Capital Structure Decision of Small and Medium-Sized Businesses

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  • Topic: Risk, Finance, Capital structure
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ATENEO DE DAVAO UNIVERSITY
School of Business and Governance

In partial fulfillment of the
requirements for Fin324

CAPITAL STRUCTURE DECISION OF SMALL AND MEDIUM SIZED ENTERPRISES A Case Study of All Systems Logistics, Inc. Phil

Submitted by:
Bijis, Dean Victor
3BM-A

Submitted to:
Ma. Grace M. Baysa
Fin324 Teacher

Abstract

Firms need capital in order to run their respective businesses, do necessary investments and eventually, grow larger. These actions and decisions are combined with high costs where both internal and external financing might be appropriate. Capital structure is the relation between debt and equity.

In this case, I have focused on the decision behind the capital structure of All Systems Logistics, Inc. I have focused on the industry and I have tried to find out how management reason about their decision. The purpose of this case is therefore to describe and analyze its decision of capital structure within its industry. Emphasis is put on the different aspects that influence the capital structure decision and to what extent this is a strategic issue colored by personal beliefs.

To fulfill the purpose, mainly a qualitative approach with primary data from structured interviews has been used. The interview was conducted face-to-face with owner and/or manager.

One theory explains that firms, especially SMEs, prefer to finance their businesses with internally generated funds. Focus of the theoretical part is on theories of what factors that affect the capital structure decision, how this can be argued to be a strategic question for SMEs, how risk affects the capital structure decision and how this decision is made in a family business. These theories are presented to shed light on the capital structure decision making process of SMEs.

From this study it is found that the majority of the companies prefer internal financing i.e. reinvested earnings, and as a second alternative to use debt in form of bank loans. The study also shows that the reasons behind this preferred order are the will of being independent, previous experience and managements’ risk-taking propensity. I believe that these factors combined with beliefs about debt and realized need for debt works as a base for how a capital structure strategy is discussed, formed and developed. From this study it can also be concluded that risk indirectly affects the capital structure decision. Last, the study concludes that even though the studied firms prefer to finance with retained earnings they all use debt more or less.

Table of Contents

1Introduction………………………………………………………………………… 1
1.1 Background………………………………………………………………… 1
1.2 Problem………………………………………………………………………… 1
1.3 Purpose………………………………………………………………………… 3
1.4 Definitions………………………………………………………………… 3

2Capital Structure Theories ………………………………………………………. 4
2.1 Foundation of capital structure decision theories…………………….…... 4
2.1.1 M&M Theorem………………………………………………………… 4
2.1.2 Information Asymmetry………………………………………………… 5
2.2 Pecking Order Theory………………………………………………………… 5
2.3 SMEs strategic capital structure decision theories………………………… 6
2.4 Risk………………………………………………………………………… 9
2.5 Characteristics affecting capital structure………………………………… 9
2.5.1 Special characteristics of family businesses………………………… 10

3Empirical Findings and Analysis ………..…………………….......................... 10
3.1 All Systems Logistics, Inc.………………………………………………….. 10
3.2 Analysis of M&M theorem………………………………………………….. 11
3.3 Analysis of the Pecking Theory …………………………………………….… 12
3.4 Analysis of SMEs strategic capital structure……………………………….…. 12
3.5 Analysis of Risk………………………………………………………………….. 13
3.6 Analysis of firm characteristics………………………………………….. 13
3.6.1 Analysis of special characteristics of family business………….. 13

4Conclusion………………………………………………………………………..... 14

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