1

Running Head: Research Proposal

Topic: The relationship between the capital structure and lifecycle of SMEs in
UK
[Name of Student]
[Name of Institute]

2
Running Head: Research Proposal

Table of Contents
1.0.Background of study............................................................................................. 3
1.1. Research aim.................................................................................................... 3
1.2.Research objectives........................................................................................... 4
1.3.Research Questions........................................................................................... 4
2.0. Literature review................................................................................................. 4
3.0. Research hypothesis............................................................................................ 7
3.1. Other tax benefits beyond debt.......................................................................7
3.2. Research design............................................................................................... 7
3.3. Secondary data................................................................................................ 7
4.0. Qualitative research............................................................................................ 8
4.1. Data collection................................................................................................. 8
5.0. Expected findings................................................................................................ 8
6.0. Conclusion......................................................................................................... 10
7.0. References......................................................................................................... 12

3
Running Head: Research Proposal

1.0. Background of study

The capital structure of a company changes over its life cycle, result of the
financing needs may change with the evolution over life cycle (Schock,
Flotow and Taube, 2013). The study of decisions SME financing should be
related to the stage of the life cycle in which the company is (Ayed and
Zouari, 2014). From initial creation to the stage maturity of the company, its
financial needs change according to their ability to generate cash flow, their
opportunities growth and the risk of carrying them out. This is reflected in
the evolution of preferences by financing and the nature of the financial
choices that businesses make during their life cycle. SME companys in the
early stages of their life cycle tend to have higher levels of asymmetry of
information, more opportunities for growth and small size, this sense should
apply appropriate financing strategies at different stages of their life cycle
(Ayed and Zouari, 2014).
Walker (1989) sought to identify the characteristic financial problems of each
phase of life cycle of SMEs, along the lines of Churchill and Lewis (1983).
According to Walker (1989), as SMEs progress in the life cycle phases achieve
access to new CP and long-term financing forms, getting the opportunity to
participate in of broader financial market segment. SMEs go through various
stages throughout their life cycle, so there may be a number changes in the
company's capital structure, as the phase of the life cycle in which company
is (Ang, 1991). According to the same author in creating SME stage, the
primary sources of capital are based on the personal assets of business
owners, friends and family of entrepreneurs. The studies Fluck et al. (1998)
and Berger and Udell (1998) show that external sources of financing beyond
the domestic sources in the creation phase of company with financing
through financial institutions. According Keasey, Pindado and Rodrigues
(2015), is not expected in the early stages of the life cycle funding is

4
Running Head: Research Proposal

obtained from financial institutions, due to problems of informational opacity

that are particularly relevant in this life stage. And also according to the
same authors, companies not constituted sufficient guarantees in the form of
assets to ensure the financing. Thus, when financial institutions finance SMEs
require to owners to personally guarantee the loan to protect institutions in
case non-compliance by firms (Berger and Udell, 1998).
1.1. Research aim
The aim of the research is to examine the relationship between the capital
structure and lifecycle of SMEs in UK.
1.2. Research objectives
To investigate the relationship between life cycle and capital structure.
To analyze the relation between the level of debt and the determinants

of capital structure of SMEs

To evaluate the contribution of capital structure theories for explaining

financing decisions SMEs in UK

To characterize the SME financing behavior throughout their cycle life
To identify the life cycle which helps to explain the behavior SME

financing
To evaluate the differences between the determinants of capital

structure over the phases of the life cycle of SMEs in UK.

1.3. Research Questions
How to explore the relationship between life cycle and capital

structure?
How to analyze the relation between the level of debt and the

determinants of capital structure of SMEs

How to evaluate the contribution of capital structure theories for

explaining financing decisions SMEs in UK

How to characterize the SME financing behavior throughout their cycle

life
How to identify the life cycle which helps to explain the behavior SME

financing
How to evaluate the differences between the determinants of capital
structure over the phases of the life cycle of SMEs in UK.

5
Running Head: Research Proposal

2.0. Literature review

According to Black (1998), the theory of the business life cycle is an
extension of cycle theory product life, which evolves from the academic
disciplines of marketing and microeconomics (Rink and Swan, 1982). In this
view the company as well as products or services, normally progress through
the following stages of the life cycle: start-up (birth), growth, maturity and
decline (Scholtens, 1999). There are several models of lifecycle that have
been proposed by various authors, considering that any company regardless
of their size, tend to go through several phases / stages over their life cycle
(Adizes, 1979; Kimberly and Miles, 1980; Scott and Bruce, 1987; Davies and
Gibb nineteen ninety; Dodge and Robins, 1992; Berger and Udell, 1998).
The number of stages in the life cycle is no consensus among researchers,
some authors have proposed models life cycle with three phases (Smith et
al, 1985), four (Quinn and Cameron, 1983; Kazanjian, 1988; Kazanjain and
Drazin, 1989, Dodge and Robbins, 1992), five (Greiner, 1972; Churchill and
Lewis, 1983; Miller and Friesen, 1984; Scott and Bruce, 1987), and ten layers
(Adizes, 1979). According Gup and Agrrawal (1996), the life cycle of
companies may present as a realistic and dynamic tool in the study of follow
financial policies by companies. Companies are born, grow and enter decline,
they can renew itself and reappear, or may to survive and disappear
(Kimberly and Miles, 1980). All business, as it develop cross distinct phases,
each with its characteristics (Scott and Bruce, 1987). The concept that
companies evolve through a financial life cycle is clearly identified in the
literature (La Rocca et al. 2011). However according Ayed and Zouari (2014),
there have been a lot of studies both on the cycle theory life as on the theory
of capital structure, but very few studies focus on how the two theories are
related.
Berger and Udell (1998), in his study of the capital structure said that the
phase of life cycle where the company is determining the nature of their
needs financial, availability of financial resources and the cost associated

6
Running Head: Research Proposal

with capital. THE proportion of debt capital in the capital structure of a

company is adjusted in response the financial needs of the company
throughout its life cycle (La Rocca et al, 2011).
Opler and Titman (1994), based on the literature review of the capital
structure and life cycle have created a simplified model with only three
stages of life (birth, expansion and maturity). There are few studies that
focus on capital structure and life cycle theory, but little information exists
suggests that, as the theory of trade-off , the proportion of debt capital
should follow a low-high-low pattern over the life stages of a company.
Companies in the early stages of life have a high risk business and not may
face financial risk, which is not the case in the later stages of life, because
Companies can now address the risk associated with the use of borrowed
capital. In step maturity, companies turn to experience an increase in
business risk, which causes that reduce the use of debt capital (Berger and
Udell, 1998). The theory of the trade-off static offers a possible explanation
of how firms choose its capital structure also provides an important support
for the theory of structure capital and life cycle of the company (Rink and
Swan, 1982). Opler and Titman (1994) in his study of the indirect costs of
failure suggested that companies in the first life stages must have lower
levels of debt than companies that are in later life stages, because the first
of the bankruptcy costs are higher. The theory of the trade-off static
suggests that the proportion of foreign capital in the structure capital of a
company should follow a standard low-high-low throughout the stages of the
cycle Company life. According to the same theory enterprises in the nonearly stages of life can afford the cost associated with debt capital, because
its bankruptcy costs are high, and their incomes are low. As businesses grow,
become larger, with more predictable earnings, which causes the bankruptcy
costs are lower. When companies are in the stage maturity, has a decrease
in their income, which leads companies to resort less to debt capital (Rink
and Swan, 1982).

7
Running Head: Research Proposal

Bulan and Yan (2009) report that according to agency theory companies in
life stages of growth and maturity should have more debt to control costs
agency. Companies with lower agency costs, are by definition those that are
directed by the owner (Ang et al., 2000), so the new companies that are in
Phase birth, which are run by the owner have lower debt (Ayed and Zouari
(2014). According to the theory agency costs, companies should follow a
pattern of low- high-high for the level of debt throughout their stages of life
cycle. Owners of the young companies rely less on foreign capital, but debt
levels gradually increase as the company grows and acquires more members
and professional managers (Berger and Udell, 1998). The theory of
hierarchical preferences suggests a strong relationship between the phase of
life and capital structure of a company. Unlike the theory of trade-off static
theory hierarchical preferences suggests a high-low-high standard for the
level of debt over the life stages of a company. According to the theory of
hierarchical preferences companies in the early stages of life, with few profits
Accumulated seek financing through debt capital, before resorting to the
external equity.
Companies that at the stage of expansion and consolidation get substantial
profits and accumulate, they need therefore to resort to less debt capital
than companies that are in the growth phase. When they reach the maturity,
retained earnings decrease, and it is at this stage that companies will again
increase its level of debt (Bulan and Yan, 2009). According Bulan and Yan
(2009), the theory of hierarchical preferences best describes the funding
patterns of mature companies than younger companies and growth. Mature
companies usually have more internal resources due to that take advantage
of higher profitability and lower growth opportunities, so the nature of the
phase of life mature business cycle are best placed to Following the theory of
hierarchical preferences (Petersen and Rajan, 1994; Bulan and Yan, 2009).
Old firms are more closely followed by analysts and are more known by

8
Running Head: Research Proposal

investors, should therefore be faced with minor problems asymmetric

information (Bulan and Yan, 2009).

3.0. Research hypothesis

According to the theories presented in the literature review, the decisions of
the structure capital may be influenced by several determinants of capital
structure, including: other tax benefits in addition to the debt, growth
opportunities, tangibility of assets, profitability, size, growth and age. Then
presents the hypothesis formulated research, according to the theoretical
framework.
3.1. Other tax benefits beyond debt
DeAngelo and Masulis (1980) argue that there is a tax savings not linked to
from debt depreciation and tax credits for investments. According to the
same authors companies who are beneficiaries of higher tax savings not
associated with the use of foreign capital, have a low level of debt. Thus,
according to the theory of the trade-off we expect a negative relationship
between the other benefits tax in addition to the debt and the level of
indebtedness of companies.
Thus, following will be the research hypotheses:
H0: There is a negative relationship between the other tax benefits in
addition to the debt and level of total indebtedness of SMEs.
H1: There is a negative relationship between the other tax benefits in
addition to the debt and indebtedness of SME.
3.2. Research design
The design of this current study will be longitudinal where the large amount
of data will be gathered which will be expensive.
3.3. Secondary data
The data will be collected from the sources such as sales report, financial
statements and company information. The data for this study will be

9
Running Head: Research Proposal

gathered from 100 UK SMEs financial reports for the year 2010-2015. The
sources of the data will be company reports of each year for each SME which
will demonstrate the result of each SME lifecycle.

4.0. Qualitative research

The qualitative research method will be employed in the research study in
order to examine the relationship between the capital structure and lifecycle
of SMEs in UK.
4.1. Data collection
The recent five years data from 2010-2015 will be gathered from 100 UK
SMEs from secondary sources or financial reports of the firms where the
financial elements will be evaluated accordingly. The data will be associated
to the lifecycle of SMEs as well as financial elements used in small medium
enterprises.

5.0. Expected findings

Small businesses prefer to use bank financing of short-term debt that longterm in order to reduce fixed costs associated with this debt (Michaelas et al,
1999). The size of a company also has an impact on the availability of debt
financing, reflecting greater reliance on small businesses in financing short
term than large companies, since financial constraints are present especially
in long-term financing (Chittenden et al, 1996 Michaelas et al. 1999). Rajan
and Zingales (1995), Chittenden et al. (1996), Michaelas et al. (1999), Frank
and Goyal (2003), Mira (2002), claim that there is a positive relationship
between size and debt and conclude that when the larger dimension of the
company business, the higher the level of debt to M / L term in the capital
structure.
Myers (1984) found that SMEs with higher profitability to rely less debt,
preferring self-financing since they intend to maintain flexibility financial.
However, Ross (1977) states that there is a positive relationship between the

10
Running Head: Research Proposal

variables due the signs of future results obtained by the level of debt. Ayed
and Zouari (2014) show that profitability is a determining factor of debt, and
the cash flows are generated during the year that can be used to reduce
debt. Masiello, Izzo and Canoro (2015) demonstrate that there is negative
relationship between profitability and debt.
The dependence on bank credit for SMEs results, among other factors, the
inaccessibility of the capital market (Mello, 1996). Dependence on the shortterm debt, according to Marsh (1982) Titman and Wessels (1988) and
Chittenden et al. (1996) reflects the difficulties of companies with respect to
providing additional guarantees, and rationing to external financing of
medium and long term, both in terms of capital as others.
Also, on the other hand, SMEs in UK must finance its growth using equity to
decrease costs agency (Peel, 2015). However, agency costs increase in
companies growing as equity become insufficient and companies need to
resort to foreign capital. Forte, Barros and Nakamura (2013) found a
relationship negative between growth opportunities and debt. Rosenbusch,
Brinckmann and Muller (2013) argue that small businesses with more growth
opportunities have more debt in the capital structure, although this
relationship becomes negative in the short-term debt. Growing businesses
have insufficient internal financing companies in growth are more likely to
issue debt.
SMEs companies exhibit high levels of debt in relation to more companies
old, they do not have high levels of profits that can be used as an internal
source financing. Chittenden (1995), Michaelas et al. (1999), Vieira and New
(2010) and Serrasqueiro et al. (2011) found evidence of a negative
relationship between age and the debt because older firms tend to have
sufficient retained earnings to finance with domestic capital. This shows that
relationship between capital structure and lifecycle of SMEs in UK.

11
Running Head: Research Proposal

Ayed and Zouari (2014) analyzed the capital structure of small and large
companies to period 1999-2006, in order to verify that financing decisions
are different depending on the type of companies. This study is based on the
assumption that the decisions of capital structure of SMEs are different from
large companies, relapsing its analysis on possible influence of the problems
of information asymmetry in relations between the owners / managers of
SMEs and lenders. SMEs show that face higher costs transaction to obtain
debt than other companies. Moreover, the level of SMEs debt does not
decrease with the increase in growth with tax benefits beyond debt or risk,
as other studies claim and do not increase the debt with effective tax rates
compared to large companies (Jindrichovska, 2013). The size and tangibility
assets are less important to increase the debt of SMEs compared to other
companies. With regard to the size the larger the organization, the more the
level is raising tangibility, which leads to reducing the information
asymmetry between owners and creditors (Fraser, Bhaumik and Wright,
2015).
Although not a sufficient condition, it is necessary for the current activity and
the development of future Business. The characteristics of the companies,
their market reputation and size set about its reliance on funding. Access to
finance banking by SMEs is still quite inaccessible by government policies
should emphasize the easier access to finance, providing a basis for new
loans, reducing the sensitivity businesses to economic cycles (Castro, Tascon
and Tapia, 2015).
Cassar and Holmes (2003) concluded that variable growth, size, profitability,
risk and collateral value of assets influence the financial structure of
Australian SMEs. The variables growth and size have a positive relationship
with the external financing ratio and the variables profitability, risk and value
of the collateral assets have a negative relationship with the ratio external
financing. The variables growth, size and value of the guarantee assets have
a positive relationship with the bank financing ratio and the variables

12
Running Head: Research Proposal

profitability and risk have a negative relationship with the bank financing
ratio. Cassar and Holmes (2003) studied the effect of the business sector in
the financial structure SMEs and concluded that there are statistically
significant differences between the debt levels of the studied sectors.

6.0. Conclusion
External financing of SMEs companys is essentially banking, given, among
other factors, inaccessibility to capital markets, and is short-term, since the
companies are unable to give additional guarantees, particularly relevant in
commercial difficult periods. In fact, the access to capital markets in general,
in terms of SMEs, characterized by a bank financing system, commonly
referred to as "bank based system" where the funding is based on the
banking system and not in the capital market. The latter situation carry on
considering "market based system," whose financing is essentially based on
the capital market, as is the United Kingdom or the United States of America.
It was clear that some assumptions are taken into account in the original
theories about capital structure (which were created in the UK context and
large companies) are not apply in SMEs. Nevertheless, the results were not
very different from the literature. Still, the use of theories that focus on the
contractual relationship between banking and Companies may be a means to
identify other important factors and complement the present study.
In future research, it would be interesting to extend the study of funding
policies SMEs to other companies, for instance by sector of activity in order
to analyze the main financing difficulties according to the needs of firms.
Another line research would be in addition to extending the sample to more
MPE, apply the analysis of clusters by variables and exploratory factor
analysis to identify the variables that determine and discriminate against
companys capital structure.

13
Running Head: Research Proposal

7.0. References
Ang, JS; ole, RA and in, JW (2000), "Agency OSTs and Ownership Structure ',
The Journal of Finance, Vol. 55, No. 1, pp. 81-106
Ayed, W.H.B. and Zouari, S.G., 2014. Capital Structure and Financing of SMEs:
The Tunisian Case. International Journal of Economics and
Finance, 6(5), p.96.
Black, E. (1998), "Life-Cycle Impacts on the Incremental Value Relevance of
Earnings and Cash Flow Measures ", Journal of Financial Statement
Analysis , Vol. 4, No. 1, pp. 40- 56.
Bulan,. and Yan, Z. (2009), "he Pecking Order of Financing and the Firm's ife
ycle" Banking and Finance Letters, Vol. 1, No. 3, pp. 1-16
Castro, P., TascOn, M.T. and Amor-Tapia, B., 2015. Dynamic analysis of the
capital structure in technological firms based on their life cycle
stages. Spanish Journal of Finance and Accounting/Revista Espaola de
Financiacin y Contabilidad, 44(4), pp.458-486.
Elsayed, K., 2014. Inventory management over firm life cycle: some
empirical evidence. International Journal of Services and Operations
Management, 19(4), pp.431-450.
Fluck, Z .; Holtz-Eakin, D, and Rosen, H. (1998): "Where Does the Money
Come from? The Financing of Small Entrepreneurial Enterprises ",
Working Paper Series: New York University Salomon Center
Forte, D., Barros, L.A. and Nakamura, W.T., 2013. Determinants of the capital
structure of small and medium sized Brazilian enterprises. BARBrazilian Administration Review, 10(3), pp.347-369.
Forte, D., Barros, L.A. and Nakamura, W.T., 2013. Determinants of the capital
structure of small and medium sized Brazilian enterprises. BARBrazilian Administration Review, 10(3), pp.347-369.
Fraser, S., Bhaumik, S.K. and Wright, M., 2015. What do we know about
entrepreneurial finance and its relationship with growth?. International
Small Business Journal, 33(1), pp.70-88.
Fraser, S., Bhaumik, S.K. and Wright, M., 2015. What do we know about
entrepreneurial finance and its relationship with growth?. International
Small Business Journal, 33(1), pp.70-88.
Jindrichovska, I., 2013. Financial management in SMEs. European Research
Studies, 16(4), p.79.

14
Running Head: Research Proposal

Keasey, K., Pindado, J. and Rodrigues, L., 2015. The determinants of the costs
of
financial
distress
in
SMEs. International
Small
Business
Journal, 33(8), pp.862-881.
Masiello, B., Izzo, F. and Canoro, C., 2015. The structural, relational and
cognitive configuration of innovation networks between SMEs and
public
research
organisations. International
Small
Business
Journal, 33(2), pp.169-193.
Masiello, B., Izzo, F. and Canoro, C., 2015. The structural, relational and
cognitive configuration of innovation networks between SMEs and
public
research
organisations. International
Small
Business
Journal, 33(2), pp.169-193.
Peel, M.J., 2015. Owner-Managed UK Corporate Start-Ups: An Exploratory
Study of Financing and Failure. Entrepreneurship Research Journal.
Petersen, M. and Rajan, R. (1994), "he Benefits of ending Relationships:
Evidence from Small Business Data ", The Journal of Finance ," Vol. 49,
No. 1, pp. 3-37
Rosenbusch, N., Brinckmann, J. and Muller, V., 2013. Does acquiring venture
capital pay off for the funded firms? A meta-analysis on the
relationship between venture capital investment and funded firm
financial performance. Journal of Business Venturing, 28(3), pp.335353.
Schock, F., Von Flotow, P. and Taube, F.A., 2013. Sources of finance in the
clean technology sector: capital structure, financial intermediation and
industry life cycle. EBS Business School Research Paper, (14-07).
Scholtens, B. (1999), "Analytical Issues in External Financing Alternatives for
SBE's"; Small Business Economics ; Vol. 12, No. 1, pp. 137-148
Tian, L., Han, L. and Zhang, S., 2015. Business life cycle and capital
structure: evidence from Chinese manufacturing firms. China & World
Economy, 23(2), pp.22-39.