Chapter 2 SME Financing: A Life Cycle Approach Small business may be thought of as having a financial growth cycle in which financial needs and options change as the business grows, gains further experience, and becomes less informationally opaque. [This is modelled] in a stylized fashion in which firms lie on a size/age/information continuum (Berger and Udell 1998, p. 622) 2.1 Introduction The means of finance employed for positive net present value (NPV) projects has important implications for the firm. The cumulative effect of these discrete financing decisions results in the capital structure of the firm, composition of which has long been a focus of research in the corporate finance discipline. Theoretical discourse on the subject originates from the irrelevance propositions of Modigliani and Miller (1958), stating that the capital structure of the firm is independent of its cost of capital, and therefore of firm value. This has spawned a substantial body of theoretical literature and empirical tests, which have focused primarily on the decision to employ debt or equity for investment projects. These studies focus on subjects of agency, signaling, and taxation, typically examining the incremental financing decision. Researchers conducting empirical investigations of SME capital structures adopt theoretical approaches developed in the field of corporate finance. These studies commonly examine determinants of financial resources employed by firms, linking them to firm or owner characteristics (See Appendix B for a review of this literature). Data employed in empirical tests is typically cross-sectional, and firm financing is modelled as a continuous process. Whilst these approaches are valuable, they largely ignore the issue of the sources of finance employed by a firm at various stages of its life cycle, and how the combination of financing changes and evolves across stages of development. This is a very important omission, as a firm’s funding requirements C. Mac an Bhaird, Resourcing Small and Medium Sized Enterprises, Contributions to Management Science, DOI 10.1007/978-3-7908-2399-8_2, # Springer-Verlag Berlin Heidelberg 2010 23