How+Do+Start-Up+Firms+Finance+Their+Assets?

` The majority of start-ups finance their purchases of assets with personal credit. Good idea? New ventures identify unmet needs and target markets into which they will sell their goods or services. In order to provide goods or services, new ventures need to provide financing to secure the assets they need (think cash, inventory, working capital to finance operating expenses) in order to generate revenues. To get these assets on their books, new ventures need either need to finance their purchase of assets through equity (usually the funds provided by founders or other private equity investors) or through debt (in the form of personal credit cards, business credit through a line of credit through banks, or trade credit, a topic I discuss in depth in New Venture Development). As I discuss in lectures on working capital management, new ventures frequently can benefit from taking advantage of trade discounts offered by suppliers (e.g., 2/10 net 30), borrowing the money to do so from banks, and repaying the bank at the end of the 30-day cycle.

Sadly, new venture managers who rely on personal credit do not enjoy trade discounts for payment within, say, 10 days or less, and pay a far less attractive interest rate to purchase inventories. If your business can buy inventory with personal credit, sell that inventory, and collect payment within 30 days, you'll be (sort of) OK using personal credit to finance your assets. Otherwise, you're basically playing the lottery.

Here are the results of a recent survey conducted through the Kauffman Institute for Entrepreneurship.


 * And now for the numbers **

25% of firms report 100% equity financing of their initial assets. The remaining 75% of start-ups can be sorted into three groups—trade credit, personal credit, and business credit. At start-up, the majority of firms (55%) rely upon personal credit, but 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.

Firms are more likely to use credit at start-up when they are larger, more profitable, more liquid, have more tangible assets; and when their primary owner has more experience and more education. Black-owned firms are significantly less likely to use credit at start-up.

Among firms that use credit, larger firms are more likely to use trade and business credit but 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 several 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.