Venture Investment Beats Bank Loans to Boost Small Business
Investment from venture capital appears to help new startup businesses grow and boost entrepreneurship better than funding from bank loans, according to a FAU new study.
The study found that the 15 states with the highest rate of growth in startup formation showed substantially higher levels of venture-capital investment compared with the 15 slowest-growing states – a median growth rate of 12.05 percent in investment compared with 3.93 percent.
Investment from venture capital appears to help new startup businesses grow and boost entrepreneurship better than funding from bank loans, according to a new study by researchers at Florida Atlantic University, York University and the University of Hong Kong.
The researchers analyzed data on small businesses compiled by the U.S. Census Bureau going back to 1995, looking at the percentage change in the number of small companies in each state in the U.S., as well as growth in employment and payroll at those companies.
Rebel Cole, Ph.D., professor and Kaye Family Endowed Chair of Finance at FAU’s College of Business, along with fellow researchers Douglas Cumming, Ph.D., professor of finance and the Ontario Research Chair at York University’s Schulich School of Business, and Dan Li, Ph.D., assistant professor at the University of Hong Kong’s School of Economics and Finance, compared those numbers with the percentage change in venture investments and bank loans to startups in each state.
The study published in the Journal of International Financial Markets, Institutions and Money showed there was a strong causal link, not just a correlation, between higher levels of venture-capital investment and the growth rates of startups in terms of employment, payroll and number of firms.
They found that the 15 states with the highest rate of growth in startup formation showed substantially higher levels of venture-capital investment compared with the 15 slowest-growing states – a median growth rate of 12.05 percent in investment compared with 3.93 percent. Bank loans were associated with a much lower growth rate – 5.38 percent in the 15 fastest-growing startup states and 2.74 percent in the 15 slowest-growing states.
Cole pointed out there has been a huge decline in small business lending by banks since 2008. When the crisis hit, bank lending to small business declined by about 20 percent, or about $150 billion.
“So, that’s a huge hit,” Cole said. “It’s recovered less than one-third of that. So there’s $100 billion less in small business loans from banks today than there was in 2008. The economy has grown a lot since then, so proportionately it’s even worse than that because it should have been an upward trend because small business lending was growing 10 or 15 percent per year before the crisis. So things are much worse than they were.”
The smallest firms – those with five or fewer employees – appear to get little help from either venture investment or bank loans to help them grow. According to Cole, one problem is that big banks do not like to make loans to small businesses, except through credit cards, which are not a good financing vehicle.
“It was the small community banks that really specialized in lending to very small businesses, and there’s just not enough of them anymore,” Cole said. “There’s been a huge consolidation. And since the crisis, the big banks have only gotten bigger, and they control the vast majority of loans in the banking sector.”