The Capital Structure Decisions of Nascent Firms * Alicia M. Robb UC Santa Cruz David T. Robinson Duke University October 22, 2008 Abstract This paper investigates the capital structure choices that firms make in their initial year of operations, using restricted-access data from the Kauffman Firm Survey. Contrary to many accounts of startup activity, the firms in our data rely heavily on external debt sources such as bank financing, and less heavily on friends and family-based funding sources. This striking fact holds even when we instrument for credit supply by purging each firm’s Dun and Bradstreet credit score of variation that owes to demand-side credit characteristics. The heavy reliance on external debt underscores the importance of well functioning credit markets for the success of nascent business activity. 1 Introduction Understanding how capital markets affect the growth and survival of nascent firms is perhaps the central question of entrepreneurial finance. Yet, most of what we know about entrepreneurial finance comes from firms that have already received venture capital funding, or are on the verge of going public—the dearth of data on very early stage firms makes it difficult for researchers to look further back in firms’ life histories. Even data sets that are oriented towards small business do not allow us to systematically measure * The authors are grateful to the Kauffman Foundation for generous financial support and to the participants at the Kauffman/JMCB Entrepreneurial Finance conference for helpful comments on an earlier draft. The usual disclaimer applies. 1