The signaling value of legal form in entrepreneurial debt financing
Felix Bracht, Jeroen Mahieu, Steven Vanhaverbeke
Journal of Business Venturing · 2024 · Volume 39 · Issue 3
DOI: 10.1016/j.jbusvent.2024.106380
Abstract
We theorize that adopting a legal form with high minimum paid-in capital requirements signals that a venture will be less likely to default on a loan: entrepreneurs who anticipate a higher likelihood of default will be less inclined to pick a legal form with high minimum capital requirements since they would be liable for the amount of paid-in capital in the case of bankruptcy. The opportunity costs of such a choice would also be higher as founding a high-capital firm would entail foregoing alternative, safer investment opportunities. Furthermore, the reputational costs and potential stigma of failure associated with defaulting when choosing a high- versus low-capital legal form may induce high-risk types to choose the latter. Importantly, we posit that the legal form choice has signaling value beyond the amount of paid-in capital: among firms with the same amount of equity and similar firm and founder characteristics, those ventures with a low-capital legal form have more difficulty in attracting the necessary external funding.
Keywords
Minimum capital requirements, Financial constraints, Access to debt, Legal form, Signaling
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