Recent Research: The financial constraints entrepreneurs face

What holds people back from starting a business? How does lifting financial constraints help promote entrepreneurship? A recent article by Vyacheslav Mikhed of the Federal Reserve Bank of Philadelphia Consumer Finance Institute,  Sahil Raina of the University of Alberta, and Barry Scholnick of University of Alberta and Federal Reserve Bank of Philadelphia Consumer Finance Institute, explores these questions, and how lifting these economic constraints affected entrepreneurial and self-employed business ventures in Canada from 2002-2016. By comparing lottery winnings to new business endeavors, they found that entrepreneurs face greater financial constraint when starting a business than those who are self-employed.

Perhaps the biggest takeaway is that entrepreneurship faces relatively equal challenges during economic booms and busts. While this seems counterintuitive, there may be an excess of ideas during booms and, therefore, a lack of adequate capital. In the bust cycle, while there is less capital overall, demand for that capital may shrink in these times and businesses may have better chances securing investment against a smaller field. The authors suggest that entrepreneurial support should focus on boosting economic capability in both cycles to ease financial constraints.  

The results show that financial constraints greatly limit the ability to start a business. The wealth shock — in this case the lottery win — proved to be significant, as 0.5 percent of incorporations in 2002-2016 were filed by lottery winners within two years of winning. This is consistent with the authors’ hypothesis that the winner had a viable business idea but lacked the capital to start.

Overall, entrepreneurial businesses increased with lottery wins, but unincorporated or self-employed businesses did not change, therefore indicating that entrepreneurs face greater financial constraints and policy should focus on alleviating said constraints in order to create the entrepreneurial culture necessary for a technology-based economy.