Why do startup valuations go down when interest rates go up?

Anew day, a new interest rate hike. A few serious faces from the Fed have announced that they will do whatever it takes to tame inflation. Wall Street invariably responds in the red, and startup outlets proclaim the tighter availability of capital and lower valuations.

But what is the actual connection between interest rates, startup capital and valuations?

Following Modern Monetary Theory (MMT), the Fed is increasing interest rates to “cool the economy” and prevent a further rise in inflation.

Despite the focus on interest rates, it is the second aspect — inflation and the consequent government response — that will have the most significant consequences for founders and the public.

Inflation affects your customers, providers and capital

The startup literature around inflation impact on startups focuses on cutting costs, getting to default positive, controlling burn and slowing hiring. But some of these measures, albeit useful during recessions, are too general to be helpful. Instead, a better way to prepare for inflation is to understand how price increases affect your business.

Each business has three major components: customers, providers (including employees) and capital. How is inflation influencing each of these factors?