Determinants of Equity Financing for Irish Technology-Based Firms

Topic: Financing is one of the fundamental resources required for enterprises to form and subsequently operate and grow.  Technology-based firms, whilst being important contributors to economic growth, innovation and job... [ view full abstract ]

Topic: Financing is one of the fundamental resources required for enterprises to form and subsequently operate and grow.  Technology-based firms, whilst being important contributors to economic growth, innovation and job creation, possess certain characteristics which make obtaining adequate financial resources especially problematic.  Equity finance has developed as a notable intermediary in financial markets, providing the funding these firms typically lack due to capital market imperfections (Gompers and Lerner, 2001).  Within this context, this paper presents an empirical examination of the determinants of equity financing for technology-based firms in Ireland.

Aim:  For a firm to be equity financed, two conditions must be fulfilled, namely: (1) founder(s) decide to seek external equity finance; and (2) equity investor(s) decide to invest in the firm (Rasmussen and Sørheim, 2012).  Although an understanding of both components is necessary to fully comprehend the nuances of equity financing, there is a preponderance of theory and evidence emphasising the supply-side, putting the decision-making of investors in the foreground (Seghers et al., 2012).  Entrepreneurs, however, are the driving force of key decisions and, consequently, demand-side factors are likely to play a crucial role in entrepreneurial financing (Cassar, 2004).  Overall, there is a need for research to look beyond supply-side issues to enhance our knowledge of the role of entrepreneurial objectives and perceptions in financing (Fraser et al., 2015).  Addressing the dearth in the literature noted by Howorth (2001) and Gregoire et al. (2011), and responding to Rasmussen and Sørheim’s (2012) call for greater focus on the demand-side of entrepreneurial financing, this paper investigates attributes of equity financed firms.  Specifically, analysis examines how factors characterising the technology-based firm and entrepreneur influence use of equity financing. 

Methodology:  Data utilised in analysis is drawn from primary-source evidence collected from a sample of 294 indigenous technology-based firms.  Fieldwork employed a structured survey administered through face-to-face interviews with equity financed firms, along with a condensed self-administered version completed online (mail/telephone upon request) by non-equity financed firms.  A total of 294 (response rate 43%) firms participated (153 (52%) equity; 141 (48%) non-equity).  Firms are categorised as being equity financed if respondents report use of at least one of the following sources during their firm’s lifecycle: private/corporate venture capital; business angel; or government-sponsored equity funding. Using a unique dataset, we estimate a probit which predicts the influence of a multifaceted assortment of explanatory factors (i.e. firm-specific, human capital, innovation-specific and financing-specific) on equity financing. 

Findings: We find that those facing lower levels of rivalry within their market have a greater probability of being equity financed.  That little threat of competition is beneficial in accessing equity investment is consistent with supply-side evidence provided by Carpentier and Suret (2015).  Additionally, the greater the firm’s export activity, the more likely the firm is equity financed.  Overall, results validate the relationship between the firm’s stock of human capital and equity finance.  Entrepreneurs within equity financed firms are highly educated and have greater industry-specific experience. Aside from the knowledge and capability gained, both of which have been identified as important signals in attracting equity investors, education and experience strengthen social capital, which may provide valuable networks and connections in gaining access to potential equity investors (Hsu, 2007).  Findings also reveal that equity financed firms have higher levels of organisational human-capital.  Although, to the best of the author’s knowledge, no other study provides evidence linking organisational human capital to equity finance, this finding is in harmony with work emphasising the crucial role of firm-level human capital (Chowdhury et al., 2014). 

Innovation activity (proxied by frequency of innovation, R&D and patenting) has a positive impact on equity.  Interestingly, innovativeness, captured through a self-appraised measure of frequency of product and process innovation, has the largest impact on equity financing.  Expenditure on R&D and patents are also positively related to equity financing. The evidence that debt is disfavoured by R&D-intensive firms is quite clear (Hall, 2002), with equity generally considered the most likely source of external capital.  That patenting has a positive and significant effect is consistent with evidence highlighting the signalling value of patents in attracting and obtaining equity (Audretsch et al., 2012).  Results show that entrepreneurial preferences affect the financing of technology-based firms.  Entrepreneurs in equity financed firms have a preference for utilising external as opposed to internal sources of finance.  This is a somewhat plausible result, in that, if the entrepreneur prefers external funding it could be assumed that they are more willing to cede the independence and control necessary to acquire equity investment. Those who wish to maintain majority control may be less likely to seek external equity and bear the loss of freedom that comes with obtaining equity investment, thus preferring to fund their business with internal capital as much as possible.  Finally, results show that equity is inversely related to debt financing.  This suggests that debt and equity may be thought of as substitutes rather than complements in the financing of technology-based firms, consistent with Audretsch and Lehmann (2004).  It is possible that these entrepreneurs understand, implicitly or explicitly, that the greater information opacity and innovation-intensive nature of their enterprises, and the increased risk this creates for external investors, necessitates equity as the most probable source of external funding. 

Research Implications: The call for the development of a more diversified funding environment for Irish businesses, moving away from an over-reliance on debt-based financing, emphasises increased use of equity capital (O’Toole et al., 2015).  By identifying those factors which lead to equity financing, evidence presented herein provides important information which can improve our understanding of potential contributory elements that can enhance use of equity.  Results serve to augment our grasp of factors influencing external equity funding, which may, in turn, be exploited in cultivating and supporting access to equity capital.  Knowledge of these factors can aid entrepreneurs in successfully obtaining equity investment.  How entrepreneurs can improve their attractiveness to potential investors has been an important focus for policy, but the academic literature has devoted little attention to this issue. 

Originality/Value: The novelties of this study lie in three directions.  Firstly, fieldwork allowed for the compilation of a unique database, based on a novel sample of indigenous firms.  This is a significant contribution, as data and evidence of this kind does not currently exist in the Irish context for a sample of firms across technology-based manufacturing and knowledge-intensive service sectors.  This extends the work of Hogan and Hutson (2005), who focus on a sample of 117 Irish software firms in their analysis of the determinants of venture capital financing.  Secondly, empirical investigation utilises both objective (e.g. firm size, age, patents) and subjective (e.g. perceived intensity of competition, perceived innovativeness) data.  Many of these factors provide new empirical evidence regarding influences on equity financing, in both Irish and international contexts.  Thirdly, analysis adopts a wider definition of equity than similar studies, which tend to focus on one source of equity financing (see Hogan and Hutson, 2005; Hsu, 2007).  Thus, we provide a broader explanation of factors influencing equity financing from the demand-side perspective. 

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