FAU research study
Venture capital funding better than bank loans for small businesses
FAU study shows venture capital investment beats bank loans to boost growing startup businesses and entrepreneurship.
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.
The smallest firms – those with five or fewer employees – appear to get little help from either venture investment or bank loans. According to Cole, one problem is that big banks do not like to make loans to small businesses, except through credit cards.
"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.