Quasi-debt and Quasi-equity in the Financial Statements of Small Firms

Abstract

The procedures for identifying and analysing financial information about privately held firms often follow those applicable for public firms. However, differences in structure and ownership focus mean approaches that are valid for large firms may not be applicable in small firms. One inappropriate use of large firm procedures that is poorly understood, but creates potentially serious problems, relates to the identification of debt and equity. Often, what is identified as debt of a small firm is fully supported by the owner's personal collateral. In that regard it carries more of the characteristics of equity than of debt (the owners' personal wealth is put at risk for an uncertain return) and is consequently often described as quasi-equity. The evidence presented in this report, although exploratory, clearly identifies that the personal assets of the business owner secure a large proportion of the debt of small firms. For two major sources of debt (bank overdraft; and, loans from mainstream financial institutions) a majority of firms secure their debt, and the average level of debt that is secured is much greater than the average level of debt not secured.