NEW FIRM FORMATION AND FINANCIAL CAPITAL

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The rate of new firm formation, i.e. how many new firms that are started, is a measure of the level of entrepreneurial activity in a country or region. Comparing rates in different regions gives an indication of which types of regions that have the best conditions for starting new firms and experiencing economic growth, since new firm formation has a positive impact on economic development (Carree & Thurik, 2003; Denis, 2004; Fritsch & Mueller, 2004; van Praag & Versloot, 2007). An extensive body of research has investigated regional differences in the rate of new firm formation and it can be concluded that the new firm formation rate does not vary greatly over time, but substantially across regions (Armington & Acs, 2002; Johnson, 2004; Fritsch & Mueller, 2007; Andersson & Koster, 2011). The pattern of regional differences in the rate of new firm formation is present also in Sweden (Davidsson et al., 1994; Andersson & Koster, 2011; Karlsson & Backman, 2011; Backman, 2015).
Since new firm formation is important for economic growth and there are regional differences in the rate of new firm formation, a logical consequence has been that many studies have focused on the regional determinants of the new firm formation rate. In other words, empirical research has thoroughly investigated why the rate of new firm formation is higher in some regions than in others (Davidsson et al., 1994; Keeble & Walker, 1994; Armington & Acs, 2002; Acs & Armington, 2004; Johnson, 2004; Fritsch & Mueller, 2007; Renski, 2014). One factor which in previous research is highlighted as an important determinant of new firm formation is access to financial capital (Evans & Jovanovic, 1989; Black & Strahan, 2002; Parker, 2004; Sutaria & Hicks, 2004; Berggren & Silver, 2010; Rogers, 2012; Robb & Robinson, 2014; Backman, 2015). This is logical, because financial resources are most often needed to start a firm, for example for buying machinery, renting or buying a shop, factory or office, or hiring employees. However, many potential firm founders do not have the financial funds they need to be able to launch their business ideas successfully (Evans & Jovanovic, 1989; Holtz-Eakin, Joulfaian, & Rosen, 1994; Cassar, 2004; Harding & Cowling, 2006). When internal funds are missing, entrepreneurs can try to obtain external financing, i.e. borrow money or attract investors who want to take an ownership position in the firm. Thus, it is reasonable that more firms are started in regions where entrepreneurs have better access to financial capital.
When a potential firm founder does not have the financial resources which are needed to start a business, a natural initial source of financing for many is family and friends, who can either supply funds by investing in shares of the firm or, more commonly, lend money to the entrepreneur (Parker, 2004). Studies in several countries show that loans from family and friends are an important source of start-up finance for many entrepreneurs (Bates, 1997; Cressy & Olofsson, 1997; Berger & Udell, 1998; Basu & Parker, 2001). In some cases, family members and friends may lend money to the entrepreneur because they are altruistic (Basu Parker, 2001). Other reasons why they may be willing to lend money even when professional external lenders, such as banks, say no are that they may have private information about the entrepreneur which banks do not have and they may be able to monitor the entrepreneur more closely (Casson, 2003; Parker, 2004). Despite family finance being relatively common for new firms, evidence suggests that it is correlated with unsuccessful entrepreneurship, such as low profitability and high failure rates (Yoon, 1991; Bates, 1997; Basu, 1998). Even though financing from family and friends may be desirable for many entrepreneurs, it is also a limited source of funds. Family loans are on average smaller than bank loans (Parker, 2004). Furthermore, family members and friends may, just as the entrepreneur, lack the financial resources which are needed. Therefore, if an entrepreneur wants to obtain the financial resources needed to start a firm, he or she may need to turn to professional investors or lenders.
A more formal source of external financing is private equity, i.e. to attract external owners, such as venture capitalists and business angels. The supply of private equity is often concentrated to one or a few spatial clusters in a country (Sorenson & Stuart, 2001; Mason Harrison, 2002; Klagge & Martin, 2005; Martin, Berndt, Klagge, & Sunley, 2005; Berggren Silver, 2010; Chen, Gompers, Kovner, & Lerner, 2010). Also, private investors tend to be more likely to finance firms in their own immediate region (Klagge & Martin, 2005; Martin et al., 2005; Berggren & Silver, 2010). This could be a consequence of that investing in a firm requires close contact, management and monitoring of the firm and that is easier for a private investor if the firm in which he or she has invested is spatially close (Martin et al., 2005; Chen et al., 2010). Even though firm founders may be willing to travel frequently to meet the investors and technological progress has made virtual meetings easier, spatial proximity is still important for investors’ knowledge of the market in which the entrepreneur operates (Agarwal & Hauswald, 2010b). Evidence of private investors’ preference of financing firms in metropolitan regions is given by Berggren and Silver (2010), who show that firms outside those regions which apply for private equity financing are more often denied. As a consequence, it is difficult for firm founders in peripheral regions to obtain financing in the form of private equity (Klagge & Martin, 2005; Martin et al., 2005; Berggren & Silver, 2010). Furthermore, relatively few firms obtain private equity financing as a result of private investors’ tough investment requirements, since they most frequently invest in firms which are innovative and have chances of strong growth (Hall & Hofer, 1993; Berggren et al., 2001; Romano, Tanewski, & Smyrnios, 2001; Berger & Udell, 2002; Winton & Yerramilli, 2008; Berggren & Silver, 2010).
Though, limited use of private equity financing is not only due to insufficient supply of funds. It is also due to entrepreneurs’ unwillingness to give up some of the control of the firm and let new owners in, so called control aversion⁵ (Cressy & Olofsson, 1997; Berggren, Olofsson, Silver, 2000; Silver, Lundahl, & Berggren, 2015). The feeling of being in control is a reason why many entrepreneurs start their businesses in the first place (Cressy & Olofsson, 1997; van Gelderen & Jansen, 2006; Parry, 2010; Silver et al., 2015). However, outsider assistance and expertise can often help new firms to perform better (Sapienza, 1992; Chrisman & McMullan, 2000 & 2004; West & Noel, 2009). Despite acknowledging the positive effects associated with attracting private investors, most entrepreneurs do not actively search for new owners, since it results in a loss of control (Cressy & Olofsson, 1997). In other words, limited demand by firm founders is also a reason why private equity is not widely used.

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Banks’ importance for new firm formation

In contrast to private investors, banks often have a widespread presence across regions (Bonaccorsi di Patti & Gobbi, 2001; Black & Strahan, 2002; Klagge & Zimmermann, 2004; Klagge & Martin, 2005; Berggren & Silver, 2010; Backman, 2015). Furthermore, banks lend money to firms; they do not take an ownership position. Therefore, the firm founder’s loss of control and independence associated with bank financing is often not as substantial as the loss when new owners are attracted (Cressy & Olofsson, 1997). Their widespread distribution and the limited loss of control may be two reasons why banks play a vital role in providing funds for new firms.

1 INTRODUCTION
2 THE SWEDISH BANKING MARKET
3 NEW FIRM FORMATION AND FINANCIAL CAPITAL
3.1 Banks’ importance for new firm formation
3.2 Indicators of the local bank sector
3.3 Inter-industry differences in financing
4 DATA, VARIABLES AND METHOD
4.1 Choice of method and data
4.2 Variables
5 EMPIRICAL ANALYSIS
5.1 Descriptive statistics
5.2 Correlation analysis
5.3 Regression analysis
6 CONCLUSIONS
7 REFERENCES
8 APPENDIX
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