The financing of business start-ups

doi:10.1016/S0883-9026(03)00029-6

Journal of Business Venturing

Volume 19, Issue 2, March 2004, Pages 261-283

https://doi.org/10.1016/S0883-9026(03)00029-6 Get rights and content

Abstract

This article investigates the determinants of capital structure and types of financing used around business start-ups utilizing a survey that reduces the confounding effects of survivorship bias. In particular, the influence of start-up size, asset structure, organization type, growth orientation, and owners' characteristics are examined both in the choice and in the magnitude of finance use. The results are consistent with the theoretical models incorporating issues, such as information asymmetries, agency theory, and transaction costs. The results also demonstrate linkages among providers of finance, maturity of assets, and the capital structure of start-ups. While the results provide insights into business finances near the time of creation, some recommendations for future research are discussed.

Section snippets

Executive summary

How business start-ups are financed is one of the most fundamental questions of enterprise research. Financial capital is one of the necessary resources required for enterprises to form and subsequently operate. Capital decisions and the use of debt and equity at start-up have been shown to have important implications for the operations of the business, risk of failure, firm performance, and the potential of the business to expand.

This article investigates the determinants of capital structure

Theories of capital structure and debt finance of start-ups

The theoretical principles underlying the capital structure and financing choices can be generally described either in terms of a static trade-off choice or pecking-order framework. Both frameworks predict differences in explicit and implicit financing costs, and consequently, the use of financing for different firms. Static trade-off choice encompasses several aspects including the exposure of the firm to bankruptcy and agency costs against the tax benefits associated with debt use.

Bankruptcy

Size

Theoretical reasons why firm size would be related to the capital structure of the firm include economies of scale in lowering information asymmetries, scale in transaction costs, market access, and risk exposure. First, smaller firms may find it relatively more costly to resolve informational asymmetries with lenders and financiers. This will lead to smaller firms being offered less capital or offered capital at higher rates to larger firms, consequently discouraging the use of outside

Sample

The initial sample for this study is obtained from the Business Longitudinal Survey (BLS) developed by the Australian Bureau of Statistics (ABS).³

Descriptive statistics

The descriptive statistics of the dependent and independent variables are provided in Table 1. The mean (median) leverage of the sample firms was .6057 (.7500). However, it is important when examining these descriptive statistics to recognize that these means and medians are calculated after the exclusion of firms beyond the bounds of “technical” solvency. Inclusion of such firms would increase the magnitude of the dependent variables. Long-term leverage appears to constitute around 20% of the

Implications

This section reviews the implications in light of the variables investigated. Size appears to be an important factor in the financing of new businesses. Consistent with the theoretical arguments developed earlier, the larger the start-up, the greater the proportion of debt, long-term debt, outside financing, and bank financing. Distinguishing between the decision to use and the proportion of financing use revealed that size was consistently an important explanation in the decision to use debt

Limitations and future research

This section discusses some of the limitations of the study and offers suggestions for improvement as well as other ideas for future research examining capital structure choices for start-ups. First, there are several factors that are unable to be controlled due to data constraints. For example, the potential influence of ethic background upon start-up finance through both resource and motivation issues has been noted by several researchers Ando, 1988, Chen and Cole, 1988, Bates, 1991, Bates,

Acknowledgments

The author would like to thank Brian Gibson, Visarut Sribunnak and the participants from the 2001 Babson College/Kauffman Foundation Entrepreneurship Research Conference for their helpful comments. The author also thanks John Purcell and the Australian Bureau of Statistics for access to the Business Longitudinal Survey data. A preliminary version of this research titled “The financing and capital structure of business start-ups: the importance of asset structure” is published in the Frontiers

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View full text

The financing of business start-ups

Abstract

Section snippets

Executive summary

Theories of capital structure and debt finance of start-ups

Size

Sample

Descriptive statistics

Implications

Limitations and future research

Acknowledgments

J. Bank. Finance

J. Bus. Venturing

J. Bus. Venturing

J. Bus. Venturing

J. Financ. Econ.

J. Bus. Venturing

J. Bus. Venturing

J. Financ. Econ.

J. Financ. Econ.

J. Bus. Venturing

The business gestation process of novice, serial and parallel business founders

Entrep. Theory Pract.

Capital issues and minority-owned business

Rev. Black Polit. Econ.

On the theory of finance for privately held firms

J. Small Bus. Finance

The influence of income taxes on the use of inside and outside debt by small businesses

Natl. Tax J.

Commercial bank financing of white- and black-owned small business start-ups

Q. Rev. Econ. Bus.

The economics of small business finance: the roles of private equity and debt markets in the financial growth cycle

J. Bank. Finance

The Origin and Evolution of New Businesses

Formal and informal financing in a Chicago ethnic neighborhood

Econ. Perspect.

Personal equity investment and small business financial difficulties

Entrep. Theory Prac.

Predictors of capital structure in small ventures

Entrep. Theory Pract.

The myths, facts, and theories of ethnic, small-scale enterprise financing

Rev. Black Polit. Econ.

Small firm growth, access to capital markets and financial structure: review of issues and empirical investigation

Small Bus. Econ.

Access to capital: a comparison of men and women-owned small businesses