Informal and Early Formal Financial Support in the Business Creation Process: Exploration with PSED II Data Set 1

Transcription

1 Informal and Early Formal Financial Support in the Business Creation Process: Exploration with PSED II Data Set 1 Paul D. Reynolds 2 11 January 2008 Abstract The second U.S. Panel Study of Entrepreneurial Dynamics [PSED II] has identified a cohort of nascent enterprises in the earliest stages of the business creation process. They are identified after the first efforts to create a business have been initiated but before the new venture has an initial period of profitability. The amount of informal financial support provided to these new ventures before they have been registered as a legal entity is separated from formal equity and debt provided after this event. The average amount of informal support is $48 thousand, but the skewed nature of the distribution is represented by a median of $4.3 thousand. The average amount of formal financial support is about $200 thousand, but the median is zero. There are some statistically significant differences related to the sources of informal and formal financial support and the status of the new ventures in the 12 and 24 month follow-up interviews, but no clear relationship to the amounts of support. Nascent enterprises still in the start-up process have higher amounts of informal and formal financial support than those reporting an initial period of profitability. The annual amount of informal support for 6 million nascent enterprises is about $102 billion dollars; the annual amount of formal support is about $145 billion; the majority of this funding is provided to ventures continuing the start-up process, not those with initial periods of profitability. Introduction Money does not start new firms. People start new firms; some money is usually required. How much money, the sources of the funding, the conditions associated with its provision, when it facilitates a start-up, and it relative importance are all topics of interest in understanding the firm creation process. There has been a considerable amount of research on these topics, reflecting wide variation in approaches, the nature of the business unit under examination as well as the stage of the business life course under consideration. Most research has indicated that 1 Prepared for the Kauffman Foundation-Federal Reserve Bank of Cleveland Conference on Entrepreneurial Finance, held on March 2008 at the Federal Reserve Bank of Cleveland. 2 Distinguished Visiting Professor in the George Mason University School of Public Policy; contact at pauldavidsonreynolds@gmail.com. Served as Co-Principal Investigator of the Second Panel Study of Entrepreneurial Dynamics along with Richard Curtin of the University of Michigan; Page 1 of 32

2 more money is helpful for business creation, growth and survival, but there is a considerable lack of precision on many issues. Extant Approaches Considerable attention has been given to the availability of financial support as a causal factor affecting the implementation of new businesses. Four different orientations illustrate the developments and limitations of extant approaches. For example, lacking direct data on business creation, much analysis by economists has emphasized reports of self-employment, or new entry into self-employment. Based on this measure of entrepreneurship the importance of the liquidity effect the availability of funds for new ventures--is often discussed as one of the most critical factors leading to new firm creation (Dunn and Holtz-Eakin, 2000; Evans and Leighton, 1989, Le, 1999). But these assessments have not only focused on a very narrow range of business creation activity omitting the substantial number of team efforts to create new ventures but often using a limited amount of independent variables. Taken as the only major independent variable, annual personal income or household net worth may indeed have a statistically significant relationship with the decision to enter into self-employment. But the broader range of business creation activity places the liquidity effect in a more comprehensive context. Data from PSED I suggests that nascent entrepreneurs prefer to utilize internal sources of funding from team members or their families, rather than external sources (Stouder, 2002). Analysis of the PSED I data that included a broad range of independent factors that may affect the decision to initiate a new firm, household income or net worth was seen to have very little effect (Crosa, Aldrich, and Keister, 2002; Kim, Aldrich, and Keister, 2006). The Survey of Small Business Finance (SSBF) has been sponsored four times by the Federal Reserve Board, in 1987, 1993, 1998, and 2003 (Mach and Wolken, 2006). The focus is on acquiring details on the types and sources of financing used by small businesses at different points in time, not tracking the same firms over time. The sample is based on listings provided in the Dun s Market Identifier (DMI) file maintained by Dun and Bradstreet, the commercial credit rating corporation. Screening focuses on identifying for-profit, nonfinancial, nonsubsidiary, nonagricultural, nongovernmental businesses with fewer than 500 employees. To be eligible the firm had to be in operation, generating expenses or revenue, at the end of 2003, whether or not Page 2 of 32

3 they were profitable. As the focus was on existing businesses, the majority was well established; 20% had been under current ownership for less than 5 years and 18% had been under current ownership for 25 or more years. Only about 200 of the 4,200 firms in the sample would be less than one year old. No information about the informal sources of financial support during the start-up phase is obtained. While providing a definitive assessment of the finances of existing small businesses, this effort is not designed to capture the unique financial situation of nascent enterprises firms in development or the relation of the financial support to later developments in the new firm. The Kauffman Firm Survey (KFS), currently in the data collection stage, has a similar sampling strategy and sample size. The sample is based on entries in the DMI file but the focus has been on obtaining a sample of new firms, rather than a sample of all small firms. To this end, new DMI listings were screened to determine new listings in the year 2004, interviewed in July 2005-July During a screening interview, principals were asked about initial incorporation in five registries, obtaining an Employer Identification Number [EIN], legal registration, initial payment of state unemployment insurance, initial federal social security payment, or the first federal tax return. Only if they reported that none of these had occurred before 2004 and one had occurred for the first time were they included in the cohort of new firms. The extent of economic activity at the time of the initial entry into the cohort is modest, 17% report no revenue in the first interview and 49% report revenue but no profits. After the first detailed interview, followups have been implemented on an annual basis. The interview schedule gives a major emphasis to financial support and the profitability of the new firm. While this data set may provide information about the development of business ventures that have been incorporated into established business registries it does not obtain any information about informal financial support, prior to legal registration of the business. It cannot be used to determine how financial support affects which nascent enterprises are established as profitable new firms (Des Roches, et al, 2007; Robb and Reynolds, 2009). There is a substantial amount of theoretical analysis, speculation, and analysis of associated with venture capital support of business activity. Indeed, this is a major focus of scholarly activity associated with the study of entrepreneurship with scholarly journals such as Venture Capital: An International Journal of Entrepreneurial Finance. At the annual Babson Conference on Entrepreneurial Research, papers related to venture capital support often take up Page 3 of 32

4 to one-third of the program of several hundred presentations. While there is no question that venture capital support for a small number of very promising enterprises has been important and that they have event been responsible for financing new economic sectors, the number of new start-ups receiving venture capital support is only several hundred each year; most venture capital support is provided to existing firms with promising opportunities for expansion (National Venture Capital Association, 2007). In comparison to the 6 million nascent enterprises in place at any given time and the 600,000 new employer firms registered each year, this is a very small and financing distinctive activity. Most of the research, even the most sophisticated analyses, emphasizes samples of convenience, examples take from the archival files of venture capital firms (Kaplan, Sensoy, and Stromberg, 2005); extrapolation to any known population of ventures in the start-up phase is virtually impossible. Little of this research attends to the informal financial support in the early stages of firm creation. The panel nature of the PSED protocol, which tracks business creation from the earliest stages, provides the capacity for assessments not available from these other data sets or approaches. By identifying new ventures from the earliest stages, the amount and sources of informal support can be determined. Follow-up interviews gather information on formal support as the nascent enterprise becomes an established legal entity. This unique information complements the descriptions developed by these other research programs that focus on later stages of the business life course. Issues for Attention The primary questions to be addressed are: 1) What are the amounts, sources and types of informal financing (before the business has been created as a legal entity) are developed during the start-up process? 2) What are the amounts, sources, and types of formal financing developed once the nascent enterprise becomes a legal entity? 3) How are these features of the financial support associated with the different outcomes of the start-up process (new firm, discontinuation, or continuation of start-up activities)? 4) What is the aggregate annual amount of financial contributions to new firm creation? The success in addressing these issues will be presented following a discussion of the research project that is the source of the data. Page 4 of 32

5 Business Start-Up Conceptualization The creation of new firms are not the direct result of macro-economic conditions, the availability of government programs, the entrepreneurial climate, the presence of friendly financial institutions, supportive family and friends, or speeches by politicians. While the impacts of all these contextual factors are important, they are assumed to be mediated by the direct actions taken by individuals. People create new firms. The PSED research program is a study of who they are and what they do to implement a new business. A conceptualization of the firm creation process is presented in Figure 1. This approach assumes that individuals pass through the first transition when they take some initial action to create a new firm. These actions may have been taken on their own behalf or as part of their job at an existing firm. Thus, nascent entrepreneurs are drawn from the adult population as independent nascent entrepreneurs and from existing businesses as nascent intrapreneurs. Social, Political, Economic, Historical Context Adult Population Nascent Entrepreneurs Start-up Process New Firm Established Firm Termination Nascent Intrapreneurs Conception Firm Birth Business Population Disengage Figure 1 Business Life Course, Context and Transitions Three transitions are critical for tracking the firm creation process. The first is conception, or initial entry into the start-up phase when a nascent enterprise is created. The other two are the outcomes of the start-up process: new firm creation or disengagement. Page 5 of 32

6 The definition of a firm birth emphasized in the PSED research program are reports of an initial period of profits, a period of positive monthly cash flow. Following this birth transition, there may be a period of being a young firm until they become an established firm. Eventually, as economic usefulness declines, the business will terminate operations. The alternative transition for nascent enterprises is disengagement from the start-up process. Disengagement is relatively straightforward, represented when the nascent entrepreneurs elected to discontinue contributions to the start-up process. The entire firm creation process is considered to occur in a distinctive social, political, economic and historical context. There is not wide agreement on the criteria for defining a new firm birth. In the PSED II paradigm the focus is on reports of initial profits, operationally defined as positive monthly cash flow for six of the past twelve months. 3 Rather than profitability, much analysis in economics and elsewhere focuses on market participation (Haltiwanger, Lynch, and Mackie, 2007; pg 32). Markets are exchanges between buyers and sellers and a new participant, either as a buyer or seller, is of considerable interest. A new participant may affect the quantity or price of transactions. This leads to defining a new business as any activity that is a participant in a market, whether or not they are profitable. The use of initial payments into state unemployment insurance programs, the initial federal social security payments, or initial filings of federal income tax returns are popular criteria for identifying new firm births. Other strategies emphasize initial listings in business registries, such as state incorporation files or the Dun and Bradstreet credit rating files. A third strategy reflects reports of labor force activity, such as the weekly hours committed to self-employment. None of these criteria initial employment, initial addition to a registry, and increase in work contributions are related to initial profitability. Other analyses using the PSED II data set have assessed the interrelationships between these diverse criteria for a firm birth (Schoonhoven, Burton, and Reynolds, 2009). Different definition provides quite different images of the firm gestation process. 3 For three or more consecutive months in PSED I. Page 6 of 32

7 PSED Research Protocol 4 The research procedure consists of three phases. The first is the identification of a representative sample of those actively involved in the new firm creation process, the nascent entrepreneurs. The second phase is the initial detailed interview with the nascent entrepreneurs. The third phase consists of annual follow-up interviews. The number of cases and timing for each phase for PSEPD II is presented in Table 1. 5 Those completing the detailed interviews received a payment of $25. Table 1 Overview of Project Design: PSED II No Cases PSED II Average length Initial screening 31,845 Oct 2005 to Feb minutes Wave A, First Detailed interview 1,214 Oct 2005 to Mar minutes Wave B, First follow-up months lag 60 minutes Wave C, Second follow-up months lag 60 minutes Wave D, Third follow-up In process 36 months lag 60 minutes To identify potential nascent entrepreneurs, a screening module was added to nationally representative omnibus telephone surveys. Each respondent was asked a series of questions about their current activities. Three were employed in the PSED II screenings: 1. Are you, alone or with others, currently trying to start a new business, including any selfemployment or selling any goods or services to others? 2. Are you, alone or with others, currently trying to start a new business or new venture for your employer, an effort that is part of your normal work? 3. Are you, alone or with others, currently the owner of a business you help manage, including self-employment or selling any goods or services to others? Those responding yes to any or all of these issues are considered potential nascent entrepreneurs and asked a series of additional questions to determine if they meet three criteria: 1) they performed some start-up activity in the past 12 months, 2) they expect to own all or part of the new firm, and 3) the initiative had not had a period of profitability in the past 12 months. Those that satisfy all three criteria are considered nascent entrepreneurs and invited to participate in a detailed interview. 4 All interview schedules, project documentation, and data sets suitable for SPSS or SAS analysis are publically available at no charge at 5 The 24 month follow-up data for the PSED II cohort was available in late fall 2008; the 36 month follow-ups were initiated in the fall of 2008 and the data should be available in the fall of Page 7 of 32

8 About 87% of those identified in the screening as active nascent entrepreneurs agree to participate in the study. For PSED II the initial screening was completed by a commercial survey firm (Opinion Research Corporation, Princeton, NJ); all detailed interview data (Waves A, B, C, and D) are collected by the Survey Research Center at the University of Michigan Institute for Social Research. The modules provided to the respondents in the PSED II project are summarized in Table 2. 6 The first column represents the material in the brief screening procedure. The second column contains the materials for the first detailed interview (Wave A) and the last two columns the follow-up interviews. The second and subsequent follow-up interviews (Wave C and beyond) are adjusted slightly to provide for additional information about a nascent enterprise that has become a new firm. The questionnaire used in the screening phase provides a small amount of sociodemographic data on all individuals involved in the national population; this is useful for assessing some factors affecting the decision to enter the start-up process. The first detailed interview, presented in the Wave A column in Table 2, includes information on the nature of the business, start-up activities implemented on behalf of the new firm, incorporation into business registries, the nature of the start-up team and helping networks, sources and amounts of financial support, evaluations of the immediate context, competitive strategy and growth expectations, along with details of the motivations, perspectives, selfdescriptions, background, and family context of the responding nascent entrepreneur. While the average phone interview was an hour long, 61% report that participation increased their interest in the start-up effort, 2% reported a reduction in interest, and 37% report no change in interest. Most did not resent the experience. The third phase involved the follow-up phone interviews. For PSED II careful scheduling has allowed the initial contact for the first follow-up to occur 52 weeks following completion of the initial detailed interview, the second follow-up 104 weeks, and so forth. The topics of the interview are listed in the Wave B column in Table 2 and vary depending on the status of the initiative at the time of the follow-up. Those nascent entrepreneurs that report they have disengaged from the initiative were asked additional questions about the reasons for their 6 Many of these modules are based on the same modules used in the PSED I interview schedules. Detailed discussions of the rationale and background are found in Gartner, et al. (2004). Page 8 of 32

9 decision to quit. Those that had started a new firm or were still in the start-up phase were provided the opportunity to update their case file with reports of new activity or changes in the start-up team or financial structure. Most of the modules related to enduring features of the responding nascent entrepreneur (self-descriptions, family background, etc.) covered in the first interview were not repeated Table 2 Overview of PSED II Phone Interview Schedule Modules Topic Modules Screening Wave A Wave B (1,2) Screening questions All Assessment of criteria for nascent entrepreneur All Socio-demographic All Wave C (1,2) A.1: Why involved, business opportunity (open ended) All A.2: Confirm same business activity All All A.3: Determine status: new firm, quit, continue All All B: Type of business, location All NF,SU NF,SU C: Legal form All All All D: Start-up activities All All All E.1: Start-up finances, entry into firm registries (3) All All All E.2: Confirm quit, exit interview Quits Quits F: Orientations toward competition All NF NF G: Owners, key non-owners, & helpers inventory All NF,SU NF,SU H: Owner demographics All NF,SU NF,SU J: Relationships among owners All NF,SU NF,SU K: Juristic (legal entity) owners All NF,SU NF,SU M: Key non-owner demographics All NF,SU NF,SU N: Helper demographics All NF,SU NF,SU P: Community resources, support for new firms All NF NF Q: Informal start-up financial support All NF,SU NF,SU R: Legal entity start-up investments, debts, net worth All NF,SU NF,SU S: Competitive strategy and target markets All NF NF T: Growth expectations All NF NF U.1: Respondent s motivation All U.2: Employment structure (3) NF NF V.1: Expense structure: summary (3) NF V.2: Expense structure: detailed (3) NF X: Respondent s career background All SU SU Y: Respondent s self-descriptions All Z: Respondent & household socio-demographics All NF,SU NF,SU NOTES: (1) After wave A, modules are provided to All respondents, only those that Quit, or those with a new firm (NF), or still active in the start-up process (SU). (2) After initial interview, modules are repeated to capture changes or new information about the activity or details on the current status. (3) Based on Kauffman Firm Survey interview schedule (Mathematica Policy Research, 2007). After the first follow-up those that reported they were managing a new firm for a full year are provided with some additional modules in Wave C. These cover the nature of the cost Page 9 of 32

10 structure that can be used to estimate labor productivity. These modules, as well as those related to the organizational structure of the firm, have been designed to facilitate comparison with similar modules in the Kauffman sponsored panel study of new businesses (Haltiwanger, Lynch, and Mackie, 2007, pg ; Mathematica Policy Research, 2007). The initial screening was completed with 31 sample replications, each with about one thousand respondents. The initial case weights to adjust the sample to match the most recent Current Population Surveys demographics were computed for each replication. These case weights were recomputed using the entire screening sample with the Current Population Survey demographics for March This dramatically reduced the range of case weights and, in turn, reduced the variation among variables associated with the weighting procedure. The PSED sample was designed to provide a representative sample of individuals involved in business creation. With one caveat, it may be considered a representative sample of nascent enterprises or firms-in-gestation. Because the screening identified individuals active in business creation, any nascent enterprise implemented by a team of nascent entrepreneurs is more likely to be included in the cohort. As a result, if the sample is considered to represent nascent enterprises, it should be recognized as including an over-representation of team efforts (Davidsson, 2004). While aware of this issue, it is assumed that the practical effect is negligible for most analyses. No adjustment for a potential over-sample of team initiatives has been implemented. Selected Interview Content: As might be inferred from Table 2, considerable information was acquired about the nascent enterprise in the detailed interviews. Two activities are particularly relevant for the following analysis of early stage financing. A unique feature of the PSED interviews is acquiring information about a wide range of activities pursued during the start-up process. The complete inventory is included in the first detailed interview, Wave A, and for any activity that has been initiated, the month and year of the initiation is obtained. In subsequent follow-up interviews, those activities that had not been previously reported are again presented to the respondent. As a result the multi-wave files provide the potential for developing an overview of the number and sequence of follow-up activities implemented during the start-up process. Table 3 presents a complete list of all activities included in the interview and the proportion that report they had initiated the activity in the initial, Wave A, detailed interview. Page 10 of 32

11 Table 3 Start-Up Activities: Item numbers, content, first wave prevalence Item Label (1) Start-up Activity Wave A Report A8 Serious thought given to the start-up 99% Q14_1 Actually invested own money in the start-up 79% D20 Began talking to customers 76% D6 Began development of model, prototype of product, service 65% D4 Initiated business plan 64% B8 First use of physical space 62% D22 Began to collect information on competitors 62% D18 Purchased materials, supplied, inventory, components 59% E13 Receive income from sales of goods or services 56% E25 Established phone book or internet listing 55% D24 Began defining market for product, service 54% D16 Purchased or leased a capital asset 53% D28 Determined regulatory requirements 53% D9 Began to promote the good or service 49% D1 Business plan completed 41% E11 Open a bank account for the start-up 39% C2 Legal form of business registered 36% D26 Developed financial projections 35% D8 Model, prototype completed 35% H17_1 Began to devote full time to the start-up 28% E5 Established supplier credit 27% E18 Hired an accountant 26% C4 Sought liability insurance for start-up 22% E1 Sought external funding for the start-up 19% E20 Hired a lawyer 18% E3 Received first outside funding 13% E7 Hired an employee 13% E22 Joined a trade association 12% G7_1 Respondent signed equity agreement 10% D11 Proprietary technology under developed 8% D13 Initiated patent, copyright, trademark protection 7% D15 Patent, copyright, trademark obtained 5% E15 Initial positive monthly cash flow 3% E26 Acquired federal Employer Identification Number [EIN] 26% E34 Filed initial federal tax return 27% E28 Filed for fictitious name (DBA) 18% E32 Paid initial federal social security (FICA) payment 17% E30 Paid initial state unemployment insurance payment 9% E36 Know that Dun and Bradstreet established listing 5% (1) Item number refers to Wave A questionnaire, available on the project website. The items requesting the date the activity was initiated or occurred generally follow the item number. Sample includes all Wave A except those with significant positive monthly cash flow prior to the initial interview, n=1,148. Page 11 of 32

12 The first column in Table 3 represents the item number in the interview schedule, the second column a summary of the activity, and the third column the percent that report the activity was initiated prior to the first detailed interview. Six activities are presented separately at the bottom of Table 3; all refer to incorporation into various business registries, most to satisfy legal requirements. Development of a legal form for the business and initiating registration was reported by 36% in the initial detailed interview in response to item C2. This appears midway down the list. Information related to financial support for the new firm, identified as modules Q and R in Table 2, make a distinction between support provided before and after the nascent enterprise has been legally registered. A summary of interview items related to financial support is provided in Table 4. The first set, from module Q, are asked for up to five members of the start-up team, those expecting to own part of the new firm. The second set, from module R, are specific to the new firm as a legal person. For most, the items refer to unilateral support provided to the new legal entity. For personal loans from the members of the start-up team, the items (R10, R11) take a different form. For all nascent enterprises, questions about both informal and formal financial support are presented to the respondent; the primary distinction is based on the date at which the legal form has been established. Criteria for Transitions. There are three critical transitions associated with a portrayal of the start-up process: (1) initial entry into the process, (2) implementation of a profitable new firm, and (3) disengagement from the start-up effort. Operational definitions have been developed to represent all three transitions. The most elaborate is related to entry into the process, conception of the nascent enterprise that is under development. The screening procedure identifies individuals active at many different stages in the business creation process; they may have become serious about the effort two weeks or many years before selection for the cohort. In order to provide a standardized measure of when the level of activity reached a critical threshold, a set of sequential criteria were used to identify a date of conception. First, at least two or more activities, excluding serious through (Item A8), had to be reported. Second, at least two activities had to occur within a 12 month period. The date of the earlier of these two activities is then considered as the date of entry into the firm creation process. If this date occurred more than 10 years before the initial Page 12 of 32

13 detailed or Wave A interview, the initiative was not considered a recent serious effort at the time of the interview and the case was excluded from the cohort. In addition, it was discovered that 40 cases appeared not to be fresh efforts to implement a new firm but reactivation of profitable firms that had been dormant; these were also excluded from the cohort. Table 4 Financial support: Item numbers and content summary Item Content Informal Formal No For each of up to five start-up team members Q4 Personal savings X Q5 Personal loans, personal and family members X Q6 Personal loans, friends, employers, or work colleagues, X Q7 Credit card loans X Q8 Personal loan from a bank or financial institution X Q9 Any asset backed loan, like second mortgage X Q10 Provided by any other source X Q12 Of total provided via each member, how much for equity X Q13 Of total provided via each member, how much a loan X Q14 Month and year of initial investment by each member X Total provided to the new business, as a legal entity R4 Additional equity provided by the start-up team members X R6 Dollar amount of asset backed loans X R7 Dollar amount of lease commitments on physical assets X R8 Dollar amount of working capital loans X R9 Dollar amount of supplier credit X R10 Dollar amount of team member 1 personal loans X R11 Dollar amount of team members 2-5 personal loans X R12 Dollar amount of spouses, relatives, kin personal loans X R13 Dollar amount of employee personal loans X R14 Dollar amount of other persons personal loans X R15 Dollar amount of credit card debt to the new business X R16 Dollar amount of bank loans to the new business X R17 Dollar amount of venture capital firm loans X R18 Dollar amount of government agency loans X R19 Dollar amount of SBA guaranteed loans X R20 Dollar amount of any other loans or debts X During the follow-up interviews, the nascent enterprise could be classified as in one of three statuses. Two involve transitions; the third is remaining in the start-up process. Page 13 of 32

14 The transition to a new firm was considered to have occurred when initial profitability had been achieved. This was defined as positive monthly case flow covering all expenses and owners salaries and wages for 6 months in a 12 month period. Disengagement from the start-up effort, or a quit, was defined when the nascent enterprise was no longer receiving any effort from members of the start up team, it did not quality as either a new firm or active start-up based on the criteria above, and the nascent entrepreneur considered themselves to be disengaged from the start-up effort. Most cases were considered to be active start-up efforts. Operationally, these were cases where the nascent entrepreneur considered them still active in the start-up process, they had devoted more than 160 hours to the nascent enterprise in the past 12 months, expected to spend at least 80 hours working on the initiative over the next 6 months, and considered this a major focus of their work career over the next 12 months. Follow-up interviews and case counts. The assessment discussed below is based on data collected in the initial detailed interview and the 12 and 24 month follow-up interviews, Waves A, B, and C. While success in the follow-up interviews was very high, 80% in Wave B, 77% in Wave C, this does not fully reflect the success of the data collection. Table 5 provides an overview of the number of cases for which information is available. It should be noted that those reporting they had disengaged from the process in the Wave B, 12 month, interview were not approached for the Wave C, 24 month, follow-up interview. Table 5 Case counts associated with completion of interviews: All waves Data collection activity Case counts Percent Initial detailed interview: Wave A 1, % Initial interview and all follow-ups: Waves A, B, and C % Initial interview and first follow-up: Waves A and B % Initial interview and second follow-up: Wave A and C 86 7 % Any follow-up interview: Wave B and C, B only, C only 1, % No follow-up data: Wave A only % From Table 5 it can be seen that outcome data is available from a follow-up interview for 87% of all cases identified in the screening and completing the initial detailed interview, Wave A. As the focus of the analysis is on the outcome status of the cases, the 156 cases without outcome data are excluded from the analysis. In addition, those cases that did not meet the Page 14 of 32

15 criteria for active entry into the business start-up process, were reactivating a dormant business, or had entered the process over ten years prior to the first interview were also deleted. This reduced the sample for analysis to 882. Weights were re-centered such that the average weight was 1.00; due to missing data, the sample size for some analysis may be slightly lower. Sequence of Start-up Events Using the date of entry into the start-up process as the timing benchmark, not the data of the first detailed interview, both the length of time required to begin the different activities as well as the sequence can be described. This is provided in Figure 2. Each bar represents the months before or after the date of entry into the start-up process. The shaded area at the end is the 95% confidence interval range for the estimate; the percentage in brackets are the percentage reporting the activity during any interview, Wave A, B, or C. The beginning of serious though about the new business, reported by 99% of the respondents, is not utilized to identify the date of entry into the process and typically occurs from 12.6 to 18.0 months prior to this event. Finance Events Timing: Months from Conception [95% Confidence Interval] SERIOUS THOUGHT [98.9%] INFORMAL INVESTMENT [83.7%] LEGAL REGISTRATION [50.2 %] FORMAL INVESTMENT [18.8 %] FIRM BIRTH [9.1 %] DISENGAGEMENT [23.6 %] START-UP ACTIVE [65.0 %] Months from entry into start-up Figure 2 Timing and Sequence of Selected Start-up Events Page 15 of 32

16 The three activities emphasized in this analysis, first forms of informal financial support, beginning the legal registration of the firm, and initial formal investments generally take place 3 months, 9 months, and 14 months after entry into the start-up process. The reports of first profits, reported for 9% of the cohort, occurs about 12 months after initial entry into the start-up process. Disengagement, reported for 24%, occurs about 23 months after beginning the start up effort. The majority of the cohort, 65%, is still in the start-up process at their last follow-up interview, and they have been in the process for an average of 41 months. This large proportion in the start-up process reflects the long time required to reach a resolution and the short nature of the period for which data has been collected. Analysis of the PSED I data suggests that it takes over 60 months for 90% of those that reach a resolution firm birth or disengagement to report an outcome. Even after six years, however, one third will still be considered active start-ups (Reynolds, 2007, pg. 56). Informal Financial Contributions The sources and amounts of informal financial support provided to a nascent enterprise before it has become a legal entity are provided in Table 6. This represents a consolidation of reports provided in all questionnaires, Waves A, B, and C. The amounts are either the total reported before the nascent enterprise had a legal status or the total reported up to the last interview completed for this case. For some cases additional informal financing may be reported in later follow-up interviews. The amount represents the total reported for up to five team members for each type of informal funding. Seven sources of funding are represented as well as the total of all contributions. The first column in Table 6 represents the item number in the questionnaires, the second the source of the funds, the third column the proportion that reported each type of funding and the last seven columns characterize the distribution of the responses, the minimum, maximum, average value, median value, and the 75, 90 and 95 percentiles. These latter measures reflect the very skewed nature of the distributions, with a large proportion reporting very small amounts and a very small percentage reporting very large amounts, in the millions. Page 16 of 32

17 Table 6 Informal Financial Support for Nascent Enterprises: Sources and Amounts [n=882; Values in $1,000] Item No Source Percent report Min Max Avg Median 75%- tile 90%- tile 95%- tile Q4 Personal savings 84.4 % 0.0 5, Q5 Personal, family loans 17.1 % 0.0 1, Q6 Friends, employers, colleagues loans 5.5 % 0.0 1, Q7 Credit card loans 11.5 % Q8 Personal bank, financial institutions loans 9.2 % 0.0 4, Q9 Asset backed loans (i.e. 2nd mortgage) 5.6 % 0.0 4, Q10 Loan, other source 0.7 % Total all financial contributions 87.4 % , Page 17 of 32

18 Some type of informal financial support is reported for 87% of the nascent enterprises. The remaining 13% had probably not yet progressed to assembling any financial support. Without question, the major source of support was from the savings of the members of the startup team, reported for 84% of the nascent enterprises. The second major source was provided by family members and relatives, reported for 17%. Credit card loans were the third most common, reported by 12%, followed by personal bank loans, reported for 9%. Loans from friends and colleagues and asset backed loans from banks were about equally prevalent, at 6%. Support from other sources was reported for very few cases, less than 1%; this suggests that all major sources of funding were covered by the items in Module Q. The average amounts are modest; the mean is about $48 thousand, with the mean provided from start-up team personal savings of about $23 thousand. Half, however, report total informal support of less than $4,300, the median value, suggesting these are very modest nascent enterprises or at a very early stage in the start-up process. On the other hand, some very substantial efforts are represented in the sample, with 5% reporting $152 thousand or more in total informal support and the highest figure reported is $13 million. Formal Financial Support Registration of a legal form for the business was reported for about 50% of the nascent enterprises; these would qualify for interview module R related to formal financial support. However, formal financial support was reported for about 37% or this group or 160 nascent enterprises in the cohort. In this module the interview items refer to support for the business as a legal entity, most amounts are responses to a single item. For two sources of support, amounts are aggregated across the firm owners, additional owner equity and start-up team members loans to the business. The total amount of support provided at the last follow-up interview, Wave B or Wave C, from the various sources is presented in Table 7. All additional equity contributions by the startup team are provided in the first row, which occurred for 27% of the legally registered firms. All other contributions were considered loans to the firm. The bottom row of Table 7 provides a summary of the total debt and equity contributions reported in the interviews. Page 18 of 32

19 Table 7 Formal Financial support for Legally Registered Enterprises [n=435; All values in $1,000s] Item No Content Percent report Min Max Avg Median 75%- tile 90%- tile 95%- tile R4 Additional team equity 26.6 % 0.0 5, R6 Asset backed loans 10.3 % 0.0 5, R7 Lease commitments on physical assets 4.3 % R8 Working capital loans 9.5 % 0.0 1, R9 Supplier credit 6.2 % R10 Team member 1 personal loans 26.2 % 0.0 5, R11 Team members 2-5 personal loans 6.5 % , R12 Spouses, relatives, kin personal loans 5.9 % R13 Employee personal loans 0.3 % R14 Other persons personal loans 1.6 % R15 Credit card debt to the new business 8.9 % R16 Bank loans to the new business 1.8 % 0.0 1, R17 Venture capital firm loans 0.8 % R18 Government agency loans 0.0 % R19 SBA guaranteed loans 26.2 % 0.0 5, R20 Other loans or debts 2.5 % Total business debt 34.5 % , Total All Financial Support 37.1 % , Page 19 of 32

20 Each row of Table 7 provides the same information as in Table 6, providing the percent reporting any financial support, the minimum, maximum, average, median, and three percentiles, 75, 90, and 95. These distributions are even more skewed than those for the informal support, reflecting the large proportion, almost two-thirds, that report no additional formal financial support of any kind. While the largest amount of additional equity reported for any nascent enterprise is $5 million, the average of additional equity is $37 thousand, the largest amount of additional debt is $17.1 million, with an average of $145.7 thousand; the largest amount of additional financing is $17.1 million, and the average is $182.7 thousand. Most striking are the large amounts associated with a very small proportion of all legally registered nascent enterprises. The large gap between the 95%-tile values and the maximum contributions reflects the very substantial amounts reported by a very small number of nascent enterprises. The nature of these extreme cases is illustrated by attention to the five largest firms. The nature of the firms reporting the largest amount of financial support is summarized in Table 8. Total support ranges from $3 million to over $17 million. There are several striking features of these new ventures. First, three of the business activities (A, D and E) are rather traditional, wholesale groceries, mining support, and a restaurant. Two (B and C) appear to be collections of individuals emphasizing computer system design. All five have a corporate legal form, although two are subchapter S corporations. Most of these well financed nascent enterprises seemed to have moved through the start-up process rather quickly. Except for Firm C, the time from conception to legal registration was from 1-3 months. Such brief gestation periods were found in an early retrospective study of new firms initiated in Minnesota and Pennsylvania; firms with the strongest growth trajectories had the shortest start-up window (Reynolds, 1993). Firm C reflects a different pattern; serious thought was not reported until 5 months after serious work on the start-up was initiated. This is not, however, unusual, as about 20% of the nascent entrepreneurs report that serious thought is not the first activity pursued. Page 20 of 32

21 Table 8 Firms Reporting Greatest Amount of Financial Support Content Firm A Firm B Firm C Firm D Firm E SIC code ( digit) Legal Form SubCS Corp Corp Corp SubCS Expected number of owners Timing of Events (Mths) Serious thought to conception Conception to owner invest 0 2 * 0 * Conception to legal registration Legal registration to formal financial Informal Investments ($1,000) Team members personal savings Personal, family loans Friends, employers, colleagues loans Credit card loans Personal financial institutions loans Asset backed loans (i.e. 2nd mortgage) Loan, other source Total informal financial contributions Formal Investments ($1,000) Additional team equity 25 2,000 5,000 4, Asset backed loans 2, ,000 2,400 Lease commitments on physical assets Working capital loans Supplier credit Team member 1 personal loans 0 5,000 1, Team members 2-5 personal loans 15, Spouses, relatives, kin personal loans Employee personal loans Other persons personal loans Credit card debt to the new business Bank loans to the new business Venture capital firm loans Government agency loans SBA guaranteed loans 0 5,000 1, Other loans or debts Total formal business debt 17,100 10,000 4,705 5,000 2,857 Total Formal Financial Support 17,125 12,000 9,705 9,000 2,957 Total Informal, Formal Financial 17,300 12,100 9,965 9,040 2,957 Standard Industry Code descriptions: A: SIC: 4470 Wholesale: Groceries, fresh foods, dairy, fish, fruits, vegetables, meats, etc. B: SIC: 7380 Business consulting, computer system design, related services C: SIC: 7380 Business consulting, computer system design, related services D: SIC: 490 Support activities for oil and gas operations, metal mining E: SIC: 8680 Restaurants, food services, and drinking places of all types Page 21 of 32

22 The large amounts of money invested in these firms seem to come from only a few sources. There are large equity investments by team members in Firms B, C, and D. Substantial asset backed loans are provided for Firms A, D, and E. Large personal loans to the firm from start-up team members are reported for firms A, B, and C. And large SBA guaranteed loans have been provided to Firms B and C. The amount of informal investments prior to legal registration are relatively small for all five, it is actually zero for Firm E, the new restaurant. These firms represent a typical finding in representative samples of nascent and new enterprises, the lack of evidence of a technological focus or expectation of market innovations among the larger initiatives. The amounts of financial resources that have been assembled, however, suggests that some start-up teams anticipate substantial success. Relationship to Outcomes After two follow-up interviews the status of the nascent enterprises is summarized in Table 9. As can be seen, the majority, two of three, are still in the start-up phase, where efforts to create an initial period of profitability continues. For one quarter the efforts to create a new firm have been discontinued. Almost one in ten (9.4%) report an initial period of profitability, reflected in monthly positive cash flow that covers all expenses and salaries for 6 of the previous 12 months. Table 9 Nascent Enterprise Status after Two Follow-up Interviews Number of cases Proportion of cohort New Firm (initial profitability) % Active start-up continues % Disengaged from process % % The relationship of the types and amounts of informal financial support is presented in Table 10. The top set of rows presents the proportion that report each type of informal support, the columns represent the outcome status of the nascent enterprise. The bottom set of rows presents the average amount of each type of support. The level of statistical significance is represented in the p-values in brackets on each row. Statistical significance is more common in relation to the sources of informal financial support, found for three types of sources and the total amount. However, the major differences Page 22 of 32

23 are either related to higher levels of support for those still in the active start-up phase or lower levels of support for those nascent enterprises that have discontinued. In terms of the amount of financial support, it is generally largest for those still in the start-up phase, this is true of several major sources personal savings from the start-up team members and asset backed loans as well as the total of informal financial support. None of these differences, however, are statistically significant. This probably reflects the wide dispersion in levels of support provided to nascent enterprises regardless of their outcome status. Table 10 Informal Financial Support and Outcome Status Item No Source All outcomes New Firm Active Start-Up Proportion Reporting Q4 Personal savings [0.000] 84.4 % 74.2 % 88.6 % 77.6 % Q5 Personal, family loans 17.1 % 17.3 % 18.6 % 13.3 % Q6 Friends, employers, colleagues loans 5.5 % 4.5 % 6.6 % 4.5 % Q7 Credit card loans 11.5 % 11.3 % 11.6 % 11.3 % Q8 Personal bank, institutions loans [0.06] 9.2 % 11.8 % 10.4 % 5.4 % Q9 Asset backed loans (2nd mortgage) [0.07] 5.6 % 10.0 % 5.8 % 3.3 % Q10 Loan, other source 0.7 % 0.8 % 0.5 % 1.1 % All informal financial support [0.000] 87.4 % 79.0 % 91.3 % 80.6 % Average Amounts ($1,000) Q4 Personal savings Q5 Personal, family loans Q6 Friends, employers, colleagues loans Q7 Credit card loans Q8 Personal bank, institutions loans Q9 Asset backed loans (2nd mortgage) Q10 Loan, other source All informal financial support The level of statistical significance is show in brackets for comparisons across rows. Quit The same analysis is provided for reports of formal financial support in Table 11. Again, the proportion reporting each form is in the top half of the table and the average amounts by type in the bottom set of rows. The results are similar to those associated with informal financial support. While there are some statistically significant differences associated with the provision of different types of financial support, there are no statistically significant differences associated with the average amounts of support. Page 23 of 32