Frenemies: Exploring interfirm credit between an incumbent and a capital‐constrained startup

Abstract

Interfirm credit, a financial relationship between two firms, has garnered recent attention due to its potential to aid innovative startups' funding challenges and shape competitive dynamics. We examine a supply chain consisting of an incumbent and a capital‐constrained startup firm. The startup's entry may cannibalize the incumbent's market share. Therefore, we model their interaction as a Stackelberg game, with the incumbent leading. The startup faces funding challenges and can opt for bank financing, interfirm credit, or mixed financing. Under interfirm credit, the incumbent and startup firms engage in financial collaboration, which requires the incumbent to decide on the trade‐off between profit sharing and market erosion. We consider two cases of financial sufficiency: (i) sufficient funds for production that satisfy the loan amount required for the startup firm's production and (ii) limited funds for production that are insufficient for the startup firm's needs and limit the startup firm's production. We find that bank financing is not always beneficial to firms. Specifically, under limited funds for production, when a startup has moderate initial available funds, he will opt for profit sharing with the incumbent and prefer interfirm credit, allowing both firms to achieve a win‐win outcome. However, suppose the incumbent strategically determines the interest rate. In that case, mixed financing becomes advantageous for both firms when the startup firm's initial available funds are high and the loan amount is ample. Finally, when the startup predetermines the loan amount, he will pursue economic funding if his product is competitive.