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Small businesses hoping to qualify for financing from a third party may be surprised to learn what kinds of factors will decrease their chances of actually getting a loan.
According to new research, unexpected changes in revenue or in a company's workforce can negatively impact a company's chances of obtaining financing. The study, conducted at the University of New Hampshire's (UNH) Paul College of Business and Economics, found that sudden growth in a company's capital or staff is not necessarily good for a business’s credit score.
"Previous studies have shown that employee and revenue size will impact how creditworthy a company is viewed by the outside world," said Devkamal Dutta, study co-author and assistant professor of strategic management and entrepreneurship at UNH. "The same goes for having established some kind of financing track record. But we wanted to dive in deeper and introduce some new measures."
So Dutta came up with two new measures that already seem to be affecting whether companies are qualifying for credit that most companies may not be aware of.
Those measures are called “emergent volatility,” or an unintended change in the number of employees and revenue; and “deliberate diversity,” or an intended change in financing.
The researchers examined more than 12,000 privately owned companies that had received equity financing between 1995 and 2010 by looking at the companies' Paydex score. Paydex is an indicator developed by financial firm Dun & Bradstreet that measures if companies were able to pay their bills in previous years.
"We selected Paydex because it's a third-party, independent source that's based on performance," said Dutta, who conducted the research in conjunction with the Institute for Exceptional Growth Cos.(IEGC) and presented it at the recent Babson College Entrepreneurship Research Conference. "Companies influence it by their actions."
The researchers found that employee volatility had a negative impact on every company's Paydex score. Revenue volatility, on the other hand, negatively impacted service companies, but helped manufacturing companies. Additionally, the researchers found that service companies with diverse sources of equity financing — such as angel funds, venture capital and private equity — saw a positive boost in Paydex scores, while manufacturing companies saw little boost.
"There are a number of possible explanations," said Jeffrey Sohl, a professor of entrepreneurship and director of UNH's Center for Venture Research. "After all, if you’re jumping up and down, hiring people and laying them off, there are going to be huge costs with training and retraining."
Mark Lange, executive director of the IEGC, said these findings are of particular importance to entrepreneurs and small business owners that often rely on funding and financing to survive and grow.
"This study has a valuable message for entrepreneurs by helping them develop new strategies to position their company for better access to capital," Lange said. "What’s more, the study also helps set the tone for evaluating growth-oriented companies differently. Growth-oriented entrepreneurial firms are often more volatile than stable, moderate growth companies. If the debt-financing world can eventually establish new standards for these risk takers for evaluating creditworthiness, it could signal that we have truly entered an entrepreneurial economy."