The Dynamics of Capital Structure in U.S. Start-Up Businesses

In this article, we examine how startup firms finance their operations over time. We empirically test the financial growth cycle theory developed by Berger and Udell (1998) using the Kauffman Firm Survey data, the largest longitudinal data set comprised of all U.S. startups launched in 2004. Simultaneously, we examine whether the pecking-order and trade-off theories explain the changes in capital structure of startups from inception to the later stages of development. Consistent with the predictions of financial growth cycle theory, at the startup stage, entrepreneurs rely on initial insider capital sources, such as personal savings, financing offered by friends and family, quasi-equity, and personal debt. Over time, as firms become less opaque, the proportion of business debt and trade credit financing in the total capital injection volume increases significantly. Although the proportion of owner’s equity in total capital injections decreases over time, the annual balance of owner’s equity increases, suggesting that owners use retained earnings to increase their ownership stake in the firm.