The Financing Choices of Young Firms David T. Robinson Duke - - PowerPoint PPT Presentation

The Financing Choices of Young Firms

David T. Robinson

Duke University National Bureau of Economic Research Institute for Financial Research, Stockholm

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Myths from the Classroom

Opaque Startups

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Myths from the Classroom

Opaque Startups

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Debt is Unavailable

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Myths from the Classroom

Opaque Startups

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Debt is Unavailable

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Credit Cards Reliance on Venture Capital

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Myths from the Classroom

Opaque Startups

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Debt is Unavailable

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Credit Cards Reliance on Venture Capital

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Friends & Family

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Myths from the Classroom

Opaque Startups

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Debt is Unavailable

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Credit Cards Reliance on Venture Capital

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Friends & Family

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A more accurate picture?

VC Informal Capital

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Formal Bank Lending Startup Capital

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Overview

Evidence on the role of debt in funding startups Distinct from the role of banks in small business activity The importance of housing as a source of collateral Policy conclusions

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The Role of Debt in Startups

The Kauffman Firm Survey

Overview

Multi-year panel on roughly 5,000 firms that were formed in 2004. ‘Formation’ means that for the first time in 2004, they: Paid state unemployment taxes, or FICA tax; Established a legal status for the business or used a tax id number; Used a Schedule C on a personal tax return. This generates a heterogeneous panel in terms of owner and business characteristics at founding Highly detailed data on business relationships, financial structure, founder background information.

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The Role of Debt in Startups

Kauffman Firm Survey

Key Survey Statistics

Founder Demographics Overwhelmingly white, non-hispanic, males Median age is 35-44; over 1

3 are over 45

The median respondent has > 10 yrs. industry experience More than 40% of respondents have had at least one prior startup About 1

2 have at least a Bachelor’s degree

Operating Statistics About 1

3 are pre-revenue; but around 1 6 have revenues that exceed $100K

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The Role of Debt in Startups

Kauffman Firm Survey 2004

All Firms

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% All Firms High Credit Low Credit Owner Equity Owner Debt Insider Equity Insider Debt Outsider Equity Outsider Debt

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The Role of Debt in Startups

Kauffman Firm Survey 2004

High Tech Firms

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% All Hi-tech High Credit Low Credit Owner Equity Owner Debt Insider Equity Insider Debt Outsider Equity Outsider Debt

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The Role of Debt in Startups

A Closer Look at Debt

39% 30% 8% 10% 7% 6% Personal loans for business Business bank loans Business Credit Cards Business Credit Line Non-bank loans Other loans

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The Role of Debt in Startups

Kauffman Firm Survey 2004

The Difference: Total Capital

50000 100000 150000 200000 250000 300000 All Firms High Credit Low Credit All Hi- tech High Credit Low Credit

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The Role of Debt in Startups

What about Garage businesses?

0% ¡ 10% ¡ 20% ¡ 30% ¡ 40% ¡ 50% ¡ 60% ¡ 70% ¡ 80% ¡ 90% ¡ 100% ¡ Non ¡ Home ¡ Pre ¡ Pre ¡ Survived ¡ Closed ¡ Employer ¡ Based ¡ Revenue ¡ Profits ¡ thru ¡2006 ¡ by ¡2006 ¡ Outside ¡Debt ¡ Outside ¡Equity ¡ Insider ¡Debt ¡ Insider ¡Equity ¡ Owner ¡Debt ¡ Owner ¡Equity ¡

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The Role of Debt in Startups

What about Garage businesses?

Garage businesses vary by size

0 ¡ 20,000 ¡ 40,000 ¡ 60,000 ¡ 80,000 ¡ 100,000 ¡ 120,000 ¡ 140,000 ¡ Non ¡ Home ¡ Pre ¡ Pre ¡ Survived ¡ Closed ¡ Employer ¡ Based ¡ Revenue ¡ Profits ¡ thru ¡2006 ¡ by ¡2006 ¡

17,269 ¡ 20,035 ¡ 31,201 ¡ 35,433 ¡ 31,784 ¡ 31,609 ¡ 2,774 ¡ 4,731 ¡ 16,268 ¡ 21,530 ¡ 18,753 ¡ 8,841 ¡ 19,353 ¡ 26,960 ¡ 44,839 ¡ 54,536 ¡ 50,087 ¡ 42,208 ¡

Outside ¡Debt ¡ Outside ¡Equity ¡ Insider ¡Debt ¡ Insider ¡Equity ¡ Owner ¡Debt ¡ Owner ¡Equity ¡

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The Role of Debt in Startups

What about Equity-backed Businesses?

0% ¡ 10% ¡ 20% ¡ 30% ¡ 40% ¡ 50% ¡ 60% ¡ 70% ¡ 80% ¡ 90% ¡ 100% ¡ ¡Angel ¡ ¡ ¡VC ¡ ¡ ¡Corporate ¡ ¡ ¡Govt-­‑Other ¡ Outside ¡Debt ¡ Inside ¡Debt ¡ Owner ¡Debt ¡ Outside ¡Equity ¡ Inside ¡Equity ¡ Owner ¡Equity ¡

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The Role of Debt in Startups

What about Equity-backed Businesses?

Again, Size Varies

0 ¡ 500,000 ¡ 1,000,000 ¡ 1,500,000 ¡ 2,000,000 ¡ 2,500,000 ¡

¡Angel ¡ ¡ ¡VC ¡ ¡ ¡Corporate ¡ ¡ ¡Govt-­‑Other ¡ 328,999 ¡ 1,499,644 ¡ 515,051 ¡ 171,145 ¡ 164,891 ¡ 628,398 ¡ 75,156 ¡ 96,030 ¡

Outside ¡Debt ¡ Inside ¡Debt ¡ Owner ¡Debt ¡ Outside ¡Equity ¡ Inside ¡Equity ¡ Owner ¡Equity ¡

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The Role of Debt in Startups

To summarize

Startups access bank debt even at their earliest stages of life.

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The Role of Debt in Startups

To summarize

Startups access bank debt even at their earliest stages of life. This is an extremely robust fact: Robust across firm types. Robust over time: debt continues to be the primary source of funding throughout the first four years of the firm’s life. Complementarity of debt/equity demonstrates that financing constraints are present.

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The Role of Debt in Startups

To summarize

Startups access bank debt even at their earliest stages of life. This is an extremely robust fact: Robust across firm types. Robust over time: debt continues to be the primary source of funding throughout the first four years of the firm’s life. Complementarity of debt/equity demonstrates that financing constraints are present. Variation in firm characteristics has a first order effect on startup size, but only a second order effect on the mix of debt/equity. Evidence that the variation in supply of debt is partly responsible for findings.

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Housing as a Source of Collateral

Capital Structure and Housing

Access to outside debt is greater when homes are more pledgable as collateral. (1) (2) (3) (4) (5) (6) (7) Home supply elasticity 0.0163*** 0.0156*** 0.0153*** 0.0149** 0.0150*** 0.0163*** (0.0058) (0.0058) (0.0059) (0.0058) (0.0058) (0.0058) State bankruptcy exemption

• 1.92
• 2.52*

(1.33) (1.48) Industry dummies No Yes No Yes Yes Yes Yes Owner characteristics No No Yes Yes Yes Yes Yes Credit score dummies No No No No No Yes Yes Observations 2,564 2,564 2,466 2,466 3,389 2,466 2,466 R2 0.004 0.029 0.040 0.058 0.048 0.061 0.062

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Housing as a Source of Collateral

The Home Equity / Entrepreneurship Channel

Adelino, Schoar and Severino, 2012

Between 2002-2007, areas with strong exogenous home price growth saw stronger employment growth This employment growth was strongest among the smallest firms Effect for 1-4 employee firms is ∼ 3x that of > 20-person firms And among firms with lower capital requirements Effect for small firms: 3 times larger in low capital-intensive sectors than high intensive ones There is generally no housing effect on “large" establishments in capital intensive industries

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Housing as a Source of Collateral

The Small Business Employment Myth

Haltiwanger, Jarmin, Miranda, 2012

Controlling for age, there is no systematic relationship between firm size and employment “Small firms" are not job creators. Young firms are job creators. They typically start small. The good ones grow, the bad ones die, destroying jobs. On net, creation outweighs destruction.

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Policy Implications

What Do These Facts Say About Policy?

To me, they point to three policy challenges associated with promoting entrepreneurship: We need to be careful to decouple policy towards business starts from policy towards small business. We need to embrace the fact that promoting innovative growth almost surely means rethinking the way we provide access to debt. We need to understand that the housing crisis is also an entrepreneurship crisis.

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Policy Implications

In Conclusion

Most “small business employment growth" is actually “young business employment growth" Startups access bank debt even at their earliest stages of life. Variation in firm characteristics has a first order effect on startup size, but only a second order effect on the mix of debt/equity. Home equity is an important source of collateral for startups. This means that in terms of policy, we need to embrace creative solutions to debt access for small firms

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