STRAVEGY

THE FAMILIARITY OF SMAI,L TECHNOLOGY-BASED
BUSINESS OWNERS WITH SOURCES OF CAPITAL:

IMPACT OF LOCATION AND CAPITALIZATION

Howard Van Auken
Iowa State University

vanaukenQai astate. edu

ABSTRACT

This paper examines issues related to the acquisition of capital by a sample of /42 small
technology-based firms. Specifically, the study investigates the relaiionship between owners

of small technology-based firms'familiarity with the aliernative sources of capital and (l)
location of the business and (2) amount of capital raised by the business. The results show
that familiarity with alternative sources of capital is affected by the location of the business
and amount ofcapital raised by the company

The results have several implications affecting small business owners, providers of capital,
and policy-makers. First, many small business owners are relatively unfamiliar with many
sources of capital that are used to fund growth. Second, owners of small technology-based
firms indicate low familiarity with government financing programs. Third, owners of small
technology-based firms in smaller communities are less familiar with sources of capital
commonly used to finance growth. Fourth, owners of small technology-based firms are
relatively unfamiliar with methods of bootstrap financing.

INTRODUCTION

Traditional finance theory assumes that the goal of the firm is to maximize the wealth of the
owners. Finance theory asserts that value is maximized through increasing the size of cash
flows and/or decreasing the risk associated with the cash flows. Variables having an

important impact on value maximization include those affecting the risk and return

characteristics of the firm. Finance theory states that firms will be rewarded by maximizing
returns or minimizing risk by a greater investor demand for ownership in the firm and,
resultantly, higher market value for the firm. Brophy and Shulman (1992) emphasize the
relevance of finance theory in the field of entrepreneurship. The development of finance
models, including the Capital Asset Pricing Model and Arbitrage Pricing Model, provide

insight into the relationship between risk and return in the context of valuation that can be
useful to entrepreneurs (Brigham & Gapenski, 1996).

Much of the theory underlying value maximization relies on the assumptions associated with
perfect capital markets (Petty 8'c Bygrave, 1993). These assumptions include, for example,
homogenous expectations, zero transaction costs, infinitely and perfectly divisible

33



Journal ofSntall Business Strategy Vol. /l, No.2 Fall/IVinrer 2000

investments, and perfect information (Brigham r(Gapenski, 1996). While these assumptions
may be valid for large public companies, the application of these assumptions to small firms
has often been questioned in the literature. Ang (1991) discusses financial issues that are
different for small firms as compared to large firms. These issues include (I) greater agency
problems arising from type of ownership (i.e. sole proprietorships and partnerships have no
agency problems and firms with separation of ownership and management have agency
problems) and higher monitoring costs associated with debt, (2) information problems arising
from asymmetric (different information available to different groups) information, (3) high
failure costs, (4) differences in taxation and (5) high transaction costs resulting in limited
access to alternative sources of capital.

Small firms'ack of access to the capital markets and information about financing alternatives
are important violations to the perfect capital market assumptions. These violations are
especially important for technology-based firms for several reasons. Product development
and marketing are oAen very lengthy and expensive for technology-based firms. In addition,
owners of technology-based firms oAen have technology/science backgrounds and limited
knowledge of financial management issues. The impact of these limitations may be more
significant for technology-firms that are located in smaller communities and have raised
limited amounts of capital.

This paper presents the results of a study that examines the relationship between the owners of
small technology-based firms'amiliarity with alternative sources of capital and the firm's ( I)
location and (2) capitalization. A better understanding of the issues associated with the
financing of technology-based companies may be beneficial due to their growing role and
importance in the US economy. The results of the study can be used by service providers and
consultants who assist owners of technology-based firms in their search for capital. The
results of the study also can be incorporated into college curriculum to provide students with
insight into the acquisition of capital, especially for technology-based firms.

The next section of the paper presents background material on small firm financing. Research
issues are examined in the study followed by the presentation of the methodology used in the
analysis. The results are presented and conclusions are drawn.

SMALL FIRM FINANCING

Finance Theory

The acquisition of capital has traditionally been one of the most difficult aspects of launching,
operating, and growing a small firm. The lack of capital may lead to cash flow shortages,
inability to pursue market opportunities, and failure. Landstrom (1992) uses agency theory to
show that asymmetric information results in small firms having greater diITiculty in raising
capital as a result of higher monitoring costs, bonding costs, and residual loss potential as
compared to larger firms. Emery and Finnerty (1997) emphasize that financing structure
provides a signal to providers of capital about the risk and return characteristics of the firm.
Signals by the owners provide information to providers of capital about the future strategies
that the firm intends on implementing and thus, can have an important impact on the potential
sources and availability of capital.

The goal of wealth maximization dictates a financing structure that is consistent with the
traditionally defined risk-return relationship. Petty and Bygrave (1993) point-out that the
goals of the firm may vary according to the type and characteristics of the firm. McMahon and
Stanger (1995) state that the traditional objective of the firm is oversimplified and not an
accurate reflection of the goals of the owner of the small firm. Ang (1992) states that the

34



Journal of Small Business S/raregy Vo/.//, /iio.2 Fall/Winier 2000

objective of the firm may be quite complicated and depend on organizational characteristics.
The objectives of owners of smaller firms may be a combination of profit, long term value
creation, taxation, family issues, and career independence.

Capital acquisition among small firms is affected by numerous factors, including economic
conditions, credit history, type of business, current financial characteristics and owner's
preferences (Chaganti, DeCarlos & Deeds, 1995). Petty and Bygrave (1993) believe that the
maturity and owner's objectives are important influences on a small firm's capital structure.

Sources of Capital

Small firms have traditionally acquired start-up capital from either personal savings or loans
from lending institutions. When traditional sources of capital are not available, owners oRen
use bootstrap financing, or "highly creative ways of acquiring the use of resources without
borrowing money or raising equity financing from traditional sources" (Freear, Sohl, &
Wetzel, 1995). Bhide (1992) believes that the ability to locate bootstrap financing identifies
entrepreneurial spirit. Other sources of start-up capital may include friends and relatives, sale
of personal assets, home equity, cash value of life insurance, issuance of stocks/bonds, credit
cards, leases, government grants, research and development/manufacturing loans, customers
and suppliers (Van Auken & Neeley, 1996).

Ongoing operations are commonly financed through profitability. Profits that are reinvested

in the finn, especially growing firms, can be an important source of capital during the earlier
years of operation. Reinvested capital enables the firm to fund growth without accessing
external funds. Maintaining strong profit margins aAer paying cost of goods sold, overhead
costs, and owner's compensation is important (Emery & Finnerty, 1997).

One of the more challenging issues facing successful firms is negotiating and obtaining
growth capital through informal and/or formal venture capitalists. Most firms are
unsuccessful in attracting venture capital and must pursue other strategies to raise capital.
Firms seeking investment from venture capitalists should recognize important differences
between informal investors and formal venture capitalist investors (Timmons, 1997). For
example, the informal venture capital market consists of a diverse set of investors who invest
in high-risk, high potential return ventures that are oAen in the early stages of development.
ln addition, informal venture capital investors typically invest smaller amount of capital than
do formal venture capitalists. Formal venture capital firms prefer to invest in firms that are in
later stages of development than informal venture capital investors (Busenitz & Piet, 1996;
Freear, Sohl, & Wetzel, 1995).

Capital Acquisition Constraints

The constraints that entrepreneurs confront in raising capital arise from several problems.
First, many entrepreneurs are not knowledgeable in business disciplines and the financial

management of a firm. As a consequence, some entrepreneurs may accept greater business
and financial risks than the potential rewards from the business. In addition, an entrepreneur's

high need for control and desire to avoid accountability can result in the development and
implementation of poor operational and financial strategies. These entrepreneurs may not
recognize or accept a signal from providers of capital about the weakness of their proposed
business concept and be unwilling to change their initial business concept (Ang, 1992; Ang,
1991).

A second group of problems is related to the quality and characteristics of the proposed
business concept. Adverse reaction to the business idea from potential lenders or investors

35



Journal ofSmall Business StratcI0 Vol. I I, i&to.2 Foll/IVtnter 2000

may occur due to the entrepreneur's inexperience, inadequate information on the proposed
business, high cost of financing smaller requests, and high risk (Petty &: Bygrave, 1993; Ang,
1991; McMahon & Holmes, 1991). Capital structure decisions can also be affected by the
owners'reference for debt that results from the tax shield associated with the debt capital
(Norton, 1991).

A third issue concerns the availability of information. Gibson (1992) believes that finance
theory associated with the acquisition of capital by small firms requires modification due to
the lack of information about alternative sources of capital by owners of small firms. This
information asymmetry increases the risk of and reduces the flow of funding to small firms
(Landstrom, 1992). Holmes and Kent (1991) refer to the limited awareness of capital
alternatives in the context of a financing gap or "knowledge gap*'. Technology-based firms in
a relatively early stage of development may find great difficulty in obtaining capital due to the
risks associated with the development of technology-related products and the transfer of
product into the market. The high research and development costs and long lead-time in

bringing the product to the market make start-up technology firms very high risk investments.

As a result, technology-based firms often have great difficulty in acquiring capital, especially

in the early stages of the product development (Mason &. Harrison, 1995).

RESEARCH QUESTIONS

The efficiency of the capital market is affected by the flow of information to both users and
providers of capital. Less eAicient capital markets lead to greater difficulty in capital
acquisition and higher costs of capital. Ultimately, firms may experience cash flow and
liquidity problems. These problems can be especially challenging for new technology-based

firms that commonly experience long product development times, high risk in

commercialization of new technology, and, as a result, causing difficulty in raising capital.
Location and capital acquisition experience of the firm may be an important factor affecting
the familiarity with financing alternatives and placing constraint on capital acquisition.

Research Question ¹I: Are owners of small teclmology-based firms who
are located in smaller communities (&2$,000 people) less familiar with
olternative sources of capital &lian owners of small technology-hosed firms
wlio located in larger communities fv2$ ,000 peoplej.

One of the basic assumptions underlying much of finance theory is that information is widely
and freely accessible to all market participants (Emery &c Finnerty, 1997). Owners of
technology-based firms in smaller communities may be less informed and, thus, less familiar

with alternative sources of capital than owners of small technology-based firms in larger
communities. On the other hand, owners of technology-based firms located in smaller
communities may be fully utilizing information technology and the expertise of service
providers to gain access to and become more familiar with alternative sources of capital. Van
Horn and Harvey (1998) emphasize the diAiculties of acquiring information by small firms
located in small communities. The unfamiliarity with alternative sources of capital may be
the result of poor dissemination of information, lack of sophistication, and/or lack of expertise
among both providers of capital and business consultants in smaller communities. In addition,
firms in smaller communities may be more isolated, have less visibility and, thus, attract less

attention by providers of capital than firms in larger communities. Lang, Calantone and
Gudmundson (1997) believe that small firms must rely on external expertise, oflen not
available in small communities, when developing business strategies. Saxenian (1990) states
that the success of small technology-based firms is negatively impacted by the lack of
information that occurs from geographic isolation. Deeds, Decarolis and Coombs (1997)

36



Journal ofSmall Business Strategy Vot. it, No.2 Fall/Winter 2000

found that geographic clustering of firms in the biotechnology industry increased
firms'ccess

to the capital.

Research Question ¹2r Are owners of small teclinology-based firms wlio
trave raised smaller amounts of capital (&$1,000,000) less familiar with
the alternative sources of capital than owners of small technology-based
firms wlio have raised larger amounts of capital (&Sl,000,000).

Owners of small technology-based firms who have raised smaller amounts of capital may
have less experience with the acquisition of capital as compared to owners of small
technology-based firms who have raised greater amounts of capital. As a consequence, the
less experienced owners may have a weaker understanding of and be less sophisticated with
the alternative sources of capital than owners of larger technology-based firms. However, the
experience associated with capital acquisition may not improve the understanding of
alternative sources of capital, but only provide owners with an understanding of the capital
acquisition process. Callahan and Cassar (1995) found that owners of smaller firms (as
compared to larger firms) were less sophisticated and used less market information in making
decisions. The constraints resulting from inexperience in the use and access of information
affects the ability of the firm to raise capital. Petty and Bygrave (1993) found that owner's
experience directly impacted the ability to raise funds from the alternative providers of
capital.

SAMPLE AND METHODOLOGY

Sample and Questionnaire Development

A sample of 500 small technology-based businesses was provided by the Small Business
Development Center (SBDC) located in a Midwestern state. The sample was constructed by
the SBDC as part of an effort to identify the scope and nature of small technology-based firms
in the state. Questionnaires were mailed to each of the 500 companies during October 1998.
After two weeks, a second questionnaire was mailed to non-respondents. A total of 142
usable questionnaires were returned, resulting in a 28.4% response rate.

The questionnaire was organized into two sections. The first section collected demographic
information on respondent firms (legal structure, community size, and total capitalization).

The second section collected information on sources of capital used to finance the business
(personal equity, stock, bonds, loans from financial institutions, loans from finance

companies, factoring, credit card, suppliers, customers, leasing, RgtD, government programs,
venture capital, individual investors, and other). In addition, respondents were asked to
indicate their familiarity with each source of capital using a I (very familiar) to 5 (not
familiar) scale.

Methodology

The data were initially analyzed using univariate statistics to evaluate the characteristics of the
sample using means and frequencies. Subsequently, the sample was segmented into two

groups. Each grouping corresponded to a research issue that was being examined. The first

partitioning of the sample was based on community size (& 25,000 people and & 25,000
people). The second partitioning of the sample was relative to total capitalization
(&$ 1,000,000 and &$ 1,000,000).

Witcoxon two sample tests of the difference between means were examined for each of the
two sample groupings (community size and total capitalization) relative to the

owners'7



Journal ofSniall Business Strategy Vot. ll, Ato.2 Fall/Winter 2000

familiarity with the various sources of capital. Owners were classified as being familiar with
the source of capital if they ranked familiarity with the source of capital as I, 2, or 3 and were
classified as being unfamiliar with the source of capital if they ranked familiarity as 4 or 5.
Finally, the familiarity with each source of capital was combined into a single variable
(familiarity with capital) that was used to measure the respondents'verall familiar with
capital. A logit regression analysis was preformed to determine whether size of community or
total capitalization had a greater impact on familiarity with capital:

Familiarity = a+ b, Size of Community+ b. Total Capitalization

These variables are operationalized in the following manner:

Familiarity: Respondents'verall familiarity with sources of capital

Si e of Community: I = (10,000
(Population) 2 = 10,001-25,000

3 = 25,001-50,000
4 = 50,001-100,000
5 = &100,000

Total Capitalization: I = &$ 100,000
2 = $ 100,001-$500,000
3 = $500,001-$ 1,000,000
4 = &$ 1,000,000

In addition, Spearman correlations between the independent variables (Size of Community
and Total Capitalization) were calculated to determine the degree of relationship between the
variables. No significant correlations were present.

RESULTS

Business Characteristics

Table I shows the demographic characteristics of the sample firms. The majority of firms
(64.1%) were organized as C-corporations and S-corporations (29.6%). The remaining firms
were organized as partnerships (3.5%), sole proprietorships (1.4%) and limited liability
companies (1.4%). The very high percentage of firms organized as corporations may be due
to the limited liability aspects of being incorporated, which may be especially relevant for
technology-based. Most respondent firms (78.9%) sold products and services (14.1%). The
remaining firms offered consulting (2.1%)and other (4.9%).

Approximately 43.7% of the lirms were located in communities having a population of less
than 10,000, 12.0% in communities 10,001 —25,000, 15.0% in towns 25,001 —50,000, 8.5%
in cities 50,001 —100,000 and 20.4% in cities &100,000. Approximately 27.3% of the firms
began operations within the last five years, and approximately 20.2% began operations more
than 10 years ago. About one-half (52.5%) of the firms began operations between 6-10 years
ago. Finally, Table I shows that about 10.4% of the firms raised less than $ 100,000 since
operations began. Approximately 25.9% raised $ 100,001-$500,000, 17.8% between
$500,0001-$ 1,000,000, and 45.9% more than $ 1,000,000 of total capital.

38



Journal ofSmall Business Srrategy Vol. ll, No.2 FallfWinier 2000

Table I: Type of Firm, Type of Ownership, Age,
Sales,

Community Size, and Total Capital Raised (n=142)

Variable Percent of Sample
7j pe of Firm

Products 78.9
Services 14.1
Consulting 2.1
Other 4.9

Type of Oiuoership
Corporation 64. I
S-Corporation 29.6
Pannership 3.5
Sole Proprietorship 1.4
Limited Liability Company 1.4

vtge of Firm (Years)
&6 27.3
6 —10 52.5
&10 20.2

Community Stet
&10,000 43.7
10,001-25,000 12.0
25,001-50.000 15.0
50,001-100,000 8.5
& 100,000 20.4

Totoi Capital Raised
&$ 100,000 10.4

100,001-$500,000 25.9
$500,001-$ 1,000,000 17.8
& $ 1,000,000 45.9

Sources of and Familiarity with Capital

Table II shows the sources, mean usage, and standard deviation of means of start-up capital
used to fund operations. The table shows that personal equity (31.32%) and loans from
financial institutions (26.63%) were the most common sources of start-up capital. This
distribution of capital is consistent with previous studies of start-up financing (see Van Auken
& Carter, 1989). Issuance of stock (11.51%),investment from individual investors (5.03%)
and other unspecified sources of capital (4.85%) were also relatively common sources of start-
up capital. All other sources of start-up capital were used infrequently. The large standard
deviations of many of the sources of capital indicated wide variation in usage. Small firm
financing is often tailored to the objectives of the owner and characteristics of the firm and,
thus, the contribution of alternative sources of capital varies by firm. (Timmons, 1999).

Table III, which shows the means of the owners'amiliarity with each source of capital (I =
very familiar and 5 = not familiar), indicates that the respondents are most familiar with
sources of capital that are traditionally associated with small firms. These sources include
loans from financial institutions (1.66), supplier credit (2.28), Si)A guaranteed loans (2.43),
and leasing (2.48). The respondents also indicated moderate familiarity with capital
investment from private investors (2.53), perhaps due to the large extent to which private
investors (i.e., angels) provide capital to technology-based firms (Freear, Sohl, & Wetzel,
1995). Owners were somewhat less familiar with stocks (2.54), asset-backed loans (2.82) and
customer-based financing (2.88). The results also indicate a relatively low mean ranking of
familiarity with government programs (state programs = 3.45, local programs = 3.45 and
federal programs = 3.56) at all levels. These low rankings are especially revealing in the

39



Journal ofSmrdl Business Strategy Vol I I, iVo.2 Fall/Winter 2000

context of the important role of government backed financing programs. Finally, the owners
were least familiar with factoring (3.57) as a source of capital.

Table II: Mean and Standard Deviation of Source of Capital (%)
(n = 142)

Source of Capital Mean (%) Standard Deviation

Personal Firiuity 31.32 36.26

I.oan I'rom financial institution 26.63 31.31

Stock 11.51 11.50

Private invcsair 5.03 15.20

State govcmmcnt programs 3.25 12.30

Vcnturc capital 2.53 14.54

Loan from finance company 2.47 9.62

Customer 1.73 11.23

I.casing 1.20 4.23

Credit card O. I I 0.72

Supplier 1.79 7.99

Research snd development 0.46 5.05

Bond 0.39 3.26

Local govcmment programs 0.27 12.30

Federal govcmment programs 0.04 0.41

Other 4.85 18.96

Table III: Familiarity with Sources of Capital

Source of Start-up Capital n Mean Ranking

Loan from financial institution 139 1.66

Supplier credii 137 2.28

SBA guaranteed 139 2.43

Lease 140 2.48

Private investor 139 2.53

Stock 140 2.54

Asset lendmg 137 2.82

Customer 138 2.88

Venture capital 139 3.10

Third party 137 3.13

Bond 138 3.13

State government programs 138 3.45

Local government programs 138 3.45

Federal government programs 138 3.56

Factoring 138 3.57

40



Journal of Small Business Strategy Vol./0 Na.2 FalllIVinter 2000

Statistical Tests

Table IV shows the results of the Wilcoxon two sample tests of differences between means of
familiarity with sources of capital relative to size of community (&25,000 population versus
&25,000 population) in which the firm is located. The table shows that owners of technology-
based firms in smaller communities are less familiar with almost all sources of capital than
owners of firms in larger communities. More specifically, owners in smaller communities are
signilicantly less familiar with stocks, investment from another company, federal government

programs, venture capital, and investment from private investors. In all case, owners in larger

communities are significantly more familiar with sources of capital than owners in smaller
communities.

Table IV: Familiarity with Source of Capital Relative to Community Size:
Wilcoxon 2-Sample Test of Difference in Means

Community Size:
(Small=&25,000

Variable Large=&25,000) Mean Response

Stock Small 78 2.88
Large 62 2.11 "

Bond Small 76 3.47
Large 62 2.71 "

Supplier credit Small 76 2.30
Large 61 2.26

Customer Small 77 3 01
Large 61 2.72

Factor Small 77 3.73
Large 61 3.36

Asset lending Small 76 2.97
Large 61 2.62

Loan from fiuaucral institution Small 78 1.59
Large 61 1.75

SBA guaranteed Small 78 2.47
Large 61 2.38

Lease Small 78 2.58
Large 62 2.35

Iuvcsuueut from other company Small 76 3.46
Large 61 2.72 vv

Federal government programs Small 77 3.79
Large 61 3.26 "

State government programs Small 77 3.61
Large 61 325

Local government programs Small 77 3.49
Large 61 3.39

Venture capital Small 77 3.45
Large 62 2 66

v'rivate

investor Small 77 2.79
Large 62 2.21 "

~ Significant at 1%
aa Significant at 5%

The results in Table IV provide several general implications. First, the results provide

evidence on whether owners of small technology-based firms are more or less familiar with
several sources of capital than owners of small technology-based firms in larger communities
(Research Issue ¹I) . The results show statistical differences in familiarity with several
sources of capital that are commonly used to finance growth. Thus, lirms in the smaller
communities may face limitations on growth due to the owner's lack of understanding of

41



Jorrrnal of Small BtrsinessSiraiegy Vol. l l, IVo.2 Fall/Winier 2000

financing alternatives. This result supports the concept that market inefficiencies in raising

capital may exist due to the lack of information about the alternative sources of capital that
may be available. Second, the results suggest that owners of technology-based firms in small
communities are equally familiar with several of the traditional sources of capital used to fund
small firms as are owners in larger communities. Sources such as loans from financial

institutions, personal savings, supplier credit, etc. are commonly used by all firms during the

initial stages of operations.

Table V shows the results of Wilcoxon two sample tests of difference in means of familiarity
with several sources of capital relative to total capitalization (0 = less than $ 1,000,000 and I =

greater than $ 1,000,000). The general trend in the table shows that owners of small
technology-based firms who have raised smaller amounts of capital are less familiar with the
several alternative forms of capital than owners who have raised greater amounts of capital.
More specifically, the owners who have raised smaller amounts of capital are significantly
less familiar with capital from supplier credit, customer financing, asset-based loans,

factoring, state government programs and local government programs than owners who have

raised larger amounts of capital.

Table V: Familiarity with Sources of Capital Relative to Total Capitalization:
Wilcoxon 2-Sample Test of Difference in Means

Capitalization
(Lower=&1,000,000

Variable Higher=&1,000,000) n Mean Response

Stock Lower 73 2.67
Higher 61 2.33

13ond Lower 72 3.35
Itigher 60 2.62 ~

Supplier credit Lower 71 2.46
Higher 60 1.97 "

Customer Lower 71 3.10
tligher 61 2.51 '~

I'actor Lower 72 3.gg
Higher 60 3.10"

Asset lending Lower 72 3.00
Higher 59 2.46 "

Loan I'rom linancial institution Lower 72 1.72
Higher 61 1.54

SI3A guaranteed Lower 72 2.47
Higher 62 2.26

Lease Lower 73 2.53
Higher 61 2.34

Investment from other company Lower 71 3.31
Higher 60 2.92

Federal government programs Lower 72 3.76
Higher 60 3.30

State government programs Lower 72 3.63
Higher 60 3.17 I

Local government programs Lower 72
3.72

Higher 60 3 P5 0

Venture capital Lower 73 3.21
Higher 60 2.92

Private investor Lower 73 2.60
Higher 60 2.43

Significant at )%
'v Significant at 5%

42



Journal af Small Business Strategy Val. l l, tV0.2 Eall/Winter 2000

A moderating influence on differences in familiarity may be differences or similarities in the
distribution of sources of capital by amount of capital raised. For example, the distribution of
sources of capital between firms that raised large amounts as compared to firms that raised
small amounts of capital may be similar. Similarities in the distribution of sources of capital
may result in similar uses and familiarity.

To investigate this issue, a Wilcoxon 2-sample test of difference in means between sources of
financing versus size of firm was completed. Size of firm was measured using amount of total
capital acquired since firm was launched (& $ 1,000,000 and & $ 1,000,000). The only
statistically significant dilTerence in mean values between firms that raised less than

$ 1,000,000 and greater than $ 1,000,000 was for common stocks. Firms that acquired more
capital used significantly more common stock in their capital structure than firms that
acquired less capital. Few differences in distribution of sources of capital by size does not
necessarily suggest that there would be no differences in familiarity. The experience gained

through acquiring capital (all types of capital) would add to the knowledge base of the owners
about the characteristics of and familiarity with sources of capital. The more that owners
interact with providers of capital (which would occur as more capital is acquired) to explore
issues related to capital acquisition, the greater their understanding of the sources of capital.
Greater experience with capital acquisition would be expected to result in greater
understanding of the sources of capital and familiarity with the sources of capital.

The results shown in Table V have several implications. First, the results provide evidence on
whether owners of technology-based firms who raised larger amounts of capital are more or
less familiar with sources of capital than are owners who raised smaller amounts of capital
(Research Issue I)2). Owners who raised smaller amounts of capital are generally less familiar
with bootstrap sources of capital than are owners who raised greater amounts of capital.
Second, the results indicate that owners who raised lesser amounts of capital are less familiar
with state and local government programs than are owners who raised greater levels of capital.
Third, the results suggest that owners are generally less familiar with the sources of capital
commonly used to financing growth (i.e. venture capital, capital from private investors, and
investment from another company) than sources of capital typically used to start-up and run
operations (i.e. loans from financial institutions, supplier credit, and SBA guaranteed loans).
These findings suggest that owners who have less experience in raising capital may be

overlooking sources of funds that might be available to fund operations. Capital constraints
may be due to lack of information about availability as well as limitations on availability of
capital.

The data were evaluated using logit regression analysis to determine whether size of
community or total capitalization had a relatively greater impact on the

respondents'amiliarity

with capital. The correlation analysis shown in Table VI shows that size of
community and total capitalization are not significantly correlated and, thus, measure different

attributes of familiarity.

Table VI: Spearman Correlation Between Capitalization and Community Size
(P-Values in Parentheses)

0=139

Capital Size

Capitalization 10 -0.0223
(0.797)

Community Size -0.0223 1.0
(0.797)

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Jottrnal ofSttiall Dttsiness Strategv Vol. I I, No.2 Fall/Winter 2000

The results of the logit regression analysis are shown in Table Vll. Both independent
variables (size of community and total capitalization) are significant at 1%. The positive
coefficients indicate a direct relationship between familiarity and (I) size of community and
(2) total capitalization. The larger (smaller) the community size and levels of capital
acquired, the more (less) familiar that respondents're with the sources of capital. Size of
community and total capitalization appear to be relatively equally important factors affecting
respondents'amiliarity with capital.

Table Vll: Logit Regression Results
Familiarity with Capital Relative to Community Size and Amount of Capital Raised

(n =75)

Dependent Variable Independent Variable Regression Cocfticicnt X

Community Size 0.3275 11.1004

Familiarity
Capitalization 0.4380 $.9239

" Signilicant at 1%

SUMMARY AND DISCUSSION

Previous research emphasized the difficulty associated with the acquisition of capital by small
firms (Ang, 1991, 1992). The discussion in the literature has suggested that the difficulty of
raising capital may be attributable to high agency and high transaction costs (Landstrom,
1992). Another explanation for the difficulty of raising capital may be the lack of
sophistication and knowledge about alternative financing sources among small business

owners. The lack of sophistication and knowledge may be especially relevant for owners of
small technology-based firms that face long product development times and high research and
development costs.

The study results have several implications for owners of small technology-based firms,
providers of capital, and policy-makers. First, the results suggest that small technology-based
business owners are relatively unfamiliar with many of the sources of capital that are used to
fund growth. This unfamiliarity with sources of growth capital may be an important
constraint on the ability of the firm to successfully continue product development, transfer
products to the market, and grow. On the other hand, the results indicate a relatively high

degree of familiarity with many of the traditional sources of capital. This is not surprising
since these traditional sources of capital are commonly used to launch and fund operations of
most types of firms.

This first implication provides an opportunity for service providers and consultants who assist
technology-based firms with their acquisition of capital. The acquisition of capital by new
technology-based firms is time consuming, sometimes requires specialized insight into the
capital acquisition process, and often is facilitated through networks/contacts. Service
providers and consultants who are familiar with these issues may bring value to technology-
based firms by providing advice on the appropriate sources of capital, where to look, how to
approach providers of capital, etc. Reliance on consultants to navigate through capital
acquisition may be beneficial in that owners can focus on product development and internal

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Journal ofSmall Business Strategy Vol. ll, No.2 Fall/Winter 2000

management issues. Knowledgeable consultants can help firms avoid costly and time
consuming mistakes.
A second implication of the study is the low familiarity with all sources of government
financing programs. Government financing initiatives directed at assisting small technology-
based firms may have limited effectiveness without business owners being familiar with and
understanding the programs. The results suggest that information on federal, state, and local

government sponsored programs may not be effectively disseminated among the small
technology-based business community.

Third, the results show that owners of small technology-based firms in small communities are
less familiar with sources of capital commonly used to finance than owners located in larger
communities. Unfamiliarity with these sources of capital may be an important constraint
affecting the growth potential of firms in the small communities. Such a finding is especially
important given the decline in small communities'opulations and in economic viability in
Midwestern states.

The third implication should be interpreted with some caution. If all firms have a similar
distribution of capital in their capital structure, then an argument could be made that familiar
with sources of capital would not vary with firm size. However, this does not account for the
knowledge about the alternative sources of capital through the process of capital acquisition.
The experience gained through capital acquisition would add to the knowledge base of the
owners about the characteristics and, thus, familiarity with all sources of capital. The more
that owners interact with providers of capital (which would occur as more capital is acquired)
to explore issues related to capital acquisition, the greater their understanding of the sources of
capital. Greater experience with capital acquisition would be expected to result in greater
understanding of the sources of capital and, also, familiarity with the sources of capital.

Additionally, some firms may locate in smaller communities because they do not require large
amounts of capital. Owners of firms that anticipate raising large amounts of capital (growth
firms) may decide to start operations in larger communities that have better networking
opportunities, greater visibility, and better access to capital. Owners of firms having a slow
growth (life-style firms) strategy may decide to locate in small communities since access to
large amounts or specialized forms of capital would not be anticipated. Evaluation of the
relationship between level of total capitalization and community size in this study, however,
revealed no statistically significant relationships.

The fourth implication is concerned with the unfamiliarity with bootstrap financing among the
firms that have raised smaller amounts of capital. Unfamiliarity with bootstrap financing can
be a constraint on the firm's financing flexibility in all stages of development, especially
during periods of illiquidity arising from seasonal fluctuations, growth, or unexpected events.

The study has several limitations that affect-the interpretation of the results and provide
insight into areas for further research. For example, the study was completed using a
relatively small sample in a single geographical area during a single time period. Other
studies could be completed in other locations focusing on different areas of the country or
population densities. A longitudinal study could reveal changes over time in financing
patterns, familiarity with alternative sources of capital, effectiveness of the dissemination of
information about financing alternatives, understanding of government-backed initiatives, and
knowledge about new financing developments. A larger sample that is national in scope
could provide greater insight into these types of differences.

Finally, the study did not specifically examine the relationship between type of product or
service offered and capitalization. Some firms (such as manufacturing or new technology

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Journal oj Sntall Business Strategy Vol. l l, iyo.2 Fall/Winter 2000

firms) require larger amounts and different forms of capital than other firms, such as
consulting or service firms. A future study could examine capitalization by major activity of
firm versus familiarity with sources of capital. The insight gained from this analysis may
provide insight into the life cycle nature of capital acquisition as well as the evolving impact
that familiarity with capital on capital acquisition. Additionally, the study did not explicitly
examine how the experience gained through raising capital affected the usage of capital over
time. A longitudinal study of capital acquisition could provide additional insight into how
experience with raising capital affects financing choices as the firm matures.

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Howard E. Van Auken is Professor of Management in the College of Business at Iowa State
University. He was a William J. Fulbright Scholar and Visiting Professor at the Instituto de
Technologico y de Estudios Superiores de Monterrey (Mexico) in 1989 and a William J.
Fulbright Scholar and Visiting Professor at Masarykova Unives ity v Brne (C ech Republic)
in 1994. He his research has been published in Entrepreneurship: Theory and Practice,
Entrepreneurship and Regional Development, Journal of Small Business Management,
Journal of Entrepreneurial and Small Business Finance, Journal of Entrepreneurship and
Small Business, Journal of Entrepreneurship, and Journal of Portfolio Management. He has
lectured or developed entrepreneurship programs in Mexico, Russia, C ech Republic,
Slovakia, Ukraine, Malaysia and Canada. He has served as Vice-President for Researcli,
Vice-President for the Individual Entrepreneurshi p Division, and Vice-President for Women 's

Entrepreneurship Division for the United States Association for Small Business and
Entrepreneurship. He has served on the editorial review boards of Entrepreneurship: Theory
and Practice, Journal of Small Business Management, and Journal of Small Business
Strategy. He was selected as the most outstanding Visiting Professor at ITESM in 1991,
awarded the Outstanding Reviewer of the Year by the Journal of Small Business Management
in 1998, and received the ISU International Service award in 1999.

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