Financing from Family and Friends

Samuel Lee () and Petra Persson
Additional contact information
Samuel Lee: Stern School of Business, Postal: New York University

No 933, Working Paper Series from Research Institute of Industrial Economics

Abstract: The constraint on informal finance is commonly taken to be high costs and limited supply. But the majority of informal investors – family and friends – is often willing to supply funds at negative returns, and yet many borrowers tap family and friends only as a last resort. We explain this paradox with a theory based on altruistic ties between the entrepreneur and his family and friends, and propose an alternative explanation of the limits of informal finance: Altruistic ties reduce agency problems in financing. But such ties also increase the entrepreneur’s aversion to failure. This makes financing from family and friends unattractive, and undermines the entrepreneur’s willingness to take risks. Altruistic ties thus constrain growth even though they relax financing constraints. We relate this insight to the limited success of group-based microfinance in generating entrepreneurial growth. Our theory underscores the value of impersonal transactions, and implies that even counterparties with social ties benefit from formal contracts and third-party intermediation. This sheds light on social-formal financial institutions, such as community funds, crowd funding, and social lending intermediaries.

Keywords: Informal finance; Family loans; Social ties; Altruism; Peer-to-peer lending; Small business (search for similar items in EconPapers)
JEL-codes: D19 D64 G21 G32 O16 O17 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2012-10-11
New Economics Papers: this item is included in nep-ent, nep-iue, nep-mfd and nep-soc
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Journal Article: Financing from Family and Friends (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:hhs:iuiwop:0933

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