The funding decision by small high- tech start-up firms: A multi-case study of Sweden
Master’s Thesis 15 credits Department of Business Studies Uppsala University
Spring Semester of 2019
Date of Submission: 2019-06-05
Abdirahman Haji Moustafa Younes Niklas Serninger
Supervisor: David Andersson
ABSTRACT
This paper examines how small high-tech start-ups in Sweden source their funding and aims to understand the underlying factors affecting these firms financing behaviour, contributing to the relatively limited field of research conducted in Europe. To fulfil the purpose of the study, a multiple case study method was implemented as the study’s research design. A literature review generated in a theoretical framework consisting of capital structure and specifically the pecking order theory. Together with our empirics, consisting of data from interviews with six different companies, the theoretical framework composed the basis for our analysis. The data from our sample displays that these firms initially source their funding through internal funds, suggesting that small high-tech start-up firms in Sweden rely heavily on their own saved funds or other personal resources available to them at the start-up face. Our findings suggests that these firms are limited in their financial options but also that independency and control is to be seen as factors to initially be funded through internal funds. Inconsistent with the pecking order theory, evidence in this paper finds that when looking for external funds, equity is the funding source rather than debt. Two conclusions can be drawn from this. First, the high-tech start-up firms seem to value the advisory of equity investor. Second, capital imperfections makes it hard to access debt. Furthermore, we find that majority of the case companies does not implement a capital structure policy since it seems to limited their financial options.
Keywords: Small high-tech start-ups, internal funds, debt, equity, capital structure, pecking order theory, Sweden
Table of content
1. Introduction ... 1
2. Theoretical Framework ... 4
2.1 Capital Structure ... 4
2.2 The pecking order theory ... 6
2.3 Previous research on high-tech start-ups: Pecking order theory ... 7
2.3.1 Internal funding ... 8
2.3.2 Debt ... 9
2.3.3 Equity ... 9
3. Methodology ... 11
3.1 Research strategy - Qualitative approach ... 11
3.2 Research design - Multiple case study ... 12
3.2.1 Selection of case companies ... 13
3.3 Research method – Interviews ... 15
3.4 Data analysis ... 17
3.5 Trustworthiness and Authenticity ... 20
3.5.1 Trustworthiness: ... 20
3.5.2 Authenticity: ... 21
4. Findings ... 23
4.1 Financing ... 23
4.2 Capital structure ... 26
5. Analysis ... 28
5.1 Financing ... 28
5.2 Capital Structure ... 31
6. Conclusion ... 33
6.1 Limitations ... 34
6.2 Further Research ... 34
7. References ... 36
8. Appendices ... 40
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1. Introduction
Innovative and small high-tech firms have progressed into an influential foundation in most developed economic systems, becoming a crucial source of employment and economic growth (Bachher and Guild, 1996). High-tech firms could be defined as corporations acting on the frontier of economy and science within a sector considered as high technology, often characterized by having an innovative approach with a high R&D activity and/or producing devices categorized as high technology items (Zakrzewska-Bielawska, 2010). The temporary conditions these firms are in when they are recently established, makes that they can be classified as a start-up (Calopa, Horvat and Lalic, 2014). Even though the early years of a firm is viewed as significant for the survival of a firm, there are only limited studies on high- tech start-up firms when studying how they are financed and their capital structure. What we do know however is that small firms, especially the new ones, are limited in their ability to raise capital in the public debt and equity market (Örtvist, Masli, Rahman & Selvarajah, 2006). Considering its importance in today’s society, it could be argued that the funding of small high-tech start-ups has developed into a central matter for scholars and decision-makers around the world.
Firms like Facebook, Spotify, LinkedIn and Instagram are examples of high tech start-ups that have progressed into prosperous and powerful corporations. However, more than 90% of high-tech start-ups fail (Marmer et al., 2011). A continual obstacle for high-tech start-ups is the shortage of capital due to the complex nature of the firms. Sjögren and Zackrisson (2005) displays how these types of firms might encounter more challenges accessing suitable financing in comparison to other firms since they are associated with greater risk and got limited fixed assets that could be utilized as collateral when issuing debt. The complex nature of high-tech firms might imply that there is a discrepancy between how they are financed and how they want to be financed. Understanding these discrepancies might provide an insight into the patterns of funding decisions for small high-tech start-up Swedish firms. In an effort to get a better understanding of funding decision and how a firm finances its overall operations, one can investigate the firm’s capital structure.
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Research on capital structure aims to explain the financing sources utilized by firms to finance investments. Capital structure has in the last couple of decades, depicted by the on- going attention it receives from researchers, become one of the most important topics in modern finance theory (Myers, 2001). Barclay and Smith (2005) argue how the pecking order theory would predict a high-tech start-up firm to have a high debt ratio since they have negative free cash flow but their findings suggest that these firms often are financed nearly exclusively by equity. This is contrary to the pecking order theory of Myers and Majluf (1984), which suggests that firms finance, will borrow rather than issuing equity. Research on capital structure seems to have concentrated much more on firms financing tactics - such as trying to take advantage of taxes - rather than financing strategies, such as having an overall target debt and equity level (Myers, 2001). The research on financing tactics has displayed the importance of taxes which corroborates with Sharpe, Cosham, Connell and Parnell (2009) findings showing that business angels play a vital role in funding UK high-tech start-up firms taking advantage of the attractiveness of the governmental support of tax exemptions.
Overall, the understanding of firms financing choices is quite limited and most of the research on firms’ capital structure has concentrated on public companies, mostly in large economies such as U.S. and U.K., which has access to a variety of financing choices and to international capital markets (Myers, 2001). Hence, the financial structure of firms has proved to be a continual puzzle in finance and much of the knowledge of entrepreneurial finance comes from companies that are already established or have received funding (Robb and Robinson, 2014). It is safe to say that today; there is no universal theory of debt-equity choices capable of explaining the whole display of firms’ financial policy choices, which is especially true for many high-tech start-up companies. There’s also limited research done specifically on Scandinavian countries that show the funding patterns of small high-tech start- ups and the funding decisions these companies face.
In recent years, several studies have begun to investigate how start-up firms generally finance themselves and how they secure funding. Robb and Robinson (2014) findings show how U.S.
start-up firms rely heavily on external debt financing such as bank loans. Looking at studies regarding high-tech start-up firms, Hogan and Hutson (2004) displays how internal funds are the most significant source of finance in Irish high-tech firms and that equity is preferred over debt, subsequently high-tech start-ups capital structure has a tendency to focus on equity investments rather than debt (Tech. 2018, p. 17). However, Sweden is considered to have a
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bank-oriented credit system where banks, i.e. debt, acts as a crucial function in the funding of firms (Magnusson, 2000, p. 219). This is further supported by Song (2005) findings showing that Swedish firms on average are greatly leveraged.
This raises questions whether, for example, Swedish small high-tech start-up firms are in accordance with the pecking order theory, following a financial rule where internal funds are preferred to external financing and debt is preferred to equity when external financing is needed. This study seeks to understand the funding decisions these companies make, the drivers behind those decisions and whether they have limited funding sources that force them to make certain funding decisions. The paper attempts to provide a contribution to the limited but increasing amount of research regarding the funding for small high-tech start-up companies in Sweden. Specifically, we are conducting semi-structured interviews with six small high-tech start-up Swedish based firms in order to understand how they finance themselves, and the underlying factors that could explain their financing behaviour. To pursue this objective, the following research question is established to be answered: How do small high-tech start-up firms in Sweden source funding?
The paper proceeds as follows. Section 2 outlays the theoretical framework of the paper, where relevant theories and a literature review are presented. Section 3 presents the methodology of the paper, where the research method, design and how the collected data are analysed and are described. Section 4 constitutes the empirics, where the findings of the 6 interviews are presented, followed by the analysis in section 5 and concluding remarks in section 6.
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2. Theoretical Framework
In this section, we present the theoretical framework for the study by initially presenting the two theories/concepts, then presenting the literature findings related to
the two theories/concepts.
2.1 Capital Structure
Studies of capital structure seek to clarify the mix of securities and financing sources utilized by firms to fund their investments and much of the research has been concentrated on firms balance sheets and the amount of debt and equity that’s been observed (Barclay and Smith, 2005). A body of theories has during the last couple of decades emerged as financial economists have embraced a more scientific approach, generating that these theories can be tested by empirical studies of e.g. corporate management (ibid.). The Modigliani and Miller theorem, published in 1958, serves as one of the most influential theoretical models about capital structure and has served as a foundation for further research on capital structure (Horvatinović and Orsag, 2018).
According to Modigliani and Miller (1958), a company's choice of capital structure is irrelevant to afirm's cost of capital. Assuming a perfect market, it doesn’t matter how a firm chooses to finance its operations, the cost of capital will still remain constant (ibid.). Whether a firm chooses to finance through short-term debt, long-term debt, convertible bonds, equity issue or debt in different currencies, the weighted average cost of capital (WACC) will still remain the same (ibid.). To understand Modigliani and Miller theorem reasoning regarding a constant WACC regardless of a company's funding choice, it is necessary to understand the market reward and risk philosophy.
Debt has a prior claim to a firm’s assets and earnings, whereas equity is the residual of assets anddebt (Modigliani and Miller, 1958). As such, the debt cost of capital is always less than the cost of equity (ibid.). However, asdebt increases in a company, the expected rate of return from investors will also increase, as they will demand compensation for the increasing risk from financial distress (ibid.). The expected rate of return demanded by equity investors is based on the spread between the cost of debt andthe overall cost of capital (Modigliani and
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Miller, 1958). This shows that any attempt of substituting debt for equity todecrease a firm’s cost of capital will have no effect on WACC. The reason is that increasing debt in a firm’s capital structure will increase the cost of equity, enough to keep WACC constant (ibid.).
In their 1958 paper, Modigliani and Miller assumed that the allocation of capital structure is irrelevant to a firm’s value. However, in their later paper published in 1963, Modigliani and Miller argue how taxes play a role in the funding decisions that firms make when sourcing finance. Interest payments are a tax-deductible expense, thus borrowing money will partially offset an interest tax shield and therefore lowering the amount of taxes a firm must pay (Modigliani and Miller, 1963). Therefore, substituting equity for debt will increase the total after-tax return and should consequently also increase a firm’s value. However, as interest rates arise due to more debt collected, the cost of debt relative to their cost of equity will increase, thus taking away the advantage of after-tax return (ibid.). At this high debt threshold, the effect of personal and corporate taxes will break-even, cancelling out a net tax advantage.
The results from Modigliani and Miller theorem propositions of 1958 are now widely accepted (Myers, 2001). However, research demonstrates how financing definitely can matter, and the main reason for that can be connected to information asymmetry, agency cost and taxes (ibid.). The theories of capital structure that have been developed after the Modigliani and Miller theorem proposition gives emphasis to different factors. For example, the free cash flow theory stresses agency costs, the trade-off theory stresses taxes and the pecking order theory emphasizes differences in information (Myers, 2001.). The different theories lead to different and in some ways opposing actions and results, which also could explain why the capital structure debate is so captivating.
There are convincing reasons to believe that, for a small high-tech start-up firm, the logic that the Modigliani and Miller theorem builds upon does not hold. The reasoning that there are imperfections in the capital market, affecting the firm’s investments decisions and leading to external financing expensive, has increased among scholars in the economic literature.
Colombo and Grilli (2007) for example, if you take asymmetric information into consideration. The information asymmetries between a firm’s manager and its outside financers could arguably be seen as most serious for small high-tech start-up firms, considering their scarce track record and the difficulty in controlling R&D activities (Revest
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and Sapio, 2012). Since the high-tech start-up firms are more familiar to the return and risks of the firm’s projects, it is difficult for the bank to assess the quality of these firms investments (Carpenter and Petersen, 2002). Ultimately, the information asymmetry is a major factor leading these firms to have poor access to debt (ibid.). The underlying fragility of the innovation process and inadequate understanding, from investors and financial institutions, of the technical aspects could increase the information asymmetries (Revest and Sapio, 2012). The pecking order theory stresses differences in information and adverse investor selection specifically with external forms of funding i.e. debt and equity. Information asymmetries are greater with high-tech start-ups due to the technology which is quite impervious to non-technical financers, especially for banks, which end up not comprehending in their assessments and evaluations when it comes to high-tech firms (Deakins and Hussain, 1993).
2.2 The pecking order theory
The pecking order is a capital structure theory in which the cheapest available source of capital is the preferable choice of a firm’s funding (Myers, 2001). According to Myers and Majluf (1984) the arisen preference of capital choice is derived from the information asymmetry between the investors and managers. Depending on the type of financial source a firm will choose, it will respectively have different information costs (ibid.). Debt, for instance, has the prior claim on earnings and assets, whereas equity is the residual left over during a liquidation process. Debt investors are therefore less exposed than equity investors to risk. As such, the announcement of debt issue should have a smaller impact on a company's stock price than equity issue (Myers, 2001).
The Equity issue is, therefore, a more expensive option and should only be utilized when debt financing is more costly (Myers, 2001). Debt can, for instance, be a more costly alternative than equity, in the occurrence of financial distress or where the firm already has a dangerously high debt ratio (ibid.). According to the pecking order theory sources of funding can range from internal sources such as retained earnings, profits, personal sources, share capital and dividends. However, as internal sources can be minimal in small high-tech start- ups in which the co-founders usually inject more money into their business, deriving from their own savings. These private capital injections into their business can be either capitalized
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as debt or as equity in the form of shareholder contribution. Hence, we will categorise all form of private capital injections as internal funds, regardless if they will be capitalized as debt or equity. The reason is that these capital injections are internally generated and not generated from external capital sources.
The pecking order sequence is therefore as followed; firms should choose internal resources such as liquid assets and or cash over external finance, as it’s the cheapest available source of capital and contains minimal information asymmetries (Myers, 2001). However, if investments exceed a company's cash and asset threshold, thus external financing should be issued in the form of debt (ibid.). Debt is issued over equity as it’s the safest security and it is followed up by convertible bonds, which is a hybrid between debt and equity. Equity is used in the last resort as it contains the highest information cost (Myers, 2001). Finally, a firm’s capital structure is shaped by its accumulated requirement from external financing (ibid.).
According to Myers and Majluf (1984) a company has no well-defined target debt to equity ratio, instead, they choose the path with least resistance and the lowest financial cost available (Myers and Majluf, 1984). In addition, Myers and Majluf (1984) assume perfect financial markets where investors lack the information on the value of their existing assets, thus investors can’t determine the value issued to finance the new investment. Further, the authors assume that managers always act in the interest of the existing shareholders, thus will not issue undervalued shares at the expense of the company owners (Myers and Majluf, 1984). Consequently, firms whose only option of financing is through issuing undervalued shares, will not go through with their investment opportunity. Hence, even in the presence of a positive net present value (ibid.).
2.3 Previous research on high-tech start-ups: Pecking order theory
High-tech based companies with their trend of popularity and innovation are considered to be the dynamic force behind the future growth and development of any economy (Maginart and Struyf, 1997). The study emphasizes on sources of funding such as internal funds, debts and equity for high-tech start-up companies in Sweden with reliance on the pecking order theory.
The theory stipulates that firms typically prioritize their source of funding firstly through internal funding, then debt and finally equity as the last option of financing (Myers and Majluf, 1984). The three different sources of financing have their own set of benefits and
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drawbacks that favour different high-tech start-ups and their funding patterns as it relates to the pecking order theory. Table 1 shows the five different studies which serves as the base to analyse different economies and how high-tech start-ups are financed in those particular economies. The analysis of the literature findings is focused solely on the financing choices by high-tech start-ups and whether the pattern of funding decisions in those economies is in line with the pecking order theory. Therefore the study findings in this section are further divided into the three sources of funding i.e. internal funds, debt and equity with the relevant corroborating study findings summarized in table 1.
2.3.1 Internal funding
According to Paul, Whittman and Wyper (2007) internal funding seems to be the favourable source of funding for start-up companies which is consistent with the pecking order theory. In contrary, high-tech start-ups usually have a high burn rate in cash due to R&D, therefore the accessibility for internal funding’s are minimal or even depleted in many cases, thus internal funding is not applicable to investigate in high-tech start-ups (Wing Tam, 2011). However, for external sources of funding, high-tech start-ups prefer equity to debt, which is contradictory to the pecking order theory of financial hierarchy (Paul, Whittman and Wyper, 2007). Reason being that most high-tech start-ups view debt as a personal liability and they would prefer equity due to the chosen investor’s value in terms of business skills, commercial contacts and networks (ibid.). This finding is also consistent with Hogan and Hutson (2005) study, in that the use of debt is rare and the primary source of external funding is equity financing thus contradictory to the pecking order theory.
The main advantage of internal funding over external sources of funding is that the primary goal for high-tech start-ups is to be independent and be in control over their firms (Hogan and Hutson, 2005). High-tech start-ups prefer to keep not only ownership of their businesses but also to have control and would be less reluctant to let outsiders into their business. For high- tech start-ups, the most important reason for doing business is the pursuit of innovation whereas for investors is the ability to maximise future potential selling value for the firm (ibid).
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2.3.2 Debt
Debt financing is valued more than equity due to owner’s lack of giving up control and the desire to be your own boss as the incentive behind starting their own businesses (Hisrich, 1986; Caird 1991). It entails that high-tech start-ups prefer debt over equity financing so as to minimise the incursion of outsiders into their business through offering equity shares for their business (Holmes and Kent, 1991; Tucker and Lean, 2003). This is also consistent with Poutziouris et al, (1999) and Paul et al, (2003) argument for debt financing choice for high- tech start-ups, rather than equity which is seen as a dilution of control, therefore, debt financing is seen as the more appealing source of financing. According to Robb and Robinson (2014) firms heavily rely on external debt sources of financing such as bank loans during their first year of operations. Which is emphasized as due to the availability of bank debt and most high-tech start-ups firms are made up of even shares of owner equity and bank debt (Robb and Robinson, 2014). The choices of sourcing financing could be different in different countries due to governmental laws and regulations, taxes and entrepreneurial cultures of different countries and people. These differences play a role in the findings of these studies and the outcome of how high-tech start-up companies source their finance capital.
2.3.3 Equity
At the initial start-up stage of the firm, these high-tech start-ups are informationally vague due to their complex nature and informational asymmetry between high-tech start-ups and potential investors (Hall et al, 2000; Schmid, 2001), and their company assets are usually intangible and knowledge-based (Hsu, 2004). When their internal funds dry up, these firms concede some control of their firms to secure funding by offering equity to potential investors such as venture capitalists. The desire and motivation to innovate and pursue sustainable development supersedes that of having full control and being wary of outsider’s influence of the firm (Hogan and Hutson, 2005). These start-ups are not public listed companies that have historical data on how to judge and base investments, therefore, the owners or managers have a significant information and knowledge advantage about their business than the potential investors (Gompers, 1995). Financing options vary at different stages of a company life cycle. According to Maginart and Struyf (1997) business angels typically invest at the risky
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stage i.e. at the start-up while venture capital firms financed at the early growth stage and finally banks were involved at the latter stages (ibid.). Bank loans are heavily collateralised which start-ups favoured internal funding as compared to bank debts due to their significant requirement of collateral for high-tech start-ups (Maginart and Struyf, 1997). Lack of collateral and other financial constraints forces some high-tech start-up firms to seek funding from business angels. Business angels are potential investors who help business owners by sharing of knowledge, experience, financial resources and managerial support which is crucial for the survival of these firms especially at their start-up stage (Calopa, Horvat and Lalic, 2014). These business angels provide skills, expertise and important business contacts and networks to help the owners grow the business so that both parties can gain significant value from each other (ibid.).
Table 1. Summary of literature findings
Research/study Country Findings: order of funding
Stuart Paul, Geoff Whittam, Janette Wyper, (2007)
Hogan and Hutson (2005)
Manigart and Struyf, (1997).
Robb and Robinson (2014)
Calopa, Horvat & Lalic, (2014).
Scotland based start-ups
Ireland based high-tech start-ups
Belgium based high- tech start-ups
Data from Kauffman firm survey
Start-up financing ventures in Croatia
Order of funding’s:- Internal funds, Equity then debt.
Order of funding’s:- internal funds, equity then debt.
Order of funding’s:- Internal funds, debt then equity.
Top three sources of funding are bank debt, personal equity and trade credit.
Financing through internal funds, financing assistance from family and friends and lastly external sources such as seed investments and business angels.
Notes: Table 1 shows the summary of five studies done in different economies such as Scotland, Ireland, Belgium and Croatia as well as one study done from Kauffman firm survey.
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3. Methodology
In this section, we describe the methodology of this paper. The ambition is to describe and motivate the choice of companies as well as the research strategy, research design and research method that we have chosen to apply in our study. Furthermore,
we discuss the method problems and the cornerstones of scientific research;
reliability and validity.
3.1 Research strategy - Qualitative approach
As a research strategy for this paper, we decided to undertake a qualitative approach.
A research strategy can be defined as the general orientation of how to conduct social research, and states that one generally distinguishes between two kinds of research strategies:
qualitative and quantitative research. In essence, we argue that the qualitative approach is suitable considering the study’s problem formulation and purpose Bryman (2012, pp. 35-37).
Bryman (2005, p. 18) supports this argumentation, describing how it is the scientific problem that determines, or should determine, what type of research design to apply in a paper. We argue that the use of a qualitative approach allows us to go more into detail of the case company’s actual feelings and behaviours. According to Bryman (2005, pp. 18-20), qualitative research does that by prioritizing the perspectives of those being studied as well interpretation of the subjects’ own belief.
Repstad (2007, p. 87) argues how it is almost inescapable to avoid quantifications of some sort in qualitative studies. That’s also true for this study. However, the systematic use of quantities in the analysis will be absent in this paper. As the aim of this paper is to understand the underlying factors determining the choices of a specific phenomenon, i.e. small high-tech start-up firms’ source of funding, this study will focus on collecting qualitative data. This is backed by Bryman (2012, pp. 401-402) who argues that a qualitative approach enables a great understanding of what’s going on in an organization, and a detailed description of their opinions. The choice of implementing a qualitative approach is also suitable if the researcher is concerned in the worldview of representatives of a particular social group (Bryman, 2012, pp. 403-404), which we think could be correlated to the aim of this study. Hence, the
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qualitative approach in this study is decided as a response to the nature of our research problem.
3.2 Research design - Multiple case study
When discussing different research designs, which ultimately directs the implementation of our research method and enables a foundation for our collection and analysis of data (Bryman, 2012, pp. 45-46), several different options were up for suggestion. Early in the research process, we understood that the decision of our research design would reflect our priorities as researchers by affecting a range of different dimensions of the research process.
Influencing the understanding of behaviour and the meaning of that behaviour in a particular context, displaying casual links among variables and generalizing the results of the research to a large group (Bryman, 2012, p. 46).
As our research design, we utilize a multiple case study method. A multiple case study approach entails the analysis of differences, similarities and connections between two or more cases that share a joint focus or objective (Gerring, 2017). We argue that this research design is the most suitable approach for this paper due to its exploratory benefits. We further argue that the multiple case study method is a feasible method considering the aim of this study and our research question, which is support by Yin (2003, p. 9) who describes how case study methods enable the researcher to understand the why and the how of present issues in depth, used for investigations to obtain insights and understanding of a phenomenon that’s recently found or unprocessed. Furthermore, Yin (2003, pp. 12-13) argues how a case study is outlined to highlight a decision or several decisions, and the underlying factors behind those decisions, which is in line with the purpose of this study.
Critics to the case study method as a research design often point out the lack of generalizability of case study research, how one case could not possibly be representative and that the results can’t be correlated to other cases or populations beyond the cases. (Bryman, 2012, pp. 69-70) However, this is not the main intention of this study. Instead, we aim to achieve a comprehensive analysis of the six high-tech start-up firms, which later are connected in a theoretical analysis. This approach is supported by Bryman (2012, p. 71) who argues that the main problem for a case study researcher is the quality of the theoretical reasoning, rather than the aim of enabling generalizable results.
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A case study implies the examination of one case. Nevertheless, several of studies investigated more than one organization. Since we conduct a multiple case study method, we argue that the generalizability of the paper is improved and it also allows comparisons of special features of cases to be identified much more readily. This is in line with Yin’s (2003, pp. 53-54) argumentation of the benefits of having a multiple case design. Yin (ibid.) further argues how multiple-case designs could be preferred since they are less vulnerable;
particularly the analytic advantage of having more than one case could be significant.
Considering the aim of this paper, the empirical analysis is conducted as a multiple case study of the 6 Swedish high-tech firms, displayed in table 2 attempting to utilize the benefits of using multiple firms. In essence, this paper aims to achieve knowledge about the financing choices that start-up firms do and what factors that lie behind those choices and thus, we considered a comparative multi-case study of the 6 small high-tech start-ups as an appropriate research design.
3.2.1 Selection of case companies
In the initial stage of the case selection process, we set out find companies in a way that could answer our research question in the best way possible. According to Bryman (2012, p. 418), this approach could be correlated to purposive sampling where the investigator’s research question is at the heart of the sampling considerations. Thus, our sample consists of six small high-tech start-up companies that we argue are relevant considering our research question. To ensure that we gain access to a wide range of companies, relevant for this research, the selected companies have different characteristics in terms of the companies’
area of focus. Bryman (2012, p. 417) supports this approach, arguing the importance of having different companies perspectives in the focus of attention.
To initiate contact and find companies for the study, we took help from tech incubator hubs, located in Malmö, Stockholm and Västerås. These tech incubators provide a social platform between investors and tech start-ups firms to venue and cross-fertilize competence and capital between one another. In addition, the incubators also provide guidance and expertise to the newly established tech firms. Through the incubators, we found six companies that suited our criteria’s that defines the companies included in the study. Defining what a high-tech firm is
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as well as what a start-up firm is, encompasses the overall criteria of the case companies included in our study.
The study uses the definition of a start-up established by Calopa, Horvat and Lalic (2014) which defines a start-up firm as a company that recently has been established and is at the stage of progress and market research, often connected to high-tech activities since the products mainly consists of software that is simple to create and recreate. The study implemented a 4-year life-span limitation for the companies to be declared as a start-up, meaning that the companies in this study were started in 2015 or later. High-tech firms are in this study defined as a firm functioning within the parameters of economy and science making products or developing activities combining the features of innovation and high knowledge base of modern information technology with various network connections with other organizations. (Zakrzewska-Bielawska, 2010). The definition encompasses classifications of high-tech companies within the manufactures in electronics, computer technology (both hardware and software), biotech, medical technology and environmental energy technology sectors (Freeman, 1985).
Table 2 encompasses the overall case selections, which highlights the different business sectors the case companies operate within and specifically their area of focus. The table indicates the case company’s start-up sector of business as well as their core area of focus to give an understanding of the type of case companies that were involved and interviewed for this study. It also shows the interviewee's role in the company to give an insight into the overall case companies.
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Table 2. Case company overview Case
company Start-up
year No. of
employees Respondents role
of the company Industry Area of focus
1 2015 5 CEO Business
services
Customer relationship
& marketing
2 2016 8 Sales manager Business
services
Digital communication
3 2018 2 CEO Business
services
Software logistics
4 2017 2 CEO Business
services
Online shopping
5 2017 3 CEO Business
services
Automation of purchases, B2B
6 2016 6 CEO Business
services
Furniture rentals
Notes: Table 2 shows an overview of the study’s case companies.
3.3 Research method – Interviews
The study conducts semi-structured interviews with open questions and follow-up questions asked during the interviews to gain a deeper understanding of the interviewee’s opinions regarding key issues. The interviews are following an interview guide (shown in Appendix B) that we developed to have a structure and framework when conducting the interviews as well as allowing room for flexibility for the interviewee’s to express their exact opinions and thoughts. The interest in conducting interviews is the emphasis on the significance and importance of getting to the interviewee’s point of view (Bryman, 2012, p.470). Six case companies are interviewed and all the interviews are recorded with the exception of those that didn’t want to be recorded. However, all interviews are transcribed to enhance the trustworthiness and authenticity of the study. Table 3 shows the interviews that were audio- recorded as well as provides a summary of the overview of the interviews conducted. Table 3 gives a depiction and insight into how we conducted the interviews and states whether the interviews were recorded or not as well as gives the duration of how long the interviews took i.e. in minutes. The roles of the interviewee’s job positions as well their gender are specified to give an insight into who participated in the interviews. We offer anonymity when
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conducting the interviews and there will be no mention of company names or interviewee’s names throughout the study. Four case companies were audio recorded and two case companies were not recorded as they wish not to be recorded.
During the process of the interviews there is at least two of us present in the interviews. We both took notes during the interviews, so that we could compare our notes after the interviews and establish some of the recurring key concepts that emerged from the interviews as a first- hand account. Those notes are also used together with the audio recording which aided in the transcriptions of the data. The benefit of transcribing the data is that it brings the researcher closer to the data, aiding in identifying key themes as well as noticing similarities and differences amongst different respondents (Bryman, 2012, p. 486). The interviews lasted approximately thirty to forty five minutes depending on how engaging the interviewee’s were during the interview process.
The interview guide we are following when conducting the interviews has different approaches to asking questions such as: introducing questions, probing questions, specifying questions and direct questions (Bryman, 2012, pp. 476-478). The interview question is formulated in an open way to prevent yes or no answers from the respondents, thus to encourage conversation and to understand the problem through their perspective. In addition, open questions have the effect of mitigating bias and subjective answers from the respondent’s (Gioia, Corley, Hamilton, 2012).
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Table 3. Summary of the interviewing process
Case company Interviewee gender Job position Audio-recorded Duration of interview
1 Male CEO Yes 41:11
2 Male Sales Manager No 33:48
3 Male CEO Yes 32:45
4 Male CEO Yes 43:21
5 Male CEO No 39:14
6 Male CEO Yes 34:16
Notes: Table 3 shows a summary of the overall interview process in a much easier manner of capturing the entirety of the process.
3.4 Data analysis
Since data from qualitative studies are drawn from interviews or observations, often with a huge amount of unstructured textual evidence, they are not unambiguous to analyse (Bryman, 2012, p. 565) Furthermore, qualitative data analysis, in comparison to quantitative data analysis, has no distinct rules of how the data analysis should be implemented (ibid.).
However, the analysis of case studies is one of the least progressed and is one of the most troublesome tasks when conducting a case study (Yin, 2003, pp. 109-110). Hence, we consider it vital to follow some sort of guidance throughout the analysis.
Thus, the step-by-step guide of how to analyse qualitative data by O’Connor and Gibson (2003) is applied to guide our data analysis. The guide consists of the following steps: (1) Organizing the data (2) Finding and organizing ideas and concepts (3) Building overarching themes in the data (4) Ensuring reliability and validity in the data analysis and in the findings (5) Finding possible and plausible explanations for findings. Table 4, an excerpt of our data analysis, shows how the data is organized in accordance with the interview guide, consisting of two overall themes: Financing and Capital structure. The interviewee’s prominent responses are quoted and later organized into different categories, which in the last step are linked to different themes. However, our first action is to get familiar with the data by reading through our transcripts, which helps us to get a general idea of what our interviewees were
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saying and what our results is looking like. The following steps in analysing the data are adapted from O’Connor and Gibson (2003) and gives clear details on how we approached to analyse the data for our study.
1. Organizing the data
Our next step is to organize the data with the help of our interview guide, which according to O’Connor and Gibson (2003) is the best way to identify and differentiate between questions and topics. Thus, we created a table (see table 6 in appendix A) consisting of four columns:
Questions from the interview guide, responses, categories and themes. The questions implemented in the table are considered to be the ones which are the most important and essential to answer our research question. The questions are organized after the two major topics in our interview guide, financing and capital structure. In the next column, with responses, the interviewees most prominent and/or frequently used answers are quoted.
According to O’Connor and Gibson (2003, pp. 67-68), this approach gives the researcher a good overview of the data and the chance to look at each question individually, enabling an easier way of finding themes in the data.
2. Finding and organizing ideas and concepts
The next phase of the analysis is to organize the interviewee’s ideas and thoughts from the stories they told us into categories. Each of the 6 responses to each question is divided into a specific category, depending on the characteristics and underlying concept in the answer.
3. Building overarching themes in the data
When we have categorized the responses, we create different themes that are connected with the categories – trying to give a deeper purpose to the data. Hence, different categories are linked to different themes emerging from the responses. The themes are central during the actual analysis.
4. Ensuring reliability and validity in the data analysis and in the findings
Our approach in ensuring reliability and validity in this paper are discussed in the section Reliability and validity. The section displays how we have adopted the criteria’s of
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trustworthiness and authenticity developed by Guba and Lincoln (1994). Hence, for a more detailed description of our course of action we recommend you to read that section.
5. Finding possible and plausible explanations for findings
In the final step of our analysis, we summarize our findings and themes, which is recommended by O’Connor and Gibson (2003). This is done under the section 5, analysis.
We go back to the literature and compare it with our findings, found differences and similarities, which in turn enabled us to find plausible explanations for them. We also discuss the implications of our findings, following the advice of O’Connor and Gibson (ibid.). To provide a logic thread through the analysis, the case analysis was structured in a way that follows the structure of the data analysis table. Under the two major topics financing and capital structure, each question was rephrased to a sub-heading where later the themes and findings were discussed.
Table 4. Demonstration of data analysis
Questions/Topics Responses Categories/Codes Themes /
Concepts
Topic: Financing
How did you finance your start-up
company?
Case 1: “We put our own money in and we also put our own hours in
and we did not take out any salaries. ‘’ (A)
Case 4: “I went in with half of the capital, and borrowed the other
half from my parents’’. (A) Case 5:” We lend money to our
own business’’. (A)
Financed through own funds (A)
Internal funds (A)
Notes: Table 4 displays our approach when analysing the data. The colour coding as well as the alphabet categorizing highlights the connection between our interviewee’s responses to how we categorized it and linked to our study literature.
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3.5 Trustworthiness and Authenticity
Ensuring the reliability and validity of a research is crucial in its credibility and authenticity of the findings of the research. Therefore, the reliability of a research is concerned with whether the results of a study is repeatable (Bryman, 2012, p. 46). It entails the replicability of a research if the findings of the study may be needed to be replicated by following through the procedures and process outlined in the study. That is why Bryman (2012, p. 47) emphasizes that for a replication to take place, a study must be capable of replication.
Validity of research, on the other hand, dictates the integrity of the conclusions generated from the study. It questions whether a measure that is derived from a concept really does reflect the concept that is supposed to be denoting (ibid.).
Due to terms like “measurements” carry nuances which are more fitting for a quantitative research, reliability and validity are significant criteria in evaluating the quality of research for a quantitative researcher (Bryman, 2012 p. 389). However, the study adopts Guba and Lincoln (1994) of trustworthiness and authenticity which is more fitting for a qualitative research. According to Guba and Lincoln (1994) trustworthiness is categorised into four criteria’s of credibility, transferability, dependability and confirmability. Whereas authenticity is categorised into five criteria’s such as fairness, ontological authenticity, educative authenticity, catalytic authenticity and finally tactical authenticity.
3.5.1 Trustworthiness:
The criteria of credibility guarantees that the research is done according to good practice and that the researcher’s ensures with their subjects that the clarifications and explanations are truthful i.e. respondent validation. Credibility is ensured through triangulation of data (Guba and Lincoln 1994). The study ensured that this criteria is followed through interviewee’s of the study being given a description of what they contributed and aided to the study when conducting the interviews to ensure a precise and accurate interpretation. Credibility through triangulation of data was done by interviewing multiple companies within the high-tech start- up sector as well as different theoretical outlooks. The criteria of transferability entail the thick and rich description or details of the respondent’s accounts of his or her findings.
Otherwise referred to as a database for making judgements about the likely transferability of findings to different milieu (Guba and Lincoln, 1994). The study took into account the
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volume of information provided so as to avoid issues of repetitions and irrelevant information that is not useful to the study. This ensures that the reader doesn’t lose focus on the purpose and providing detailed descriptions of the scope of the study.
The criteria of dependability refers to the objective and systematic recording of data in all phases during the research process that should be accessible in an appropriate manner. This ensures merit of the research and adopts an auditing approach towards qualitative research (Guba and Lincoln, 1994). The study ensured this criterion by interviews conducted have all been recorded (with the exception of respondents that wish to exercise anonymity and wish not to be recorded) and transcribed to enhance the trustworthiness of the research. This allows for transparency for the study and outlines a clear detailed description of the methodology implemented. The final criteria of confirmability details the degree of objectivity by the researcher and the ability of the researcher to curb biases and personal judgements in the study (Guba and Lincoln, 1994). Guaranteeing absolute objectivity is a difficult task in a qualitative research. However, for the study to meet this criterion, there was zero interference, manipulation or meddling of the collected data before analysis of the data.
3.5.2 Authenticity:
The role of authenticity in a research is to raise awareness concerning wider issues of political impact of the research (Guba and Lincoln, 1994). The criteria of fairness pose the question of does the research adequately represent the different viewpoints of the respondents expressed in the study (ibid). With that, the study ensured that company employees at various job positions have been interviewed in order to have the different their viewpoints accounted for. The criteria’s of ontological and educative authenticity regards whether or not the study helps the participating respondents and or interviewee’s in understanding the study phenomena better as well as posing the question of whether or not the research helps members understand or grasp better the perspectives of study respondents (Guba and Lincoln, 1994). The study took into account careful discussion of our research purpose with the case companies so as to clarify any doubts and help the respondents better understand the study phenomena. Different viewpoints from different respondents allowed our study subjects to have an overall better understanding of the phenomena.
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Lastly, the criteria’s of catalytic and tactical authenticity entails whether the research has acted as a stimulus for the research respondents to effectively change their conditions as well as if the research took the required steps to actively engage in action the study respondents through empowerment of the study subjects (Guba and Lincoln, 1994). Through that, the study took careful consideration into the development of the theoretical framework section.
The study has used credible theories as the backbone to better understand how the case companies source capital finance structure. The nature of the financial landscape dictates the type and choice of finance structure they prefer to have and the option they are left with when other alternatives are not available to them.
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4. Findings
In this section, the findings from the conducted semi-structured interviews are presented. We present the findings in accordance with the core questions utilized in
our interview guide that has two major topics, financing and capital structure.
The findings from this section aims at specifically highlighting the key responses that are related to the study literature and themes. Specific questions that are connected with the study themes and the responses from the data will serve as the base for reflecting the data back to the literature in the analysis. The questions cover two main topics of financing and capital structure, which have several questions under each topic that relates to concepts from the study literature. The results from the findings will then serve as the benchmark when doing analysis in section 5.
4.1 Financing
Case companies initial financing method and the reasons behind it:
The data shows that all six case companies initially financed their start-ups through their own funds, common responses included:
We put our own money in and we also put our own hours in and we did not take out any salaries (case 1).
All the founders agreed to put up our own money to see what we could with the company ourselves (case 2).
We lend money to our own business (Case 5).
In a similar manner case company 3 also financed its company through internal funds:
...The company was financed exclusively with my own saved funds (case 3).
Case 4 had an approach of combining own saved funds with contribution from his parents when the company initially started:
I went in with half of the capital and borrowed the other half from my parents (Case 4).
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This is interesting because we categorized the funding method as internal funds. Typically, someone who provides capital to a start-up business can be considered as a business angel.
However, business angels acquire an equity stake in a company when they finance it which wasn’t the case with case company 4 parents. Neither did they require any interest rate. The parent’s intention was solely for the purpose to help their son with his business and they didn’t require anything in return, therefore we classified it as internal funds.
As it relates to the reasons for the start-ups financing their companies through internal funds, the owners expressed the lack of many options available to them when they started their business. Most owners expressed that most banks wouldn’t lend them money because they considered their business to be risky. This was evident from responses of:
Banks considered my business to be risky and I don’t have many options (case 6).
The banks and Almi didn’t feel we had long track record for our business (case 5).
Case 2 and 3 responses were similar, indicating the desire for them to invest their own money so that they could develop and grow their business before seeking additional investments.
..We didn’t look for who wanted to invest in our idea, we wanted to develop the firm by ourselves (Case 2).
Those two cases expressed that they wished to develop their businesses by themselves before seeking outside investments. Their responses show that these firms were more concerned with actually developing their businesses rather than being focused on looking for help from outside financiers. There are incentives for these firms to not involve the pressure from outside financers, for instance through investors which may impose time restrictions and deadlines for these start-ups to meet certain requirements and demands. This is evident by the answer from case 4’s reasoning of why the company financed itself through internal funds.
..to be able to progress my ideas in peace (Case 4).
The changes of source of financing during company lifecycle:
The owners’ displayed a high degree of unanimity by shifting their initial sources of financing to an equity form of financing as their business grew and developed. With the exception of case 1 and 6 that had debt as their next sequence financing option, the rest of the firm’s expressed they are either invested with an equity-based investment or are interested in a different kind of equity investment ranging from crowd-funding, seed investments and business angels:
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…we are looking into equity funding. (Case 3).
…I searched for capital and had a person I knew to invest (Case 4).
Equity financing seems to be the majority choice of our case companies, seemingly due to the lack of access to bank loans and their disadvantageous terms. Banks typically consider high- tech start-ups to be risky and therefore tend to not grant them funds. However, when they do grant funds, they come with high interest rates. However, Case 1 and 6, initially using internal funds, described how their sources of financing had changed to debt, or that they are looking into funding through debt:
Yes, it has changed. We use Grants and loans from Almi (Case 1).
It has not changed, but we are looking into peer to peer lending (Case 6).
After consuming their internal funds, Case 1 managed to secure funding through grants and loans from Almi. The owner had some interesting thoughts regarding funding gaps when building company traction which lasts 12-18 months. In those gaps, the firms need investment to stay afloat while they are building and developing their businesses, hence, making it difficult to not only gain traction but to keep that momentum going with limited funds.
Preferred choice of finance as a start-up for the case companies:
In this question, the data evolved an interesting finding in that start-ups may finance their business initially in one way but would actually prefer to finance it a different way. Only case 3 and 4 preferred self- funding due to the reasons given below:
I would prefer self-funding, without having any creditors or investors, all the profits goes to me as the owner of the company (Case 3).
Personally, I would prefer self-funding. I have never liked to be dependent on others and I try to avoid loans. I have never, for example, paid my mobile phone as an instalment loan. You know what I mean? (Case 4).
Case 3 and 4 were coherent in their preferred choice and how their businesses were actually financed, which is through internal funds. Independence seems to be the incentive for them to prefer financing through their own funds and not relying on external financiers. However, the rest of the cases shows the discrepancies between how they financed their businesses and how
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they would have preferred to finance it. These discrepancies highlight the challenges small high-tech start-ups face when funding their businesses.
Case 2 preferred equity financing as well as having a good match with the right potential investor:
I would probably say the best solution for me would be some sort of seed investments or angels that know the sector you’re in and can help you with not just money but also wisdom and guidance to help with your business (Case 2).
Case 2 expressed how benefiting from the right match of equity investor helps their business to develop through the guidance and expertise provided by them, showing how equity investor’s knowledge could be an important factor when seeking funds. The owner expressed how this factor was crucial in the sense that having the right match of investor that believed in his company and devote non-monetary resources besides money to his company would help the business to develop and grow. However, case 1, 5 and 6 would prefer loans from banks as their preferred option if they had access to it explaining:
..You get the best deals with the banks but ahh, maybe I’m not sure I think Region Västmanland and Almi would be the most ideal I think. The combination of both grants and loans would be good but yeah I think that would be ideal (case 1).
We would say bank loan as it is the cheapest way of financing at the moment (case 5).
The overall reasoning for these firms to prefer debt is due to the fact that they consider it to be the cheapest option of funding. Furthermore, control seems to be a factor that affects these owners preferred choice of funding, when issuing equity, the control of the owners weakens.
Our findings show that only one out of six case companies would prefer equity, which indicates explicitly that control is a factor in their preferred choice of funding.
4.2 Capital structure
The implementation of a capital structure policy
The findings from the data show that five out of six cases did not have a clear or specific capital structure policy for their firms. The responses included:
No we don’t have any specific policy, but we choose our investors wisely (case1).
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No, we don’t have anything like that. Everything is decided by the founders (Case 2).
No, I don’t have any policy but I sure do think about the pros and cons regarding finance (Case 4).
The majority of the cases didn’t have a specific capital structure policy in place for their firms. The findings suggest that implementing a capital structure policy is not necessarily beneficial, or needed, since they are limited in their funding options. However, the owners’
did express that even though they don’t implement any clear capital structure policy, they do choose their investor’s wisely and think about their long-term value of what the investor brings to their firms.
Case company 6 is the only case that had a capital structure policy stating that:
Yes, we do have a policy. Well, it’s to not give away so much equity, in other words we would rather have bank loans and low solvency than stronger equity and lower ownership in the company (case 6).
The company explains the importance of having a capital structure policy for their firm as:
…The lenders will always look at our financial statement and we therefore want to have a capital structure that will help us to borrow money from traditional banks (Case 6).
However, they also express that having a capital structure policy has affected their choices of financing:
I believe that our choices for funding is limited and I can’t therefore freely choose how on how I want my balance sheet to look like. Like I said before I would rather not give away equity if I am not forced to (Case 6).
Case company 6 sees a value in having a capital structure policy, which is to have bank loans and not give away too much equity. The benefits of implementing the policy seems to be to ensure that the firm keeps track on its aim to borrow money rather than issuing equity and give away control of the firm. However, the findings suggest that even though they do have a policy in place, the firm is limited in the funding options they have, which further complicates their financing decisions.
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5. Analysis
In this section, an analysis is presented based on the collected data and our theoretical framework. The theoretical framework function as a foundation for the
analysis, applied to enhance deeper understanding when addressing the study’s research question. The analysis follows the thread of table 6 (shown in Appendix A) by going into the different topics, financing and capital structure, and questions from
the interviews in a systematic way. The results from the analysis are used to draw conclusions in the following section.
5.1 Financing
Case companies initial financing method and the reasons behind it:
From the data, it is evident that all six cases initially financed their start-ups through their own funds, which is in line with what Myers and Majluf (1984) pecking order theory would predict, the financing rule in which internal funds are systematically preferred over external financing. However, our findings displays that four out of six case companies would have preferred to be financed in another way if they had the option which contradicts the pecking order theory. It is important to note the distinction between our companies at investigation and the ones serving as the backbone of the theory. Our case companies are small high-tech start-ups and not the large and mature companies of Myers and Majluf (1984) that can utilize retained earnings generated from profits as their source of internal funds. As such, our definitions of internal funds as mentioned before are all internally generated capital, including shareholder loan and shareholder contribution injected in the company.
As it relates to the reasons for these high-tech start-ups financing their companies through internal funds, they expressed the lack of options available to them when they started their businesses. Limited options for firms seems to be one of the major reasons for these start-ups to put up their own money when they couldn’t secure funding for their businesses. Most firms expressed that most banks wouldn’t lend them money because they considered their business to be risky. This could be correlated to Revest and Sapio (2012), arguing how the information asymmetries between a small high-tech start-up firm and outside financiers as banks are more severe considering their scarce track record and the complexity of the innovation process.
