Financing from Family and Friends
Samuel Lee, Assistant Professor of Finance
Samuel Lee, Petra Persson, Financing from Family and Friends, The Review of Financial Studies, Volume 29, Issue 9, September 2016, Pages 2341–2386, https://doi.org/10.1093/rfs/hhw031
Abstract
Most informal finance comes from family and friends. Existing informal finance theories cannot match two characteristics of family finance: family investors may accept below-market or even negative returns, yet borrowers often prefer formal finance. We argue that social preferences make family finance cheap but create shadow costs that nonetheless discourage its use: Committing family funds to risky investment displaces intrafamily insurance and undermines limited liability. The same characteristics that sustain familial insurance thus render family finance a poor source of risk capital. Even when overcoming capital constraints requires social ties, intermediation and semiformalization may therefore be crucial for promoting risk taking.