Business start-ups and young enterprises introduce new products to the market and employ new processes for production. In order to create these new products and processes, firms often engage in R&D. Since conducting R&D is an expensive task, substantial financial resources are required. However, the internal financing capacity of young firms is limited because young firms generate no or a very low sales volume in the first years succeeding market entry, and no revenue reserves from previous years are available. In the case of limited internal financing, loans can relieve financing constraints on R&D activities. The relationship between R&D activities and loan financing can also be argued to go in the opposite direction. The ability of young enterprises to tap external financing sources depends, among other things, on growth opportunities which may be generated by R&D activities. Moreover, R&D expenditures are rather allocated into intangible assets that cannot serve as collaterals. This reduces a firm’s possibility of loan financing.

In this paper, we explore empirically the bidirectional relationship between R&D and loan financing. We use data from the first two waves of the KfW/ZEW Start-up Panel, a unique survey data set of young firms in Germany founded in the period from 2005 to 2008. Descriptive results show that 20% of young firms use loan financing, whereas 13% of firms conduct own R&D activities. Moreover, in descriptive, bivariate comparison firms without R&D expenditures use a higher share of loan financing in total financing than firms conducting R&D.

In a first step, we estimate single-equation models that explain, first, the share of loan financing and, second, firms’ R&D intensity, defined as R&D expenditures over total sales. Our estimates reveal that the share of loan financing is basically determined by firm-specific variables derived from traditional theories of corporate finance like static trade-off theory or pecking order theory. Entrepreneur-specific variables only play a subordinate role for explaining the capital structure. On the contrary, both firm-specific and entrepreneur-specific variables are decisive for the level of firms’ R&D intensity. In the single-equation models, we find neither an effect of R&D intensity on the share of loan financing, nor an effect in the opposite direction.

In a second step, we estimate a simultaneous, two-equation model in order to account for the interdependence of R&D activity and loan financing. Our results show that the coefficient estimates for the exogenous covariates hardly differ between the single-equation models and the simultaneous, two-equation model. However, the two-equation model proves that there is in fact a significantly positive, interdependent relationship between the share of loan financing and R&D intensity. Yet unobserved random shocks are negatively correlated across the two equations. In response to a negative random shock, for example, firms decrease their leverage and simultaneously reduce their R&D activities.

Fryges, Helmut, Karsten Kohn and Katrin Ullrich (2012), The Interdependence of R&D Activity and Debt Financing of Young Firms, ZEW Discussion Paper No. 12-016, Mannheim, published in: Journal of Small Business Management. Download


Fryges, Helmut
Kohn, Karsten
Ullrich, Katrin


innovation financing, capital structure, start-ups, KfW/ZEW Start-up Panel, Germany