The Capital Structure Decisions of New Firms

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NBER WORKING PAPER SERIES

THE CAPITAL STRUCTURE DECISIONS OF NEW FIRMS Alicia M. Robb David T. Robinson Working Paper 16272 http://www.nber.org/papers/w16272

NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 August 2010

The authors are grateful to the Kauffman Foundation for generous financial support. Malcolm Baker, Thomas Hellmann, Antoinette Schoar, Ivo Welch, and seminar participants at the Kauffman/Cleveland Federal Reserve Bank Entrepreneurial Finance Conference, the University of Michigan, the Stockholm School of Economics, the Atlanta Fed, and the NBER Summer Institute Entrepreneurship Meetings and the Kauffman/RFS conference on entrepreneurial finance provided helpful comments on previous drafts. Juan Carlos Suarez Serrato provided expert research assistance. The usual disclaimer applies. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2010 by Alicia M. Robb and David T. Robinson. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

The Capital Structure Decisions of New Firms Alicia M. Robb and David T. Robinson NBER Working Paper No. 16272 August 2010 JEL No. G21,G24,L26 ABSTRACT This paper investigates the capital structure choices that firms make in their initial year of operation, using restricted-access data from the Kauffman Firm Survey. Contrary to many accounts of startup activity, the firms in our data rely heavily on external debt sources such as bank financing, and less extensively on friends and family-based funding sources. This fact is robust to numerous controls for credit quality, industry, and business owner characteristics. The heavy reliance on external debt underscores the importance of well functioning credit markets for the success of nascent business activity.

Alicia M. Robb UC, Santa Cruz arobb@ucsc.edu David T. Robinson Fuqua School of Business Duke University One Towerview Drive Durham, NC 27708 and NBER davidr@duke.edu

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Introduction

Understanding how capital markets affect the growth and survival of newly created firms is perhaps the defining question of entrepreneurial finance. Yet, much of what we know about entrepreneurial finance comes from firms that are already established, have already received venture capital funding, or are on the verge of going public—the dearth of data on very early stage firms makes it difficult for researchers to look further back in firms’ life histories.1 Even data sets that are oriented towards small businesses do not allow us to measure systematically the decisions that firms make at their founding. This paper uses a novel data set, the Kauffman Firm Survey (KFS), to study the behavior and decision-making of newly founded firms. As such, it provides a first-time glimpse into the capital structure decisions of nascent firms. In this paper we use the confidential, restricted-access version of the KFS, which tracks nearly 5,000 firms from their birth in 2004 through their early years of operation.2 Because the survey identifies firms at their founding and follows the cohort over time, recording growth, death, and any later funding events, it provides a rich picture of firms’ early fundraising decisions. Rather than attempt to test specific theories of capital structure, our main goal is a more modest, descriptive one: to examine the financing choices that firms make when they launch, and ask whether any patterns emerge from the data. This is motivated in part by the widely held view that frictions in capital markets prevent startups from achieving their optimal size, or indeed, from starting...
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