past year, says William Dunkelberg, chief economist at the National Federation of Independent Business. A March PNC poll of small business owners found that borrowing costs beat out insurance expenses and energy prices as their top concern.
Luckily, you can cushion your business against the impact of higher rates. The first step is to curtail the use of credit cards, which are typically the most expensive kind of financing. As long as you have collateral, you can try to get lower-cost bank debt instead.
Lock in your borrowing costs by converting short-term and floating-rate financing — generally lines of credit — to longer-term, fixed-rate debt. Making the switch means you'll likely pay a little more in the short term: As of April, fixed rates on credit lines were running 0.25 to 0.5 percentage point above floating rates. But you'll be protected against future increases, and you'll have the certainty of knowing, to the penny, your monthly interest costs.
If your bank isn't willing to convert your floating-rate debt into fixed rate or is charging too much to do so, take a look at interest-rate swaps. Swaps are contracts to convert a variable-rate loan into a fixed-rate one, and you don't have to buy the swap from the same bank that made the loan. A swap will cost you about half a percentage point. "At about $7 million to $10 million in sales, companies become good candidates for a swap," says Ken Martin, regional executive for business banking at Bank of America.
Like Stevens, if you have a big capital-intensive project looming, consider borrowing sooner rather than later. Those with strong cash flow can ask their banks to split the loans in two, with one part carrying a fixed rate and the other a floating rate. "If rates rise, the business can pay down the floating-rate portion," says Martin. "If not, it benefits from the lower rate." Martin suggests beginning with a 50-50 ratio and adjusting it according to how much your sales and cash flow might be affected by higher rates. Then you can forget about watching the Fed and get back to running your business.