This lead to lots of people investing in companies. As long as those companies paid out more money than those low interest rates, it was worthwhile. But at the same time, this meant companies didn’t have to be profitable, because they could pay out investors from money that other investors gave them???

I’m not an economist, but this is how I understand it works. If interest rates are low and your company can deliver 2% returns to investors, more people will invest in your company rather than leaving their money in the bank. Your company can ALSO borrow money from banks at near-0 interest and deliver a 2% return on that borrowed money (I’m probably over-simplifying, here, but I hope not by too much…). Basically, after building and selling more of your product thanks to the borrowed money, your company will have enough to return the money they borrowed from the bank and then some. If interest rates are 5%, your company now needs to be much more profitable for the whole thing to work.

This is why I understand most companies (even big and solid ones) have what is considered a “healthy” amount of debt. As long as your company can earn enough to repay that debt and keep something, not taking that debt is considered a lost opportunity.

If you’re a start-up, though, you’re almost by definition not profitable to begin with. You need money in exchange for a promise of big future profits. Access to that money becomes a lot more challenging with higher interest rates, so you might not be able to operate at a loss for long enough to turn profitable.

EDIT: as I see a lot of discussion on speculation, stock market and such. While these elements do exist and magnify the effects of the higher interest rates, I think the basic mechanism can also be explained without them. Low interest rates are a way of pumping “free” money into the economy, when you stop doing it, the economy goes to shit in various ways. For instance:

You have no job but own a car. You plan to drive to the countryside, buy $100 worth of potatoes and resell them in the city for $110. You estimate that gas will costs you $4. You have only one problem, you don’t have $100. But hey, interest rates are super-low! You can borrow $100 from the bank and give them $101 back after selling your potatoes, so you’re good to go! In the end, you’re $5 richer, as you’ve spent $105 and earned $110.

WAY #1 things go to shit: if rates had been higher, you wouldn’t have even be able to start your business (low interest rates attract more new businesses to the market)

Now say you want to do this again. Your net worth is no longer 0, you have $5! Can you buy $5 worth of potatoes and go on without borrowing any more? Not worth it, you would barely be able to cover your gas costs. So, even if your business is overall profitable, you still rely on borrowing. Given your earlier success, if anything you will probably want to try borrowing more and go for $200 worth of potatoes this time! Note that in this example you started with an owned car; if you’d had to buy one, it would take you years to repay the car and start actually turning a profit.

WAY #2 things go to shit if rates get higher now, you will have to shut down your business. You will still have earned some money, but you can’t continue

Fast-forward a few years, your business is moving about $1M worth of potatoes You buy them for $1M and sell them for $1.05M, earning a cool $50K. From your years in the potato business, you have accumulated $200K in cash. Now, if you want to buy your $1M worth of potatoes, you still rely on the bank to lend you money. OR at this point, you could scale back your business and only use your cash reserves to buy potatoes. You would buy for $200K and make $10K every time. But rates are still so low and demand for potatoes is still very high, so why wouldn’t you borrow and make a $50K profit instead? Or, by borrowing $2M maybe you could buy a field and start growing your own potatoes (since the farmer started raising his prices).

WAY #3 things go to shit if rates get higher now, you might still have a sustainable business, but you will need to scale it back and probably cut some costs. Maybe not too shitty for you, but probably not great news for the people you’ve hired to help you (“guys, due to difficult market conditions, our business has now 5 times less profit and we have to downsize”)

And I haven’t even touched on how an unexpected event, let’s call it Schmovid, can leave you with $1M in potatoes that you’ve already paid but nobody can buy any longer. Your $200K savings have been wiped and now you’re $800K in debt with the bank. You’re starting to recover and… NOW the borrowing rates get much higher.