Small Firm Financing Frictions : How Salient are they and what are their Real Effects? Review and Perspectives for New Research

We review the literature on the sources of financing and associated financing frictions facing small firms. Using data from the Survey of Business Owners, we first show that about half of small firms do not report using any external finance either for startup or for expansion. Among those that do, bank and credit card-based borrowing by the business and its owners account for the overwhelming share of external finance. Second, we highlight that there is growing evidence of heterogeneity in financing frictions facing small firms: a substantial share of firms may not even seek external finance or benefit from relaxed constraints because they do not wish to grow; on the other hand, relaxing constraints has large measured effects on investment and employment for certain sub-populations of small firms. This heterogeneity has important implications for how average effects are interpreted in academic studies, as well as for how policy is enacted. We conclude by noting the greater availability of micro data on small firm financing in recent years. This has the potential to generate substantial insight on the degree to which the rise of financial technology can overcome traditional financing frictions, as well as enhance our understanding of the effectiveness of different types of government interventions on small business financing and growth