Interest rises drop a clanger

Many of today’s business owners in South Africa will remember the 1990s. Interest rates were a talking point all the time. Negotiations around bank facilities, car loans and mortgages were routinely argued with riders such as “prime less 3” or even “prime less 5”, meaning that if the prime interest rate was 15%, then the loan would attract interest of 10%.

The movement in interest rates were a very movable feast, more often hiking up hugely from from one month to the next, then only very slowly coming down – or so it seemed. At the time South Africa was an indebted nation. That is to say that those with access to credit were heavily indebted and paying huge monthly amounts to banks, and certainly living on the edge.

Individuals were borrowing money to purchase small businesses, and using the business proceeds to repay the loans. Inflation was high, so generally speaking if cash flows were strong enough to obviously meet repayment requirements in the first year, the lender was fairly safe about being repaid in subsequent years.

Then the disaster occurred…

Interest rates shot up beyond the inflation rate. And then they went up again. And again. Almost without warning (it seemed) the prime rate was above 25%. This meant that loans were being repaid on enormous amounts, at rates today reserved for consumption borrowings of poor people. (How’s that for an indictment on the loan sharks of today?)

So those of us old enough to remember will remember this as well:

  • Consumer spending had to drop because consumers had much higher bond and car loan repayments, and no money for much else.
  • Businesses watched their profits collapse because of the double whammy of dropping consumer spending and their own increase in loan repayments. Lower sales turnover with higher operating costs and interest payments. A perfect cash flow nightmare.

For most businesses, this is where the primary struggle was.

But for those of us trying to sell businesses for people, there was another layer to this onion. Businesses were making much lower profits, so their values were already falling. But even worse:

  • Business buyers were being asked to borrow at higher interest rates, and so were not able to pay as much as before.
  • Business buyers who were cash flush and did not have to borrow, were earning much higher interest rates just to sit on their money, without risking it in volatile small businesses under pressure for survival.

So demand for small businesses went down.

On the other side of the fulcrum:

  • Business owners under cash flow pressure, struggling to pay creditors started looking for investors (who were quite happy to keep their cash in the banks at high interest rates – see above).
  • Business owners in real trouble, and unable to pay their bills dumped their enterprises on the market.

So the supply of businesses went up, in a difficult market.

An over supply in an environment of lack of demand. Values collapsed. They stayed collapsed for several years, and people looking to retire at that time were forced to hang on for better times. Some did not make it.

There is a feeling that interest rates are going to start going up again, after years in almost civilised territory. If they do rise, those who have cash will smile, those who have borrowed heavily will sweat.

But for sure; sales will go down, profits will fall and values will decline.

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