An Empirical Investigation of the Growth Cycle Theory of Small Firm Financing

The financial growth cycle model for small and medium size enterprises (SMEs) proposed by A. N. Berger and G. F. Udell postulates that financial needs and financing options of SMEs change as firms become larger, older, and more transparent informationally. The model predicts that as a firm grows, it will attract venture capital as a source of intermediate equity, and mid-term loans for intermediate debt; finally, as it is more informationally transparent, it acquires access to public equity or long-term debt. The Berger-Udell model is tested on a sample of 954 U.S. SMEs drawn from the 1994-1995 National Survey of Small Business Finances. Three types of financing were devised: insider funding, venture capital/mid-term loan, and public equity/long-term loan. The effect of the firm’s age, size, and information availability was analyzed with respect to the type of financing. Found that the Berger-Udell model did not fully account for the relationship between firm characteristics and capital structure decisions. Contrary to the model, only firm size was an accurate predictor of capital structure decisions; size only indicates the decision whether to use insider financing, as opposed to public equity or long-term debt; and firm size does not predict the choice of venture capital/mid-term debt instead of public equity/long-term debt. Larger firms are more likely to use public equity or long-term debt as opposed to insider funding.Therefore, the growth cycle of SMEs does not follow one model. (TNM)