1. Stuart Fraser
Warwick Business School
stuart.fraser@warwick.ac.uk
Sumon Bhaumik
Aston Business School
S.Bhaumik@aston.ac.uk
Mike Wright
Imperial College Business School
mike.wright@imperial.ac.uk
What Do We Know About The
Relationship Between Entrepreneurial
Finance and Growth?

2. The Issues
• Private sector firms should have adequate access to finance.
• Available data suggest significant decline in both debt and
equity finance flows to SMEs.
• Widely held perception that funding gap yet to be bridged
that builds on a very long-standing debate.
• Complex and nuanced issues not completely understood.
– low demand?
– contraction in supply?
• Policies targeting funding gaps to promote firm growth,
require analysis of:
– factors that affect funding gaps and how they change over
life-cycle.
– relationship between funding gaps and business growth.

3. 19.3%
8.8%
10.0%
1.1% 1.0%
16.2%
6.8%
7.7%
1.0% 1.2%
13.1%
7.8%
6.7%
1.8%
0.1%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
Overdrafts Term loans Leasing and hire purchase
agreements
Invoice finance Equity finance
Application rates
2001-4 2005-8 2008-9
Decline in demand

4. Tightening supply
10.9%
5.4%
2.1%
8.6%
11.0%
7.2%
2.4%
5.3%
16.1%
14.1%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
18.0%
Overdrafts Term loans Leasing and hire purchase agreements Invoice finance
Rejection rates
2001-4 2005-8 2008-9
VC rejection rates higher than for banks or angels

6. The Issues
• Aims:
– Distinguish between issues well understood those less
clear.
– Identify gaps in the academic literature to be addressed to
better inform policy making.
– Recognise implications of greater heterogeneity than
hitherto in both demand and supply side factors.
– Policy Implications.
– Research Implications.

7. Growth finance and market failure
What do we know?
• Asymmetric information
• Failure in the market for finance can be alleviated by
– Firm’s ability to post collateral
– Firm’s access to trade credit
– Due diligence and monitoring
• Market and agency risk
• Contracts, staging, board seats
– Firm’s relationship with banks
• Monogamous vs. multiple banking relationships
• Facilitation of “arm’s length” banking by way of credit
scoring

8. Heterogeneity
• Demand side
– Entrepreneurial cognition
• Growth and control objectives
• Perceptions of supply (‘discouraged borrowers’)
– Type of firm ownership
– Stage of firm life-cycle
• Supply side
– Traditional debt and equity providers
– Financial and monitoring/added value support
– Emerging providers

9. ⋮
Cognitive/financial
constraints
Sources of
finance
- Banks
- Angels
- VC
External finance
tendency
Internal finance
tendency
Discouraged
borrowers
Other internal
finance users
Demand
Supply
Demand
Supply
Perceptions
of supply
Entrepreneurial
cognition
Funding gaps
Funding gaps
Figure 1: Entrepreneurial Finance and Growth: An Integrated Framework
GROWTH
Cognitive/financial
constraints
Able to get some
external finance
Unable to get any
external finance
Growth/life
style
objectives
Lifecycle
stage
Reliant on
internal finance
Supply=Finance+
board service (VC)

10. Funding gaps, perceptions
and growth
• Research for Breedon Review (Fraser, 2012) and by NIESR (2013)
shows significant increases in funding gaps (rejection rates)
following financial crisis.
– Overdraft rejection rates increased in relative terms by over 50% in 2009
(compared to 2004) and term loan rejection rates increased by 163%
• These analyses rigorously control for risk profiles (credit ratings,
collateral, financial relationships and other business/owner
characteristics) which impact access to finance
– So the findings suggest supply has tightened.
• Similarly rates of financial discouragement have increased
(controlling for risk profiles) suggesting entrepreneurs’ perceptions
of the supply of funding have deteriorated.
– This is a key factor underlying the falling trend in finance demands.

11. When is a funding gap not a
financial constraint?
• To move the policy debate forward, we need to look at the
relationship between funding gaps and business performance.
• Funding gaps only negatively impact on business performance
if finance providers are offering too little finance (i.e., financial
constraints):
– Conversely, no effect if entrepreneurs are seeking too
much finance (due e.g., to entrepreneurial ‘over-
optimism’).
• Similarly discouragement will only negatively impact on
business performance if it results in too little investment
– Discouragement might be ‘good’ if unviable firms decide
not to apply for funding.

12. Initial findings
• Initial analysis using UKSMEF data for 2004-2009 finds significant
negative effects of overdraft rejection on sales growth in 2007-8 and
2008-9
– For an average firm this means a reduction in sales from £3.2m in 2007 to
£2.1m in 2008 and from £3.3m in 2008 to just over £1m in 2009.
• Findings consistent with financial constraints due to insufficient
working capital in the early stages of the financial crisis (2007-8) but
with more severe constraints in 2008-9.
• However, no evidence of financial constraints prior to the financial
crisis.

13. Initial findings
• Similarly, holding sales in 2007 constant, term loan
discouragement is associated with a 57% reduction in sales by
the end of 2008.
• These findings point to both financial and cognitive
constraints on growth.
– Specifically they are consistent with the widening of govt. assistance in
2009 to include support for working capital (under the EFG) and
moves to promote ‘non-bank’ sources of finance (Breedon Review).
– They are also consistent with the commitments made by the Business
Finance Taskforce (2010) to restore confidence in the lending process
(including support for mentoring, the publishing of lending principles
and the establishment of a transparent appeals process).

14. Non-bank finance
• Equity gaps vary between sectors, regions and stages of
finance.
• Questioning of spatial proximity arguments
– May be able to access VC if can signal quality
– Angels invest cross-border
• Generally positive effect of VC & PE on growth even after
controlling for (significant) selection effects
– Importance of experience and specific expertise
• Affected by fund type
– Independent (domestic) VCs have shorter term sales growth;
syndication important
– experienced government backed less growth but greater
survival

15. Non-bank finance
• PE backed buyouts
– Evidence of growth on various dimensions
– Employment effect more controversial
– Again effect of experience and expertise
– Better than non-buyouts through recession
• Angels
– Fewer high growth cases but fewer failures
– More flexible involvement but less involvement
when distress

16. Non-bank finance
• Alternative Investment Markets
– Liquidity issues
– About half raise funding
– Share price performance generally weak
• Direct investment by pension funds and family
offices
– Emerging trend
– Recruiting investment bankers
– Questions over expertise to help portfolio companies
but variety may emerge in this respect

17. Policy Implications
• Credit market
– Potential for credit market intervention to make a difference in
availability of finance and economic performance.
– Issues about take-up & delivery of assistance.
• Awareness of policies to rebuild trust
– Promotion of greater sharing of credit information may help improve
credit scoring models and reduce entry barriers for non-bank credit
providers.
– Learn from other countries in terms of best practice in the design and
delivery of support
– Address issue of potential drag from zombie companies
• Equity market
– Stimulate cross-regional mobility of funding provision
– Assess complementarity/substitutability of different types of equity
providers, business bank, etc.
• Competition
– Effects of competition in both credit and equity markets not clear cut
in terms of availability and terms

18. Research Implications
• The role of finance and entrepreneurial cognition
in explaining firm growth
• Understanding financing decisions
• Governance, finance and growth
• Involvement of financiers
• Modes and patterns of growth and finance
• Context, finance and growth
• Scaling-up and finance
• Entrepreneurs, finance and growth

19. Thank you!
Questions?
For more information about this White Paper contact us on:
stuart.fraser@warwick.ac.uk
S.Bhaumik@aston.ac.uk
mike.wright@imperial.ac.uk