It’s easy to underappreciate the effect that increased interest rates really have on the economy. Intuitively, when rates go up, debt gets more expensive. But that’s not the only effect. When rates go up, access to capital also gets much tighter. It’s not just more expensive, it’s also harder to come by. But not for everyone and certainly not by the same degree. Not only are small businesses seeing higher interest rates (close to 10% in many situations vs. 5ish% a year ago) than larger competitors, but in many cases they just can’t access the capital at all.
On the flip side, companies like T-Mobile, Apple and Merck have all sold bonds this month with yields still close to 5%. One major difference is that small companies are largely tapping banks (who have had their own problems) while larger companies can tap the bond markets. In the meantime, in order to get liquidity for their LPs, many Venture Capital GPs are selling secondary strips. This is all indicative of the same issues across several different markets, but some of the symptoms (lack of liquidity and dilution) help us understand the medicine.
If we are to look at company balance sheets today, companies that have more than 250 employees have $61B more cash today than they did a year ago. In sharp contrast, companies with fewer than 250 employees have seen their balance sheet shrink by ~$7B. There are obviously a number of moving parts that cause that, but the biggest issue by far is access to capital and the levers that companies can pull when they don’t have access.
Investors often refer to beta, or relative sensitivity to economic moves when describing assets and it’s times like this that remind us as to why. As an economic expansion takes place, access to capital is easy. Businesses don’t have to be as good at what they do as they might have to be in a tighter economic environment. We bring this up because market participants often see downturns and limits on capital access as negative.
But the truth is, these situations force companies to be better. It’s why the markets (particularly markets for small companies) spring back with such high velocity in recoveries. Not only does negative sentiment abate, but management teams learn lessons to make their companies stronger. Especially the little ones.