Sources of Financing For New Technology Firms: Evidence From The Kauffman Firm Survey

The paper was written Susan Coleman from the University of Hartford, and Alicia M. Robb from the University of California. It was presented at the 2010 USASBE Conference in Nashville, TN.

Abstract

This article uses data from the Kauffman Firm Survey to explore the financing sources and strategies of new technology-based firms. Findings reveal that technology-based firms, and particularly high tech firms, raise larger amounts of capital at startup than firms on average. These findings also suggest that, contrary to the Pecking Order and Life Cycle theories, owners of high tech firms are both willing and able to use external equity as a financing source.

EXECUTIVE SUMMARY

This research examines the sources and amounts of financing used by startup firms included in the Kauffman Firm Survey data. In particular, it was our intent to focus on the financing strategies of new technology-based firms. Our findings seem to disprove the Pecking Order and Life Cycle theories, at least in the case of high tech firms. The Pecking Order theory (Myers, 1984; Myers & Majluf, 1984) states that firm owners prefer to use inside equity and outside debt to avoid diluting their ownership position and giving up control. Our results reveal, however, that high tech firms had a significantly higher probability of using both outside debt and outsider equity than medium tech firms. Further, high tech firms used a significantly higher ratio of outsider equity than medium tech firms. These results suggest that the owners of high tech firms are more open to using a number of different sources of financing to ensure firm survival, development, and growth. It appears that the owners of high tech firms are willing to trade off their concerns regarding dilution and control in return for larger amounts of external capital that will help them to achieve firm goals. By the same token, these results seem to refute the Life Cycle theory (Berger & Udell, 1998) which states that newer firms are forced to rely on internal rather than external sources of capital. Our findings reveal that technology based firms raised substantial amounts of both external debt and equity, even in their startup year.
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TIP OF THE WEEK

Self-Financing

A recent study by Well Fargo found that approximately three out of every four entrepreneurs surveyed started their businesses with money from their personal finances. While this method may seem like a barrier to starting a business, the entrepreneurs only needed capital of about $10,000 to launch their businesses (Wells Fargo 2006). These findings are consistent with previous surveys that found that start-ups generally began with $7,000 to $10,000 and that self-financing was used by 70 to 85 percent of all start-ups.
When self-financing, the entrepreneur may draw upon any number of potential sources of personal funds, including the following:

1. Personal cash. Entrepreneurs who have some personal net worth may draw upon their personal assets to support a new venture. These funds may be invested directly into the business in the form of equity. Personal cash assets might come from cash in bank accounts or investments that can be liquidated. Common uses of personal cash invested in the business include buying equipment, inventory, and other start-up expenses. Personal cash may also be used as a back-up source of cash for personal needs for those times when a business is not able to pay the entrepreneur a salary. A common rule of thumb is to have enough cash saved to cover at least six months of basic personal living expenses before starting a business. It takes time for any business to reach breakeven then to be able to provide consistent cash flow to pay the founding entrepreneurs. Many entrepreneurs are forced to give up a new business simply because they cannot afford to give business enough time to reach this point.
2. Other personal assets. Often a business grows out of a part-time endeavor, personal interest, or hobby. In such cases, the entrepreneur already will have purchased tools and equipment that they had purchased as students studying video production at Belmont University. This equipment became an asset of the business and was treated as part of their equity contribution as shareholders of the business. Other common assets that are brought into a business include computers, cell phones, and office furniture.
3. Unsecured personal credit. A new venture is not likely to be able to secure credit financing. Many entrepreneurs will use personal credit cards or unsecured personal lines of credit to help finance a business startup. When personal credit is used for the business, it is essential to track personal versus business transactions very carefully in order to ensure clean record keeping. If an entrepreneur plans to use a personal credit card for the start-up, it is preferable to get a separate credit card for the business trans-actions. Some credit card companies explicitly prohibit the use of personal credit cards for business purposes. Entrepreneurs should read carefully the terms of use in the credit card contract for any personal credit card being considered for use in the business.
4. Second mortgage on property. For entrepreneurs who have built up equity in real estate, securing a second mortgage on a home or other property may be a way to fund a business start-up through a bank loan. It is important to understand that this will be treated as a personal loan by the bank. The entrepreneur will be personally liable for the repayment of the loan independent of the success or failure of the business.
5. Pledging other personal assets. The entrepreneur also may be able to obtain a loan for the business by pledging personal assets that are easily liquidated and have verifiable market value, such as publicly traded stock or government bonds. Again, this loan will likely be considered a personal loan by the bank and not a direct loan to the business.
6. Working a second job. During the start-up of a new business, many entrepreneurs continue to work their "day job" to support their personal expenses. If the new venture requires the entrepreneur to work during the daytime hours, the entrepreneur may pick up an evening job. If the business hours of the new venture are flexible, the entrepreneur may be able to keep a daytime job to make ends meet. A significant challenge is deciding when to phase out of the second job and rely fully on the proceeds of the transition. However, in reality the entrepreneur often is faced with a difficult, potentially risky decision of when to leap into a full-time, exclusive commitment to the new business.

The ICSB World Conference 2010 will be taking place June 24-27, 2010. It will be held in Cincinnati, Ohio, USA. The deadline for submissions is February 15, 2010 and the Early Registration Deadline is April 30th, 2010. ICSB invites you to invite you to submit papers, case studies, workshop and/or symposia proposals that deal directly or indirectly with: * Entrepreneurship Education * Individual Entrepreneurship * Women and Minority Entrepreneurship * Small Business and SME's in Developing Economies * Public Policy * Entrepreneurship and Technology * Family Business * Corporate Entrepreneurship * International Entrepreneurship * Entrepreneurship in the Arts * Entrepreneurship Across the Curriculum * Social Entrepreneurship * Additional topics of interest and value to ICSB's membership.
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Small Business Institute Journal: Volume IV

The Small Business Advancement National Center at the University of Central Arkansas is honored to be able to present to you the October Edition and Fourth Volume of the Small Business Institute Journal.
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SBI 34th Annual Conference:"Business Aloft"

The 34th SBI annual conference is taking place in beautiful Albuquerque, New Mexico beginning February 18, 2010 through February 20th, 2010. The focus is How to Rise to the Top in Difficult Times including lessons from Main Street, Wall Street & the Ivory Tower.For more informationClick Here.

Allied Academies

The Allied Academies will hold its Spring 2010 international meeting in New Orleans, Louisiana. Presentation dates will be Wednesday April 14 through Friday April 16, 2010. Conference Paper Submissions and Registration are due by March 5. Base registration, on or before March 5, is $300, late registration after that date will be $350. To provide you with maximum outlets for your research, the Allied Academies will hold joint meetings of all its member academies.For more informationClick Here

SBI Journal - Request for Papers And Reviewers

The Small Business Institute is now requesting papers and reviewers for the fifth volume of the Small Business Institute Journal. If you are interested in submitting a paper please visithttp://www.sbaer.uca.edu/sbij/about.phpto see the guidelines and submission procedure. If you are interested in becoming a reviewer or would like more information please email us atsbij@uca.edu.The fifth issue is to be published April 2010.

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