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 Brookings (Robinson) Promoting Innovative Growth 1 / 20

Myths from the Classroom Opaque Startups Brookings (Robinson) Promoting Innovative Growth 2 / 20

Myths from the Classroom Opaque Debt is ✲ Unavailable Startups Brookings (Robinson) Promoting Innovative Growth 2 / 20

Myths from the Classroom Opaque Debt is ✲ Unavailable Startups � � � � ✠ Credit Cards ❄ Reliance on Venture Capital Brookings (Robinson) Promoting Innovative Growth 2 / 20

Myths from the Classroom Opaque Debt is ✲ Unavailable Startups � � � � ✠ Credit Cards ✒ � � � � ❄ ✛ Friends & Reliance on Family Venture Capital Brookings (Robinson) Promoting Innovative Growth 2 / 20

Myths from the Classroom Opaque Debt is ✲ Unavailable Startups ■ ❅ � ❅ � ❅ � ❅ ✠ � Credit Cards � ✒ � � � ❄ ✛ Friends & Reliance on Family Venture Capital Brookings (Robinson) Promoting Innovative Growth 2 / 20

A more accurate picture? Formal Bank VC Informal Capital Lending ❅ � ❅ � ❅ � ❅ � ❅ � ❅ � ❅ � ❅ � ❅ � ❅ � ❘ ❄ ❅ � ✠ Startup Capital Brookings (Robinson) Promoting Innovative Growth 3 / 20

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 Brookings (Robinson) Promoting Innovative Growth 4 / 20

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. Brookings (Robinson) Promoting Innovative Growth 5 / 20

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 Brookings (Robinson) Promoting Innovative Growth 6 / 20

The Role of Debt in Startups Kauffman Firm Survey 2004 All Firms 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% All Firms High Credit Low Credit Owner Equity Owner Debt Insider Equity Insider Debt Outsider Equity Outsider Debt Brookings (Robinson) Promoting Innovative Growth 7 / 20

The Role of Debt in Startups Kauffman Firm Survey 2004 High Tech Firms 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% All Hi-tech High Credit Low Credit Owner Equity Owner Debt Insider Equity Insider Debt Outsider Equity Outsider Debt Brookings (Robinson) Promoting Innovative Growth 8 / 20

The Role of Debt in Startups A Closer Look at Debt 6% 7% 10% 39% 8% 30% Personal loans for business Business bank loans Business Credit Cards Business Credit Line Non-bank loans Other loans Brookings (Robinson) Promoting Innovative Growth 9 / 20

The Role of Debt in Startups Kauffman Firm Survey 2004 The Difference: Total Capital 300000 250000 200000 150000 100000 50000 0 All Firms High Low All Hi- High Low Credit Credit tech Credit Credit Brookings (Robinson) Promoting Innovative Growth 10 / 20

The Role of Debt in Startups What about Garage businesses? 100% ¡ 90% ¡ 80% ¡ 70% ¡ 60% ¡ Outside ¡Debt ¡ 50% ¡ Outside ¡Equity ¡ Insider ¡Debt ¡ Insider ¡Equity ¡ Owner ¡Debt ¡ Owner ¡Equity ¡ 40% ¡ 30% ¡ 20% ¡ 10% ¡ 0% ¡ Non ¡ Home ¡ Pre ¡ Pre ¡ Survived ¡ Closed ¡ Employer ¡ Based ¡ Revenue ¡ Profits ¡ thru ¡2006 ¡ by ¡2006 ¡ Brookings (Robinson) Promoting Innovative Growth 11 / 20

The Role of Debt in Startups What about Garage businesses? Garage businesses vary by size 140,000 ¡ 120,000 ¡ 100,000 ¡ 54,536 ¡ 50,087 ¡ 80,000 ¡ 44,839 ¡ 42,208 ¡ Outside ¡Debt ¡ Outside ¡Equity ¡ Insider ¡Debt ¡ 60,000 ¡ Insider ¡Equity ¡ 21,530 ¡ Owner ¡Debt ¡ Owner ¡Equity ¡ 16,268 ¡ 18,753 ¡ 26,960 ¡ 8,841 ¡ 40,000 ¡ 19,353 ¡ 4,731 ¡ 2,774 ¡ 20,000 ¡ 31,201 ¡ 35,433 ¡ 17,269 ¡ 20,035 ¡ 31,784 ¡ 31,609 ¡ 0 ¡ Non ¡ Home ¡ Employer ¡ Pre ¡ Based ¡ Pre ¡ Revenue ¡ Survived ¡ Profits ¡ Closed ¡ thru ¡2006 ¡ by ¡2006 ¡ Brookings (Robinson) Promoting Innovative Growth 12 / 20

The Role of Debt in Startups What about Equity-backed Businesses? 100% ¡ 90% ¡ 80% ¡ 70% ¡ 60% ¡ Outside ¡Debt ¡ Inside ¡Debt ¡ 50% ¡ Owner ¡Debt ¡ Outside ¡Equity ¡ Inside ¡Equity ¡ 40% ¡ Owner ¡Equity ¡ 30% ¡ 20% ¡ 10% ¡ 0% ¡ ¡Angel ¡ ¡ ¡VC ¡ ¡ ¡Corporate ¡ ¡ ¡Govt-­‑Other ¡ Brookings (Robinson) Promoting Innovative Growth 13 / 20

The Role of Debt in Startups What about Equity-backed Businesses? Again, Size Varies 2,500,000 ¡ 2,000,000 ¡ 628,398 ¡ 1,500,000 ¡ Outside ¡Debt ¡ Inside ¡Debt ¡ Owner ¡Debt ¡ 1,000,000 ¡ Outside ¡Equity ¡ Inside ¡Equity ¡ 1,499,644 ¡ Owner ¡Equity ¡ 164,891 ¡ 75,156 ¡ 500,000 ¡ 328,999 ¡ 515,051 ¡ 0 ¡ 96,030 ¡ 171,145 ¡ ¡Angel ¡ ¡ ¡VC ¡ ¡ ¡Corporate ¡ ¡ ¡Govt-­‑Other ¡ Brookings (Robinson) Promoting Innovative Growth 14 / 20

The Role of Debt in Startups To summarize Startups access bank debt even at their earliest stages of life. Brookings (Robinson) Promoting Innovative Growth 15 / 20

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. Brookings (Robinson) Promoting Innovative Growth 15 / 20

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. Brookings (Robinson) Promoting Innovative Growth 15 / 20

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 R 2 0.004 0.029 0.040 0.058 0.048 0.061 0.062 Brookings (Robinson) Promoting Innovative Growth 16 / 20

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 Brookings (Robinson) Promoting Innovative Growth 17 / 20

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. Brookings (Robinson) Promoting Innovative Growth 18 / 20