Venture capital (VC) financing and traditional bank lending can have variable effects on small-firm growth. The authors compare and contrast these two sources of entrepreneurial financing on a statewide basis to uncover statistical correlations among four measures of small-firm growth and the type of financing used. Although bank lending is more prevalent, VC financing is shown to have a higher correlation with small-firm growth variables.
The authors analyze venture capital (VC) and bank lending for small-firm entrepreneurial financing. They compare the two sources of financing to identify which source plays a more important role in small-firm formation and growth. Previous literature has highlighted bank financing and VC as important sources of finance, but few studies compare the two. VC lending, rather than bank lending, is seen as providing more support to entrepreneurs by offering strategic, managerial, human resources, marketing, and financial advice. It also provides a network of strategic alliances with suppliers and customers and legal and accounting advisers. But bank financing is more readily available.
By collecting US state-level data to compare key levels of economic growth that can be attributed to either VC or bank financing, the authors find that VC is economically and statistically significant in stimulating new firms, new establishments, new employment, and new payroll at the individual state level, especially for firms with 5–19 employees. They find no statistical significance for those same factors with bank lending. Thus, the authors argue that although VC is a much smaller portion of new firm borrowing, it plays a more significant role than banks do in economic growth.
How Is This Research Useful to Practitioners?
Bank lending, with its large branch network and vast financing capabilities, seems like the more probable source of economic growth for small entrepreneurial firms. However, the authors’ analysis shows otherwise. Policymakers at the state and national levels could use this research to create policies to incentivize VC financing. Because VC is known to cluster in highly entrepreneurial areas, such as Silicon Valley, states and cities could be encouraged to highlight their own areas of entrepreneurship to attract new VC firms. And as new companies seek different sources of financing, they might be encouraged by the success of VC funding.
The authors also note a recent shift in the focus of academic studies to the effects of VC on entrepreneurial activities. They offer insight into whether this shift is warranted.
How Did the Authors Conduct This Research?
The authors analyze VC financing by using the returns to institutional investors and bank lending by using bank assets, capital, and deposit-to-asset ratios. They examine balanced panel data for more than 50 states from 1995 to 2011 and focus on small firms with fewer than 100 employees, divided into subcategories of 0–4, 5–19, and 20–99 employees. The authors analyze four elements of economic growth: the annual number of new firms, the annual number of new establishments, the growth rate in the number of employees, and the growth in total payroll in thousands of dollars. They control for various factors that may influence entrepreneurial activity, such as growth in personal income, population, education, government policy, and patents. The authors run regression analysis on the data to look for relations among bank lending, VC financing, and economic growth in the variables listed. They find a significant relationship between VC financing at firms with 5–19 and 20–99 employees but no relationship between bank lending and the economic variables tested.
Because of the prevalence of bank lending across the United States compared with VC, I would have expected bank lending to show a greater level of economic significance. I found the authors’ research interesting, and I hope it will lead to more studies on this topic.