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The "Liability of Newness" and Small Firm Access to Debt Capital: Is There a Link?

  • Susan Coleman

    (University of Hartford)

Registered author(s):

    Literature pertaining to the “liability of newness†contends that newer firms face particular difficulties and a greater risk of failure. This article seeks to determine if “newness†is also a disadvantage in the acquisition of debt capital. Results indicate that newer firms were significantly less likely to have lines of credit and were also significantly more likely to have been turned down for their most recent loan. Even when we control for length of relationship with the primary financial services provider, personal guarantees, and collateral, younger firms were still more likely to be turned down for loans. Small firms are an essential part of the United States economy. According to the U.S. Small Business Administration (SBA), there were 22.9 million small firms, defined as firms having 500 or fewer employees, in the United States in 2002 (Small Business by the Numbers, 2002). In fact, small firms represent 99 percent of all firms in this country. They provide approximately half of Gross Domestic Product as well as the majority of new jobs. Small firms are also an important source of innovation in the development of new products, services, and technologies. Given the role played by small firms, it is in our interest to identify factors that contribute to their likely success. In keeping with that, studies of small firm survival and failure have repeatedly identified difficulties with financial management and an inability to secure adequate sources of capital as major contributors to dissolution (Gaskill et al., 1993), Lussier, 1996; Watson et al., 1998). Many small firms are launched with inadequate financial resources. To compound this problem, small firms, unlike larger, publicly-held firms, are unable to raise capital in the public debt and equity markets (Ang, 1991). Alternatively, they are restricted to sources of capital that include the owner’s savings, loans from family and friends, trade credit, and loans from banks and other financial service providers (Berger & Udell, 1998; Bitler et al., 2001). Even in the case of bank loans, however, small firms are more likely to be denied than larger, more established firms. As noted above, the inability to secure external sources of capital raises the risk of firm failure. On a slightly less dire note, inadequate capital may also restrict the firm’s ability to grow, to hire employees, or to introduce new products and services thus impairing profitability and growth in the long term.

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    Article provided by Pepperdine University, Graziadio School of Business and Management in its journal Journal of Entrepreneurial Finance and Business Ventures.

    Volume (Year): 9 (2004)
    Issue (Month): 2 (Summer)
    Pages: 37-60

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    Handle: RePEc:pep:journl:v:9:y:2004:i:2:p:37-60
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    1. James S. Ang, 1991. "Small Business Uniqueness and the Theory of Financial Management," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 1(1), pages 1-13 , Spring.
    2. Allen N. Berger & Gregory F. Udell, 1998. "The economics of small business finance: the roles of private equity and debt markets in the financial growth cycle," Finance and Economics Discussion Series 1998-15, Board of Governors of the Federal Reserve System (U.S.).
    3. Mitchell A. Petersen & Raghuram G. Rajan, . "Trade Credit: Theories and Evidence," CRSP working papers 322, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    4. Frederick C. Scherr & Timothy F. Sugrue & Janice B. Ward, 1993. "Financing the Small Firm Start-Up: Determinants of Debt Use," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 3(1), pages 17-36 , Fall.
    5. Binks, Martin R & Ennew, Christine T, 1996. " Growing Firms and the Credit Constraint," Small Business Economics, Springer, vol. 8(1), pages 17-25, February.
    6. Leeth, John D. & Scott, Jonathan A., 1989. "The Incidence of Secured Debt: Evidence from the Small Business Community," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 379-394, September.
    7. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    8. Petersen, Mitchell A & Rajan, Raghuram G, 1994. " The Benefits of Lending Relationships: Evidence from Small Business Data," Journal of Finance, American Finance Association, vol. 49(1), pages 3-37, March.
    9. Christine T. Ennew & Martin R. Binks, 1995. "The Provision of Finance to Small Businesses: Does the Banking Relationship Constrain Performance," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 4(1), pages 57-73 , Spring.
    10. Blackwell, David W & Winters, Drew B, 1997. "Banking Relationships and the Effect of Monitoring on Loan Pricing," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 20(2), pages 275-89, Summer.
    11. Berger, Allen N & Udell, Gregory F, 1995. "Relationship Lending and Lines of Credit in Small Firm Finance," The Journal of Business, University of Chicago Press, vol. 68(3), pages 351-81, July.
    12. David W. Blackwell & Drew B. Winters, 1997. "Banking Relationships And The Effect Of Monitoring On Loan Pricing," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 20(2), pages 275-289, 06.
    13. Avery, Robert B. & Bostic, Raphael W. & Samolyk, Katherine A., 1998. "The role of personal wealth in small business finance," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 1019-1061, August.
    14. Marianne P. Bitler & Alicia M. Robb & John D. Wolken, 2001. "Financial services used by small businesses: evidence from the 1998 survey of small business finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Apr, pages 183-205.
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