The Fed’s efforts to get inflation under control might make entrepreneurship tougher — especially for minority and women-owned businesses.
Fed Chair Jerome Powell is expected to announce a minimum 75-basis-point interest rate hike this week, the third consecutive rate hike of this size. When federal debt becomes more expensive, banks and creditors often respond by increasing interest rates on their own products in order to remain profitable. These moves create strain for small business owners and entrepreneurs by making business capital more expensive or more difficult to access.
The challenges are amplified for minority and women-owned business enterprises (MWBEs) because they are more likely to either be given higher interest rates on business loans or be denied funding altogether. Black-owned businesses are 20% less likely to receive a loan from a large bank than white-owned businesses, even when “characteristics and performance” are similar, according to data from the Federal Reserve. And despite women and men having similar average FICO scores, women receive, on average, a 33% smaller business loan than men.
“More than 40% of Black and Latinx small businesses were at the brink of closing their doors or had to close their doors because of the pandemic,” says Michael Pugh, President and CEO of Carver Federal Savings Bank, a Community Development Financial Institution (CDFI) and one of the largest African- and Caribbean-American managed banks in the United States. “The primary reason for that is that they were very limited in terms of access to capital.” Pugh says that many entrepreneurs leverage personal credit cards to get their business aspirations off the ground, a decision that exposes them to personal liability in the event the business fails.
The Fed says it will continue hiking rates until inflation is under control, an activity expected to carry well into 2023. If you’re a business owner or solopreneur carrying a credit card or loan balance, knowing your options for securing healthy debt will become increasingly important in the months ahead as the potential for a recession looms.
Here are some money moves you should consider taking now.
Avoid Using Personal Credit Cards for Funding
Most entrepreneurs in America are solopreneurs, meaning they are their company’s only employee or member. The US Small Business Administration calls these entities nonemployer firms, and says they account for 81% of all businesses in the United States. It may feel tempting to commingle business and personal bank accounts for the sake of convenience, but financial planners and current business owners alike say cutting money corners now can lead to trouble down the road.
“It is easy to get lost in the cash flow side of the business, especially when you are in investing mode,” says Madeleine Park, Chief Marketing Officer of Threshold Brands, a franchise purchasing firm. “Having a clear idea about your finances will allow you to invest where needed but ensure that the business stays profitable and growing at a steady rate.”
Floating expenses on personal cards defeats the purpose of having a limited liability company (LLC) or business formation in the first place, which is to protect your personal financial assets in the event of business failure. No one starts a business expecting to fail, but the reality is that many do: 18.4% fail in the first year, and 49.7% have failed after five years, based on a LendingTree analysis of U.S. Bureau of Labor Statistics data from 2021.
If your business encounters legal challenges or faces a judgment as a result of unpaid debts, using a personal credit card or checking account for business expenses will weaken your protections. A lawyer could argue that, since your personal accounts were involved in the running of the business, your personal assets should be up for grabs to pay off unpaid debts. Setting up a separate business bank account and/or getting a business credit card will help you keep yourself protected.
Closing the Gender Gap
Women-owned businesses produce $1.9 trillion in annual sales, but a woman’s ability to operate autonomously both in terms of personal finances and entrepreneurial funding is still recent.
The Equal Credit Opportunity Act of 1974 gave women the ability to open their own credit card and loan accounts. However, women were still not allowed to receive business funding because of the perception that they were “less reliable” borrowers. A woman had to have a man to co-sign their business loan up until 1988, when HR 5050, the Women’s Business Ownership Act, was signed into law. Since the 1970s, the number of women-owned businesses has grown by over 3,100%, but 88% of these businesses make less than $100,000 in revenue a year.
There are funding resources specifically for women entrepreneurs available at the US Small Business Administration and your local Community Development Financial Institution (CDFI). A searchable database of CDFIs is here.
Don’t Wait Until It’s Too Late to Create Your Cash Cushion
Next week’s increase won’t be the last time interest goes up. Powell has previously communicated that he expects to raise rates as much as needed to pull inflation down and give consumers relief, even if that means making business debt more expensive. If you’re sitting on a lot of debt, the time to transfer or diversify into lower-interest options is now.
“Think about getting access to capital, a line of credit, or a business credit card before you need it, because by the time you need it, it’s generally too late,” says Pugh. “Figure out what’s needed in order to get that working capital or business credit card, even if you don’t use it right away, and then get to work.”