New ventures must adapt their financial decisions during recessionary periods
Access to finance and the choice of capital structure are pivotal issues for firms, particularly in a recession context when there is a considerable disruption to markets and financial institutions.
A recent study1 analyzed the financial vulnerability of new ventures to adverse macroeconomic environments and investigated whether the capital structure of Portuguese firms responded to economic downturns.
New ventures founded during crises periods have higher values of debt ratios for total and short-term debt, higher profitability, higher growth of assets but lower values of total fixed assets to total assets. New ventures established between 2006 and 2015 had, on average, 14.5% profitability, indicating that the adverse business environment was not the main concern, as firms could sell and create economic value. The problem was in receiving cash on time and the ability to repay suppliers and other creditors.
Despite the credit limitations and the high cost of capital during the crisis, Portuguese new ventures still use debt to finance over 66.5% of their assets. Almost 50% of the debt was due in the short term (less than one year), which raises red flags in term of liquidity and capacity to fulfil the payment obligations.
Ventures that were financed mainly with equity resorted to less short-term debt, had higher liquidity and profitability (27.2% vs 13.2% for ventures mainly financed by debt) but experience lower growth. These findings need to be interpreted with some caution as only the firms that were better managed and more profitable survived to be included in the study during the entire period.
Finally, no matter the type of financing, new ventures decrease their size and fixed assets during the crisis.
Portugal is a very interesting case study, as it has experienced some of the worse effects of the crisis with significant job losses, a drop in labor productivity and a large number of firm closures. Likewise, in Portugal, the credit constraint drastically reduced the financing alternatives available to smaller and newer firms, thus making them more dependent on domestic banking credit conditions.
Alternatively, there are some entrepreneurship support programs that may be appealing for those seeking news ways of finance. For example, the government has set up an Entrepreneurship and Self-Employment Support Program to support the creation of new businesses by unemployed individuals, young people or disadvantaged people looking for a job or facilitating access to finance.
Summing up, the aftermath of the last crisis serves as a lesson that new ways of financing may be necessary to respond to and overcome the crises. This insight is very useful for the present pandemic as firms may be in dire need of financially reinventing themselves.
1. Guedes, M.J., Saraiva, T, & Felício, T. (2020) “Does the capital structure of new ventures differ as a response to a financial crisis?”, Working Paper, ISEG, Universidade de Lisboa.