Debt Financing of Small OTC Firms Reporting to the SEC

Although the concept of financial growth cycle proposed by Berger and Udell (1998) is intuitively appealing, empirical evidence has been scarce due to data limitations. In this study, we use a novel data set, small emerging firms trading on the OTC market and filing annual reports with the SEC, to provide empirical support for the financial growth-cycle paradigm. We find that as firms develop and gain track records, their debt usage increases and debt specialization decreases, suggesting a gradual easing of supply-side constraints. Further, positive sales and positive cash flows mark two milestones in debt financing: Positive sales broaden the firms’ access to various segments of the debt market, and positive cash flows deepen their relationships with banks. We also examine binary features of debt in our sample and find that convertible debt peaks when firms start generating sales, and firms increasingly rely on secured debt as they grow.