Small Business Economics

, Volume 29, Issue 4, pp 435–452

The Choice between Bank Debt and Trace Credit in Business Start-ups

  • Nancy Huyghebaert
  • Linda Van de Gucht
  • Cynthia Van Hulle
ORIGINAL PAPER

DOI: 10.1007/s11187-006-9005-2

Cite this article as:
Huyghebaert, N., Van de Gucht, L. & Van Hulle, C. Small Bus Econ (2007) 29: 435. doi:10.1007/s11187-006-9005-2

Abstract

This paper investigates the choice between bank debt and trade credit in business start-ups. While trade credit is more expensive than bank debt, suppliers tend to follow a more lenient liquidation policy when client firms encounter financial distress. As a result, suppliers are more willing to renegotiate the outstanding debt or grant additional debt whereas banks are more likely to liquidate borrowers upon default. Given the risky nature of business start-ups, we argue that the entrepreneur’s choice of debt instruments reflects these differences in liquidation policy between lenders and is thus determined by the venture’s failure risk, the entrepreneur’s private control benefits that are lost upon liquidation and the liquidation value of firm assets. Using unique data on 325 first-time business start-ups, we find that firms in industries with high historical start-up failure rates and entrepreneurs who tend to highly value private benefits of control use less bank debt. These effects are especially prevalent in start-ups where assets have a high liquidation value and thus banks are more likely to liquidate the venture following default.

Keywords

bank debt capital structure entrepreneur private benefits of control start-up trade credit 

JEL CLASSIFICATIONS:

C31 G21 G32 L26 M13 

Copyright information

© Springer Science+Business Media, Inc. 2007

Authors and Affiliations

  • Nancy Huyghebaert
    • 1
  • Linda Van de Gucht
    • 1
  • Cynthia Van Hulle
    • 1
  1. 1.K.U. LeuvenLeuvenBelgium