1. 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

2. 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? With Kauffman Firm Surveys (“KFS”) data, we are able to examine the substitutability and connections among the alternative sources of credit finance for closely held start-up firms. Cole-Sokolyk 1

3. 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 50% of all U.S. private-sector employment and produced 64% of net job growth in the U.S. between 1993 and 2008. Census research finds that the majority of job creation is accounted for by start-ups at their creation and the majority of job destruction is accounted for during firms’ early years. 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-Sokolyk2

4. Related Literature: Capital structure of privately held firms (Berger and Udell, 1998; Cole, 2010; Cole, 2012; Robb and Robinson, 2012) Trade credit at privately held firms (Petersen and Rajan, 1997; Berger and Udell, 1998; Cunat, 2007; Cole, 2010; Giannetti et al. 2011; Robb and Robinson, 2012) Firms using little or no debt are capital-constrained and, as a consequence, grow more slowly (Schumpeter, 1934; King and Levine, 1993; Rajan and Zingales, 1998) Cole-Sokolyk 3

5. 4 Data: Kauffman Firm Surveys (KFS) 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 2004. Firms are a stratified random sample of all U.S. start-ups in 2004. As of year-end 2011, data were available for the initial year and for five follow-up years (2004-2009). Plans are in place for follow-up surveys for at least two additional years.

6. Research Design: We examine what percentage of firms use credit and what type of credit at the firm’s start-up and during the first five years of operations (KFS 2004-2009). We examine the amount of credit used at the firm’s start-up and during the first years of operations (KFS 2004-2009). We investigate what factors explain a start-up’s decision to use credit (KFS 2004). Conditional upon using credit, we examine the decision as to what type of credit to use; and, how the amount of credit is allocated across different credit types (KFS 2004). Cole-Sokolyk 5

7. Credit Categories: 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. Any Credit: Firm reported that it used either trade credit, business credit, or personal credit during the reference year. Cole-Sokolyk6

8. 7 Table 2 (Panel A): Use of Credit by Young Firms by Year

9. Cole-Sokolyk 8 Table 2 (Panel A): Use of Business Credit

10. Cole-Sokolyk9 Table 2 (Panel A): Use of Personal Credit

11. Cole-Sokolyk10 Table 2 (Panel B): Exclusive Use of Credit by Type

12. Cole-Sokolyk11 Table 2 (Panel C): Use of Multiple Types of Credit

13. Cole-Sokolyk12 Table 3: Amounts of Different Types of Credit

14. Cole-Sokolyk 13 Table 7: Determinants of Credit Use at Start-Up: Firm Characteristics (Odds Ratios)

15. Cole-Sokolyk14 Table 7: Determinants of Credit Use at Start-Up: Owner Characteristics (Odds Ratios)

16. Cole-Sokolyk15 Table 8: Determinants of the Percentage of Total Liabilities (TL) Financed by Trade, Business or Personal Credit: Firm Characteristics

17. Cole-Sokolyk16 Table 8: Determinants of the Percentage of Total Liabilities (TL) Financed by Trade, Business or Personal Credit: Owner Characteristics

18. Summary: We document that about 25% of start-up firms do not use any credit to finance their assets. For the remaining 75% of start-ups, we analyze their sources of credit. – At start-up, the majority of firms (55%) rely upon personal credit, and a sizable fraction of firms 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-Sokolyk 17

19. 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-Sokolyk18

20. 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-Sokolyk19

21. Summary: We contribute to the growing literature that analyzes data on start-up firms from the Kauffman Firm Survey. We present new evidence on the use of credit by start-up firms during their first six years of existence. We contribute to the capital-structure literature that focuses on privately held firms. We provide new evidence on the mix of credit upon which young privately held firms rely. We contribute to the trade-credit literature on privately held firms. 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. We document that about 25% of privately held firms are financed exclusively with equity at start-up, and that this percentage changes by very little during the firms’ first five years of life. Cole-Sokolyk20