Abstract A dynamic theory of the small firm is expounded, assuming entrepreneurs maximise business value over a finite time horizon. Its predicted trajectories for key financial variables depend on which of debt and equity are cheaper. The predictions are compared with empirical evidence constructed from three years of primary source data on one hundred and fifty new businesses.
Evidence largely confirms predictions of the model, favouring a cheap equity view.
As capital and sales rise steadily, debt is retired rapidly, except when interest rates on long-term debt are low. Dividends are usually deferred.