For Growing Businesses, What Works Better, Bank Loans, or Venture Investment?

Douglas Cumming and Dan Li reported yesterday at The Wall Street Journal Online that, “Bank loans and venture investment are both crucial sources of capital for growing businesses.

But which does a better job of helping those companies grow and boosting entrepreneurship overall?

“To tackle that question, together with our co-author Rebel Cole, we analyzed data on small businesses that were compiled by the U.S. Census Bureau going back to 1995. The results were published in the Journal of International Financial Markets, Institutions, & Money.”

The Journal article stated that, “The conclusion? In general, venture capital plays a greater role in stimulating the formation and growth of new firms.”

Cumming and Li explained that, “The results: Higher levels of venture-capital investment meant more new startups and more growth at existing startups. We used statistical methods to establish that there was causality involved, not just correlation, and found a very strong causal link.

“Among the findings we uncovered were that the 15 states with the highest rate of growth in startup formation showed substantially higher levels of venture-capital investment compared with the slowest-growing states—a median growth rate of 12.05% in investment versus 3.93%.

In contrast, the fastest- and slowest-growing startup states saw a much lower growth rate of bank loans—5.38% and 2.74%, respectively.”

Graph From The Wall Street Journal

Yesterday’s Journal article added that, “Why does venture investment have more impact than bank loans, when loans are such a commonly used form of finance for entrepreneurs? It comes down to time and attention.”

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