Financing Unquoted High-Growth Companies: From Extending

1988). Retained earnings represent inside equity created by profitable companies (Frank and Goyal,
2005). However, if a company’s growth rate is high relative to its profitability, internal funds may not
be sufficient and external finance will be necessary to support company growth (Smith and Smith,
2000). Hence, scholars generally assume that internal finance will be insufficient to finance a high
growth strategy and that high-growth companies are particularly likely to raise outside debt or equity
finance in order to realize high-growth (Michaelas, Chittenden, and Poutziouris, 1999).
Nevertheless, not all companies will have automatic access to sufficient outside financial resources in
order to carryout crucial investments in tangible and intangible assets needed to achieve high growth.
Given the existence of market imperfections, such as asymmetric information and transaction costs,
external finance is costly, if available at all (Berger and Udell, 1998). Asymmetric information entails
that outside investors have less information about company prospects than company managers. This
implies that external investors do not know whether the investment projects for which companies
search finance are as valuable as managers claim. These information problems are especially
important for uncertain companies, such as young and small companies, which lack a track record of
past performance and where publicly available information is sparse. Investors may require a risk
premium, thereby offering only an “average” price for the securities offered by the company, to
compensate for the risk of selecting companies with poor projects. Moreover, the perceived risk of
adverse selection (i.e., the risk of selection companies with bad projects) may become so high that
investors decide to ration credit to these informationally opaque companies (Stiglitz and Weiss, 1981).
Additionally, public equity and debt finance are subject to significant costs, including market due
diligence, distribution and security registration, which are essentially fixed and create economies of
scale in issue size (Berger and Udell, 1998). These economies of scale in issue create a barrier which
small and young companies may not be able to overcome. Hence, transaction costs make particular
types of external finance extremely costly. Overall, the process of obtaining sufficient outside finance
is a process fraught with difficulties and this especially for new and small ventures.
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