Outside or inside the firm? The impact of debt financing on the exit routes of start-up firms

This study explores the impact of initial debt financing on the survival of start-up firms by identifying three types of exit routes: bankruptcy, voluntary liquidation, and merger. Using a discrete-time duration model for Japanese start-up firms, we examine how debt financing affects the time from founding to exit. We find that firms that initially rely on debt financing from outside creditors are more likely to go bankrupt and that long-term debt, rather than short-term debt, is significantly associated with the time to exit due to bankruptcy. In contrast, such firms are less likely to liquidate voluntarily, and a lower long-term debt ratio is associated with a shorter time to voluntary liquidation. Moreover, they are less likely to exit via merger, and a lower long-term debt ratio is associated with a shorter time to exit via merger. Furthermore, the likelihood of bankruptcy, unlike voluntary liquidation and merger, is influenced by macroeconomic conditions. Does initial debt financing determine the exit routes of start-up firms? Debt financing plays a prominent role in raising funds for small and medium enterprises, especially in bank-centered economies such as Japan. We examine the impact of debt financing on the exit routes of start-up firms by focusing on debt financing from outside or inside the firm. The results reveal that reliance on long-term debt financing from outside creditors increases the likelihood of bankruptcy while decreasing the likelihood of voluntary liquidation and merger. Our findings suggest that reliance on long-term debt financing from outside creditors constrains a firm's strategic options due to ongoing payment requirements and leads to a loss of flexibility in decision-making. Such initial funding dominates the exit routes of firms.