Where do young firms get financing?

From the Federal Reserve Bank of Atlanta:  Young firms are likelier than older firms to contribute to job growth, but less likely to get financing. So where do they turn?

Reduced economic uncertainty and strong income growth can help those in search of equity financing, as investors become more willing and able to open their pocketbooks. But even when the economy is strong, there is a business segment that’s had an especially difficult time getting financing. And as we’ve highlighted in the past, this is also the segment that has had the highest potential to contribute to job growth—namely, young businesses.

Why is it hard for young firms to find credit or financing more generally? At least two reasons come to mind: First, lenders tend to have a rearview-mirror approach for assessing commercial creditworthiness. But a young business has little track record to speak of. Moreover, lenders have good reason to be cautious about a very young firm: half of all young firms don’t make it past the fifth year. The second reason is that young businesses typically ask for relatively small amounts of money. (See the survey results in the Credit Demand section under Financing Conditions.) But the fixed cost of the detailed credit analysis (underwriting) of a loan can make lenders decide that it is not worth their while to engage with these young firms.

While difficult, obtaining financing is not impossible. Over the past two years, half of small firms under six years old that participated in our survey (latest results available) were able to obtain at least some of the financing requested over all their applications. This 50-percent figure for young firms strongly contrasts with the 78 percent of more mature small firms that found at least some credit. Nonetheless, someyoung firms manage to find some credit.

This leads to two questions:

  1. What types of financing sources are young firms using?
  2. How are the available financing options changing?

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