How Do Businesses Finance New Investment?

This paper investigates how UK firms finance new investment and whether their choices follow a financing hierarchy consistent with leading theories of capital structure. Using a survey of 2886 firms conducted by the UK Department for Business and Trade and the Bank of England (2020–2023), we examine six financing sources: retained earnings, owner's capital, trade credit, bank loans, non-bank debt, and outside equity. Our findings show that retained earnings dominate investment financing, followed by injections of capital from owners, while bank and non-bank debt are secondary sources and outside equity remains marginal. Econometric analysis reveals that retained earnings substitute for all other sources, whereas owner's capital is complementary to both bank and non-bank debt. Financing patterns vary systematically by firm size, age, and investment type. Overall, the results provide strong support for the pecking order theory, with additional insights from life-cycle theory, and highlight the importance of policy in shaping SME access to finance during periods of economic disruption.