The Office of Advocacy recently published a study that revealed that the majority of small privately owned businesses opt for debt financing over equity financing. The report studied two competing capital structure theories - the “pecking order” theory and the “trade-off” theory.

According to the “pecking order” theory, small companies finance their assets in the following order: internal capital, debt, equity. The “trade-off” theory, however, says that small businesses prefer the tax benefits of deductible interest and therefore, debt financing.

After extensive statistical analysis, the Office found that the “pecking order” theory most adequately describes the capital structure of small privately owned firms. The study also found that generally a firm’s age, size, profitability, liquidity, risk and use of financial services correlates with the business’s leverage ratio (debt divided by equity). Typically, firms that are younger, less profitable, smaller, riskier, less liquid, and/or obtain more financial services from bank or non-bank institutions have higher leverage ratios.

For more information on the study’s findings, refer to theSBA report.