Small businesses are disproportionately bearing the burden of the US Federal Reserve's push to fight inflation with the highest rates in decades.

Soaring costs of financing and tighter access to credit are squeezing companies with less than 500 employees, which already tend to pay a larger share of revenue on interest and rely more on short-term and floating-rate debt than bigger companies.

The Fed is largely expected to keep its benchmark interest rate high following a run-up of 525 basis points since March 2022. The elevated borrowing costs have led to predictions that small businesses will soon pay a greater share of revenue toward interest. With rates at their highest levels in years, banks have become more reluctant to extend credit without strengthening terms or boosting costs, forcing many small business owners to scramble to stay afloat.

"Larger businesses have teams of people working on this, navigating how they can best remain competitive and absorb those costs," said Holly Wade, an executive director with the National Federation of Independent Business (NFIB). "With a smaller business, sometimes it's just the owner left to figure it out themselves. It's always going to be more challenging for smaller firms."

Interest takes bigger bite of small-business revenue

The relatively steeper costs confronting smaller businesses center on financing differences with their larger counterparts. Small businesses paid an estimated interest of more than 5.75% of revenue in 2021, compared to 1.75% for larger companies, according to an Oct. 15 analysis by Goldman Sachs economists.

Since 2000, small businesses have spent an average of 6.82% on interest payments, compared to 2.61% for large businesses.

"Small businesses spend a larger share of output on interest payments than larger businesses, reflecting both higher interest rates on small business debt and a higher debt-to-output share on average," wrote Spencer Hill, a senior economist at Goldman Sachs and one of the authors of the analysis, in an email. "The conventional explanation of the higher interest rate is that firm size is negatively correlated with credit risk — in other words, it is safer to lend to larger firms, other things equal."

The interest burden for small businesses will rise to about 7% in 2024 and climb further to nearly 8% after that — levels last seen in the mid-1990s, according to Goldman's forecast. In 2021, the interest burden stood at 5.75%.

In addition, smaller businesses rely on different forms of credit, making them more in need of short-term refinancing and more exposed to changes in interest rates than larger companies.

About half of small-business debt is made up of credit lines, short-term loans and other floating-rate debt, compared to about 20% for large businesses, according to Goldman's estimates.

"The smaller businesses often rely on similar forms of credit than consumers, like credit cards, and therefore may also feel the greater debt-servicing burden than larger organizations that can borrow over longer duration," said Gregory Daco, chief economist at EY-Parthenon.

Scaling back

Gene Marks, the owner of a financial technology consulting firm just outside Philadelphia, has seen the effects of higher interest rates and tighter credit from many of his 600 clients, mostly small businesses throughout the mid-Atlantic.

Clients have scaled back expansion plans or delayed purchases of new equipment, both due to the higher cost of financing and issues getting credit and taking on new debt. Banks are not pulling back credit lines, Marks said, but are more reluctant to extend them. While business owners believe that rates have likely peaked, they are not dropping much in the near term.

"This is a 2024 issue," Marks said. "It's not going to be easing anytime soon."

The rising costs of financing are a growing concern for small businesses, but inflation and the historically tight labor market still lead the list of worries.

A poll of small-business owners and operators conducted in the summer for MetLife and the US Chamber of Commerce found that rising interest rates were a top concern for 17% of respondents and access to credit or a loan for 10%. This compares to 52%, who listed inflation as a top concern.

In the NFIB's September survey of small-business economic trends, 23% of owners listed inflation as their most important problem, down from 30% a year ago, and 23% listed quality of labor, up from 22% a year ago. Meanwhile, only 4% listed financing and interest rates as their top problem, but that compares to just 1% a year ago.

"Not many are saying it's the biggest problem, but it's a growing concern for many of them," Wade with NFIB said.