The "Liability of Newness" and Small Firm Access to Debt Capital: Is There a Link?

Abstract

Literature pertaining to the “liability of newness” contends that newer firms face particular difficulties and a greater risk of failure. This article seeks to determine if “newness” is also a disadvantage in the acquisition of debt capital. Results indicate that newer firms were significantly less likely to have lines of credit and were also significantly more likely to have been turned down for their most recent loan. Even when we control for length of relationship with the primary financial services provider, personal guarantees, and collateral, younger firms were still more likely to be turned down for loans. Small firms are an essential part of the United States economy. According to the U.S. Small Business Administration (SBA), there were 22.9 million small firms, defined as firms having 500 or fewer employees, in the United States in 2002 (Small Business by the Numbers, 2002). In fact, small firms represent 99 percent of all firms in this country. They provide approximately half of Gross Domestic Product as well as the majority of new jobs. Small firms are also an important source of innovation in the development of new products, services, and technologies. Given the role played by small firms, it is in our interest to identify factors that contribute to their likely success. In keeping with that, studies of small firm survival and failure have repeatedly identified difficulties with financial management and an inability to secure adequate sources of capital as major contributors to dissolution (Gaskill et al., 1993), Lussier, 1996; Watson et al., 1998). Many small firms are launched with inadequate financial resources. To compound this problem, small firms, unlike larger, publicly-held firms, are unable to raise capital in the public debt and equity markets (Ang, 1991). Alternatively, they are restricted to sources of capital that include the owner’s savings, loans from family and friends, trade credit, and loans from banks and other financial service providers (Berger & Udell, 1998; Bitler et al., 2001). Even in the case of bank loans, however, small firms are more likely to be denied than larger, more established firms. As noted above, the inability to secure external sources of capital raises the risk of firm failure. On a slightly less dire note, inadequate capital may also restrict the firm’s ability to grow, to hire employees, or to introduce new products and services thus impairing profitability and growth in the long term.

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