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NUMBER 28

By Timothy Dunne, Scott Shane, and James B. Thomson

POLICY DISCUSSION PAPER

Workshop on Entrepreneurial
Finance: A Summary

NOVEMBER 2009

POLICY DISCUSSION PAPERS

FEDERAL RESERVE BANK OF CLEVELAND

Workshop on Entrepreneurial Finance:
A Summary
By Timothy Dunne, Scott Shane, and James B. Thomson

This Policy Discussion Paper summarizes papers that were presented at the
Workshop on Entrepreneurial Finance, which was held March 12–13, 2009, at the Federal
Reserve Bank of Cleveland. Researchers presented new empirical research that exploits
data sets on entrepreneurial activity that are based on broad and representative data
samples. Papers in the workshop focused primarily on analyses of the sources and
structure of start-up finance, including the importance of bank lending, venture capital,
angel investors, and owner equity.

Timothy Dunne is the
Chong K Liew Professor
of Economics at the
University of Oklahoma.
Scott Shane is the
A. Malachi Mixon,
III, Professor of
Entrepreneurial Studies
at the Weatherhead
School of Management at
Case Western Reserve
University. James B.
Thomson is a vice
president in the Office
of Policy Analysis at the
Federal Reserve Bank of
Cleveland.

Materials may be
reprinted, provided that
the source is credited.
Please send copies of
reprinted materials to the
editor.

POLICY DISCUSSION PAPERS

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ISSN 1528-4344

FEDERAL RESERVE BANK OF CLEVELAND

Introduction
In March of 2009, the Federal Reserve Bank of Cleveland and the Kauffman Foundation jointly
hosted a workshop on entrepreneurial finance that brought together scholars in the field. The goal
of the workshop was to present new empirical research that exploits data sets on entrepreneurial
activity that are based on broad and representative data samples. The research presented employed
data from relatively new survey instruments, such as the Kauffman Firm Survey, as well as data
from well-established programs, such as the Survey of Small Business Finances. Additionally, some
of the data sets highlighted are in the public domain, while others are available to researchers only
through restricted access. It was clear from the workshop presentations that both privately and
publicly sponsored data are valuable sources of information on entrepreneurial activity.
Papers in the workshop focused primarily on analyses of the sources and structure of start-up
finance, including the importance of bank lending, venture capital, angel investors, and owner
equity. While many of the studies focused on the analysis of U.S. data, several papers offered
international perspectives. In addition, several papers emphasized differences in the financing
structure of new firms across demographic groups.
This Policy Discussion Paper provides a brief summary from each paper presented at the workshop. The overview is organized broadly into five themes: bank financing; topics in international
entrepreneurial finance; demographics and entrepreneurial financing; industry and institutional
settings; and angel investors.

Bank Financing
Alicia M. Robb and David T. Robinson investigate the capital structure choices that firms make
in their initial year of operation in their paper “The Capital Structure Decisions of New Firms.”
Using restricted-access data from the Kauffman Firm Survey, they find that, contrary to many accounts of start-up activity, firms rely heavily on external debt sources such as bank financing and
less extensively on friends- and family-based funding sources. This finding is robust to controls for
credit quality, industry, and business owner characteristics. It is a feature both of the cross-section
of firms at their founding date and of the time-series of firm financing decisions. Formal credit
complements other sources of funding, rather than substituting for it. The heavy reliance on external debt underscores the importance of well-functioning credit markets for the success of nascent
business activity.
The paper “Information Asymmetries between Lenders and the Availability of Competitive
Outside Offers” by Lamont K. Black examines the effect of information asymmetries between
lenders on the availability of competitive outside loan offers. Existing lenders to firms tend to
have private information about firms that is not available to other potential lenders, which creates
an information asymmetry between “inside” lenders (those with more information about a firm)
and “outside” lenders (those with less). Due to this information disadvantage, outside lenders face

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an adverse selection problem. The paper solves a benchmark model of information asymmetries
in lending and finds that an increase in firm transparency causes the outsider to win more “good”
firms. This reflects the effect of better public information. The outsider also wins fewer bad firms
because it faces less of a “winner’s curse.” The total effect on outside lending depends on the net
of these two effects. An analytical solution shows that an increase in firm transparency leads to a
decrease in the likelihood of a firm receiving a competitive outside loan offer. The model’s main
prediction is tested using a sample of small business firms that borrow either from an existing
lender or a new lender. The evidence generally suggests that transparent firms are less likely to
borrow from a new lender.
In “Small and Medium-Sized Enterprises, Bank Relationship Strength, and the Use of Venture
Capital,” Allen N. Berger and Klaus Schaeck use data on small and medium-sized enterprises
in Italy, Germany, and the United Kingdom to analyze bank–firm relationships and how these
relationships influence a firm’s use of venture capital. They examine whether firms substitute
venture capital for multiple bank relationships to avoid the rent-extracting behavior of the main
bank. The empirical results are consistent with this hypothesis and robust to changes in specification, estimation method, and sample. The paper uses matching methods to explore whether firm
performance differs between firms that use venture capital and those firms that rely on multiple
banking relationships. They report that the use of venture capital positively affects firm performance in terms of growth and R&D spending; however, such performance effects do not arise
from multiple banking relationships.

Topics in International Entrepreneurial Finance
Larry W. Chavis, Leora F. Klapper, and Inessa Love study the use of different financing sources for
new and young firms in the paper “Entrepreneurial Finance around the World: The Impact of the
Business Environment on Financing Constraints.” They use a unique data set of over 70,000 firms
(most of which are small) in over 100 countries from the World Bank Enterprise Surveys. The authors find that, in all countries, younger firms rely less on bank financing and more on informal
financing. Moreover, younger firms have better access to bank finance in countries with stronger
rule of law and better credit information, and that the reliance of young firms on informal finance
decreases with the availability of credit information. Overall, the results suggest that improvements
to the legal environment and availability of credit information are disproportionately beneficial for
promoting access to formal finance by young firms.
In the “Determinants of Start-up Firm External Financing Worldwide,” John R. Nofsinger
and Weicheng Wang report on the determinants of the initial start-up financing of entrepreneurial firms in 27 countries. Their study looks at how institutional investors and informal investors
respond to product type (new vs. existing product), production technology (new vs. existing
technology), and entrepreneur experience when providing finance to start-up firms. Using data
from the Global Entrepreneurship Monitor survey, the authors’ findings suggest that informal

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investors prefer financing new firms that have new products, whereas institutional investors
are more willing to provide finance to firms with existing products and to more-experienced
entrepreneurs.

Demographics and Entrepreneurial Financing
Alicia M. Robb, Robert W. Fairlie, and David T. Robinson use a new panel data set from the
Kauffman Firm Survey to examine racial differences in the incidence and determinants of financial
capital use among young firms in their paper “Financial Capital Injections among New Black and
White Business Ventures: Evidence from the Kauffman Firm Survey.” Looking across all firms, the
authors find a heavy reliance on owner’s equity at startup that declines substantially in subsequent
years. Reliance on external debt, however, does not decline as the startup ages. The authors report
that black-owned businesses face persistent difficulty in accessing external capital markets. These
businesses rely much more on owner equity than do white-owned ones, indicating that blackowned businesses face more difficulty in raising external capital. Direct evidence on average levels
of external capital reveals large differences between blacks and whites. Regression analyses indicate
that racial disparities in the amounts and types of early financing between blacks and whites do not
entirely disappear after controlling for differences in credit quality, human capital, and firm characteristics. Blinder-Oaxaca decomposition estimates identify several factors contributing to lower
average capital injections for black-owned businesses. The most important factor contributing to
racial differences in financing levels are credit scores, especially for financial injections in the years
following startup. Lower levels of start-up capital and initial sales are also found to be associated
with lower levels of capital use in the two years after startup for black-owned businesses.
In “Gender and the Availability of Credit to Privately Held Firms: Evidence from the Surveys
of Small Business Finances,” Rebel A. Cole and Hamid Mehran analyze differences in the availability of credit between male- and female-owned firms. Using data from the nationally representative Surveys of Small Business Finances, which span a period of 16 years, the authors first
document a series of empirical regularities in differences between male-owned and female-owned
firms. Female-owned firms are significantly smaller as measured by sales, assets, and employment;
younger as measured by firm age; more likely to be organized as proprietorship and less likely
to be organized as corporations; and have fewer and shorter banking relationships. Female owners are younger, less experienced, and less educated. Comparing across groups, there appears to
be some difference in the availability of credit to male-and female-owned firms. Female-owned
firms are more likely to be credit-constrained because they are more likely to be discouraged from
applying for credit but not more likely to be denied credit when they apply. However, these differences are not statistically significant in a multivariate setting, when controls for additional firm
and owner characteristics are included in the statistical model.

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Industry and Institutional Settings
The paper “Does Debtor Protection Really Protect Debtors? Evidence from the Small Business
Credit Market” by Allen N. Berger, Geraldo Cerqueiro , and María Fabiana Penas studies how different levels of debtor protection across U.S. states affect small firms’ access to credit, as well as the
price and non-price terms of their loans. The research uses data from the Survey of Small Business
Finance. They find that unlimited liability small businesses (sole proprietorships and most partnerships) have lower access to credit in states with more debtor-friendly bankruptcy laws. In addition,
these businesses face harsher loan terms—they are more likely to pledge business collateral, have
shorter maturities, and borrow smaller amounts. For limited liability small businesses (corporations and limited liability partnerships), the authors report a reduction in credit availability, but of
smaller magnitude, together with an increase in the loan rate. The results also suggest that the personal bankruptcy law disproportionately affects firm owners with low home equity values.
Entrepreneurs rely on a spectrum of financing options for new companies, including informal
sources of capital, bank loans, and venture capital. Sheryl Winston Smith looks at the relationship between the type and source of financing and success in high-tech entrepreneurial ventures
in “Capital Structure and Entrepreneurial Performance: New Firm Innovation and Survival.”
Nascent high-technology ventures are often highly information opaque for outside investors,
with consequent implications for the availability of financing in the earliest, riskiest phase. The
author uses the Kauffman Firm Survey data set to analyze entrepreneurial performance in relationship to financing and ownership over time, drawing on the data from the baseline survey of
new businesses started in 2004 and subsequent follow-up surveys. The paper finds that nascent
high-technology firms are more likely to have outside equity than firms in non-high-technology
industries. However, with regard to bank loans, high-technology firms do not appear to be more
likely to utilize this method of financing than non-high-technology firms.
In “Informal and Early Formal Financial Support in the Business Creation Process: Exploration with PSED II Data Set,” Paul D. Reynolds describes the patterns of financing for a cohort of
nascent enterprises in the earliest stages of the business creation process, The data come from the
second U.S. Panel Study of Entrepreneurial Dynamics [PSED II]. Firms in the sample are identified after their first efforts to create a business have been initiated but before the new venture has
an initial period of profitability. The amount of informal financial support provided to these new
ventures before they have been registered as a legal entity is separated from formal equity and
debt provided after this event. The author reports that the average amount of informal support
is $48,000, but the distribution is highly skewed with the median amount of informal support
being only $4,300. The average amount of formal financial support is about $200,000, but again
the distribution is highly skewed with the median amount of formal support being $0. There are
some differences related to the sources of informal and formal financial support and the status of

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the new ventures in the 12- and 24-month follow-up interviews, but no clear relationship to the
amounts of support.

Angel Investors
In “Expected Returns of Angel Investors,” Ramon P. DeGennaro and Gerald P. Dwyer Jr. estimate
the expected rate of return to angel investors. The authors note that previous research has calculated realized internal rates of return on angel investments but that internal rates of return are subject
to misinterpretation due to nonlinearities and statistical biases. Perhaps more importantly, though,
realized internal rates of return do not drive financial decisions. Rather, expected returns drive financial decisions. The authors utilize data from the Angel Investor Performance Project to estimate
expected returns. The estimate of an equally weighted average of expected returns is about 58 percent annually. This is comparable to the expected return on venture capital investments.
Jess H. Chua and Zhenyu Wu analyze post-investment involvement of angel investors in the
paper “Value Added by Angel Investors through Post-Investment Involvement: Empirical Evidence and Ownership Implications.” While the post-investment involvement for venture capital
is well studied, little is known about this activity for angel investors. Using data from the Angel
Investor Performance Project, the authors estimate the impact of post-investor involvement of
internal rates of return. The findings suggest the post-investment involvement increases the internal rate of return, and the authors posit this is because of mentoring channels versus monitoring
channels. The authors recognize, however, that the data contain some important limitations with
regard to low response rates and sample selection issues.

Conclusion
The conference covered a broad range of papers in terms of techniques used, questions addressed,
data sets queried, and sources of financing investigated. Perhaps the broad message of these papers
is that a deeper understanding of the sources and structure of start-up finance is needed.

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Papers Presented at the Conference
The Capital Structure Decisions of New Firms
Alicia Robb, UC Santa Cruz
David T. Robinson, Duke University
Information Asymmetries between Lenders and the Availability of Competitive Outside Offers
Lamont Black, Board of Governors, Federal Reserve
Small and Medium-Sized Enterprises, Bank Relationship Strength, and the Use of Venture
Capital
Allen S. Berger, University of South Carolina, Wharton Financial Institutions Center and Center, Tilburg University
Klaus Schaeck, University of Wales at Bangor
Entrepreneurial Finance around the World: The Impact of the Business Environment on
Financing Constraints
Larry W. Chavis, University of North Carolina at Chapel Hill
Leora F. Klapper, World Bank
Inessa Love, World Bank
Determinants of Start-up Firm External Financing Worldwide
John R. Nofsinger, Washington State University
Weicheng Wang, Washington State University
Financial Capital Injections among New Black and White Business Ventures: Evidence from
the Kauffman Survey
Alicia Robb, UC Santa Cruz
Robert W. Fairlie, UC Santa Cruz
David T. Robinson, Duke University
Gender and the Availability of Credit to Privately Held Firms: Evidence from the Surveys of
Small Business Finances
Rebel A. Cole, DePaul University
Hamid Mehran, Federal Reserve Bank of New York
Does Debtor Protection Really Protect Debtors? Evidence from the Small Business Credit
Market
Allen S. Berger, University of South Carolina, Wharton Financial Institutions Center and Center, Tilburg University
Geraldo Cerqueiro, CentER, Tilburg University
Fabian Penas, CentER, Tilburg University
Capital Structure and Entrepreneurial Performance: New Firm Innovation and Survival
Sheryl Winston Smith, Temple University

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Informal and Early Formal Financial Support in the Business Creation Process: Exploration
with the PSED II Data Set
Paul Reynolds, George Mason University
Expected Returns of Angel Investors
Ramon P. DeGennaro, University of Tennessee
Gerald P. Dwyer, Federal Reserve Bank of Atlanta
Value Added by Angel Investors through Post-Investment Involvement: Empirical Evidence
and Ownership Implications
Jess H. Chua, University of Calgary
Zhenyu Wu, University of Saskatchewan

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