H OW D O S TART -U P F IRMS F INANCE T HEIR A SSETS : E VIDENCE F ROM THE K AUFFMAN F IRM S URVEYS Rebel A. Cole DePaul University Tatyana Sokolyk Brock University Entrepreneurial Finance and Innovation Conference Boston, MA June 9-11, 2012

Introduction: How do start-up firms finance their assets? How does the use of credit change from the firm’s start-up through the first critical years of business growth and development? In this study, we provide some answers to these questions by analyzing the Kauffman Firm Surveys (“KFS”) data. With this unique dataset, we are able to test the fundamental theories of capital structure and examine the substitutability and connections among the alternative sources of credit finance for closely held start-up firms. Cole-Sokolyk 1

Introduction: Why is this research important? According to the IRS, there are more than 30 million businesses in the U.S., of which 99.97% are privately held. According to the SBA, small businesses account for half of all U.S. private-sector employment and produced 64% of net job growth in the U.S. between 1993 and Also, recent Census research finds that the majority of all job creation is accounted for by start-up firms at their creation; and that majority of job destruction is accounted for by start-up firms during their early years. Therefore, a better understanding of what types of firms use credit and the sources of credit finance can help policymakers to take actions that will lead to more jobs and faster economic growth. Cole-Sokolyk3

Summary: First, we examine firms that use no credit to finance their assets. – We find that about 25% of firms report 100% equity financing of their initial assets. Second, for the remaining 75% of start-ups, we analyze their sources of credit, which we separate into three groups— trade credit, personal credit, and business credit. – At start-up, we find that the majority of firms (55%) rely upon personal credit, but that a sizable fraction of firms also use business credit (44%) and trade credit (24%). – As firms develop, they decrease the use of personal credit and increase the use of business credit. Cole-Sokolyk4

Summary: We also examine which firm and owner characteristics explain a start-up’s decisions to use credit and, conditional upon using credit, what types to use. We find that firms are more likely to use credit at start- up when they: – are larger, – are more profitable, – are more liquid, – have more tangible assets; and – when their primary owner has more experience and more education, and is white. Cole-Sokolyk6

Summary: Among firms that use credit, we find that: – larger firms are more likely to use trade and business credit but are less likely to use personal credit; – firms with more current and tangible assets are more likely to use both trade and business credit but are less likely to use personal credit; – firms with better credit scores are more likely to use business credit; – corporations are more likely to use both trade and business credit but are less likely to use personal credit; – firms with multiple owners are more likely to use business credit but are less likely to use personal credit; – owners with more prior business start-ups are less likely to use personal credit; and – female owners are more likely to use personal credit. Cole-Sokolyk7

Related Literature: Capital Structure of Privately Held Firms: Berger and Udell (JBF 1998) Cole (SBA Research Study 2010) Cole (FM 2012 forthcoming) Robb and Robinson (RFS 2012 forthcoming) Cole-Sokolyk8

Related Literature: Trade Credit at Privately Held Firms: Petersen and Rajan (RFS 1997) Berger and Udell (JBF 1998) Cunat (RFS 2007) Cole (SBA Research Study 2010) Giannetti et al. (RFS 2011) Robb and Robinson (RFS 2012 forthcoming) Cole-Sokolyk9

10 Data: Kauffman Firm Surveys (KFS) The KFS is the largest and most comprehensive dataset on U.S. start-up firms, providing information on firms’ use of credit, as well as various firm and owner characteristics. It tracks a panel of 4,928 U.S. businesses established during Firms are a stratified random sample of all U.S. start-ups in As of year-end 2011, data were available for the initial year and for five follow-up years ( ). Plans are in place for follow-up surveys for at least two additional years.

Credit Categories: Any Credit: Firm reported that it used either trade credit, business credit, or personal credit Trade Credit: Firm reported that it used trade credit during the reference year Business Credit: includes either of the following categories: business bank loan, business credit line, business loan from nonbank institutions, business credit card, business credit card issued on owner’s name, business loan from the government, business loan from other businesses, business loan from other sources. Personal Credit: includes either of the following categories: personal bank loan by the primary owner, personal bank loan by other owners, the primary owner’s personal credit card used for business purposes, and the other owners’ personal credit cards used for business purposes. Cole-Sokolyk11

Cole-Sokolyk12 Table 2 (Panel A): Use of Credit by Start-Ups by Year

Cole-Sokolyk13 Table 2 (Panel A): Use of Business Credit

Cole-Sokolyk14 Table 2 (Panel A): Use of Personal Credit

Cole-Sokolyk15 Table 2 (Panel B): Exclusive Use of Credit by Type

Cole-Sokolyk16 Table 2 (Panel C): Use of Multiple Types of Credit

Cole-Sokolyk17 Table 3: Amounts of Credit Used

Cole - Sokolyk18 Table 3: I think we should delete this Slide. I can just mention this when I am discussing prev/ slide Credit Amount / Total Liabilities

Cole - Sokolyk19 Table 3 Distribution of Different Types of Credit Amounts from

Cole-Sokolyk20 Table 7: Determinants of Credit Use at Start-Up: Firm Characteristics (Odds Ratios)

Cole-Sokolyk21 Table 7: Determinants of Credit Use at Start-Up: Owner Characteristics (Odds Ratios)

Cole-Sokolyk22 Table 8: Determinants of the Percentage of Total Liabilities (TL) Financed by Trade, Business or Personal Credit: Firm Characteristics

Cole-Sokolyk23 Table 8: Determinants of the Percentage of Total Liabilities (TL) Financed by Trade, Business or Personal Credit: Owner Characteristics

Conclusions: In this study, we use data from the Kauffman Firm Survey to analyze how U.S. start-up firms finance their assets. Our study contributes, in several important ways, to both the entrepreneurship and finance literatures. First, we contribute to the growing literature that analyzes data on start-up firms from the Kauffman Firm Survey. (See, e.g., Coleman and Robb 2009; Fairlie and Robb 2009; Cole 2011; Coleman and Robb, 2011; Robb and Watson, 2011; and Robb and Robinson, 2012). We present new evidence on the use of credit by start-up firms during their first five years of existence. Second, we contribute to the strand of the capital-structure literature that focuses on privately held firms. (See, e.g., Ang, 1992; Berger and Udell, 1998; Cole, 2008; Ang, Cole and Lawson, 2010; and Robb and Robinson, 2012). We provide new evidence on the mix of credit upon which privately held firms rely at start- up and during their first five years of life. Cole-Sokolyk25

Conclusions: Third, we contribute to the trade-credit literature on privately held firms. (See, e.g., Petersen and Rajan, 1997; Cunat, 2007; Cole, 2010; and Giannetti et al., 2011.) We document the importance of trade credit to start-up firms during their first five years of life, including its explosive growth during the first year. Finally, we provide new evidence to the growing literature on zero-debt firms. (See, e.g., Strebulaev, 2006; and Cole, 2012). We document that about 25% of privately held firms are financed exclusively with owners’ equity at start-up, and that this percentage changes by very little during the firms’ first five years of life. Cole-Sokolyk26