Corporate Finance: Financing Preferences of Startups

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Corporate Finance: Financing Preferences of Startups
Paula Kokare, Project Manager, Switzerland

Small firms, especially startups, face significant difficulties acquiring external funds due to various reasons. Unlike mature firms.
Sanyal and Mann (2010) researched 4200 US based start-ups to determine financing specifics of new enterprises. Overall, startups were observed to make use of bootstrapping, owners' internal equity and short term debt, such as overdraft and credit card debt, as the primarily source of funding. The authors proved certain characteristics determine the capital structure of new ventures:
  1. TANGIBLE ASSET BASE: Startups with higher tangible capital bases will have better access to and higher usage of external debt financing. With the increase in capital base, the usage of external debt in the form of bank loans and credit cards increases the most significantly. External equity financing is used the least often by such firms.
  2. INTANGIBLE ASSET BASE: If a business possesses high levels of intangible assets, such as IP rights and trademarks; and the owner brings specific knowledge, skills and capital to the firm, asset specificity is high. This means that assets are not transferable, have low liquidation value and represent a high risk for debt providers. Therefore, entrepreneurs of such firms would reach out more often for external equity instead.
  3. OWNERSHIP STRUCTURE: Team-run start-ups will very likely use their own funds more extensively and have network of angels and VC firms to support them in return for equity. Hence, minimal usage of external debt.
  4. OWNER CHARACTERISTICS: Start-ups with financially educated owners will have lower likelihood of involving external equity providers (VC funds and Business Angels). Instead they will be able to arrange banks lending or government funding (debt).
  5. HIGH TECH: High-tech companies are researched to rely more on external equity financing rather than using their own internal financing.
  6. SIZE AND LOCATION: Very small and home-based enterprises use their financing, short-term debt, e.g. credit card and overdraft facilities more often. This is mainly caused by information unavailability about these ventures.
Modigliani, F. & Miller, M. H. (1958) “The Cost of Capital, Corporation Finance and the Theory of Investment" American Economic Review Vol.48 pp. 261– 297
Myers, S. and Majluf, N. (1984) "Corporate Financing and Investment Decisions when Firms have Information that Investors do not Have" Journal of Financial Economics 13(2) pp.187-221.
Sanyal, P. and Mann, C. (2010) "The Financial Structure of Startup Firms: The Role of Assets, Information, and Entrepreneur Characteristics" Boston: Federal Reserve Bank of Boston.

Startup Capital
Charles Alter, Consultant, United States
I attended a talk this week by Steve Wozniak, founder of Apple Computer along with Steve Jobs. He was asked what advice he would give to startup companies that would increase their chances for success. He said: "Do everything you can on the cheap and with your own money and avoid venture capital".

Sage advice in my experience and what I've been counseling companies for years regarding how to grow and prosper. This approach supports a "skunkworks" mentality that fosters creativity and agility, all critical components of successful businesses.

Atanacio Muñoz, Pachuca, Hidalgo. Mèxico
Atanacio, Professor, Mexico
Dear colleagues, we can say that analysis by business experts shows that in terms of growth and prior debt these factors are very important and largely condition corporate finance.
- The fastest growing companies are using a financing scheme based on the Theory of Hierarchy, i.e. mainly retain earnings and debt;
- The expansion of smaller growth companies is performed using a more balanced manner to the various sources of funding.
- The analysis on the largest companies and lower indebtedness shows that these companies move to more moderate levels of leverage.
Etimados colegas: Se puede decir que de acuerdo al análisis efectuado por expertos empresariales plantean que en función del crecimiento y del endeudamiento previo ponen de manifiesto que estos factores son muy importantes y condicionan en gran medida la financiación empresarial. Así, las empresas de mayor crecimiento siguen el esquema de financiación establecido por la Teoría de la Jerarquía, es decir, principalmente beneficios retenidos y deuda; mientras que la expansión de las empresas de menor crecimiento se efectúa recurriendo de una manera más equilibrada a las distintas fuentes de financiación. El análisis efectuado sobre las empresas de mayor y menor endeudamiento pone de manifiesto que estas empresas se mueven hacia niveles más moderados de apalancamiento.


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