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Financing Practices and Preferences for Micro and Small Firms

Article in Journal of Small Business and Enterprise Development · February 2013

DOI: 10.2139/ssrn.1683182

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 Financing Practices and Preferences for Micro and Small
Firms

by

Nikolaos Daskalakis*

* Athens University of Economics and Business, 76 Patission Street, GR – 104 34,

Athens, Greece. Tel: 0030 211 4017285, e-mail: ndaskal@aueb.gr
Small Business Institute, 46 Aristotelous Street, GR – 104 33, Athens, Greece. Tel:
0030 210 8846852, e-mail: daskalakis@imegsevee.gr

Electronic copy available at: http://ssrn.com/abstract=1683182

 Financing Practices and Preferences for Micro and Small
Firms

Abstract
In this paper I investigate the level of access of the opaque micro and small firms
to finance. The objective of the paper is threefold: first to analyze how small and
micro firms finance themselves, second to investigate what their financing
preferences are and third to explore their opinions on how they evaluate the financing
sources and the various obstacles to gain access to them. The simultaneous
investigation of these issues reveals valuable information in the well known financing
gap of small enterprises. I use a sample of Greek small and micro firms,
representative of the population of small and micro firms in Greece, which cover
99.6% of the total number of firms operating in Greece. The data are derived from the
answers in a structured questionnaire. The main conclusions are a. regarding equity
financing: firms rely heavily on their own funds however they would not raise new
equity from sources outside the family; thus, there is a reluctance in using new outside
equity (venture capital, business angels and so on) b. regarding debt financing, firms
have limited access to debt but they would use more debt than they currently do; thus,
there is a financing gap in their access to debt finance, c. regarding grant financing,
micro and small firms should be better informed and more encouraged to participate
in state grants and co-financed projects; thus, there is an informational gap in grant
financing.

JEL classification: G3, G32, L26

Keywords: Capital Structure, Micro and Small firms, Survey

This work was supported by the Small Business Institute and was organized and processed by the
author. All errors, omissions and conclusions remain the sole responsibility of the author.

Electronic copy available at: http://ssrn.com/abstract=1683182

 Financing Practices and Preferences for Micro and Small
Firms

1. Introduction
In recent years, small and medium enterprises (SMEs) have gradually raised the
interest of both academics and policy makers questioning the undisputed dominance
of large and multinational firms in the previous decades. Numbers have proven that
SMEs dominate in the general business activity and offer a remarkably large number
of jobs. Specifically, in the European Union, in 2005, SMEs accounted for 99.8% of
the total number of enterprises operating in EU-27, covering 66.7% of total
employment in the non-financial business economy sector1. This increasing attention
is politically illustrated by the European Charter for Small Enterprises, developed
within the Lisbon Growth and Jobs strategy framework and approved by the European
Union in 2000. Recently, another policy tool has been developed by the European
Commission, under the “Think Small First” principle, known as the “Small Business
Act”, recognizing that “…now it is time once and for all to cement the needs of SMEs
in the forefront of the EU’s policy…”2.
Consequently, much of the academic analysis has also been shifted to test the vast
area of SMEs. One of the major topics that has been analyzed is the level of access of
these firms to finance. Several studies demonstrate that SMEs are more financially
constrained than large firms. Beck and Demirguc-Kunt (2006) state that there is
substantial evidence that small firms have less access to formal sources of external
finance. Beck at al. (2006) find that younger and smaller firms report higher financing
obstacles. Beck et al. (2008) conclude that small firms use less external finance,
especially bank finance.
Similarly to the above mentioned studies, the main objective of this paper is to
analyze the level of access to various sources of finance of the small enterprises in
Greece. However, besides conducting the first attempt to investigate access to finance
for small firms in Greece, this paper, according to the author’s knowledge, is the first
to simultaneously tackle and combine the following three important factors for small
firm financing.
1
Statistics in focus 31/2008, EUROSTAT, Enterprises by size class-overview of SMEs in the EU.
2
Commission of the European Communities, A “Small Business Act for Europe”, COM(2008) 394,
Brussels, 19.6.2008.
 First, so far, the main approach of analysts on the issue of SMEs financing is
oriented to the traditional main sources of capital for large enterprises, namely equity
and debt. Theories of capital structure were not developed with the small enterprise in
mind (Ang 1991). Although several authors acknowledge that small businesses are
not “scaled-down versions” of large businesses (Cressy and Olofsson 1997), when
they investigate their capital structure, they focus on the very same sources that large
firms use. The need to incorporate other than the traditional financing sources in the
financing pattern of SMEs is provided by Beck et al. (2008). In this paper I consider
this differentiation of the small business, including distinct sources of funds which are
very important for small firms, namely a. family funds in contrast to funds outside the
family b. the various grants projects developed by the state and c. microloans. To the
author’s knowledge, this is the first attempt to incorporate these sources in the access
to finance issue focusing on the practice of SME financing.
Second, besides analyzing the current capital structure of small firms, I also
investigate the financing preferences of the small entrepreneurs. Specifically, they are
asked to denote how they would finance their investments and daily operations in case
they faced no access constraints. Comparing their preferences with their current
financing, I conclude interesting remarks on the well-known SME financing gap3.
Within the framework of this rationale, the methodology used in this survey includes
a questionnaire in which some questions are designed in a manner that focus on
getting the entrepreneurs’ opinions in various financing issues. Thus, the survey
focuses on shedding some light to the important issue of how the entrepreneurs
themselves evaluate various financing sources and the corresponding obstacles to gain
access to them.
Third, another important consideration that should also be underlined refers to the
sample of the firms studied. Most studies use samples based on the listed firms in a
stock exchange, or use large samples of SMEs without testing population
representativeness of these samples according to any criterion. However, in the case
of large, listed enterprises (which most studies focus on), these firms represent a very
small percentage of the total number of enterprises in the economy, providing
conclusions for a distinct area of entrepreneurship. Beck et al. (2008) denote that due
to data limitations, empirical results are based on analysis of the largest, and perhaps

3
For a detailed both theoretical and empirical approach on the SME financing gap issue, see: OECD,
(2006), The SME financing gap: Theory and Practice.
unrepresentative, firms across countries. In the case of studies in the broader area of
SMEs, there is usually no representativeness test of the sample according to the
population of the economy, raising questions on which exact area the conclusions of
the study may apply to. As a matter of fact, most studies depend on published data
from financial statements; however, the majority of firms are not obliged to prepare
financial statements and these statements are usually prepared by large firms. In this
study, I use a representative sample of enterprises of the Greek economy as a whole,
according to the geographic criterion.
The remainder of the paper is as follows. Section 2 briefly presents some
interesting data on the European and the Greek SME sector. Section 3 provides a brief
background of the financing patterns of micro and small firms. In section 4 I present
the data and the methodology followed. Section 5 presents the empirical results and
section 6 concludes the paper.

2. SMEs in Europe and Greece

As already mentioned, SMEs represent the 99% of the total number of enterprises
in Europe, employing 66,7% of total employment of the private sector. Table 1.1
presents interesting data on numbers and percentages of enterprises and employees
per size for 2005. Enterprises are divided into size groups, according to the definition
of the European Commission4.
The table shows that there are 18 million micro firms in EU-27 that account for
91.8% of the total number of enterprises, offering jobs for 37.510.000 people, namely
the 29.6% of total employment. Adding small firms as well, they both represent
98.7% of the total number of firms, offering half of the jobs. The Greek economy is
based on small firms in even larger figures in terms of total firm numbers and
percentages.

4
Recommendation 2003/361/EC: As from 1 January 2005, the category of micro, small and medium-
sized enterprises (SMEs) is made up of enterprises which employ fewer than 250 persons and which
have an annual turnover not exceeding €50 million, and/or an annual balance sheet total not exceeding
€43 million. Within the SME category, a small enterprise is defined as an enterprise which employs
fewer than 50 persons and whose annual turnover and/or annual balance sheet total does not exceed
€10 million. Within the SME category, a micro enterprise is defined as an enterprise which employs
fewer than 10 persons and whose annual turnover and/or annual balance sheet total does not exceed €2
million.
 Table 1: Numbers and percentages of enterprises and employees per size in EU-
27, 2005

Industry and services1

Enterprises Employees
Number % Number %
Micro firms
(1-9 employees) 18.035.044 91,8 37.510.000 29,6
Small firms
(10-49 employees) 1.353.000 6,9 26.100.000 20,6
Medium firms
(50-249 employees) 213.000 1,1 21.300.000 16,8
Large firms
(250+ employees) 41.000 0,2 41.700.000 32,9
Total
19.647.000 100 126.700.000 100
1
excluding financial intermediation and public
administration
Source: EUROSTAT

Table 2 presents numbers and percentages of enterprises per size in Greece for
2004. Specifically, in 20045 there were 902.631 firms operating in Greece, offering
jobs for approximately 2 million people. The vast majority of them were micro firms
(97.3%), whereas adding small firms as well, they both represent 99.6% of the total
number of firms. Also note that almost 30% of the firms are self-employed persons.

Table 2: Numbers and percentages of enterprises per size in Greece, 2004

Employees per firm Number of firms %
0-4 853.706 94,5
5-9 25.331 2,8
10-19 12.558 1,4
20-29 4.096 0,5
30-49 3.199 0,4
50-99 1.994 0,2
100+ 1.747 0,2
Total number of firms 902.631 100
Source: National Statistical Service of Greece

To sum up, micro and small firms with up to 50 employees represent a very
important area. Their ability to create jobs, their flexibility to adapt easily to the
economic environment and their endurance in unfavourable periods have attracted
several researchers in the recent years. However, this is a vast area, as figures show,
an area to be further explored.

5
The most recent data for the total population of the Greek firms are from 2004.
 3. Financing patterns for micro and small firms
To explore the theoretical base of financing patterns for the small and micro firms,
the staring point is the traditional theories of capital structure determination. Within
this framework the key element is to consider how size may affect financial structure.
Size has been thoroughly investigated as an important determinant of capital structure
by researchers, both on the level of large firms (Marsh 1982, Bennett and Donnelly
1993, Rajan and Zingales 1995, Panno 2003, Ojah and Manrique 2005, for Greece
Eriotis at al., 2007, Vasiliou et al., 2005) and on the level of SMEs (Kotey 1999,
Michaellas et al. 1999, Sogorb-Mira 2005, Garcia-Teruel and Martinez-Solano 2008,
Hernandez-Canovas and Koetter-Kant 2008, for Greece: Daskalakis and Psillaki
2008, Psillaki and Daskalakis 2009). The main finding is that size does affect capital
structure determination; however size is viewed as a determinant in the above
approach, not as a division criterion between large and small firms. Academic
literature has shed some light in recognizing the differences between capital structure
of small and large firms (Petit and Singer, 1985, Chittenden et al. 1996, Cressy and
Olofsson 1997, Jordan et al. 1998, Beck et al. 2008). In the following paragraphs I
summarize the three most important capital structure theoretical approaches, namely
a. the debt tax shield, b. the asymmetric information approach and c. the agency costs
approach, viewed by the scope of micro and small firms.
Applying the debt tax shield approach to micro and small firms, Pettit and Singer
(1985) have argued that tax considerations are of little attention for SMEs because
these firms are less likely to generate high profits and therefore are less likely to use
debt for tax shields. Furthermore, Michaellas et al. (1999) conclude that tax
considerations do not influence the debt level of SMEs. Thus, small and micro firms
are expected to use relatively low debt levels, to avoid potential financial distress
costs.
Regarding the asymmetric information approach, the financing pattern implied by
this approach is the well known pecking order theory, developed by Myers (1984) and
Myers and Majluf (1984). Ang (1991), Holmes and Kent (1991), and Cosh and
Hughes (1994) have emphasized that the pecking order theory can be easily applied in
small and medium sized firms. Specifically, small firms are often opaque and have
important adverse selection problems that result in credit rationing and therefore bear
high information costs (Psillaki, 1995). These costs can be considered nil for internal
funds but are very high when issuing new capital, whereas debt lies in an intermediate
position, through for example asset securitization (Jobst, 2006). Thus, small and
micro firms are expected to rely heavily on internal funds, use lower levels of debt
and avoid external equity financing. Another issue that favors the application of the
pecking order pattern of financing for micro and small firms refers to the “control”
factor. Specifically, in case internal funds are not enough, these firms will prefer debt
to new equity mainly because debt means lower level of intrusion and, most
importantly, lower risk of losing control and decision-making power than new equity.
Agency costs must be carefully considered within the small firm financing
context. Managers of micro and small firms are, most likely, managed by their
owners, and thus there are actually no (or very few) agency costs of equity. On the
other hand, agency conflicts between shareholders and lenders may be particularly
severe, mainly due to firm opaqueness, as Van der Wijst (1989) and Ang (1992) note.
Thus, small and micro firms are expected to use relatively high levels of equity and
low levels of debt.
Summing up the above, micro and small firms are expected i. to rely heavily on
internal equity financing, ii. to generally avoid debt financing, and iii. to use external
equity financing as a last resort.

4. Data and methodology

4.1. Design
Concerning the research methodology followed, I conduct a survey study on the
level of access to various sources of finance of the small enterprises in Greece. The
conclusions are based on the opinions of the respondents in a structured questionnaire,
consisted of 10 questions. The questionnaire is designed according to the special
attributes of the micro and small enterprises. The questions are expressed in such a
way so that they can be comprehensible by people that are not familiar with the
finance terminology and theory. Prior to sending, it was tested by a panel of experts,
resulting in minor adjustments where necessary.
The choice of this type of methodology is not new to the academic field of
finance. Graham and Harvey (2001) were the first to use questionnaire to test several
fields of corporate finance, including the capital structure issue. Their path was
followed by Bancel and Mittoo (2004) and Brounen, de Jong and Koedijk (2006) for
European firms and Vasiliou and Daskalakis (2009) for firms in Greece. However, all
these studies focus on large firms, most of them listed in stock exchanges.
 I chose to use this type of methodology for the following three reasons: a. the lack
of quantitative published data for most of the small firms in Greece, b. the inherent
advantages of the survey-based methodology and c. the study design itself, regarding
the analysis of financing preferences of the small firms.
Regarding the first reason, my main goal was to conduct a study that could lead to
results and conclusions that could be expanded to all firms operating in Greece.
However, from the total firm population only 5% (approx. 45.000 firms) are limited
liability companies that are obliged to prepare and publish financial statements. Thus,
quantitative data for the remaining 95% are actually nonexistent. The lack of data
from published financial statements holds for other European countries as well,
though at a lower extent, as the legal form of sole proprietorship, that generally does
not obligate firms to conduct and publish financial statements, covers high
percentages of the firm population in state members6. Thus, a survey-based
methodology is perhaps the only way to gather data in order to explore how firms that
do not publish financial statements decide on financing practices.
Regarding the second reason, there is a plethora of inherent advantages of this
type of methodology. The most important advantages are the following: a. important
information can be gathered that is not available from published data, b. data is not
distorted from practices like for example “creative accounting” and c. compared to
other field studies (i.e. interviews and observation) bias is reduced and data are more
objective. However, survey methodology does have potential problems. Graham and
Harvey (2001) refer to the following potential problems: a. surveys measure beliefs
and not necessarily actions, b. survey analysis faces the risk that the respondents are
not representative of the population of firms and c. survey questions may be
misunderstood. I try to consider all these three issues, as described in the following
sections.
Regarding the third reason, one of the main concerns of the study is to analyze the
financing preferences of the respondents. “Preferences” refer to qualitative
information that cannot be gathered through data from published financial statements.
The other was to analyze the firms’ actual level of access to finance. Thus, the study
design itself requires information that can be gathered only by applying a field study.

6
According to the Eurostat database, almost half of the European firms are sole proprietorships,
ranging from 18.8% in Luxemburg and 25.9% in the UK to 82.4% in the Czech Republic and 95% in
Greece.
 4.2. Delivery and response issues
Delivery and response issues were organized as follows: A list of 567 firms was
given to four graduate students, who were asked to contact firms and ask them to fill
in the questionnaire through the telephone communication. This way, the risk that
survey questions may be misunderstood is minimized. Furthermore, telephone contact
increases the probability that the person to whom the questionnaire is aimed at, will
fill in the questionnaire, compared to other contact methods like mailing or e-mailing
the questionnaire.
The survey period lasted one month, (01.09.2008-01.10.2008). The final sample
of the study consists of 191 small firms in Greece. The most important non-response
reason is the unwillingness to answer to the questionnaire (40.1%) followed by lack of
time (27.1%).

4.3 Summary statistics and data issues

Table 3 presents the sample demographics.

Table 3: Sample demographics

Number % of total Number % of total
Employment One employee 56 29,3% Industry Wholesale and retail comerce 93 48,7%
2-3 employees 86 45,0% Manufacturing 51 26,7%
4-5 employees 26 13,6% Construction 15 7,9%
6-9 employees 8 4,2% Hotels and restaurants 11 5,8%
10-19 employees 11 5,8% Real estate 10 5,2%
20-49 employees 4 2,1% Transports and communication 4 2,1%
Total 191 100% Entertainment, sports 3 1,6%
Health and social care 2 1,0%
Turnover Up to €50 thou 76 40,0% Education 2 1,0%
€51 thou -100 thou 41 21,6% Total 191 100,0%
€101 thou - €200 thou 26 13,6%
€201 thou - €500 thou 23 12,0% Age of 1-3 years 25 13,1%
€501 thou -€1 m 12 6,4% company 4-10 years 47 24,7%
€1 m + 12 6,4% 11-20 years 53 27,7%
Total 191 100% 21-40 years 56 29,3%
40 + years 10 5,3%
Total 191 100%
Financing Yes 87 45,6%
Adequacy No 98 51,3% Owner - Yes 182 95,2%
Missing 6 3,1% Manager No 9 4,8%
Total 191 100% Total 191 100%

The sample firms are mostly (92.1%) micro firms (up to 9 employees), reflecting
the business environment in Greece and in Europe as well. Note also that almost one
third of the respondents (29.3%) are self-employed entrepreneurs, reflecting the
general situation in Greece. I take under serious consideration this sample sub-group;
an employer should be distinguished from a self-employed person. According to
Henley (2005), the transition from sole-trader to employer of others may be a
significant one, as it involves substantial adjustment costs, notably in having to
manage the payment of labor taxes and social insurance contributions, and in having
to gain awareness of employment legislation. Thus, I also analyze how self-
employment financing practices differ from micro and small firm financing.
In terms of sales revenue, more than half of the firms (61.6%) denoted that their
sales were less than €100,000. Regarding the industry coverage, I deliberately left
some specific industries out of the survey, namely the primary production
(agriculture, animal husbandry, fishery and mining) and financial and leasing firms,
because these industries have special financing characteristics that might distort the
results and conclusions of the survey. Almost half of the sample firms (47%) are
operating in the wholesale and retail commerce and the second industry in the
hierarchy is manufacturing (26.7%).
Companies can be considered as being rather established, as most of them operate
for more than 4 years (89.9%), which is important in terms of having gained enough
access to finance to be able to operate for a long period of time. An important, though
rather expected, characteristic is that in most of the firms (95.2%), the owner of the
firm is also the manager; this actually cancels the agency costs of equity capital
structure theoretical approach.
Financing adequacy is actually a question that is presented in this section for
disposition issues regarding the structure of the paper. The question asks the
entrepreneurs whether they consider their financing to be adequate according to their
needs. The qualitative information of this question is crucial, because the behavior of
the entrepreneur that denotes that his financing is adequate to cover his needs, may be
completely different from the behavior of the entrepreneur that is in need of further
financing. The analysis of this question shows that the answers are split almost in the
middle. There were 6 entrepreneurs (3.1%) that did not answer the question. From the
remaining 185 respondents, 87 of them (45.6%) denote that their needs are covered by
their current financing, whereas the remaining 98 denote that their financing is not
adequate. Last, it is important to underline that the sample is representative of the
population according to the geographic criterion, as explained in the Appendix.
 5. Results and Discussion
The results of the survey are separated into three distinct categories. In the first
category I analyze how small and micro firms finance themselves, in the second
category how they would prefer to finance their operations and investments and in the
third category how they evaluate the financing sources and their access to them. For
each question that is structured upon using the Likert scale, I calculate the “mean
score” as a measure of significance. I also separate the sample in two groups, using
the following criteria:
1. Based on the level of employment, into “self-employed” and “employers”.
2. Based on their financing adequacy, into firms for which financing is
adequate and those that their financing is not adequate.

5.1. How do micro and small firms finance themselves?

Entrepreneurs are asked to denote their use of short-term debt and long-term debt,
revealing information about their current financial structure (Table 4).

Table 4: Financial structure

Number % of total
Short-term debt No short-term debt 108 56,7%
to total assets 0.1%-20% 11 5,9%
20.1%-40% 3 1,6%
40.1%-60% 1 0,5%
60.1%-80% 1 0,5%
80.1%-100% 0 0,0%
I do not know 66 34,8%
Total 191 100%

Long-term debt No long-term debt 99 51,6%

to total assets 0.1%-20% 7 3,7%
20.1%-40% 0 0,0%
40.1%-60% 1 0,5%
60.1%-80% 2 1,1%
80.1%-100% 1 0,5%
I do not know 81 42,6%
Total 191 100%

There are two main conclusions from the analysis of the firms’ capital structure.
First, entrepreneurs seem to avoid both short- and long-term debt, as more than half of
them do not use either short-term debt (56.7% or 106 entrepreneurs) or long-term debt
(51.6% or 97 entrepreneurs). Second, entrepreneurs denote that they “do not know”
the debt to total assets ratio. This means that they do use debt, however they either do
not know the exact debt to total assets ratio, or that they are confused in classifying
their debt into short- or long-term. For example, traditional types of short-term debt
are provided to them by the banks as long-term debt, confusing the entrepreneurs
about the classification of their debt.
I also calculated correlation coefficients between each financial structure variable
and the main demographic variables to capture their interrelationships (Table 5).
Regarding the two financial structure variables, the answers “I do not know” have
been removed before calculating the correlations.

Table 5: Correlation coefficients

Age of Short-term debt Long-term debt to

Employment Turnover company to total assets total assets
Employment 1.000 0.535** 0.168* -0.147* 0.011
Turnover 1.000 0.207* 0.096 0.183*
Age of company 1.000 -0.154* -0.178*
Short-term debt to total
1.000 0.785**
assets
Long-term debt to total
1.000
assets
**. Correlation is significant at the 0.01 level (2-tailed).
*. Correlation is significant at the 0.05 level (2-tailed).

The correlation coefficients reveal some interesting information. First, it is rather

expected that bigger firms in terms of employment tend to present higher turnover.
Furthermore, the longer a firm operates, the bigger it is (in terms of both turnover and
employment), however, the less debt it seems to use. This is consistent with other
empirical findings (Hyytinen and Pajarinen, 2007, Pfaffermayr et al, 2008) and is
explained by the fact that younger firms usually lack sufficient internal funds. Thus
rely more on debt than older ones.
Another important conclusion is that smaller firms in terms of employment seem
to use more short-term debt than larger firms and simultaneously, larger firms in
terms of turnover seem to use more long-term debt than smaller firms. Another
important finding is the very high correlation coefficient (0.785) between the two
financial structure variables. This finding leads to the conclusion that firms that use
short-term debt seem to use long-term debt as well, and simultaneously firms that do
not use short-term debt tend not to use long-term debt as well. Thus, it seems that
firms either do not use no debt at all, or they have developed relationships with banks
that drive them to use both long-term and short-term debt.
The main conclusion of the preceding analysis is that equity financing is very
important to small firms, much more important than debt. Small firms do not have
access to financial markets, thus their equity comprises mainly by own funds (or
family funds) and by subsidies/grants received by the state. Considering that own
funds are a priori the main financing equity source, entrepreneurs are asked to denote
whether they have applied for financing to the government bodies7 that offer
subsidies/grants (table 6)8. The results show that almost 4 out of 10 firms have applied
for state subsidies/grants and almost 60% of these applicants have succeeded in
raising funds.

Table 6: Application and success rates of state grants

Number % of total
Application Have applied 74 39,0%
for state grants Have not applied 117 61,0%
Total 191 100%

Success in Have succeded 44 59,0%

application Have not succeded 30 41,0%
Total 74 100%

Regarding the reasons why most of the entrepreneurs did not apply for
government grants, answers are split mostly on two groups: either they did not know
one of the bodies or the programs they offered, or they did not have to apply due to
several reasons (for example, it did not concern them, they did not have the
qualifications and so on). Other reasons such as that they think that the procedures are
time consuming and that they believe they would have little chances are not so
important.

7
The four most important government bodies that have developed subsidies/grants are: a. “Manpower
Employment Organization” (OAED), b. “Hellenic Organization of Small and Medium Enterprises and
Handicraft” (EOMMEX), c. “The Development Law” and d. “Credit Guarantee Fund for Small and
Very Small Enterprises” (TEMPME). Other grants are included in the category “Other co-financed
projects”. Thus, all grants are included.
8
Venture capital financing is also considered as an alternative source for equity financing. However,
venture capital financing is underdeveloped in Greece.
 5.2. How would micro and small firms finance themselves?
Financing preferences often differ from the actual practice of financing. Bearing
in mind that small entrepreneurs face severe difficulties in gaining access to finance,
analyzing preferences and comparing them with practice reveals valuable information
for the financing gap of the small entrepreneur. I distinguish between investment and
operating activities and ask entrepreneurs how they would rank the main financing
sources of funds, in terms of preference. Tables 7 and 8 present the results of their
rankings regarding their choice to finance investments and operating activities
respectively.

Table 7: Rankings of financing preferences for investments

Employment Financing adequacy

Ranked as first
choice (191) Self-employed Employers Yes No
(56) (135) (87) (98)
Long-term bank 65 16 49 29 36
debt (34.03%) (28.57%) (36.30%) (33.33%) (36.73%)
Equity Reserves 40 10 30 23 16
(past profits) (20.94%) (17.86%) (22.22%) (26.44%) (16.33%)
New equity from
23 10 13 6** 17**
family (includes
(12.04%) (17.86%) (9.63%) (6.90%) (17.35%)
own funds)
Short-term bank 17 6 11 8 9
debt (8.90%) (10.71%) (8.15%) (9.20%) (8.16%)
New equity 4 1 3 3 1
outside family (2.09%) (1.79%) (2.22%) (3.45%) (1.02%)
** denotes a significant difference at the 5% level.

For both tables, the first column describes the various financing sources and the
second column depicts the number of entrepreneurs that rank each financing source as
their first choice. For example, 65 of 191 entrepreneurs (or 34.03%) denoted that they
would choose long-term bank debt as their first choice to finance their investments. In
columns 3-4 and 5-6, the sample is separated into two groups, based on the
employment and financing adequacy criteria respectively. For each group I present
the number of the entrepreneurs belonging in this group that would choose the source
as a first choice, and the respective percentage. For example, 16 of the total 56 self-
employed (or 28.57%) would choose long-term bank debt as their first choice to
finance their investments. Similarly, 17 of the 98 entrepreneurs (or 17.35%) that
denoted that their current financing is not adequate, would choose to raise new funds
from their family as their first choice to finance their investments. To test statistical
difference in the answers between each group of respondents, I calculate the chi-
square, based on the percentages, testing the null hypothesis that both percentages are
equal.
The results show that entrepreneurs seem to prefer debt from equity. Specifically,
considering that equity consists of old equity (reserves) and new equity (from family
and outside family), and debt consists of short-term and long-term debt, 82
entrepreneurs (42.93%) prefer debt as a first choice to finance their investments and
67 entrepreneurs (35.07%) would choose equity financing.
Focusing in each financing source separately, long-term bank debt has the highest
percentage (34.03%) as a first choice of investment financing, followed by equity
reserves (20.94%) and new equity from family (12.04%).
Self-employed seem to prefer new equity from family to a larger extent when
compared with employers. It also seems reasonable that entrepreneurs with adequate
financing would use more equity reserves than entrepreneurs that do not cover their
financing needs. However, the only statistically significant difference calculated
refers to the financing adequacy criterion, where entrepreneurs that do not cover their
financing needs, would use new equity from family to a larger extent than
entrepreneurs who possess adequate funds.
I also test statistical difference between each pair of consecutive sources (for
example between long-term bank debt vs. equity reserves), using the chi-square test.
Specifically, the null hypothesis is that there is no difference between each financing
source of each pair in terms of preference. Thus, in case x firms have ranked two
sources as a first choice, then, the expected N for both sources will be x/2. Using the
chi square, I test the probability the observed N for each source of a pair to be
statistically different from the expected N.
Regarding the investment financing preferences, the pairs of consecutive sources
that are analyzed are the following:
a. Long-term bank debt vs. Equity reserves as a first choice
b. Equity reserves vs. New equity from family as a first choice
c. New equity from family vs. short-term bank debt as a first choice
d. Short-term bank debt vs. New equity outside family as a first choice
Table 8 presents the results of the first pair of consecutive sources.
 Table 8: Chi - square test results for the pair:
Long-term bank debt vs. Equity reserves as a first choice
Observed Expected
N N Residual
Long-term bank debt as a first choice 65 52.5 12.5
Equity reserves as a first choice 40 52.5 -12.5
Total 105

Chi-Square 5.952a
Degrees of freedom 1
Probability 0.015
a
0 cells (0%) have expected frequencies less than 5.

Following the same procedure, the chi-square values and the corresponding
probabilities all pairs are:
Pairs of consecutive sources Chi-square Probability
a. Long-term bank debt vs. Equity reserves as a
5.952 0.015**
first choice
b. Equity reserves vs. New equity from family as
4.587 0.032**
a first choice
c. New equity from family vs. short-term bank
0.900 0.343
debt as a first choice
d. Short-term bank debt vs. New equity outside
8.048 0.005***
family as a first choice
***, ** denote a significant difference at the 1% and 5% level respectively.

According to the results, the null hypothesis that there is no statistically significant
difference between each group of the pair is rejected for the first two and the last pair
of sources, so firms do seem to prefer a. long-term bank loan from equity reserves, b.
equity reserves from new equity from family, and c. short-term bank debt from new
equity outside family. The results show that there seems to be a clear hierarchy
between the first three financing sources preferred as a first choice.
Entrepreneurs’ preferences seem to be different on the issue of financing their
operating activities, where the importance is shifted from debt to equity (Table 9).
Specifically, 156 of them (81.67%) denote as their first choice equity sources,
whereas only 22 of them (11.51%) would choose debt first. Focusing in each
financing source separately, equity reserves has the highest percentage (52.88%) as a
first choice of operating activities financing, followed by new equity from family
(28.27%) and long-term bank debt (7.85%). Self-employed seem to rely on new
equity from family to a larger extent than employers, keeping in line with their
 investment financing preferences. There do not seem to emerge any noteworthy
results from the financing adequacy criterion.

Table 9: Rankings of financing preferences for operating activities

Employment Financing adequacy
Ranked as first Self-employed Employers Yes No
choice (191) (56) (135) (87) (98)
Equity Reserves
101 (52.88%) 27 (48.21%) 74 (54.81%) 49 (56.32%) 50 (51.02%)
(past profits)
New equity from
family(includes 54 (28.27%) 21 (37.50%)* 33 (24.44%)* 25 (28.74%) 28 (28.57%)
own funds)
Long-term bank
15 (7.85%) 4 (7.14%) 11 (8.15%) 6 (6.90%) 9 (9.18%)
debt
Short-term bank
7 (3.66%) 1 (1.79%) 6 (4.44%) 1 (1.15%) 6 (6.12%)
debt
New equity
1 (0.52%) 0 (0.00%) 1 (0.74%) 1 (1.15%) 0 (0.00%)
outside family
Overdraft 0 (0.00%) 0 (0.00%) 0 (0.00%) 0 (0.00%) 0 (0.00%)
* denotes a significant difference at the 10% level.

I also test statistical difference between each pair of consecutive sources following
the same procedure the chi-square values and the corresponding probabilities all
consecutive pairs, regarding the operating activities are:
Pairs of consecutive sources Chi-square Probability
a. Equity reserves vs. New equity from family as
14.252 0.000***
a first choice
b. New equity from family vs. Long-term bank
22.043 0.000***
debt as a first choice
c. Long-term bank debt vs. short-term bank debt
2.909 0.088*
as a first choice
d. Short-term bank debt vs. New equity outside
4.500a 0.034
family as a first choice
e. New equity outside family vs. Overdraft as a There are not enough valid cases for
first choice processing. No statistics are computed.
a
2 cells (100,0%) have expected frequencies less than 5. The minimum expected cell frequency is 4.0.
***, * denote a significant difference at the 1% and 10% level respectively.

According to the results, the null hypothesis that there is no statistically significant
difference between each group of the pair is rejected for the first two pairs of sources,
so firms do seem to prefer a. equity reserves from new equity from family and b. new
equity from family from long-term bank debt.
Comparing the answers for investment and operating activities financing, the main
conclusion is that entrepreneurs seem to rely mostly on equity reserves to cope with
their daily operations, whereas they would choose mainly long-term debt to finance
their investments. It is important to denote that from the 97 entrepreneurs that do not
use long-term debt in their current capital structure, 23 of them would use it as a first
choice and 7 of them as a second choice to finance an investment. Thus, there is
indeed a financing gap between how entrepreneurs would finance their investments
and how they are currently using the financing sources. Another important result is
that they seem to avoid raising new equity funds outside family, leading to the
conclusion that they are most probably interested in preserving the control of their
business, an implication that is very strong for small firms in general.

5.3. How do entrepreneurs evaluate the financing sources and their access to
them?
I ask entrepreneurs questions regarding access issues to both equity and debt
sources. As far as access to equity financing is concerned, they are asked to evaluate
the importance of the government bodies in facilitating access to finance. The results
are presented in Table 10.
Entrepreneurs are asked to evaluate the importance of the government bodies in
facilitating access to finance, on a scale from 1=Not important at all to 5=Very
important. Thus, the mean score shows how they evaluate the government bodies9.
Self-employed entrepreneurs evaluate the government bodies as being more important
than employers do; however the difference is not statistically significant. An
important result is that entrepreneurs that consider their financing being adequate
evaluate the government bodies as being more important than those that their
financing is not adequate.

Table 10: Evaluation of government bodies

Employment Financing adequacy

Mean
Self-employed Employers Yes No
(56) (135) (87) (98)
Government bodies 3.07 3.22 3.01 3.30** 2.92**
** denotes a significant difference at the 5% level.

9
The “government bodies” category contains the evaluation of all bodies (OAED, EOMMEX,
Development Law, TEMPME and Other co-financed projects) on an average basis for each
entrepreneur.
 A deeper analysis is conducted in the case of access to debt financing. First, I ask
entrepreneurs whether they think that access to debt financing today is hard or easy in
general, and harder or easier compared to the past (Table 10). Second they are asked
to denote whether they agree (on a Likert scale) on some obstacles to debt financing
(Table 11).
Table 11: Access to debt financing

Employment Financing adequacy

Mean
Self-employed Employers Yes No
(56) (135) (87) (98)
Access to debt
3.70 3.64 3.73 3.87** 3.54**
financing today
Access to debt
financing compared 4.03 4.12 3.99 4.07 4.01
with the past

According to the respondents’ answers, access to debt financing today is easy, and
much easier than before. These answers are not compatible with the recent financial
crisis that resulted in decreased liquidity by the financial institutions. Possible
explanations about these answers are the following. First, the survey took place during
1st and 31st of September 2008, when although the worldwide financial crisis had
already been spread to the financial system, it had not yet made the Greek financial
institutions to be reluctant in providing debt. Furthermore, there is always a lag
between the consequences of the decisions of the financial institutions to reduce their
loans to firms and the firms’ realization of this decision. Thus, it is very probable that
the firms’ past experience regarding access to debt financing was shaped at a long-
term perception, where indeed the five years before the financial crisis took place,
their access to debt financing was considerably improved. Regarding the sample
groupings based on the employment and the financing adequacy criteria, it is worth
noting that entrepreneurs with adequate funds regard access to debt financing today as
being relatively easier when compared with entrepreneurs with uncovered financing
needs.
Regarding the obstacles to debt financing (Table 12), small entrepreneurs consider
high interest rates as being the most important obstacle. Loans to small entrepreneurs
indeed bear relatively high interest rates, due to several reasons that have already been
highlighted in the literature, reflecting the higher risk of small enterprises caused by
the firms’ opaqueness and their low collateral. Thus, this first place is rather expected.
 Table 12: Obstacles to debt financing
Financing
Employment
adequacy
Mean Self-employed Employers Yes Yes
(56) (135) (87) (98)

Interest rates are too high 4.27 4.25 4.27 4.18 4.36

Loan procedures are exaggerating 3.88 3.89 3.88 3.91 3.88

There are no attractive financial 3.80 3.86 3.77 3.75 3.86
tools for small firms
Banks are not willing to bear the 3.70 3.76 3.68 3.60 3.81
risks that a small firm involves
Banks require too high collateral to 3.65 3.61 3.66 3.60 3.74
approve a loan
Banks require too much
3.57 3.70 3.51 3.47 3.66
information to approve a loan
The period between the agreement
and the granting of the loan is too 2.90 3.00 2.86 2.75 3.04
long

However, the interesting conclusion of this hierarchy is that entrepreneurs care

about the outcome of the risk they carry, denoting high interest rates as the most
important obstacle, whereas evaluating less the causes of this outcome, like the risk,
collateral and information “variables”. The second, most important obstacle to debt
financing according to the entrepreneurs is the exaggerating loan procedures, which
reflects the high burden of bureaucracy that they feel they have to deal with. Bearing
in mind that the business environment in general in Greece suffers indeed from high
levels of bureaucracy, small entrepreneurs view the loan procedures as another source
of bureaucratic burden that they would like to avoid. Another important finding is that
small entrepreneurs denote that there are no several attractive financial tools for small
firms. Sample groupings did not result in any important differentiation in the
respondents’ answers.
The last two questions refer to the use of micro loans (<€25.000). First I asked
entrepreneurs whether during the last three years they have applied for a microloan.
Almost 20% of the respondents denoted that they have applied for a micro loan during
the last three years (table 13).
Although this 20% seems rather low, bearing in mind that almost half of the small
firms do not enter the credit market, the final conclusion is that almost half of the
small entrepreneurs seem to ask for microcredit. Thus, microcredit is indeed
important for small entrepreneurs. As a matter of fact, this need for micro loans has
already been explored by the European Commission (EC), resulting in the JEREMIE
initiative, which is a joint initiative of the EC and the European Investment Fund with
the European Investment Bank aiming to improve access to finance for micro to
medium-sized enterprises and in particular the supply of microcredit.

Table 13: Answers to the question: “Have you applied for a micro loan during the last
three years?”
Number % of total
Micro-loan Yes 32 17,0%
application No 149 78,0%
Missing 10 5,0%
Total 191 100%

The last question of the questionnaire asks entrepreneurs to evaluate possible

advantages that favor their choice of a micro loan (table 14). Safer and quicker loan
pay-back is the most important reason for entrepreneurs regarding their choice of a
microloan, followed by less collateral, quicker loan procedures and simpler loan
procedures. An important conclusion is that self-employed persons seem to evaluate
all reasons much more importantly than employers.

Table 14: Answers to the question: “How important are the following reasons that
would lead you choose a microloan”
Financing
Employment
adequacy
Mean
Self-employed Employers Yes No
(56) (135) (87) (98)
Safer and quicker loan
4.05 4.33*** 3.93*** 3.94 4.15
pay-back
Less collateral 3.70 3.92* 3.61* 3.63 3.79
Quicker loan procedures 3.61 3.82* 3.53* 3.52 3.71
Simpler loan procedures 3.59 3.90*** 3.46*** 3.50 3.70
*, *** denote a significant difference at the 10% and the 1% level respectively.

6. Conclusions
The paper investigates financing issues regarding the vast area of the micro and
small firms (< 50 employees). These firms represent a 98.7% of the total number of
firms in Europe, offering half of the jobs. Despite their importance, they have not yet
been thoroughly investigated, mainly due to data limitations. The research field refers
to their level of access to various sources of finance, which is one of the most
important obstacles that small entrepreneurs have to deal with. Micro and small firm
financing differs from the typical financing pattern of large firms. The need to
incorporate other than the traditional financing sources in the financing pattern of
SMEs is illustrated in Beck et al. (2008). In this paper, I bear in mind these
differentiations focusing on the financing practices of micro and small firms.
Furthermore, except for the financing practices, I also investigate the financing
preferences of small entrepreneurs, aiming at the exploration of the well-known
financing gap for micro and small firms.
Concerning the research methodology followed, I conduct a survey study on the
level of access to various sources of finance of the small enterprises in Greece. The
conclusions are based on the opinions of the respondents in a structured questionnaire,
which consists of 10 questions. Specifically, I use a sample of Greek small and micro
firms, representative of the population of small and micro firms in Greece, according
to the geographic criterion. The main conclusions of the survey are categorized into
three distinct groups: a. regarding equity financing, b. regarding debt financing and c.
regarding grant financing.
Regarding equity financing, firms seem to rely heavily on their own funds,
however they would not raise new equity from sources outside the family. Thus, there
is a reluctance in using new outside equity (venture capital, business angels and so on.
Regarding debt financing, firms have limited access to debt but they would use more
debt, specifically long-term debt, than they currently do. Thus, there is a financing
gap in their access to long-term debt financing. Regarding grant financing, micro and
small firms should be better informed and more encouraged to participate in state
grants and co-financed projects; thus, there is an informational gap in grant financing.
Relating financing practices with theoretical approaches, there is strong evidence
that micro and small firms follow the pecking order financing approach, which can be
explained by the relatively high agency costs of debt and the fear of losing control in
case of external equity (funds outside the family). Furthermore, the tax-shield factor
does not seem to influence financing practices. However, it should be noted that small
entrepreneurs would use higher long-term debt levels than they currently do, implying
difficulties in gaining access to this source of financing.
 The study covers a rather broad area of financing sources that could be further
explored. For example, grant financing in micro firms could be explored in terms of
efficiency. Further research could also focus on simultaneously investigating large
and small firms, or in investigating potential differences within the broad SMEs
definition, namely differences between micro, small and medium firms. There can
also be industry studies. Nevertheless, the area of small firms is vast and small firms
are indeed important. Thus, it is important to start getting to know them in the level
we already know large firms.

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Appendix
Sample representativeness
The sample is representative of the population of all Greek micro and small firms,
according to the geographic criterion, applying the chi-square goodness-of-fit test.
Specifically, I group the sample firms that belong in the same geographic group and I
compare them with their weighted value of the population. Next, the chi-square test is
applied to test the differences between the observed and the expected weighted
frequencies (Table A.1).

Table A.1
Number of sample firms and weighted values of population firms belonging in
each geographic group
Geographic groups Observed Expected weighted Residuals
frequencies frequencies
East Macedonia and Thrace 11 9,0 2,0
Central Macedonia 36 32,9 3,1
West Macedonia 7 5,4 1,6
Thessaly 14 11,7 2,3
Epirus 8 5,8 2,2
Ionian Islands 7 5,7 1,3
West Greece 11 10,1 0,9
Central Greece 11 8,7 2,3
Peloponnese 7 9,7 -2,7
Attica 50 68,9 -18,9
North Aegean 4 3,5 0,5
South Aegean 11 8,2 2,8
Crete 14 11,4 2,6
Total 191

Statistical test
Chi-Squarea 11,073a
Degrees of freedom 12
P-Value 0,523
a
1 cell (7.77%) has expected frequency less than 5.

The results show that the null hypothesis cannot be rejected. Thus the sample is
representative of the population according to the geographic criterion.

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