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source of funds will depend upon the size of the business. For example, small firms withturnover of GBP 50,000 are likely to have very different capital structure from smallfirms with turnover of GBP 1M. Another important factor that tends to affect the type offinance employed by a small enterprise is the industrial sector in which it operates. A firmwhich has tangible assets such as land and buildings that can be offered as security, suchas a firm in the property sector, is likely to find it easier to obtain funds than a firm in asector whose assets are intangible in nature, such a firm in the advertising industry whosemain assets tend to be creative, reflecting skills of the personnel they employ.There is a very limited opportunity for small firms to raise funds in the equity markets.The main markets for small business in which to raise fund in the Alternative InvestmentMarket (AIM), but only a very small proportion of small business in the developed anddeveloping countries are eligible listing. In addition, there is some evidence to suggestthat a large proportion of owner-managers of small firms are reluctant to seek equityfinance from external sources (Cowling et al, 1991; Binkset al 1990b). This reluctance isprimarily due to managers desire to maintain his independence and control of thebusiness (Keasey and Watson, 1993).According to Tucker and Lean (2003) one of the problems faced by small firms whenattempting to raise finance is information asymmetry in that they cannot prove the qualityof its investments projects to the provider of finance (usually banks). Small firm’smanagers often suffer from lack of financial sophistication, as they are often product orservice specialists, not specialists in the area of finance. Thus, the information asymmetryproblem is partly one relating to difficulties in the spheres of communication and19
credibility. This is compounded by the fact that new or recent start-ups businesses may beunable to provide evidence of a good financial performance track record. Banks inparticular rely on past financial performance as an indicator for the future profitability ofprojects. According to Titman, Fan and Twite (2003), a principle source of the financialconstraints, influencing capital-structure, may be the existence of asymmetric informationand the cost of contracting between companies and potential providers of externalfinancing. Problems of financial constraints are potentially high in presence of poorlydeveloped financial system. A well-developed financial system can facilitate the ability ofa company to gain access to different sources of finance, providing cheaper finance toworthy companies (Guiso, Sapienza, Zingales, 2004)Owing to lack of business experience of many small owner-managers in the early yearsof the business, business risk may be more significant than large firms. Small firmsgenerally have smaller financial reserves to draw on in times of crises and are alsorelatively highly geared compared to larger firms due to the difficulty and expense ofattracting new equity finance. Thus, such firms are characterized not only by higher