Monica Birrenkott wasn't expecting to see interest rates as high as 11.5% when she sought funding for her new event-production business this summer.

It was a contrast from what she experienced during the pandemic, when the Shakopee resident took advantage of historically low interest rates to refinance her mortgage and buy a car.

Though the business landscape seemed favorable for her Full Swing Productions company — which specializes in LED video panel rental and installation — as in-person events returned, an unfavorable lending environment made Birrenkott question whether it was the right time to start a business. She did end up registering her startup in June, but knew it'd be tough to begin paying off the loans before the company generated significant revenue.

As the Fed raises rates to calm inflation, the high cost of credit is squeezing small-business owners. Particularly vulnerable are newer businesses that benefited from historically low rates in recent years and are still establishing themselves, a group that includes many women and people of color.

Between January 2020 and April 2023, the number of incorporated, self-employed people of color rose from about 1.7 million to 2 million nationally, according to the Federal Reserve. Since 2020, women have made up nearly half of entrepreneurs, compared to less than a third before the pandemic, according to small-business payroll firm Gusto Inc.

Financing a business has historically been a challenge for underrepresented groups. Of employer-firm startups that applied for financing in 2022, those people of color owned were about twice as likely to be denied as their white-owned counterparts, according to the Fed. Gusto reported male owners received private capital investments at more than twice the rate of women.

"I would describe it as business as usual in the fact that access to capital is certainly more challenging in minority and low- and moderate-income communities," said Kenneth Kelly, chair and CEO of First Independence Bank. "The fact that rates have risen so swiftly over such a short period of time has created a little bit of shock in the system."

Lending institutions have tightened criteria, and consumers are taking on less debt. According to the Kansas City Fed, new small-business lending in the second quarter declined nearly 17% year-over-year.

The Federal Open Market Committee (FOMC), which sets financial policy, met last week and opted to leave rates unchanged at 5.25% to 5.5%. Fed officials have signaled they intend to leave rates higher for longer as they rein in an unexpectedly resilient economy.

Rate hikes are working as intended and driving inflation down, if more slowly than economists predicted. But impeding economic growth hits those who can least afford it, said Stephen Spears, senior vice president of Twin Cities community banking at Bremer Bank.

"It has become a real problem for the consumer, a real problem for buying a home and certainly a real problem for business owners," he said.

Rude awakening

Those most affected opened their doors in the past few years. Businesses launching now know capital will be expensive and hard to get while older businesses might recall times with double-digit rates.

"What jades everyone's view of the concept of rates is really the seven-year period of stability that occurred in the mid-teens, where there was not a change in that rate, and everyone got very accustomed to rates being very low," said Maggie Ference, Small Business Association (SBA) director at Huntington Bank.

To help, Bremer launched small-business owner education programs in June. U.S. Bank expanded a lending program for female-, people of color- and veteran-owned businesses after acquiring Union Bank last year. Huntington started a program to support women, people of color and veteran small-business owners in 2020.

But rate hikes are also stretching financial institutions.

"[Business owners] will come back to us and say, 'Oh, my gosh, our interest rate has gone up so much,' and obviously, we have compassion for that, but our costs have gone up to fund the loans as well," said David Scott, executive vice president and director of commercial banking at Sunrise Banks.

The prime rate, which banks charge their most creditworthy customers, has risen from 3.25% at the height of the pandemic to 8.5%. That rate links to other interest rates, including government-backed SBA loans, which become more popular when the economy tightens.

Though SBA loans are intended to provide credit to businesses that might not otherwise qualify, data show loan awards disproportionately favor white and male business owners.

Big cost for small business

Birrenkott looked to nonprofits and grants for funding and received a $100,000 loan at a 6.75% rate through WomenVenture, the only female-focused community development financial institution, or CDFI, in Minnesota. She took out a larger second loan through Bank Vista at 9.75%.

LeeAnn Rasachak, WomenVenture's chief executive, said clients come to the organization — primarily serving women and those who identify as Black, Indigenous or people of color — to escape double-digit rates. Higher rates are creating a bigger problem for those business owners who continue to take on debt but are not making price adjustments for their services or products, she said.

Katie Steller of Minneapolis salon Steller Hair Co. this year started making interest-only payments on the SBA Economic Injury Disaster Loans she received in 2021. Though the interest rate is less than 4%, it's a large expense considering she's absorbing higher costs for products while still trying to stabilize a business the pandemic disfigured.

Steller, who launched her salon in 2013, has considered seeking additional loans but couldn't bear more debt and higher interest.

"Those increased rates and inflation and how the economy is going, there's real detrimental effects on small businesses," she said.

Alexis Dishman, small-business chief lending officer at Community Reinvestment Fund (CRF), said payment relief and connections to lower-cost loan options can help clients who are struggling with cash flow or loan payments.

Strong startup growth among women and people of color coming out of the pandemic "makes it even more important for organizations ... to really sharpen our pencil and support the entrepreneurs" with resources to navigate ups and downs, she said.

WomenVenture's bank partners are creating products more suitable to socially and economically disadvantaged groups, Rasachak said, but she's worried the current lending environment might cause some small-business owners to not expand or hire.

"While there are solutions available, and people are actively working on them," she said, "it may not be fast enough."