The security issue decision: evidence from small business investment companies

Using a unique transactions-level dataset, this paper examines the investment choices of small business investment companies (SBICs), which are private venture capital firms licensed and regulated by the U.S. Small Business Administration (SBA). SBICs make debt and equity investments in small businesses, and we seek to explain their security choices. We focus on factors suggested by asymmetric information and contracting theories of security choice. Overall, our results are consistent with the predictions of contracting theory, although certain aspects of our results also support asymmetric information models. We find that projects generating tangible assets are more likely to be financed with debt than nondebt securities, consistent with contracting cost theories. We also find that repeat financings are more likely to be debt than are initial transactions between a particular small business-SBIC pair, which we interpret as evidence consistent with asymmetric information models. In addition, we find that increased firm risk generally decreases the probability of using debt, as do high levels of growth opportunities. Finally, we show that the characteristics of the SBIC providing the funding are important correlates of security choice. SBICs using higher amounts of funds or guarantees from the SBA are less likely to provide debt financing than other SBICs, while SBICs that are organized as partnerships or affiliated with banking organizations are less likely to provide debt financing than other SBICs.