Small Business and Debt Finance

Abstract

It is tempting to view debt as the less glamorous side of entrepreneurial finance. In the context of an entrepreneurial firm's financial growth cycle, it is generally believed that infusions of external debt typically follow infusions of external equity (e.g., see Pratt and Morris, 1987). Moreover, the organized venture capital market - a relative newcomer on the financial stage that primarily provides external equity - has garnered much of the publicity associated with financing technology-oriented start-ups. This characterization in which equity is of overwhelming importance, however, masks the vital role played by debt in entrepreneurial finance. The proportion of debt in the capital structure of small businesses in the U.S. is similar to the 50% overall proportion of debt in the capital structure of all U.S. businesses. Perhaps surprisingly, this also holds true for the youngest firms in the U.S. (firms less than two years old) where debt represents about 52% of the capital structure.' Even for high-growth start-ups in which private equity financing dominates in the earliest growth stages, debt financing assumes a major role in the capital structure by the time these firms go public. For the 3,676 firms that went public between 1985 and 1999, the average debtlasset ratio just before the initial public offering (IPO) was about 33%.'