How Sensitive is Young Firm Investment to the Cost of Outside Equity ?

We estimate the sensitivity of investment to the cost of outside equity for young firms. For estimation, we exploit differences across firms in eligibility to a new tax relief program for individual outside investors in the UK. On average, investment increases 1.5% in response to a 10% drop in the cost of outside equity. This average conceals substantial heterogeneity: 1% of eligible firms issue equity in response to a subsidy that would have doubled investors’ returns, implying large outside equity issuance costs for the majority of young firms. Conditional on issuing new equity, however, firms invest eight times the issued amount. Additional evidence suggests that the marginal funding is provided by the same investors that provide equity, but in the form of debt. Consistent with financing frictions’ theories of capital structure, the results imply a large complementarity between outside equity and debt-like securities in young firms.