*2.2. SMEs and Financing Gap*

Another stream of studies focused on the barriers to innovation, which may be analyzed with regard to: the stages of the innovation process (such as: knowledge, invention, implementation, diffusion, and adaptation), the levels of innovation (microeconomic and macroeconomic barriers), and the nature of factors (financial, personal and organizational, socio-cultural, and legal factors). The variety of barriers to innovation were recently discussed in (Assink 2006; Hueske and Guenther 2015; Madeira et al. 2017). In particular, the access to external financing and the existence of capital constraints that may negatively affect the firms' innovative activity was underlined by Angilella and Mazzù (2015); Colombo and Grilli (2007). Accordingly, the existing empirical evidence shows that the key determinant of the SMEs development is access to sufficient funds. As proved by Kersten et al. (2017), SMEs finance has a positive significant impact on firm performance, capital investment, and employment. However, SMEs often face various problems while searching for new sources of funds. Kumar and Rao (2015) identified the main problems of insufficient funds for SMEs: (1) demand gap, due to the effect of various capital structure determinants, (2) supply gap (limited availability of funds for SMEs), (3) knowledge gap (lack of knowledge on the accessibility of funds, and (4) benevolence gap (unwillingness of financial institutions to provide funds to SMEs). Various financing patterns of SMEs addressing the problem of financing gap were identified and analyzed by Moritz et al. (2016); Ou and Haynes (2006); Whittam and Wyper (2007). Some studies refered exclusively to the debt financing gap (Colombo and Grilli 2007; De Moor et al. 2016; Neely and Auken 2012), while others focused on the equity financing gap (Deffains-Crapsky and Sudolska 2014; Durvy 2007; Papadimitriou and Mourdoukoutas 2002).

Capital structure decisions have been the focus of research attention since the seminal works of Modigliani and Miller (1958). The main theoretical explanation for the capital structure determinants was provided by the pecking order theory (POT). As suggested by Donaldson (1961) and further developed by Myers and Majluf (1984), the observed capital structures reflect the relationship between internally available funds and investment requirements. The POT suggests that companies have a hierarchy of preferences concerning sources of funds. That is the consequence of asymmetric information between management and potential capital providers. This issue may cause firms to avoid raising external equity by issuing new shares. At the same time, while the access to debt may be limited, firms may be forced to postpone or to cancel valuable investment opportunities, including innovative ones. In these circumstances, firms prefer internal finance; they try to avoid new equity issues, and their borrowings are a residual between desired investment and the supply of retained earnings. Colombo and Grilli (2007) explained the modified pecking order financing for innovative firms, including private equity financing (from Angel investors and Private Equity/Venture Capital funds) before debt capital. The importance of venture capital for innovative firms is widely discussed in the literature (Da Rin and Penas 2007; Wadhwa et al. 2016; Wu et al. 2019).

Our study, however, addresses the relevance of internal finance, external equity, and debt financing for SMEs, which is consistent with the modified or 'bridged pecking order theory' (BPOT). The BPOT assumes that SMEs move directly from self-funding (internal equity) to external equity (provided by private equity investors) in preference to, or instead of bank finance, as suggested by Whittam and Wyper (2007). The importance of internal finance as the primary source of funds for smaller firms is discussed by Ou and Haynes (2006), who declared that the significance of external equity for SMEs seems to be overstated. Therefore, based on the BPOT findings and the financing gap facing by SMEs, we may assume that the SMEs' innovative activity is financed first with the internal finance. As a result, the types of innovations undertaken by SMEs may be limited due to the external capital constraints (both in terms of debt and external equity). In this respect, the second question addressed in this study is as follows:

**RQ2:** Is there any association between the type of innovations in SMEs and the relevance of a given type of financing?
