Abstract
This paper investigates the choice between bank debt and trade credit in business start-ups. While trade credit is more expensive than bank debt, suppliers tend to follow a more lenient liquidation policy when client firms encounter financial distress. As a result, suppliers are more willing to renegotiate the outstanding debt or grant additional debt whereas banks are more likely to liquidate borrowers upon default. Given the risky nature of business start-ups, we argue that the entrepreneur’s choice of debt instruments reflects these differences in liquidation policy between lenders and is thus determined by the venture’s failure risk, the entrepreneur’s private control benefits that are lost upon liquidation and the liquidation value of firm assets. Using unique data on 325 first-time business start-ups, we find that firms in industries with high historical start-up failure rates and entrepreneurs who tend to highly value private benefits of control use less bank debt. These effects are especially prevalent in start-ups where assets have a high liquidation value and thus banks are more likely to liquidate the venture following default.
Similar content being viewed by others
References
Agrawal A., Narayanan N. J., 1990, ‹Corporate Capital Structure, Agency Costs, and Ownership Control: The Case of All-Equity Firms’ Journal of Finance 45(4): 1325–1331
Ang J., Cole R., Lin J., 2000, ‹Agency Costs and Ownership Structure’ Journal of Finance 55(1): 81–106
Armendariz de Aghion B., 1990, ‹International Debt: An Explanation of the Commercial Banks’ Lending Behavior after 1982’ Journal of International Economics 28(1–2): 173–186
Audretsch D. B., Mahmood T. 1994, ‹The Rate of Hazard Confronting New Firms and Plants in U.S. Manufacturing’ Review of Industrial Organization 9(1): 41–56
Audretsch D. B., 1995, Innovation and Industry Evolution Cambridge, MA: The MIT Press
Benink H. A., Llewellyn D. T., 1994, ‹Fragile Banking in Norway, Sweden and Finland: An Empirical Analysis’ Journal of International Financial Markets. Institutions and Money 4(3–4): 5–19
Berger A. N., Udell G. F., 1998, ‹The Economics of Small Business Finance: The Roles of Private Equity and Debt Markets in the Financial Growth Cycle’ Journal of Banking & Finance 22(6–8): 613–673
Brouwer M., Hendrix B., 1998, ‹Two Worlds of Venture Capital: What Happened to US and Dutch Early Stage Investment?’ Small Business Economics 10(4): 333–348
Bruyat C., Julien P. A., 2001, ‹Defining the Field of Entrepreneurship’ Journal of Business Venturing 16(2): 165–180
Burkart M., Ellingsen T., 2004, ‹In-Kind Finance: A Theory of Trade Credit’ American Economic Review 94(3): 569–590
Carey M., Post M., Sharpe S. A., 1998, ‹Does Corporate Lending by Banks and Finance Companies Differ? Evidence on Specialization in Private Debt Contracting’ Journal of Finance 53(3): 845–878
Chemmanur T. J., Fulghieri P., 1994, ‹Reputation, Renegotiation and the Choice between Bank Loans and Publicly Traded Debt’ Review of Financial Studies 7(3): 475–506
Cook L. D., 1999, ‹Trade Credit and Bank Finance: Financing Small Firms in Russia’ Journal of Business Venturing 18(6): 689–708
Cunat, V., 2002, ‹Trade Credit: Suppliers as Debt Collectors and Insurance Providers’, working paper, Universitat Pompeu Fabra
Davila A., Foster G., Gupta M., 2003, ‹Venture Capital Financing and the Growth of Startup Firms’ Journal of Business Venturing 18(6): 689–708
Deloof M., Jegers M., 1996, ‹Trade Credit, Product Quality, and Intragroup Trade: Some European Evidence’ Financial Management 25(3): 33–43
Demsetz H., Lehn K., 1985, ‹The Structure of Corporate Ownership: Causes and Consequences’ Journal of Political Economy 93(6): 1155–1177
Donckels, R., 1993, KMO’s ten Voeten uit. Van Onderzoek tot Actie, Roularta Books
Doi N., 1999, ‹The Determinants of Firm Exit in Japanese Manufacturing Industries’ Small Business Economics 13(4): 331–337
Dun and Bradstreet, 1994, The Failure Record, Annual Publication
Evans, J. D., 1998, ‹Are Lending Relationships Valuable to Equity Holders in Chapter 11 Bankruptcy?’, Ph.D. Dissertation. Georgia State University
Fisman R., Love I., 2003, ‹Trade Credit, Financial Intermediary Development, and Industry Growth’ Journal of Finance 58(1): 353–374
Franks J. R., Nyborg K., 1996, ‹Control Rights, Debt Structure, and the Loss of Private Benefits: The Case of the UK Insolvency Code’ Review of Financial Studies 9(4): 1165–1210
Franks J., Sussman O., 2005, ‹Financial Distress and Bank Restructuring of Small to Medium Size U.K. Companies’ Review of Finance 9(1): 65–96
Freedman J., Godwin M., 1992, ‹Legal Form, Tax and the Micro Business’, in: Caley K., Chell E., Chittenden F., Mason C. (eds), Small Enterprise Development: Policy and Practice in Action, London: Paul Chapman Publishing, pp. 105–130
Hamilton B. H., 2000, ‹Does Entrepreneurship Pay? An Empirical Analysis of the Returns to Self-Employment’ Journal of Political Economy 108(3): 604–631
Harhoff D., Stahl K., Woywode M., 1998, ‹Legal Form, Growth and Exit of West German Firms – Empirical Results for Manufacturing, Construction, Trade and Service Industries’ Journal of Industrial Economics 46(4): 453–488
Hart O., 1995, Firm Contracts and Financial Structure, Clarendon Press, Oxford
Houston J., James C., 1996, ‹Bank Information Monopolies and the Mix of Private and Public Debt Claims’ Journal of Finance 51(5): 1863–1889
Huyghebaert, N., 2000, The Capital Structure of Business Start-ups, Ph.D. Dissertation. K.U. Leuven
Huyghebaert N., Gaeremynck A., Roodhooft F., Van de Gucht L. M., 2000, ‹New Firm Survival: The Effects of Start-up Characteristics’ Journal of Business Finance & Accounting 27(5–6): 627–651
Huyghebaert, N. and L. M. Van de Gucht, 2005, ‹The Determinants of Financial Structure: New Insights from Business Start-ups’, European Financial Management, forthcoming
Huyghebaert N., Van de Gucht L. M., 2004, ‹Incumbent Strategic Behavior in Financial Markets and the Exit of Entrepreneurial Start-ups’ Strategic Management Journal 25(7): 669–688
Johnson S., 1998, ‹The Effect of Bank Debt on Optimal Capital Structure’ Financial Management 27(1): 47–56
Katzner D. W., 1992, ‹The Structure of Authority in the Firm’ Journal of Economic Behavior and Organization 19(1): 41–67
Laitinen E. K., 1994, ‹Prediction of Failure of a Newly Founded Firm’ Journal of Business Venturing 7(4): 323–340
Manigart S., De Waele K., Wright M., Robbie K., Desbrières P., Sapienza H. J., Beekman A., 2000, ‹Venture Capitalists, Investment Appraisal and Accounting Information: A Comparative Study of the US, UK, France, Belgium and Holland’ European Financial Management 6(3): 389–403
Mann R. J., 1997, ‹The Role of Secured Credit in Small Business Lending’ Georgetown Law Journal 86(1): 1–44
Manove M., Padilla J., Pagano M., 2001, ‹Collateral versus Project Screening: A Model of Lazy Banks’ The Rand Journal of Economics 32(4): 726–744
Maruani M., 1996, ‹Industrial Sociology and the Challenge of Employment’ European Journal of Industrial Relations 2(1): 113–122
Mian S. L., Smith C. W. Jr., 1992, ‹Accounts Receivable Management Policy: Theory and Evidence’ Journal of Finance 47(1): 169–200
Mueller, E., 2003, ‹Private Benefits of Control, Capital Structure and Company Growth’, working paper, London School of Economics
Ng C. K., Smith J. K., Smith R. L., 1999, ‹Evidence on the Determinants of Credit Terms Used in Interfirm Trade’ Journal of Finance 54(3): 1109–1129
OECD, 2001, Bank Profitability, Financial Statements of Banks 2001, OECD Paris
Ooghe H., Manigart S., Fassin Y., 1991, ‹Growth Patterns of the European Venture Capital Industry’ Journal of Business Venturing 6(6): 381–404
Petersen M. A., Rajan R. G., 1994, ‹The Benefits of Lending Relationships: Evidence from Small Business Data’ Journal of Finance 49(1): 3–37
Petersen M. A., Rajan R. G., 1997, ‹Trade Credit: Theories and Evidence’ Review of Financial Studies 10(3): 661–691
Reid G. C., 2003, ‹Trajectories of Small Business Financial Structure’ Small Business Economics 20(4): 273–285
Remolona E. M., Wulfekuhler K. C., 1992, ‹Finance Companies, Bank Competition, and Niche Markets’ Federal Reserve Bank of New York Quarterly Review 17(2): 25–38
Repullo R., Suarez J., 1998, ‹Monitoring, Liquidation and Security Design’ Review of Financial Studies 11(1): 163–187
Robinson K. C., McDougall P. P., 2001, ‹Entry Barriers and New Venture Performance: A Comparison of Universal and Contingency Approaches’ Strategic Management Journal 22(3): 659–685
Scholtens B., 1999, ‹Analytical Issues in External Financing Alternatives for SBEs’ Small Business Economics 12(2): 137–148
Scherer F. M., 2001, ‹Assessing Progress in Research on Industrial Evolution and Economic Growth: A Review Article’ Small Business Economics 16(3): 237–242
Schwartz A., 1997, ‹Priority, Contracts and Priority in Bankruptcy’ Cornell Law Review 82(4): 1396–1419
Smith R. A., 2002, ‹Race, Gender and Authority in the Workplace. Theory and Research’ Annual Review of Sociology 28(1): 509–542
Wagner J. and R. Sternberg, 2004, ‹Start-up Activities, Individual Characteristics, and the Regional Milieu: Lessons for Entrepreuneurship Support Policies from German Micro Data’, Anals of Regional Science 38(2), 219–240
Wilner B. S., 2000, ‹The Exploitation of Relationships in Financial Distress: The Case of Trade Credit’ Journal of Finance 55(1): 153–178
Wilson N., Summers B., 2002, ‹Trade Credit Terms Offered by Small Firms: Survey Evidence and Empirical Analysis’ Journal of Business Finance & Accounting 29(3–4): 317–351
Author information
Authors and Affiliations
Corresponding author
Additional information
An erratum to this article can be found at http://dx.doi.org/10.1007/s11187-007-9068-8
Rights and permissions
About this article
Cite this article
Huyghebaert, N., Van de Gucht, L. & Van Hulle, C. The Choice between Bank Debt and Trace Credit in Business Start-ups. Small Bus Econ 29, 435–452 (2007). https://doi.org/10.1007/s11187-006-9005-2
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11187-006-9005-2