The pecking order hypothesis: does it apply to start‐up firms?

Purpose – The purpose of this research is to explore whether the “pecking order hypothesis” (POH) applies to the capital finance preferences of start‐up businesses. Design/methodology/approach – In‐depth interviews with 20 Scotland‐based entrepreneurs were conducted in order to reveal the subtleties of the capital finance preferences which applied to a sample of start‐up firms. To ensure reliability and validity, data was analysed using a systematic schema. Findings – Consistent with the POH we found that entrepreneurs in start‐ups turn to internal sources first, that is, their own funds. In contradiction to the POH, however, evidence in this paper finds that where external funds are required, the main source is equity rather than debt. In the majority of cases, in depth interviews show that a bridged pecking order applies in that the businesses move from self‐funding to external equity in preference to, or instead of bank finance. Two reasons for this pattern can be established. First, entrepreneurs consider debt to be a personal liability as it invariably requires to be underwritten by personal guarantees. Entrepreneurs place a self‐imposed limit on the extent to which they are prepared to mortgage their assets. Second, entrepreneurs deliberately seek out equity investment as a means of obtaining added value over and above the finance invested. Rather than the external equity being viewed as expensive, it is viewed as good value as a well‐chosen investor can add business skills and social capital in the form of commercial contacts and access to relevant networks. Practical implications – Entrepreneurs searching for investment should assess the post‐investment role they wish investors to play. Successful consideration of this issue will make it more likely that a start‐up business obtains external finance and that entrepreneurs achieve good “matches” with investors, and vice versa. Originality/value – The value of this paper rests in its finding that a bridged pecking order may apply to start‐up firms in that entrepreneurs move directly from self‐funding to equity.