Financing from Family and Friends
53 Pages Posted: 30 Jun 2012 Last revised: 27 Oct 2014
Date Written: June 2012
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.
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