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Financing from Family and Friends

Samuel Lee1,2,3; Petra Persson3,4,5

1 Santa Clara University · 2 Swedish House of Finance · 3 New York University · 4 Research Institute of Industrial Economics · 5 Columbia University

Review of Financial Studies 2016 open access

Financing from family and friends is the predominant type of informal finance. This paper proposes a theory that reconciles two seemingly paradoxical traits of this form of finance, namely, it is often provided at negative prices but nevertheless eschewed by borrowers. A central prediction is that such finance, while breeding trust, deters risk taking. Demand is thus constrained: entrepreneurs may forgo risky investment rather than finance it through family and friends. Formal finance is valuable precisely because it is regulated only by contract. The highlighted trade-offs between formal and informal finance are potentially relevant for the provision of microventure capital.

DOI
10.1093/rfs/hhw031
Volume
29 (9)
Pages
2341-2386
Language
en
Export
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Sources
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