ABSTRACT Why do some start‐up firms raise funds from banks and others from venture capitalists? To address this question, I study a model in which the venture capitalist can evaluate the entrepreneur's project more accurately than the bank but can also threaten to steal it from the entrepreneur. Consistent with evidence regarding venture capital finance, the model implies that the characteristics of a firm financing through venture capitalists are relatively little collateral, high growth, high risk, and high profitability. The model also suggests that tighter protection of intellectual property rights encourages entrepreneurs to finance through venture capitalists.

Why are contracts not fully indexed? In a setting in which fully indexed contracts are feasible, we find that when price‐level data are gathered with delay, these contracts are not renegotiation‐proof. The contracts that replace them entail a lower level of welfare for the parties to that contract. They also imply that real variables respond to nominal shocks.